Convincing employers of the fundamental value of even the most basic pension has become a job many advisers thought they would never have to do. We have become used to the sound of defined benefit schemes contracting and collapsing. Now we are seeing defined contributions schemes scaling back what they are offering. Take the example of American Express which recently announced it is to temporarily suspend contributions to its company stake holder scheme until January 2011.
Corporate advisers face the challenge of helping HR directors to persuade financial directors of the importance of supporting company pension schemes, no easy task when the latter will argue the choice is either to cut pension contributions or lay off staff.
The risks facing defined contribution scheme members is recognised by the Pensions Regulator and the FSA which have recently issued guidance to employers on talking to their employees about pensions whether defined benefit, defined contribution or contract-based schemes. Delegates at the Corporate Adviser/Axa round table, DC pension investments: a time for change agreed communication is key, both with employers and scheme members, but saw serious challenges ahead.
There is some serious spadework to be done. Professor David Blake, director of the Pensions Institute, says no amount of education is going to help people to really understand the complexities of a 40 year investment horizon and a 30 year decumulation horizon.
“People aren’t able to visualise themselves 40 years older than they are now living in poverty. The most useful education to get across is the high percentage of their salary that they need to save. The contributions going in are way too low.”
Will Allport, director of product strategy, UK & Ireland at Alliance Bernstein, said trying to educate people into being their own chief investment officers is a strategy doomed to failure.
“We need to educate to help prompt decision making, to help prompt people’s understanding of how much they need to save to generate a comfortable retirement that is critically important.”
He said the industry has done a poor job at helping people to feel comfortable with the idea of volatility.
“The only way to avoid poverty in retirement is to have risk in your portfolio and as soon as you have risk you have volatility. That is what we need to address educationally.”
But the situation is not just scheme members’ attitude to risk or appreciation of the consequences in retirement of their decision making today, but also the issue of what pension vehicles are open to them.
Mark Rowlands, head of consultant relations at Axa Corporate Benefits, makes the point that there is much difference of opinion in the market as to what makes good practice in a defined contribution scheme. There may be employer sponsors offering a proper pension scheme, almost a replacement for defined benefit schemes, which at an appropriate funding level gets the member to a similar place.
But he adds: “The problem we have are the number of defined contribution schemes out there where the sponsor hasn’t put enough money in and the members haven’t either. Despite all the communication about trying to get them to visualise what retirement will look like, left to their own devices they are not going to pay in more money.”
Gary Smith, senior investment consultant at Watson Wyatt, felt there was hope if they are given a figure to start with. “Most individuals say if they knew what was a reasonable amount to pay they would probably pay in more than they are paying in now. If you ask them what they want to pay they will start from zero, but if you tell them what it should be they will vary around that figure.”
Jon Pearce, managing director of Ferrier Pearce, agreed there are some basic steps that can be taken to engage members, advocating the use of online tools such as pension modelers.
“If you can get a member to look at one and put in what they are paying and what they are likely to get that is pretty compelling. We should also be showing them the cash lump sum they could take, and how that would affect their income each month.
“They also need to have an explanation of what all the information on a benefit statement means, because too often it is an A4 page list of figures with no clear explanation of what it is all about,” Pearce said.
Auto-enrolment will also have the effect of freeing up one aspect of the communication package, said Rowlands. “Communication has often been a process to physically get someone signed up to join the pension scheme, rather than explaining the building blocks – which are that you pay in this amount of money, to fund the retirement outcome. The joining bit should be automated and the communication bit on what you should be doing as an individual and what your employer is doing for you,” he said.
The other key challenge for advisers is in getting the employer to focus on how private sector pensions can add value over personal accounts. Is there a danger that providers and employers see personal accounts as the benchmark for what they should be doing?
However, Katharine Photiou, principal at Mercer, was more confident about the private sector, which will always try to differentiate with insurance companies and providers launching alternative solutions.
“We are going to see the more sophisticated investment solutions competing against personal accounts but I think we are also going to see solutions wider than pensions in the next few years with savings offerings as well,” she said.
More likely the pensions regime could see a combination of personal accounts used for large, high turnover industries and organisations, with employers then offering something more substantial after an employee has stayed with the employer a requisite time.
“A lot of employers and certainly a lot of clients we speak to have got a paternalistic attitude,” said Allport. “They have grown up with it with their DB plans and they do see that pension as a moral virtue. They really believe that they need to be doing something to help their employees.”
Rowlands could see retirement solutions in the workplace going even further down the holistic route, with some savings locked away in a pension scheme and some savings more accessible in an Isa or a cash account.
“That appeals to a lots of employees because they have got student debt and are trying to get on the housing ladder. Some employers will think: ‘Personal accounts are okay, but if we actually want to get the best people into our firm we need to provide the best total reward type of solution’. Effectively they are bringing together flexible benefits and total reward and joining pensions up into other things.”
Another area the industry needs to gets to grips with is segmentation, said Photiou. “The most efficient industries segment their audiences. We haven’t really done that as an industry. Take the advertising industry for example: it knows exactly what it is trying to say and who it is trying to say it to. I think we have got a long way to go in pensions in comparison to those other industries.
“If you talk to 25-year-olds they never think that they are ever going to get old. But over the age of 40 they get some sense of their own mortality. They start to think about whether they have saved enough for their pension.”
Inevitably there is going to be overlap in pension provision as employers hedge their bets with personal accounts in the early months of employment and for young staff with other pressing needs for their spare cash, alongside a company scheme for more mature staff and a general mix of remuneration options. This presents a real opportunity to the corporate adviser who can ply the employer with some valuable differentiators to keep staff happy.
“We know that the Government wants to avoid incentives for people to opt out of pension schemes,” said Cheseldine. “But there seems to be an acceptance that if an employer offers a new graduate employee the choice of 8 per cent into a personal account or 8 per cent off their student debt within a flex option, that is not actually an incentive to opt out as long as the employer is paying 3 per cent of their money towards the student debt.”
Cheseldine points out that though the rules aren’t out yet, the general theory is that regulators want to stop employers saying to staff: ‘If you don’t join the personal accounts will give you 1 per cent extra salary because that saves me 2 per cent of salary.’ “So long as employers are being grown up about this and try to help people, that will probably be okay,” says Cheseldine.
What advisers and providers desperately want is the next set of rules from Government. Once it gets a clearer handle on how the post-2012 world will operate the industry be able to start creating solutions that add value to employers and educate employees in meeting their lifetime financial needs.