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Default funds – new guidance

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Hamish Wood, Head of Investment Sales at AEGON UK discusses the implications of the guidance issued by the DWP on default funds.

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Surveys continually show that over 80% of the members of a DC arrangement invest in the default so getting it right is a key aspect of any DC plan. There is no consensus as to the strategy that is most appropriate however the majority of default funds will aim to achieve reasonable growth for individuals until retirement nears and then introduce an element of risk reduction.

Two recent developments will result in a closer focus on default funds and have implications for providers, employers and advisers. In December 2010, a set of principles for DC were published by the Investment Governance Group (IGG) setting out best practice for contract and Trust DC
arrangements. The principles modelled on the original Myners Principles, cover six key areas.

More pertinent from a default perspective is the DWP guidance on default funds for auto-enrolment. Following consultation, the guidance, which is based on IGG principle 4 (Appropriate default strategy) was issued in late May. The DWP has avoided being prescriptive about the design of the default but its expectations on a number of key aspects are clear:

1. Governance of the default
The ongoing responsibility for the default may vary between the provider, adviser, employer and governance committee depending on the specific circumstances. It sets out the stages at which responsibilities should be considered and says that roles and responsibilities should be clearly defined and available to members on request.

2. Designing the default option
The default should be designed keeping in mind the membership profile and certain standards. It covers setting a clear objective, stating what the fund or strategy is designed to achieve and how it will be achieved. The default approach should incorporate a risk management strategy
which mitigates members investment volatility over the lifetime of the product. This allows lifestyle, target date and other funds that reduce risk automatically to be used as a default.

3. Reviewing the default option
The design, performance and continued suitability of the default should undergo a full review by the designated party at least every three years and when certain events occur. The guidance gives examples of events that might trigger a review including a change to the charge structure, significant change of employer structure or member demographic, significant changes in the financial markets or economy and significant and relevant legislative changes occur. The guidance also states that the designated party should be able to provide proof such as written documentation that a review has been carried out. It also suggests that the default should be monitored at regular intervals throughout the year.

4. Communicating the default
The Occupational and Personal Pension Schemes (Automatic Enrolment) Regulations 2010 specify that when an individual is automatically enrolled into a workplace pension, they must be given information on the default option. The DWP guidance sets out the key aspects that hould be included.

Implications of the guidance
The DWP outlines two scenarios;
1. The employer engages an adviser to design a bespoke default fund which is then built by the provider.
2. The employer uses a standard default fund offered by the provider

The first places greater responsibility on the employer as it will need to be closely involved with the adviser and provider in reviewing the fund and taking responsibility for it. The employer would also need to consider what happens if the adviser changes or another event meant a review
was appropriate. Ideally a strong ongoing governance process involving input from the employer, adviser and provider should also be established for this scenario.

The second scenario places all responsibility for the fund with the provider. The employers’ responsibility will be limited to selecting an appropriate provider typically with the help of its adviser.

It is likely that only the largest employers with established pension or governance committees will be in a position to design a bespoke approach. In most cases the employer will want to be confident that it has selected the right provider and effectively delegate responsibility for the default to it. This makes sense because the providers role is to understand the pensions and investment markets and offer suitable default approaches.

It is encouraging that the guidance will not be prescriptive about how the default strategy should operate. It is important that providers can offer a range of options with differing risk profiles so allowing the employer and its adviser to select the most appropriate for its workforce.

Hamish Wood

Head of Investment Sales, AEGON UK
hamish.wood@aegon.co.uk
07740 897 184

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