DC – a change of direction needed?

Nick Cook considers the fear of DC under-delivery, what the next generation of DC pension plans might look like and the step changes needed to get there

DC plans are now a significant force in pension provision in the UK – but experience suggests that DC in its current form is unlikely to provide adequate wealth for future generations. In a recent survey conducted by Watson Wyatt in conjunction with the Financial Times, the biggest fear of pensions experts over the next 10 to 15 years was that DC would under-deliver.

With the increased reliance on DC pension provision, the under delivery of DC plans would leave many members financially unprepared for retirement. However, steps can be taken to mitigate this potentially disastrous outcome. There is a need to explore the roles and responsibilities of the fiduciary, sponsor and individuals in successful retirement planning. The industry also needs to consider the place of DC pensions in a holistic wealth management framework.

More realistic savings levels
On average, one third of adult life is now spent in retirement. Link this to a general pattern of low pension scheme take up rates, savings levels and member engagement together with misguided investment choices in
DC pension plans and the situation looks somewhat bleak going forward. The risk is that employees cannot afford to retire and work longer than they (and perhaps their employers) want to which may lead to reduced enthusiasm, commitment and productivity.

Employers can of course address this in part by determining the contributions that they are prepared to pay to their DC plans. However, realistic savings levels do not necessarily equate simply to higher employer pension contribution rates. Employers can and should encourage and facilitate greater personal commitment through a combination of effective communication, education and engagement programmes, and perhaps making available other employer sponsored savings vehicles to meet the needs of those that don't 'buy in' to the traditional pensions model.

Stronger fiduciary role
Where applicable, trustees are generally best placed to consider key risks to DC members (administration, understanding, charges, investment and retirement options) and address them accordingly. However, employers also have a key role to play here either in supporting the trustees of occupational DC schemes or undertaking such functions themselves under contract-based arrangements. In fact, a strong fiduciary structure can add significant value to both the members and also to the DC plan sponsor (ensuring it gets maximum value for its benefits spend).

When considering a fiduciary's role it is taken as read that quantitative areas will be addressed; for example ensuring that contributions are paid on time and that benefits are paid out accurately in a timely manner. However, it is the qualitative areas that can add real value. For example, structuring appropriate fund ranges and defaults, monitoring service providers, and periodically analysing member behaviour and understanding so that a process of continuing improvement can be targeted.

Improved DC delivery
One of the greatest drivers to improving DC delivery and avoiding members being unprepared for retirement is effective communication and member understanding. In the past, member communications have tended to focus primarily on the provision of information, much of it driven by technical and legislative factors. However, the key message here is that 'information is not communication'. Evidence shows that DC plans with less generous contribution rates linked to effective high quality communication programmes are more highly valued by members than DC plans with more generous contribution rates but lower quality communication programmes.

Sponsors of DC plans should seek to improve member engagement by adopting more of a consumer-driven marketing approach, with a view to promoting the plan rather than just providing information. As an example, using non pension/technical analogies can be very effective in helping members understand the key issues such as different types of DC investment risks and the best ways to address them. Fundamentally DC engagement needs to focus on communicating three major concepts:

• Know how much you'll need
• Contribute as much as you can afford
• Make your money work

More efficient, innovative investment
Members are not typically equipped to deal with the complex financial matters underlying their DC investments, but getting it right can have a significant impact on the outcome at retirement.

Greater use of multi-investment opportunities packaged into efficient vehicles may help to address the needs of members, for example by providing access to several different asset classes and return drivers in a single investment vehicle. This may include real estate, private equity, hedge funds, commodities and others. The emphasis will be on providing apparently simple solutions to members which may be underpinned by sophisticated and innovative investment structures. In other words, investment options that are simple but not simplistic.

There is also a need for more innovation and product development focussed on the post-retirement period, linked to effective and comprehensive member education. Given that retirement may cover a 25 to 30 year time frame, annuitisation at 65 may not necessarily be the best financial decision.

Enhanced employer value
Employers provide pension arrangements for many reasons. In addition to 'paternalistic' reasons, these may include aiding recruitment and retention and being able to release employees from their workforces when they want to. Whatever the reasons, employers will generally be looking for value for money, costs within budget and risk minimisation.
However, in today's world of more mobile employees with greater financial commitments, in some circumstances traditional DC pension arrangements alone might not provide the best return on investment or best meet the needs of all employees.

Smarter, more holistic engagement
It is all well and good spending time discussing and considering ways of improving DC plans. However, in an environment of a possibly prolonged credit crisis and increasing levels of debt, high costs of housing, student loan repayments and increased job mobility, is it really realistic to believe and expect that traditional pension vehicles will be a main priority for employees at all ages irrespective of their individual circumstances?

Pension and non-pension savings vehicles can and should be integrated for a more holistic approach to savings generally and retirement planning. Employers can play a key part here through broad ranging communication and education strategies that consider company benefit arrangements together rather than in isolation. Indeed, many employers are showing an increasing willingness to consider and offer employees a greater range of employer packaged and promoted savings options such as:

• Shorter term savings vehicles to pay off student debt or to save for housing deposits
• Longer term non-pension vehicles targeted to ultimately provide retirement income but with flexibility for early access if required
• Group self-invested personal pension plans to receive the proceeds of maturing share plans in a tax efficient manner

There is much innovation and development in this area. For example, some employers are showing a willingness to pay contributions to alternative savings vehicles which has lead to some providers looking at launching corporate ISAs that introduce the benefits of payroll deduction facilities, institutional investment returns and tailored/ branded communication materials.

It is recognised that DC plans in their current form are unlikely to deliver adequate wealth in retirement for many participants, which is of serious concern given the increasing reliance on DC pension provision as the major source of retirement income. Such recognition is a good starting point to take corrective action.

The next generation of DC plans, if they address and adopt the principles outlined here, as well as being offered alongside other employer sponsored benefits in a joined up and effectively communicated manner, should provide required levels of income and therefore deliver value for plan sponsors and participants alike.

However, plan sponsors, fiduciaries, providers and participants all have a role to play in making this work.

- Pensions Age August 2008