Firstly, a key area to consider is the investment proposition. While employers may be keen to provide their employees with a wide range of investment choice, it can be a confusing experience for employees. Schemes need to seriously consider restricting fund choices in a manageable way. Prudential’s own research suggests that a narrower range of perhaps 10 to 13 fund choices is what most members want – the trend to increase the number of funds available appears to be of benefit to very few individuals.
Schemes also need to look carefully at the selection of the default fund. Research has shown that around 90 per cent of scheme members select the default fund – typically equity tracker funds which may not necessarily suit their individual risk profile or their investment needs. A more appropriate choice might be a target return fund which invests in an unconstrained and diversified mix of assets rather than being wholly dependent upon the equity markets. The benefits of increased diversity can ensure that scheme members have access to sectors that offer better relative value at any one particular time and reduce overall volatility of investment returns. Also, when managed with an unconstrained structure, the manager is not distracted by reference to relative group performance and asset strategy can then be driven by the primary objective of achieving a target return above wage inflation.
Offering lower volatility managed fund alternatives (that can target specific rates of return) is particularly relevant now as we continue through a period of increased market uncertainty and average DC values attain greater significance. A greater number of people have been investing in DC schemes for a prolonged period and they have substantial assets, subject to risk in traditional passive equity funds.
Target returns funds give the opportunity to simplify communications and hence improve the likelihood that members will make the right choice. We can move away from the traditional approach of explaining how equities, property and bonds behave – focusing instead on the return that members need to achieve and the level of risk they can take.
The recent fall in the value of DC pension schemes highlights the fact that now, more than ever, members need to manage their funds. When they receive their annual statements in the next few weeks, it will be a stark reminder that this investment risk has been transferred to them. However, employees need to take account of their own attitude to risk and a holistic view of their financial position and here worksite communication can help in informing people.
Finally, usually when new DC schemes are selected, the focus is on maximising take-up and then ensuring that members receive regular communication so that they can make informed decisions around fund selection and contribution levels. Little thought is given to what happens when the members buy their annuity, a decision which once made, cannot be changed. It is likely to have more impact on the members’ actual pension paid than the annual management charge as the fund builds up.
Given the significance of this conversion phase, you could expect that this would be a time where considerable support would be made available to scheme members. This is not always the case and it raises a vital question for advisers, employers and trustees – are they satisfied that members receive the support they need when turning their capital into income.
Employers and trustees therefore, have a responsibility to employees/members to ensure their provider has a strong record on annuities as many of their scheme members will not exercise the open-market option – 60 per cent of employees select an annuity from their DC provider. The issue here is that not all providers of DC plans are competitive annuity providers – exercising OMO is therefore important and as an employee approaches retirement, it will become vital to engage with them and ensure they have all the information to select the right form of retirement income for their individual needs.