Tom Murray, Head of Product Strategy LifePlus Solutions at Majesco questions whether auto-enrolment will ultimately succeed in ensuring individuals have sufficient pension savings at retirement.
There have been many articles about the success of auto-enrolment over the last year, and certainly in terms of the numbers that have been newly introduced to pension savings as a concept, it is very impressive. Over nine million people have been auto-enrolled into pension schemes since the start of the programme and the opt-out rate of c.8% has remained remarkably consistent.
Even last April, when the amount being taken from the employee tripled from 1% to 3%, fears of a big increase in the numbers opting out of the savings programme were not realised. Major providers such as NOW Pensions reported an increase of just 0.2% in opt-outs over the initial months after the change. Whether this will hold this month as the next jump in employee contributions – from 3% to 5% - kicks in, is being watched carefully. But there are reasons to be hopeful, as this is a far lower percentage increase than last years and that one didn’t cause a panicked exodus.
So, in terms of getting people to save, auto-enrolment has undeniably been a success. The question is whether it will succeed in its overall aim of having people arrive at their point of retirement with sufficient savings to make a difference to their lifestyle in their old age.
Here, there are some causes for concern. Although there are large numbers saving, the amount of engagement they have with their savings is highly questionable. According to Moneywise, a staggering 84% of auto-enrolled savers are invested in their schemes default fund. This is a good indicator that people are not directly engaged in the process of saving and there is a big danger that they are assuming that their contributions will just result in a pension when they are older, without bothering about the details.
There is a danger that, having read the literature and decided not to opt-out, workers feel that their retirement is now sorted.
You can lead a horse to water
The communications that must be made to employees prior to enrolment in their workplace pension scheme are highly regulated but the difficulty is that no matter how hard you try, you cannot insist that people pay attention. Nor can you be sure how much of it they have absorbed. Surveys have shown that the majority of individuals hearing the word pension, assume that it is the traditional idea of a pension i.e. a regular payment extending throughout their retirement.
However, the overuse of default funds is a strong indicator that not a lot of attention is being paid. Employees are not actively engaging and as a result are likely to be surprised and even disappointed when they get to retirement age and see the size of their pension pot.
If we are to use the same approach as we have used to encourage pension saving, then ways must be found to repeat the nudge process around engagement so that individuals are regularly reviewing their pensions and making decisions around it. Because there is a definite need to get more engagement if the outcome is to have a reasonable effect on the retirement levels of the individuals.
Getting greater engagement from scheme members would make a huge difference to auto-enrolment outcomes. Firstly, engagement should lead to far more people moving from their default funds into funds that are more appropriate to their age. Those at the start of their working life should be taking on more risk in order to increase the growth in their fund whilst those nearer the end of their working life should be more cautious in order to prevent against the risk of having a sudden downturn in the market right at the point where they are retiring. This would help deliver a better return overall on their lifetime savings, and thereby increase the chances of the pension making a significant difference in their retirement.
The second issue is the amount being saved. This month it has risen to 8% of pensionable pay, with 5% coming from the employee and 3% coming from the employer. This is widely regarded as being an insufficient level of contribution and doesn’t compare well internationally. Australian contributions are currently at 9.5% and are scheduled to rise to 12% by 2025. Given the fact that auto-enrolment is a relatively new process, great care must be taken not to force contributions up too quickly, but a sustained campaign is needed to encourage people to voluntarily put more of their earnings into savings, and the sooner the better.
Thus, a big nudge programme to get people more engaged with their pensions could be hugely beneficial to the overall programme. The key would be to enable people to engage whenever and however they wanted to. The provision of online tools to enable people to model extra contributions and see how it will affect their retirement outcomes would be key to this process, as would automated guidance that would be available on the 24x7 basis that the “always on” society demands. However, given that to date, the majority people have generally resisted all programmes designed to make them plan for their later life, it is undoubtedly a big ask.
Outcomes, outcomes, outcomes
When it comes down to it, all people really care about when it comes to their pension is how much they are going to get. Survey after survey show that people still automatically think of pension in terms of the weekly / monthly amount that they will get rather than in terms of the lump sum that will generate it. Yet, the whole auto-enrolment is focused on creating this large sum of money for retirement and is not clear on how to manage an income from it.
