Senior consultant for DC, Hewitt Nic Nicolaou
Head of corporate solutions,
Hargreaves LansdownBob Marriott
Markets research manager,
Heath LambertGary Smith
Watson WyattMark Canning,
Aon ConsultingTo automate contribution collection, are there further services that providers should develop?
Cheseldine: Automation is likely to be of interest in a number of different areas – enrolment into the plan, investment into defaults and in particular increases in contributions. The so-called Smart pensions (Save More Tomorrow) which are credited as the brainchild of behavioural psychologist Shlomo Bernartzi, are designed to harness the power of member inertia to achieve realistic savings rates.
Nicolaou: It would be extremely useful if more providers’ systems actually allowed for multiple pay periods. There are a limited number of providers that allow employers to apply contributions in a truly flexible way, combining monthly and weekly or fortnightly, for example. Some providers are able to deal with multiple payrolls more easily than others. The key thing for all developments is to keep it simple.
Marriott: Most providers have contribution collection sorted out in terms of the physical transfer of monies. It is the quality of the data on which the contribution is calculated that cause problems, with the wrong amount being collected because it is based on the wrong salary figure. The area that providers need to consider is whether they should get further involved into HR systems and into providing payroll systems. At the smaller end of the group market offering payroll systems at some cost to the employer or even no cost may make life easier for providers if they integrate into the contribution collection system and offer some protection against personal accounts.
Smith: Most providers now offer straight-through processing, removing the risk of human error and streamlining the collection and allocation of contributions. Indeed, by now this should be standard practice within our industry. Providers should be looking to develop more advanced premium collection technology to recognise scheme-specific contribution and increment structures such as Smart. As straight-through processing has developed, the onus has been on the employer to manage the contribution collection process and in future this task should be made easier by increased functionality within the service that the provider offers. We would like to see the employer interfaces developed so that they are linked up to member self-service facilities sharing information about the investment and contribution decisions made by the membership. This will become more important as members increasingly self-serve.
Canning: A growing number of providers are changing their contribution processes to a method where employers “push” the contribution to them rather than the provider collecting it. The advantage is that the employer is in control of exactly what is remitted to the provider and it helps avoid the need for additional, time-consuming processes such as reconciliations and suspense accounts. We would, therefore, urge all providers to adopt this process.
Some providers have decided to automatically increase the net contributions they collect for contract-based plans from April 2008 following the change to the basic tax rate from 22 per cent to 20 per cent. Wisely, this means that the there will no reduction in the overall contribution being made to the scheme. We feel that this is in contract-based plan members’ own interests and we hope will be a decision that all providers reach soon.
In your experience, what is the member and employer demand for the US-style developments like Smart (Save More Tomorrow approach) that is, repeated automatic top-ups, salary sacrifice and access to pension illustration tools?
Cheseldine: There is limited experience in the UK in respect of some of these options. Clearly, salary sacrifice (or salary exchange) is gaining in popularity and many providers and schemes are offering access to modelling tools. What all of these have in common is that they tend to be driven by supply rather than demand. That is, we typically find that clients have limited awareness of the opportunities for increased efficiency via these options and one of our roles is to explain the potential implications of their introduction.
Having said that, once the options are introduced, they are received very positively and there is extensive evidence in the US (most recently in research by the Heritage Foundation) showing that even those members who opt out of automatic entry and/or increases are in favour of it in principle.
Nicolaou: There is definitely an appetite for this at the quality end of the market. Many employees are unable to fund their pension at a realistic rate when they first join their company pension scheme but are happy to commit to increase their commitment over a period of time. Employers are keen to see employee contributions at a realistic level and this is a very simple way of achieving this across the board. Where we have introduced this idea, there has been interest from employers. The most important thing from everyone’s perspective is that the providers’ systems and the employer’s payroll are able to cope with the automatic increases. In addition, any projection systems used must be able to show the benefit of this approach.
Marriott: There is some demand for all these facilities but at the moment the greatest demand is for salary sacrifice. Whether this survives the Budget remains to be seen. Salary sacrifice is popular because it is “tax avoidance”, not because people want to save for retirement. In general, people are not conscious of their needs in retirement because, unlike the US, most UK workers expect the state to provide. The issue is not providers having facilities but providers doing more to create a demand for savings.
