Pensions Age DC roundtable

The Pensions Age Defined Contribution panelists met on three occasions in 2004 to contemplate the future of DC provision in the UK; and to discuss any shortcomings they, as providers and advisers, felt needed to be addressed in order to secure the future of the DC product.

Following the success of these events, the panel have re-convened this year to tackle the issues that are likely to affect the industry in 2005. Topics this month include the effectiveness of lifestyle default funds; how to boost DC contribution rates, especially among smaller companies; and how commendable each political party’s pension manifestoes are in advance of the General Election

BACK TO ROUNDTABLE MAIN

Chairman: Roger Cobley is president of the Pensions Management Institute and a director of international investment consultancy Stamford Associates Limited. He also acts as chairman and/or trustee director of several pension funds; is a fellow of the Institute of Actuaries; and an Associate of the Society of Actuaries; is a Freeman of the City of London; and a Liveryman of the Worshipful Company of Actuaries. Roger was elected to PMI Council in 2000 and has been President since 2003. He is a past chairman of PMI Eastern Group and is a former OPAS Adviser.

Steve Busby is head of sales development at Prudential where he is responsible for the development of the life company’s existing and future defined contribution and defined benefit pensions propositions. Steve has over 25 years’ financial services industry experience and has previously held roles in pensions administration, IT and other technical areas. More recently, Steve has been heavily involved in the construction of Prudential's in-house and third party investment proposition across the defined contribution range of products.

Richard Parkin is head of DC product development at Fidelity Investments, having joined in the company in September 2002. Richard began his career in the pensions industry at Towers Perrin's Asset Consulting Services in 1994. Four years later he joined Phillips & Drew as pooled product development manager, ultimately becoming director of product development at UBS. He has been an associate of the Pensions Management Institute since 1992 and is regularly quoted in the press representing Fidelity Investments’ views on DC.

Jeremy Ward is responsible for all aspects of pensions marketing at Friends Provident, including strategy, product management, pricing, communication, systems development and external funds. He has been very closely involved with the development of the innovative 'New Generation Pensions' systems which introduced true straight-through processing to the group pensions market. In 2003, Jeremy directed the development and launch of FP’s Activ range of multi-manager funds. Previous roles include head of product management and head of strategic marketing.

Andrew Cheseldine is a senior consultant in Watson Wyatt's Benefits Practice. Andrew’s principal area of expertise is in advising on and implementing employee benefit programmes, particularly DC pension arrangements including GPP plans. Andrew has particular experience of advising non-UK organisations on all aspects of starting up subsidiary operations in the UK. Before joining Watson Wyatt in 1997, Andrew had 18 years experience working for insurance companies and financial advisers, specialising in advising on employee benefits.

Tony Baily is a principal consultant with Hewitt Associates where he provides strategic consulting ideas to companies and pension scheme trustees on a full range of pensions and benefits issues. These include valuations and funding, benefit design and communication, sales and acquisitions, scheme restructuring and changes from government reform. His personal clients include major UK and multinational organisations. Tony regularly speaks at conferences and seminars on pensions issues, and he is also a fellow of the Institute of Actuaries.

Default lifestyle funds

Chairman: "Stakeholder regulations have always required a default fund to be offered and the latest set of rules has now limited this to a lifestyle option only. What impact will this have on DC design and is lifestyle a good choice?

Cheseldine: I think it is a good thing that the default should be lifestyle. It is clearly a better option than a with-profits default, which a couple of providers have had. We have always argued, however, that there should be more than one lifestyle option available for members as the danger is that a lot of people will see one default and think it is a recommendation.

I also think it would be helpful if instead of designing investment options that are complicated, we built products that fulfiled a certain objective. Is it efficient, reasonable, even fair to give people with limited financial education all these powerful financial tools and then expect them to build an appropriate investment model? We think it would make more sense if you built a number of lifestyle options and said, for example, this one will be suitable for someone that is going to buy a level annuity, or an index-linked annuity, and so on.

Parkin: The problem, though, with basing a fund choice on what benefits people are going to buy is that many won’t know what they will buy until they get there – picking a lifestyle default at the age of 20 is difficult. Nonetheless, because government is saying lifestyle is the only allowable default on the stakeholder, that gives it some sort of safe harbour status.

