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Education is the key

In the US, defined contribution has now overtaken defined benefit to take the lead in the funding for retirement stakes.

The UK Government has been said to have derived much of its inspiration for stakeholder and IPA from 401(k). According to leading researchers Cerulli & Associates, 70 per cent of DC assets are already held in 401(k) plans. This is forecast to rise to 75 per cent over the next three years.

On this side of the Atlantic, we Brits are beginning to follow our American cousins&#39 example in making the transition from defined benefit to defined contribution.

Watson Wyatt estimates that annual contributions for DC this year (including payments into GPPs) will total £5.8bn. This may be some way behind the £7.7bn for DB but this leading actuarial consulting firm reckons it won&#39t be long before the positions are reversed.

By 2005 the figures will be £8.5bn for DC compared with just £5.1bn for DB. Stakeholder and IPAs will no doubt accelerate the changeover but there will also be other forces at work.

Employers generally, including some of the largest plcs, are now beginning to realise that defined-benefit occupational schemes may not be the most appropriate for the changing labour markets – high job mobility and workforce turnover, short-term contracts, etc – of the 21st Century.

The DC scheme offers key advantages to employers. They are able to budget in advance for future outgoings with some certainty and, of course, the dreaded minimum funding requirement does not apply.

So the UK is now following the US in making the move from DB to DC. But will we follow our American cousins&#39 example when it comes to sharing out the business between the three main types of institutional player – life insurer, bank and specialist fund management house? In the US, the life insurers, with their established distribution channels, were the dominant force in the early days of 401(k). But since then they have been usurped by the major specialist investment houses. The banks have also lost market share to the fund management companies but not to the same extent.

As in the UK, the investment specialists dominate the US performance league tables – in both the institutional and retail client fields. Fund management is their prime activity. Those that operateon a global scale have research and fund management teams spread across the major investment centres of the world. Other businesses whose main focus lies in other areas of expertise tend to lag somewhere behind.

But the major investment houses of the US have now moved on so that they offer employers much more than fund management skills. The wide range of additional services available cover both the administration and employee communication fields.

Thanks to modern technology, costs are coming down from a base that is already low. With the imminent arrival of stakeholder here in the UK, much has already been said and written about worksite marketing and employees using the internet to keep in touch with their investments.

But for the big US fund managers this is old hat – they have been doing these things for years. Now they intend to apply their expertise and experience on this side of the pond.

Here is a just a taste of what is available in the US and will soon be on offer in the UK. Not only can employees use a variety of media to track their investments, change or redirect contributions or switch from one fund to another, they actually use them in practice.

The low-charging structures – shades of stakeholder here – leave little or no margin to cover the cost of individual advice. Instead, employees have to make their own investment decisions. The key is to educate them.

The educational message may vary, depending on the life stage a member has rea-ched within the scheme. At the beginning – the pre-enrolment part of the membership cycle – the topics covered range across a wide spectrum.

The employee learns about the need to provide for retirement, how pensions fit within an overall financial plan and the differences between DC and DB. From selecting an appropriate contribution level, the syllabus moves on to the investment alternatives (asset classes, risk levels, etc) and choosing between them.

Then it&#39s a case of explaining the various ancillary services (online account access, call centre, and so on) available to the prospective member. And the course concludes by going through the application process.

For employees approaching retirement, the topics covered are very different. The financial aspects – such as whether or not to take tax-free cash, what to do with the money if they do take it, and the alternative ways of tak-ing pension income – are, of course, included.

But each member is also prepared for the lifestyle implications – ways of spending their time, keeping fit and healthy, etc – of making the transition from working career to retirement. And this is not the end of the communication/education process. It extends beyond the retirement watershed.

Will the global asset management firms come to dom-inate UK DC pensions as they have in the US? I bel-ieve the answer to be a resounding yes.

These specialists start with the advantage of their years of practical experience in an economy similar in so many ways to our own. They are not weighed down by the baggage of having to administer generations of intricately complicated products from the past. And they have a clean and untainted image.


Tony Filbin

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