Smith: Save more tomorrow has not yet been widely publicised in the UK so there is at present little awareness or demand from employers and members. However, we recognise the value of such contribution structures to combat member inertia and under provision. The value of these structures may well depend upon the specifics of each group of employees. An alternative is to increase member engagement with the use of communication options such as illustration tools that encourage regular reviews. Experience shows the use of online tools as relatively low compared with overall scheme membership. However, members who have access to these tools are generally more active, switching their investments and changing contribution rates. We expect the use of these tools to increase as the DC fund grows.
Canning: The functionality of pension illustration tools varies quite widely in the market from basic retirement calculators to various “what if” modelling tools. The more advanced tools can take into account other pension benefits held elsewhere, as well as the impact of altering contribution levels and/or retirement ages. It is these “full picture” tools that are of greatest benefit and we are seeing increasing usage by members.Salary sacrifice is becoming a common approach and its attractiveness is likely to increase given the imminent changes to the upper earnings limit for NI contributions from April 2008. Following promising results in the US, we shall be interested to learn of the DWP’s findings into two Smart case studies it is currently piloting in the UK. We believe that many plans will offer Smart going forward. Some plans already offer this facility to members but they are in the minority and I believe that there is a demand for it.
How important is the ability for the member to self-service their pension such as making additional contributions and fund selections direct with the insurer?
Cheseldine: This is an extremely important option but, to put it in context, it is unlikely that more than 10 per cent to 15 per cent will make use of it. All the available evidence shows that where there is a default, 90 per cent of members invest their funds in it and only very rarely will they switch those funds into an alternative investment option. Therefore, the option is only really relevant to a minority of members but it is still a substantial group of employees, typically the most voluble, and it is clearly in the plan sponsor’s interests to have them as engaged as possible. It follows then, that the better the communication, the greater the member engagement and the more likely that the plan will meet its underlying objectives as a reward tool.
Nicolaou: Increasingly members are engaging with their pension funds online. Functionality is extremely important and this needs to include fund values, contribution history, past performance, fund switching and what if calculators.
It is paramount that this functionality is available not just for contributing members but for all members (some insurers actually remove this capability when members stop contributing). As DC funds mature and average values increase, the number of funds able to be held in a members account will become more important.
Marriott: For a small proportion of employees it is quite important to self-service their pension. For the vast majority, it is not. Most people log in when they first join a pension plan and rarely do thereafter. Providers might do better if they made self-service a lot of easier. Recently, someone wanted to top up a pensions and having forgotten the “at least eight character alphanumeric password”, they also failed to remember the answer to any of the key questions needed. A new password was sent which had to be activated in a set number of days which was not convenient. Online security is important but life is too short for this sort of thing and after all they were only trying to pay in. A cheque was written to another provider and the original provider will probably lose the arrangement. If we want consumers to use computer access rather than pen and paper, we have to smarten our act up on this.
Smith: The facility for members to use e-commerce to self-serve their pension arrangement is now almost certainly a hygiene factor when implementing a new DC scheme. As with pension illustration tools, it is anticipated that the interest from an individual member to self-serve will increase as the size of their fund increases. The passing of instructions to increase contributions to the employer’s payroll department should be made more efficient. The ability for members to switch funds from a self-service site is also important and could also be made more efficient. We would not want to see fund switching levels start to increase too dramatically as a result of self service. Instead, we would like to see members carrying out an annual review, and tools that make rebalancing investment portfolios more straightforward would help here.
Canning: Member engagement can be a problem and interactive options offered by providers such as modelling tools and risk profilers can help combat apathy. Members often want the freedom to control their own pension plans and on line access means that members can self-service their pensions 24/7. Self-selection of funds works effectively if a member is given online questions on attitude to risk with the results of this then determining the funds that are most appropriate. However, self-selection should be complemented by a robust management information report from the provider, e.g. by reporting the number of fund switches members have carried out any unexpected trends can be investigated by the adviser. The provider must have effective processes in place to ensure that the employer is aware as soon as a member has elected to pay additional contributions so that collection through payroll is carried out promptly.
