That well known Chinese proverb “Give a man a fish and you will feed him for a day. Teach a man to fish and you will feed him for a lifetime” can be applied to helping employees to make good pension decisions.
Enrolment in to Defined Contribution (DC) schemes have long been seen by the industry and employees alike as the poor relation in the occupational pension space, especially where there is a Defined Benefit (DB) comparative. But, with the onset of auto-enrolment, more and more DC schemes are being put into place and focus has now turned towards improving these schemes. This is being done through increasing contribution rates from both the employer and employee, introducing a wider variety of investment choices and by improving members’ understanding of their options.
Aside from their regulatory obligations post auto-enrolment, there are still many important reasons why employers should offer pensions to their staff. Like many aspects of employee benefits and engagement, each facet will be weighted differently for different employers and at different times. Pension benefits need to:
Remain competitive, to attract and retain the best staff
Enhance total reward
Provide a long term tool for engagement
Provide a cost effective reward
Encourage saving for retirement
However, if employees do not understand or value this benefit then the investment will not meet these objectives and worse still, poor decisions made by employees may create issues which may raise negative feedback to their employer. For many ordinary people pensions are still a mystery and often invoke confusion, fear and mistrust. Over the last decade the press has been littered with stories of pension deficits and stock market crashes wiping billions off pension funds and now auto-enrolment, with the likes of Alan Sugar and Theo Paphitis, is encouraging people to opt in. Employees must be helped to understand their occupational pensions and be given support to make suitable decisions. When it comes to DC schemes there are five decisions points that are fundamental during the life cycle of these schemes:
Fund investment choice
Timing to take the pension
Annuity/ pension selection
The issues of how much to contribute and fund investment choices are decisions that will need to be taken often during an individual’s life. As with savings and investment decisions, pension options need to be regularly reviewed and need to reflect an individual’s financial circumstances, needs and attitude to risk – all of which will change over their lifetime. There are still many people who do not change their bank/ building society account; some staying with the same provider all their life. This is not because they don’t want better performance from their money but the task of researching the market, finding the best account and then completing all the forms necessary deters them. In the investment industry lack of awareness and inertia are well known barriers, which product providers sometimes rely on.
Benefits/ pension professionals are often concerned about the volume of scheme members in the default fund or who have never made a request to increase their contribution. These professionals know that they have used their best efforts in arranging a great DC pension benefit with excellent employer contribution rates, well negotiated scheme fees and a range of suitable fund investment choices for members. However, if individuals don’t take advantage of these options then the likelihood is they won’t get the best pension outcomes; they won’t value their pension benefits as much as they could and so employers won’t get the levels of engagement they want from this pension investment.
Why is this more of an issue now than it has been in the past? Auto-enrolment will mean more workers will be in a scheme and so pension spend will increase. With concerns around the future of the state pension, people will need to provide for their own future financial security. With the abolition of the default retirement age, a big factor in an employee’s decision to retire will be financial security. The investment options in schemes arranged some time ago will be based around the assumptions that workers will be aiming to retire at a certain age, however this can no longer be assumed. With pension spend likely to be one of the highest investments within your benefits spend, employers will want to optimise the payback from this outlay, particularly given ongoing pressures on budgets.
So what’s the solution? As well as a need for a spread of best practice and increased awareness, the most obvious solution lies with employers providing their staff with more information, more education and more support to make informed pension decisions. Employees need to understand that DC schemes are different from DB schemes. The responsibility for the outcomes they will get at retirement relies heavily on them. They need to make those five decisions wisely, review them regularly and continue to make measured decisions. To help them, they need to have access to information, pension outcome calculators, education and advice and employers need to build this into launch, and ongoing, communication programmes. Employees will need regular reminders – lack of awareness and inertia are constant barriers that will need to be overcome. Educating employees about expected pension outcomes is easy and can be starkly demonstrated with offline and online tools. Explaining asset classes, investment funds and risk are complex issues. Providing staff with the criteria to assess and select the most suitable fund needs to address these issues and is not straightforward. In addition, employers need to consider who should deliver these messages as they need to be explained without bias and no particular route should be promoted.
