Towers Watson has welcomed the rise in pre-packaged annuity protection or “Pre-retirement” funds which offer defined contribution (DC) schemes more opportunity to ensure investment portfolios are appropriate for members of DC schemes in the approach to retirement. However, this also demonstrates the increasing specialism and focus expected of schemes delivering DC pensions, according to the firm.
Nico Aspinall, head of DC Investment in the UK said: “We welcome these solutions as we believe they significantly improve the protection characteristics available to DC members close to retirement. Until now this has been neglected by our industry and I am pleased to see that annuity protection funds might actually start to do what they say on the tin. This represents a big step forward in protecting the benefits of DC members and can reduce the risk of disappointing members. These solutions have been specifically designed for DC members, rather than being cobbled together from investments that were built for a different purpose, and if used correctly will dramatically improve the certainty members have about the amount of income the DC pot will purchase. But they are more sophisticated and fiduciaries need to make sure they understand what they are putting in member portfolios, and that this will require more on-going oversight.”
In a research paper entitled: Pre-retirement investing, the company asserts that while the improvements offer greater protection against changes in annuity prices, they are limited by the fact that at the moment these are single solutions designed for default funds which have to try to meet the differing needs of individuals as they approach retirement. In addition, the role of credit in these solutions is under scrutiny particularly in respect of whether it actually improves funds’ ability to track annuity price movements, particularly during poor markets.
Nico Aspinall said: “Understanding the risks to which an individual is exposed at different stages to retirement is important in determining how risk should be adjusted in the years prior to retirement. We have adopted risk metrics which focus on the actions individuals can take in response to changes in expected benefits which include altering contributions, changing the date of retirement or accepting a different level of income received in retirement. For these members in particular, risk should be measured in relation to income, not capital. Gaining certainty over retirement income at an appropriate time must be a big part of the solution.”
In the paper, Towers Watson highlights the reasons that traditional, bond index-based solutions are failing, and outlines how pre-retirement funds are becoming more appropriate for the needs of different groups of individuals in the run-up to retirement.
Nico Aspinall said: “These solutions are much more closely linked to annuity prices in that they are sensitive to many of the factors affecting annuities. Some of these factors, like profit margins, fiduciaries can do nothing about, but there are improvements which can be made in respect of the others. These new approaches capture interest-rate risks, factoring in both duration and cash-flow profiles, and the level of credit risk taken by insurers as well as how it is managed. This means they can track annuity prices much better than existing solutions which might have a mismatch of 10% to 20% each year against annuity prices. In our view this is too much for members close to retirement and could mean the difference between retiring when the member expects or much, much later. While the improvements don’t solve the problem entirely, they make a valuable contribution.”
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