To this end, the arrival of pension freedoms has really made it difficult. For the financially aware, this has been a boon as they have been able to access and manage their pension savings. However, it does mean that the individual is left carrying the whole longevity risk completely on their own shoulders.
For the less financially aware, and that probably includes most of the 84% disengaged auto-enrolled contributors, pensions freedom holds big dangers. To suddenly expect people who are not financially aware to make key decisions to manage their money across their retirement taking into account the longevity risks and the investment risks is asking a lot, particularly at a time of life when cognitive ability is scientifically proved to be slowing. It is little wonder that there has been such a surge in pension scams affecting older savers and how so many of them have been hood-winked out of their life’s savings by unscrupulous crooks. Those who chose an annuity at the start have often ended up being better off in the long run, despite the low rates of return at this time.
Therein, lies the danger for the government. Having encouraged such a huge number of people to save for their retirement, they might still be left carrying the weight of providing for many of them, if they dissipate their money too quickly. No doubt some will squander the lump sum quickly in their retirement but even those who are trying to make it last are going to have difficulty. Essentially, they are carrying the risk of longevity and the investment risk completely on their own. Given the lack of experience in these fields that many of them have, then it is likely that many will burn through their savings quite quickly and end up requiring their state pension and other state supports as a backstop.
This is an issue that won’t be faced by those with the luxury of a defined benefit pension, which will keep paying out as long as they live. But the majority of these schemes have either closed or closed to new members as the companies sponsoring them struggle with the deficits in the scheme and the weight of that liability on their balance sheet.
To make auto-enrolment a true success, changes must be made both to the accumulation and the decumulation phases. It is going to be difficult to engage workers more with their pensions, and thereby encourage them to increase their provision for their retirement. And in the decumulation phase it is likely that many will find the difficulties of managing their own money successfully to be too difficult.
Thus, the announcement by the Government that it is going to proceed with legislation to provide for a new option in the retirement world, the Collective Defined Contribution scheme is extremely welcome. This is a scheme which shares the advantage of the usual money purchase scheme in that the employer can work out their costs in advance and avoid taking on any risk. However, rather than the individual bearing all the risk, the longevity risks and investment risks are pooled across the scheme.
From the point of view of the employee, the promise is of a target income in retirement, which is more in line with what they would expect from a pension. And the involvement required is minimal, as the contribution levels are fixed, and the investment strategy is overseen by trustees and carried out by investment professionals.
The initial legislation is being setup in response to Royal Mails request to be allowed to setup such a scheme. But, once it is up and running, more schemes are envisaged. Whilst scale is required in order to benefit from pooling, the approach is not restricted to large firms as other countries have shown by allowing schemes to be setup based on an occupational basis, so that all members would have a similar profile, and therefore no particular group would be subsidising another group.
Whilst the income level isn’t guaranteed, the ability of experts to provide better investment returns is almost certain to ensure higher returns, as is the fact that one’s pension contributions remain collectively invested even during one’s retirement. This removes the pressure to de-risk towards the end of one’s working career, which can cause a dampening down of returns in the later years of one’s pension.
Similarly, longevity issues are pooled, and the actuaries ensure the overall pension fund is level each year, by changing the pensions being accrued and in payment, even downwards if required. Whilst this doesn’t remove all risk, it does reduce it substantially from the risk level of an individual defined contribution plan.
Leave it to experts
In terms of auto-enrolment, the ideal therefore would be CDC schemes for different work sectors, where employers could auto-enrol their staff into a scheme with a pool of similarly profiled employees. This would give the scale required in order to provide the pooling to lower the risks and give the employees a far greater degree of security than they would have with existing DC plans.
It also means that the Government and Financial Bodies can get out of the business of nagging people to take control of their pensions when it is clearly beyond the capacity of most of the population to manage these types of risks. Sometimes people just don’t want control.
This article was originally commissioned for the April 2019 edition of the Investment Life & Pensions Moneyfacts Magazine.