Which of the following investment and fund options is most important and why?
l Passive and/or active investment
l Provision of default fund
l Provision of lifestyling funds/options l Ability for the intermediary to tailor and set fund selection across different scheme categories
l Ability to narrow fund selections
Cheseldine: As we identified earlier we would expect of the order of 90 per cent of members to opt for a default where it is made available. Therefore, it should have commensurate focus applied. Where there is a default, this is likely to be some form of lifestyle option and, subject to it offering greater flexibility at retirement than historical lifestyle arrangements, this is likely to be appropriate.
The choice of active versus passive funds presents an interesting conundrum and there is a potentially different answer when we consider default and self-select funds.
Hewitt believes that active (especially unconstrained) managers can add real value net of fees. However, this presupposes that members’ investments can and will be switched from underperforming managers when appropriate. If members’ funds are likely to languish in poorperforming active funds over the long term (few managers provide consistently highly rated performance over the long term), then it is quite possible that members would be better off in passive alternatives. So the question is, how proactive will trustees be in switching members assets from one manager to another?
Nicolaou: Passive and/or active investment.
Both are important. While Hargreaves Lansdown believes active management is worth paying for, individuals who do not wish to take the cost risk of using an active manager should be able to use the best passive manager (best tracking error) at the lowest possible cost.
Provision of default fundWhile Hargreaves Lansdown would advocate that members should take an interest in their own investments, it is clear that many members do not wish to make a decision at the time of joining a scheme. There are other considerations such as how much to contribute and when to retire (and when they will be able to afford to retire). So deferring the responsibility for where to invest is better than not joining at all.
The quality of the default in our opinion is paramount and while cost is a consideration, maintaining a high quality default should be a significant part of the advisers remit.
Provision of lifestyling funds/optionsWe believe lifestying is not necessarily the best answer for all members. However for members who are not regularly reviewing their investments/retirement options leading up to retirement, lifestyling offers some level of protection.
Ability for the intermediary to tailor and set fund selection across different scheme categoriesThis will become more important as fund choice widens within schemes. Group Sipp will become an increasingly important DC offering with 1,000s of investment choices available. A well designed scheme will push members towards the appropriate level of choice. Those members who have no interest will see little more than the default and those members who have more interest will see the choice appropriate to their needs.
Ability to narrow fund selectionThis really links in with the above, the fund choice should be appropriate to the level of interest knowledge of the audience.
Marriott: With the exception of the provision of both active and passive funds which is in some ways a hygiene factor that all providers need to offer, all the options are to do with someone exercising a choice of which investment is offered to the member or policyholder. Restricting investment choice can be dangerous and the courts have yet to test the situation where a fund not offered because of lifestyling, narrow fund choice or tailored fund selection outperforms and the selected fund is a poor. Default funds at least do not impose a choice they simply offer a facility to those who do not exercise a fund selection, which is about 90 per cent of joiners. The importance of default funds is that they make life easy for the average person but the suitability of the fund needs reviewing from time to time.
Smith: Generally, members are reluctant to make active investment choices. It certainly makes the investment decision simpler if a default fund, or a limited range of investment choices, is made available. Members take solace in the knowledge that thought has been put into the design and construction of the options presented to them. The data shows that a high percentage of member’s assets are invested in defaults, where they apply. Making the correct asset allocation decision will probably have the greatest impact on the value of a member’s final benefits but members are often not equipped to make these decisions. A well constructed range of risk graded investment options that is well communicated will make that selection easier for the member. Lifestyling can certainly play a part. Passive investment options are often selected if the trustees or the employer does not want to play an ongoing governance role over the fund range. However, if the scheme sponsor is more actively involved in governance, white-labelled investment options, where the underlying investment managers can be replaced, have the potential to achieve improved returns.
Canning: Member engagement can be a problem and interactive options offered by providers such as modelling tools and risk profilers can help combat apathy. Members often want the freedom to control their own pension plans and on line access means that members can selfservice their pensions 24/7. Self-selection of funds works effectively if a member is given online questions on attitude to risk with the results of this then determining the funds that are most appropriate. However, self-selection should be complemented by a robust management information report from the provider, for example, by reporting the number of fund switches members have carried out any unexpected trends can be investigated by the adviser. The provider must have effective processes in place to ensure the employer is aware as soon as a member has elected to pay additional contributions so that collection through payroll is carried out promptly.