To get the best out of DC we need to harness both engagement and inertia
Much is written and said about the need for more “engagement” in pensions, but how realistic a prospect is it? How much can we really expect of members in defined contribution (DC) pension schemes?
To try and find out we commissioned Bdifferent*, a specialist financial services market research firm, to speak to a number of pension scheme members to see what they knew about their pensions and what they hoped to get out of them.
It won’t come as a surprise that we found most members showed very little interest in retirement. Pay, property, children and holidays come far higher up their list of priorities. More worrying was that those closer to retirement were often just as blasé as their younger colleagues.
I've had a fatalistic approach to retirement: it's going to be rubbish; I've always been aware that I won't have much, but I have never been bothered with it. (Older member)
And to prove that a little knowledge is a dangerous thing, we found that received wisdom about pensions was often confused or contradictory. For instance, a pension was seen as low risk, yet investing in shares was seen as high risk, with few appearing to understand the link between the two. Equally, there seemed to be a misplaced belief that a pension was “free money” which carried an implicit guarantee from the employer.
So where does this leave the sponsor?
Under growing pressure from the media and regulators for more engagement, they may feel it’s all too difficult. They may therefore be tempted simply to hand over the whole responsibility to a contract scheme provider.
We totally understand their frustration. We too would question whether the bulk of members will ever want to engage productively with their pension, except perhaps on the eve of retirement when it’s too late. However, rather than subcontracting the problem, we suspect there is a better approach – or rather “approaches”, for we would argue that there should be one for the receptive minority and a different one for the rest.
It will be good in the long run but I couldn’t tell you how much I have got in there, I couldn’t tell you how much comes out or anything really. (Younger member)
At its best, we believe a good pension can be used not only to attract good workers, but also to make them want to stay. This is all the more of a priority as “human capital” becomes increasingly important for many businesses. At the moment, however, our survey suggests many members do not really have any idea of the aims of their pension, or what the results might be when they retire.
By doing more to raise members’ awareness of the importance of their pension, we believe more people will want to become more involved. This will require employers, advisers and service suppliers working together to improve the image and value of pensions.
I got a letter the other day, but I didn’t even read it.
Such a strategy is, however, only likely to appeal to a minority, the more thoughtful few. The reality is that most are likely to be unmoved by such efforts, at least in the short term. For this group – likely to be by far the biggest – we think schemes need to exploit people’s natural inertia. By making it easy to do the right thing, most members will accept what is done for them. They may even assume that it comes with some sort of seal of approval.
This is the approach auto enrolment has used so successfully to reverse the downward trend in private sector pension saving, adding six million new DC savers since 2012. For these members who have started saving – many for the first time – the next best thing that can happen to them is for their money to be directed towards a really well designed default fund.
In exactly the same way, trustees are likely to be doing the best thing for the majority of their members if they offer default funds designed for the majority.
To put a lot of money into something [when] I don’t know how long I am going to last seems daft, I would prefer to enjoy it now.
To do that successfully over a full savings career requires, we would argue, not one but several default funds. Each needs to cater for a distinct phase of the savings journey and the varying ability of savers to tolerate risk. And with pension flexibility now a reality, the final default fund may need to cope with the saver who remains invested in retirement while also receiving an income.
Certainly, whether they are increasing engagement or tackling inertia, sponsors and trustees may need to expend more effort. But in doing so, they should not hesitate to seek help from their advisers and investment providers. By everyone working together and sharing the burden, DC pensions can be made a lot more valuable for all involved, but especially for members.
*Research involved 10 DC schemes and 56 members between 22 February and 2 March, 2016.