Are defaults fit for purpose? Two pension schemes give their views
The triple threat of low-contributions, increasing longevity and freedom and choice has meant that old style defaults are no longer fit for purpose.
As a result – schemes should be rethinking their strategy through the retirement savings journey.
The early stages
While DC schemes may not have a specific liability they are trying to manage – they do need to think about what members might need and expect in retirement. That could be a replacement ratio, a certain pot size or a drawdown fund that will last for life.
Tesco’s pensions manager, Ruston Smith said: “Typically over a working lifetime people will have between 11 and 13 pots… so there’s lots of uncertainty about what they will need from you as a scheme.”
That’s why, when Tesco closed its DB scheme and shifted people into its retirement plan, it carried out research into average income, retirement date and quizzed members to find out what their hopes and expectations would be.
They found that on average their members would need pots of £250,000 to meet their needs. While that money could come from a variety of places (other pension pots, ISAs, the state pension), data like that can help schemes understand what a member’s retirement picture might look like.
Investment performance is down to us”
There are two main factors which define how big a member’s pot will grow. Their contributions and the return on investments.
Schemes have limited power to influence how much a member can contribute. As Smith puts it: “For a member it’s all about affordability… They have other financial responsibilities. They might need to pay more but they might not be able to afford to pay more and it might not be the right thing if they have debts with interest.
“Investment performance is down to us.”
So DC pension funds have a huge responsibility to their scheme members to help them achieve the best possible returns on their savings.
When the Siemens pension scheme did some research on its membership the trustee board was extremely concerned that members were not getting sufficient investment returns to end up with an adequate retirement. So they looked at what they could do to improve things.
For a member it’s all about affordability”
Robert Bennett, senior manager, pensions investment at Siemens, said “The trustees measure the performance of the component parts. They were increasingly concerned as they saw the price of annuities rise… there was a feeling that members weren’t taking enough risk early on.
So the scheme introduced a global equity strategy, which took slightly more risk in the early years. The projections suggest that this could increase members’ outcomes by 4%.
The other end of the scale
Most scheme members, regardless of whether they have small or large pots, will no longer be targeting an annuity.
This means that the flightpath needs to shift to ensure the assets at retirement match the kinds of assets that are suitable for either a cash lump sum or a drawdown product.
The Tesco DC scheme, which is only three months old, carried out research on its membership to find out what those needs might be. At the moment – most of the membership is planning to take cash.
So the scheme has updated its flightpath accordingly, shifting to target cash as members indicate that they are getting ready for retirement
Siemens is predicting that a large proportion if its membership will eventually look to go into drawdown.
Bennett said: “It doesn’t feel like targeting an annuity will be right for our membership
“The scheme is able to administer a number of drawdown events post retirement, so they can stay within the scheme. They can have a finite number of crystallisation events, but can’t use it like a bank account.
“It does feel like our default strategy is delivering more or less what members need but we know there are pieces of work we need to do in 2016.”
That work is likely to take the form of finding ways to direct members towards drawdown.
As for the future, the Siemen’s scheme is likely to start aping the Tesco scheme – in so far as it uses a very similar investment strategy to that used in the DB scheme.
For Smith – the future lies in deferred annuities. He said: “The cherry on top is deferred annuities. We’re working with partners to look at that.”