in DC pensions are as low as 50%. This has been one of the factors that have lead to the proposed Employer Responsibilities and Personal Accounts model. The Government sees the introduction of auto-enrolment increasing the take up of DC pensions, perhaps by up to 90%.
Fear also plays a part in workplace DC pensions with employees being anxious about making investment choices. Our own research into employee attitudes in 2007 revealed that most did not understand the investment options available to them. There is no doubt that as employers have gradually moved workplace pensions from a DB trust-based environment to contract DC pensions, the transfer of risk to employees has had an impact. The removal of trustee governance from workplace pensions is an issue and it is one that does concern many paternalistic employers and the regulators, including the Pensions Regulator and DWP. Do employees understand this transfer of risk? Yes, where advice is being provided but in some cases there is a risk that the communications provided do not help the employee to make a decision on investment choice. Where an employee does choose to join a DC pension scheme, very often the default fund is the investment option taken. In principle this is reasonable as the default fund should provide an investment profile that suits the majority of employees. Some of the key elements that should be present are:
• An adequate exposure to different asset classes with risk rating eg cautious, balanced and adventurous
• A lifestyle switching element that gradually reduces the exposure to any downside as an employee approaches the decumulation phase
• A rebalancing mechanism to keep the asset exposure at the right levels
• A governance programme that makes sure the components of the fund are fit for purpose
• Interactive tools and communications that engage the employee
It sounds easy but given the current economic climate how many default funds could claim to have all of these elements? Historically, equities have provided the best returns in terms of asset classes and should be present in a default fund. Looking at current market conditions some may argue against that and for some the fall in equities may be painful.
In particular where a five year lifestyle switching strategy is in place the reduction in risk is positive but a material reduction to equity exposure in a short time frame may reduce the possible upside in terms of returns. A longer period of switching is beneficial as the risk reduction is more gradual and the potential upside is greater.
I mentioned the issue of governance and this is causing some debate in our market. Wrapping a governance programme around a default fund is vital in the contract-based DC market. This provides reassurance to employers, ceding trustees and ultimately employees. Knowing that the fund is reviewed on an annual basis and changes made to make sure it is fit for purpose in the long term is highly valuable. Communicating the outcome of this governance to all of the key stakeholders mentioned before may prevent ‘knee-jerk’ reactions in difficult economic times. With all of these components available a good default fund can provide real reassurance as scheme members receive their pension benefit statements and consider their future. There’s no need to panic!