 By Morten Nilsson, CEO, NOW:Pensions
Auto-enrolment is now approaching the sixth month of the staging process,yetit is still very much in its infancy and it will be many months before providers can draw any real conclusions fromthe employee and employer datathey hold.However early indications from companies and consultantshave suggested thatopt-out rates are between five and eight per centfor some of the largest UK companies, which is significantly different from earlier predictions of between twenty and thirty per cent. It’s worth noting that it is still very early in the phasing-in process and the number of employees opting out could still rise, but theseinitial figures are positive. Analysis of data available in early August should provide more reliable long-term trends,but if the opt-out rate stays at 20 per cent or less, we can deem auto-enrolment a success.
For now, the main focus for providers is the on-boarding process of the large volumes of employers staging in the second quarter of 2013, through to the end of 2014. It will be a challenging period for the industry and it may bring to light capacity issues for some providers. The auto-enrolment process is still very new, andemployers have to adapt to new processes in order to meet their auto-enrolment requirements. Our experiences with employers have shown that many are struggling with the complexity of the auto-enrolment legislation, but this is of course where providers can help.
Aside from any difficulties experienced on the employer side, regulatory bodies have been focusing their attention on the impact consumers will face from being enrolled into a poorly managed pension scheme, and various regulatory frameworks are in the process of being established. Both the ABI and NAPF are in the final stages of creating a code of conduct for charges, and the Office of Fair Trading (OFT)is conducting a market investigation to evaluate competition and assess if there is market pressure on providers to lower charges.
The success of auto-enrolment will depend on the ability of providersto build trust and confidence amongst theirmembers;however the past behaviour of some schemes has tainted the reputation of the pensions industry over the past decade and disenfranchised many with pensions. To start rebuilding this, it’s essential that we have regulation on two levels; avoiding needlessly high scheme charges to ensure pension pots are protected, and guaranteeing a good structure for the funds into which members’ money is invested.These two factors have huge bearing on future retirement income.
Some low-cost providers utilise passive fund management strategies to ensure good retirement income. Whiletheseprovide value for employees that pay in the minimum contributions, we believe this strategy cannot smooth the volatility of members’ funds over their career. Members need strategies which are dynamic and can actively manage their exposure to market risk rather than active funds that gain exposure through stock picking (alpha).
It comes down to member engagement. We view one of the key risks from an investment point of view is the ‘set and forget’ default fund strategy risk. Members may not necessarily have sufficient knowledge (or interest) to understand their own risk profile and the decision they initially make often remains unchanged until life-styling kicks-in 10-15 years before retirement. This poses a serious risk to members during the accumulation phase, and it therefore needs to be managed via a fund that is actively managed so that riskis taken off the table to protect members from serious drawdown.
We believe diversificationis the most important factor; diversifying risk across several asset classes and managing this within one fund is the most important factor to protect members from downside risk during the accumulation phase.
The currentglobaleconomic outlook isstill a matter of much debate, with commentators predicting a period of sustained low economic growth in the UK and Europe as governments’ battle with a rising debt burden and growing inflation expectations, as the longer term effects of quantitative easing come into fruition. In order to combat the uncertainty we face, we need funds that can adapt to their changing environments and take advantage of the differences in the behaviour of assets at different points in the business cycle. A diversified strategy,coupled with active risk management, can provide the framework needed to ensure that the value of a member’s pot is less drastically impacted when there is a shock to the system. If regulators can drive consolidation within the industry, we should see a strategic move away from passive, to actively managed funds. It is these funds that can provide members with the benefits of economies of scale, and a less volatile investment product to maintain their trust and confidence.
The future looks bright for auto-enrolment and the regulatory framework being introduced by The Pensions Regulator could bring further benefits to members. It’s our responsibility, as an industry, to re-build confidence in the UK pensions system, and if we can increase employee engagement and educate the auto-enrolment population, we can recreate a savings revolution in the UK.
It is essential that schemes adoptan agreed ‘Codes of Conduct’ on charges, given the threat members face by enrolling into high charging schemes. The next step is for providers to focus on building a robust default fund for their members and as a result, increase their members’ confidence.We believe this can only come from ensuring schemes havea TER of 0.5%pa or less over the longer term, good governance (including strict investment governance), strict record keeping guidance and above all, a good quality investment default fund. If we can adopt these principles we will be moving towards a more efficient pensions system. We are still some distance away from a perfect market, but the industry’s governing bodies are moving us in the right direction.
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