Lifestyle has been around for a long time and there have been various attempts at trying to make it more effective. For example, some consulting firms have been talking about dynamic design so that it actually switches into bonds a bit earlier if you have had a good run in the equity market, which as administrators makes us squeal as there will be all sorts of complications of doing that effectively.

It is interesting how in the US there is a trend back towards lifestyle from self-select strategies. While you can always come up with complaints about how it works, most other options have bigger drawbacks.

Busby: I also think that default is the wrong word as for many it implies that it is a safe option, and it means people don’t make any sort of decision, which is not what we are looking for either. Just going into a default fund because you think it is safe is not appropriate.

Baily: Can I raise a point that takes us a step back? Everyone is complaining about members not being active enough about investment decisions, but shouldn't we stop worrying about that and start worrying about getting people to contribute? Whether you invest in equities or bonds there is never going to be a right answer at the time you make that decision as it is just a risk and reward trade-off. The most important thing we need to do is get people paying contributions; it is a second order decision as to where they invest their money.

Busby: I am not sure that is strictly the case. I think a big part of it is about making people comfortable with that decision, otherwise they won’t contribute in the first place, so you must do both.

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Fund choice

Chairman: So, we need to restore confidence; we need to give people an incentive to save; and we need to make things simpler. I have worried for a long time about the proliferation of investment funds available under an average GPP or DC scheme and the open architecture approach seems to encourage this, despite the fact that the majority of the funds on offer are never used.

Baily: There was a great experiment run by Shlomo Benartiz in the US, which highlights the problem with too much choice. He went to a supermarket and set up two different displays of jam – an extensive display which had 24 choices and a more limited display which had just 6 choices. The results were startling. Sixty per cent of shoppers stopped at the extensive display and appeared to consider making a purchase, but only three per cent of shoppers actually purchased jam.

By contrast, only 40 per cent of shoppers stopped at the more limited display, but 30 per cent bought jam. If you give people too much choice they can become overwhelmed and can fear making the wrong choice. What we need to do with investors is to try and help them overcome the fear of making the wrong choice and encourage them to make a positive decision.

Chairman: Is the proliferation of choice there, to a certain extent, to protect the consultant so it can never be claimed the member wasn’t given enough choice?

Ward: I think there is an element of that. I also think that from a provider’s perspective what drives the proliferation of funds is the fact that consultants don’t all like the same funds, and while we would love to have a choice of three funds, Watson Wyatt and Hewitt, for example, would have a very different view about what were the right ones; and then once they are on the platform, the advisers need a strong reason to exclude them.

Busby: I agree with Jeremy that from a provider point of view we have to have the whole universe of funds so that consultants and employers can make decisions appropriate to their needs. Saying that, the workplace survey that we recently completed implies that where over 15 funds are offered people find the selection daunting and switch off.

Baily: We keep saying range of funds, but there’s not really that big a range – there are equities, bonds or cash. At the moment for DC, there is generally no property, no liability-driven investment and no alpha funds. We should be encouraging trustees of DC schemes to look at a broader range of investment options for financially sophisticated investors, without overloading other members. Doing this with
contract-based schemes though is likely to be difficult.

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Education and member choice

Chairman: So how can we make the range per scheme a little less intimidating for members so that they are better able to make investment choices?

Parkin: At the risk of this sounding slightly Stalinist I am not sure we should be encouraging people to make more choices anyway – we are trying to suggest that by empowering them they will make better financial choices than we as financial services professionals, or are we just trying to cover our backs?

There seems to be this obsession with getting people to understand the product. Why do they need to understand the product? They need to understand what they are tying to use the product to do – for example I want to use a car to get from A to B – I don’t need to understand how the engine works.

Chairman: But isn’t it the case that in the automotive industry, unless there is something seriously wrong with the car you can’t sue the manufacturer; however in the financial services industry you can; so employers need more protection.
It seems, therefore, that while the government is keen to promote the work-place as the best place for pension provision, they are saddling the employer with problems, we are not giving them a safe harbour, and I think that is something the FSA should action.

Busby: We are, however, never going to get rid of risk and ultimately we need to be supporting people by making them more aware that they are taking a decision that involves an element of risk. I also think we need to get closer to what their underlying needs are and we need to be designing programmes to fit those needs, whether they be lifestyle programmes or not. We are the experts in the industry and we need to make people fully aware of the implications of being in these programmes and the fact that they are not totally risk-free.

