Edmund Downes, Pensions Manager at Aviva, asks “Could or should a shared risk scheme be used for auto-enrolment?”
The Government have re-opened discussions on reinvigorating occupational pensions, with Steve Webb indicating that they are open to a reduction or removal of indexation and, a possible reassessment of whether and how risk sharing could operate. These are perfectly sensible and worthwhile objectives in many ways which, in isolation, could and perhaps should be supported. Risk sharing could work in both DC and DB schemes. In the former perhaps as some kind of investment or annuity rate underpin, in the latter as the ability for the employer to make their promise conditional on investment returns being achieved.
However, I am concerned that many scheme members will be unable to understand what this then means to their scheme. Will they really understand at some deeper level what they are entering into? I doubt they will feel they’ve bought into the outcome, whatever it is. And my guess is that most members will gloss over the possible downsides and concentrate on what they want the scheme to deliver, or what they believed they were told.
Communicating risk sharing
I must admit that I have to work very hard myself to understand how DB schemes operate. Understanding a set defined benefit promise is achievable for most people. The link between the level of benefit and the number of years you work for an employer is intuitive, but going any further than this is far more difficult. Calculating the present value of a future benefit requires a grasp of compound interest rates. Then you have to add in what are reasonable rates to use and what other assumptions are needed.
Understanding how a benefit promise is conditional on some or all of those assumptions being met is near impossible, I would guess, for any but a tiny fraction of the population. Underpins on DC schemes are certainly easier to communicate, but is the level of understanding really going to be much higher?
So can we expect an average person to decide on whether to join or stay in a scheme based on the relative likelihood of a number of potential scenarios? I doubt it, and it doesn’t even seem fair to ask the question. But, is it then okay for a scheme or employer to simply state “We don’t know how good this will be for you, but it is probably better than you not joining”.
Impacts of auto-enrolment
Now add auto-enrolment into the equation. I am a great supporter of auto-enrolment, but always thought that the goal should be that either the member understands what they were entering into, or the outcome should be designed to meet the members’ needs so they don’t have to understand it. Otherwise the opt-out, and indeed auto-enrolment itself, could be deemed ineffective.
Can we really get to the position where we could say that the outcome is unclear for members but it doesn’t really matter? And, if it doesn’t matter under risk sharing DB schemes and underpinned DC schemes, then what are the ramifications of that in the wider world? If understanding is no longer deemed to be important, even when some risk is borne by the member, why one rule for auto-enrolment and one rule elsewhere?
How do we draw lines around this subject and define what is an acceptable level of understanding, or potential misunderstanding? I am certain that I don’t know but I am absolutely sure that the industry needs more guidance and help if risk sharing is to take off in the way that the Government might hope.