Telling employees that fund choice 1 is 90 percent government bonds, that fund choice 2 is 75 percent UK equities with a lifestyle default that switches to government bonds and then cash from their 55th birthday could be a start. But it won’t necessarily yield good decisions. They need more information than that, such as what that information actually means, what to do with it and then be inspired to go out and do it. They need to understand how these asset classes are performing, what the risks and benefits of each asset class are, what has changed in the last four years, whether that change is possibly a blip or a permanent one, the impact of costs, long term savings and investment performance over a 10 /20 / 30 year period.
This type of education communication raises the profile of the benefit and increases the opportunity for engagement. This can provide both your organisation and your staff with improved pension outcomes, which in turn ensures you are maximizing on the benefits spend. This can be illustrated nicely with a case study for a company we recently worked with directly addressing this issue. As part of the preparations to accommodate auto-enrolment a well known UK retailer reviewed its current pension schemes. The retailer employs 53,000 people in the UK, 24,000 of which are eligible for auto-enrolment; 1,300 are members of the DB scheme, 2,200 are members of an existing DC scheme and 20,000 plus who will need to be auto-enrolled by March 2013. The company set the following pension strategy:
To close its DB scheme to future salary increases although members will still enjoy accrual of years. Members’ pensionable salaries were frozen at the average of the best 3 years in the last 10. In addition members were offered the choice to join a new DC pension scheme where the employer would contribute 10 percent of total salary or the employee could opt for a 10 percent salary uplift. If members chose to join the DC scheme offered they were required to contribute 5 percent of only the salary increase beyond the level frozen in DB interests
Design a new DC scheme which would be offered to all existing (old) DC members. Whilst this new scheme is not the initial auto-enrolment scheme it is open to all employees once they have been with the company for 6 months
Design a communication plan to ensure members were made aware of the changes, understood their choices and had access to financial advice
The communication strategy was to comprise two phases: phase one to deal with DB members; phase two to communicate the new DC scheme to all employees.
It was important to the company and scheme trustees that the communication exercise was led by an external provider. The trustees were concerned that employee’s knowledge of assets and funds would be low and so they wanted a provider who was specialist in financial education but who could also provide individual advice. They felt that the pension adviser would not be 'independent' enough. Close Brothers were chosen because of their eminence in the financial education market.
The company objectives through this strategy were:
To ensure DB members were treated fairly and compensated for the loss of future DB salary increase benefits To design the new DC scheme to provide members with a scheme ‘for today’ to reflect current needs and offer creative and flexible investment choices. They felt that the old default fund approach was not working and they wanted members to have a range of trustees’ 'strategies' plus the option to choose individual funds in the investment selections
To educate staff so that as many as possible contribute to an effective pension
To reduce the company’s overall pension cost (including future payments)
To prepare for auto-enrolment
To provide support to all members via a communication programme to enable them to understand their choices and make informed decisions
The first phase of communications took place between 31 August and 29 October 2012. Members were invited to attend face to face seminars in 11 regional locations across Britain from Belfast to Glasgow to London. The company wanted staff to have access to face to face seminars to present a fully transparent and open approach to these changes and enable fully active question and answer sessions. The trustees’ main area of concern was how many employees would opt out of the occupational scheme altogether. In these difficult economic times, they feared many might take this option. They were also interested in whether staff would accept the 10 percent salary uplift or the 10 percent pension contribution and that those moving to the new DC scheme made the correct pension strategy/fund choices.
In the first phase of communications, over 475 members attended seminars and gave excellent satisfaction scores and feedback. Members responded extremely well to the scheme changes, many reporting positively to their employer about the change and the communication exercise. In terms of results, the company was extremely pleased with the exercise, the increased engagement, positivity from members and the exceptional results. Only three members opted out entirely (and these were all nearing their normal pension age and so were expected to retire shortly), 88 percent chose the option to contribute to the new DC scheme with the remaining 12 percent choosing the salary increase. In these tough economic times the company felt this was an exceptional result and attributed it entirely to the communications exercise. This has reaffirmed their strategy and they are now proceeding onto phase two of their communication plan with confidence and enthusiasm.
Director, Financial Education Services