Chairman: Maybe we should get smarter about asking questions in a decision tree-like process as I don’t think that we can support individual advice, but we do need to guide people down the track. Should employers be required to do this?

Cheseldine: I would argue they should want to do it, not because they are very nice people but it is a question of risk management. Despite the general perception that DC is low risk, employers still have significant risks when offering DC schemes – management risks, investment risks, administration risks and communication risks.

Busby: I think that DC is the poor relation of DB, a finding highlighted in the Turner Report, and some employers go into it with the idea that they don’t have to get involved very much. We need to change that perception.

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Smaller companies

Chairman: I am really concerned about the overlay of requirements on the employer, in particular the smaller employer. How are we going to encourage pension provision in smaller companies – is it going to come down to compulsion? Or perhaps we need a central scheme to which those people can start to contribute which is either industry wide or geography based?

Ward: We have had some experience of affinity schemes/industry-wide schemes and the difficulty is that even when you have got an industry-wide scheme you have still got that barrier of having to communicate with each individual employer. You have got something for them, but someone still has to sell it to them and the economics don’t work to allow you to do that profitably as individual small employers.

Parkin: Also, because union membership is not as pervasive as it is in somewhere like Australia that does hold back the formation and success of industry-wide schemes. That’s not necessarily an argument for re-unionisation of the work-force but I think some of the enablers that allow industry-wide schemes to exist in other countries don’t exist in the UK.

Busby: I agree. Our experience of working with the TUC has been that employers are different from union to union as they come from different industries, and you need to have a differentiated product for each of those industries. While industry-wide schemes are a very good idea for bringing scale, which gives us as a provider the economies we require, in practice it has never worked as well as it should.

Chairman: I think we have got to be much more positive about things and I think we have to be much more effective with our packaging. One problem I have is that our tax system, that allows tax relief on contributions, doesn’t really highlight the fact that you actually get something from the government. It would be better to emphasise that there is partial matching of contributions from the Inland Revenue.

Busby: I think matching is a good idea – we just need to get away from the age and service-related area of matching – I think being able to offer one for one or two for two is an incentive for people to save, and it works.

Cheseldine: Some of our clients doing combined benefit statements are issuing state benefit statements to people even if they haven’t joined the company scheme to say, “this is what you are going to get from the state – tough cookies, it’s not much. Now do you want to think about joining the pension scheme?”

Busby: This whole area is hugely confusing for consumers. You have FSA illustrations on one basis; SMPI on another basis; and potentially own scheme illustrations on a third basis. Combined forecasts which require the integration of company benefits with some sort of State-related benefits can be seen as adding another layer of confusion.

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Pension manifestoes: General Election

Chairman: I suspect that for the first time in ages, if ever, pensions will be high up on the political agenda for the General Election, and this is going to force the parties to disclose their plans, and they will want to have some differentiation.

Cheseldine: I think it is quite unusual that we have got different attitudes from the various parties. The Tories have put their proposals forward and largely they are looking to un-wind the trend towards means-tested benefits which we agree entirely with. Labour, on the other hand, is waiting until Turner which will happen after the election which seems quite a strange decision as I would have thought pensions were going to be pretty high on the manifesto list.

Ward: It seems like a cop-out to me as Turner outlined the four different ways of approaching the pensions issue and the four different parties can only really differ in their balancing between the four.

Baily: The question is: are the political parties the best at coming up with ideas about pensions? Probably not, as all they are looking at is four years’ time as opposed to forty years’ time.

I suppose I am a bit of a cynic. For example, the Liberal Democrats have targeted women, which is where they think the swing vote is going to be. The Conservatives have targeted the grey vote as they are looking at reducing the council tax bill and re-linking State pensions to earnings rather than prices. And Labour have pretty much kept their powder dry for the time being.

Ultimately it may come down to who is going to be in charge. Brown is seen as “old school Labour”, likes means-testing and Blair is seen as following the popular vote, which is pushing toward a Citizen’s Pension – flat rate, not means-tested and based on residency.

Parkin: I must say I can’t read any of the politicians’ announcements about pensions without massive cynicism. While I do broadly agree with some of the Tory proposals, reading some of the things about re-instating the links with earnings you wouldn’t think it was them that actually took it away in the first place – the tax raid actually started a year before Labour came in.

In fact, none of the parties have a good record on pensions, apart from perhaps the Lib Dems who have never had a chance to show it. But it smacks of massive dishonesty and political positioning rather than anything else."