Pensions - Articles - Auto-enrolment - 10 challenges for DC pension plans in 2013

 A New Year, with old and new challenges for DC pension plans

 
 • Implementing auto-enrolment will remain the focus for this year
 • Scheme payouts will rely upon service quality rather than cost cutting
 
 Mercer has prepared a watch-list of 10 challenges facing companies involved in the auto-enrolment process. Auto-enrolment and defined contribution (DC) pension arrangements have been centre stage for 2012 and are set to continue to dominate in 2013. However, with ongoing market volatility and a continuing swell of regulatory change on the horizon DC scheme sponsors, trustees and governance committees need to be aware of the opportunities and challenges that lie ahead.

  

 Paul Macro, a Partner in Mercer’s DC business commented, “Implementing auto-enrolment will be a focus for many organisations in 2013 and meeting deadlines will be a challenge for many because they are simply not ready. Sponsors and trustees will have to grapple with the practicalities of selecting and implementing appropriate DC providers. Companies should offer value for money to their pension scheme members, but backing a scheme solely on the basis of cheap fees will not deliver the returns pensioners expect.”
 “Equally important is employee communication. Companies should be up front about the amount which members are expected to contribute each year. They should provide a variety of alternative investment fund structures and should be transparent on scheme charges. All of this will take time and effort but it is needed if employee expectations about the amount they are able to retire on are not to be disappointed in the long-term.”
 Mercer’s new year watch-list looks at ten potential pitfalls, or opportunities, for the year ahead:

 
 1. Prioritise auto-enrolment.

 Preparing for auto-enrolment takes time and can be a complex process to implement. It is critical to success that employers begin the planning process as early as possible. The consequences of not doing so could be large fines and/or reputational damage.
 2. Value for money not bargain basement
 Employers should weigh-up cost and overall service quality with great care when considering a new pension scheme or changes to an existing one. Companies may opt for one with minimal administration or investment charges, but to ensure employee buy-in the scheme must provide the level of service and investment returns expected by the membership. This may not be possible with schemes operating at bargain basement rates.
 3. Adequate pension contributions are essential
 Employers need to carefully consider scheme contribution rates to ensure that contribution levels are both sustainable in the long-term and are likely to provide a suitable level of retirement benefit for employees.
 4. Smart governance is the key to success
 The Pensions Regulator’s focus on DC governance is only going to increase, so a successful scheme needs an appropriate governance structure in place. Ideally, trustees should have DC expertise and ensure that sufficient time is spent to deal with the breadth of issues that are likely to arise following auto-enrolment, such as a changed membership profile and increased communication requirements.
 5. Out with the old and in with the new?
 Existing schemes may see increases in charges following an influx of auto-enrolled employees. Many may need changes to contribution structures to meet auto-enrolment requirements or company budgets, or may not provide sufficient investment flexibility. Companies need to be clear of their goals before committing to a new scheme or remaining with existing ones.
 6. Revamp default pension fund options
 Default pension fund structures have traditionally been the favourite among members but this almost certainly represents apathy rather than actual popularity. Ensuring that the default fund is as good as it can be should therefore be a fundamental objective of any governance body. The fund should also take into account the benefits of diversification.
 7. Ensure investment options fit the member demographic
 Scheme members have widely differing levels of financial knowledge, so different investment approaches should be made available to fit their needs. Those that don’t choose the default fund find that access to a focused range of funds, categorised by risk rather than asset class, is preferable. This approach also provides the flexibility to enable trustees or scheme providers to change asset allocation and fund managers quickly in response to market changes.
 8. Prepare for the rise of income drawdown
 Taking income from your pension fund while the fund remains invested and continues to benefit from any growth (‘income drawdown’), is increasingly popular practice amongst members. However, most members are in the scheme default lifestyle structure. These are funds that invest for growth, mainly using equity investment, when the pension scheme member is young and then switch away from equities to fixed interest and cash investment as retirement draws near (a ‘lifestyle fund’).
 Lifestyle funds are likely to be appropriate only for those expecting to purchase an annuity and are not appropriate for income drawdown where a very different approach to de-risking is required. Scheme managers should be prepared to offer alternative approaches.
 9. Guarantees could add value
 Investment guarantees promise to pay a fixed percentage of any stock market gain and generally promise to return investor capital if the market nosedives. Historically, guarantees have been viewed as expensive, but as they gather interest in the market and reduce in cost, it might be worth reconsidering. Demand from trustees and members for these sorts of investments, which can offer a more predictable pension pot or protect against losses in rough economic seas, is climbing.
 10. Tell them what you are going to say, tell them and tell them again
 Clear communication is vital in a DC scheme. Companies should be clear and up front about the amount which members actually need to contribute to receive a meaningful pension. Employee engagement will suffer if scheme members discover, too late, that they cannot afford to retire when anticipated. Scheme members may also be much of the way through a lifestyle fund before realising that the asset mix for an expected pension may be inappropriate for their circumstances, for instance if they decide to retire early.