By Morten Nilsson, CEO of NOW: Pensions
Auto-enrolment has finally arrived and the new legislation is set to boost DC assets under management significantly over the coming years. The new workplace pension reforms will provide significant business opportunities for existing schemes as well as new entrants to the market, as millions of new savers begin contributing to a pension scheme for the very first time. The new legislation will go some way to addressing the problems faced in the UK around falling contribution levels, an ageing population and low household saving. However for auto-enrolment to fully change the attitudes of consumers and entice them into saving a higher percentage of their salaries, there are underlying issues within the pension industry itself that need to be addressed. A recent report released by the Pensions Institute and sponsored by NOW: Pensions - ‘Caveat Venditor:
The brave new world of auto-enrolment should be governed by the principle of seller not buyer beware’- highlights theneed for change within the industry due to the detrimental effect of enrolling members into a poor quality schemes.
The report’s key findings highlight the need for change amongst pension funds, and call for a review of the regulatory framework that governs the pensions industry. According to the report, members face vastly different retirement lifestyles depending on the scheme into which they are auto-enrolled. Lack of clarityhas made it extraordinarily difficult to evaluate schemes’ TERs - some older schemes have TERs of c3% which has resulted in thousands of employees paying six times the annual charge available to them if they were enrolled into a newer scheme with TERs between 0.3% - 0.5%. Auto-enrolment has been designed to address the pension’s savings gap amongst low-median salaried workers;if this cohort is enrolled into poor quality schemes with excessive charging structures, they will face severe detriment in retirement.
Our analysis shows that the difference between charges can have a huge impact on final fund value; a 22 year-old who begins investing £133 a month, with an annual contribution rise of 2% and a compound growth rate of 6% per year - until age 68 could have £170,000 difference in funds depending on the scheme they are enrolled into. If this individual was enrolled into the NOW: Pensions scheme they would have a pot of £473,000 at retirement, compared to them being enrolled into a high charging scheme with a funds under management charge of 2% where they would have a fund of £302,000. This highlights the fact that charges have a huge impact on members, and that old style contract schemes that continue to mask their charges in complexity must be regulated and/or banned from being used as an auto-enrolment scheme. The above example illustrates the need for regulators to crack down on opaque charging structures used by schemes, and if auto-enrolment is to succeed, members need certainty that they are getting value for money.
Auto-enrolment necessitates default funds to be constructed so that they are fit for purpose, especially as 90-97% of members will be enrolled into default funds . For default funds to be deemed suitable for auto-enrolment this requires regulation on two main levels; charges (discussed above) andinvestment governance. The report reveals that the structure of somedefault funds being used for auto-enrolment is alarming and a definite cause for concern,with many still highly weighted towards equities and implementing strategies with 80% equity allocations as a default. Equity investments are highly volatile in the short to medium term and the large range of expected outcomes when investing in this asset class make pension saving similar to playing the lottery.
In order to keep the auto-enrolment population engaged, members need to see less volatility in their pension savings.If they see their fund value decrease, many will stop contributing. Members need an investment strategy that protects them from downside risk, thus helping to smooth the volatility of their investment over their career and still allow them to get the best possible return. In my view, there are 3 things that need to be obtained: 1) a truly diversified riskallocation in the portfolio, 2) a strong and active riskmanagement framework, and 3) the ability to react quickly to market conditions via a smart implementation that ensures liquidity and agility. Only through such a framework can you ensure that a portfolio is suited to achieve optimal market exposure with minimal uncompensated risk, and thereby give good returns at an acceptable risk level in any economic environment.
Auto-enrolment will only work if members trust their provider and therefore decide to ‘opt-in,’ and building confidence in the industry will only come from a regulatory environment that aims to protect consumers interests. According to recent consumer research conducted by NOW: Pensions, when asked what factors would encourage them to save into pension scheme, 43% of consumer responded saying that knowing their pension provider was trustworthy would encourage them to do so.
Currently neither the Pensions’ Regulator (tPR) nor the Financial Services Authority (FSA) regulate charges or the quality of default funds, and the industry has proved that self-regulation does not work. We’re therefore calling for the Pensions’ Regulator and other governing bodies (NAPF, ABI, FSA and IMA) to implement quality standards that would allow only certified schemes to operate in the auto-enrolment space. Thiscertified quality standards would be based on schemes achieving a long-run TER of 0.5% or lower, strict investment governance framework and funds providing a reliable measure of downside risk that meets international best practices.
This approach would also act as an incentive for schemes to become more member-centric, as without a certified quality mark many will lose significant business and be viewed as a pariah by employers. The schemes unable to change their behaviour and continue to exploit members will eventually be removed from the industry as employers turn their back on poor quality schemes. This should drive efficiency throughout the industry and schemes will begin competing on quality as well as price. In the end, the direct beneficiary of this regulation will be members who will benefit from lower charges, thus helping them to secure a higher level of income on retirement.
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