Understanding Pensions 2020

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U N D E R S T A N D I N G P E N S I O N S 2 Balancing activism with apathy A lot of people don't realise they have the ability to actively manage their pension investments, and many that do choose not to. But does this level of apathy hinder or actually help pension providers? he big success story of pension savings in the UK is auto-enrol- ment. Insights from behavioural economics were used to create the scheme in 2012 to "nudge" more people into saving a percentage of their income in workplace pension schemes. Employees can choose to opt out of the pension scheme, but given that many are not aware of the fact that they're saving into a pension automatically, opt-out rates have been very low. The scheme's success is down to the power of inertia. But the flipside of iner- tia is that employees hardly engage with their pension savings. Indeed, only a third of workers realise workplace pen- sion schemes are invested in the stock market, according to recent research from Hargreaves Lansdown. Many don't realise they can actively change what their pension is invested in. Does this level of apathy and lack of understanding pensions hinder or help pension providers? "Pension providers do not encourage their customers to decide to switch to other funds and there seems an in-built assumption that people are not interested and will not bother to make active deci- sions," says former pensions minister Bar- oness Ros Altmann. She notes that the more traditional final salary pensions did not typically permit members to choose their invest- ments and the trustees are responsible for all such decisions, which again means pension savers never needed to engage with investment decisions. "This lack of engagement can be beneficial to pension providers, because they do not face tough scrutiny from customers," says Lady Altmann. "The complexity of products and lack of transparency have often allowed a proliferation of high hidden charges, which were not in the member's interest." Marina Gerner T Most workplace pension schemes will invest employees automatically into the scheme default fund, explains Victoria Rut- land, chartered financial planner at EQ Inves- tors. Typically, this means that during the early stages of a person's pension savings, the fund heavily invests in equities and then pro- ceeds to move into lower-risk assets such as bonds or cash, as people approach retirement. However, as Rutland points out, for most of our working life, our pension is predom- inantly invested in equities, which means it can fluctuate significantly. "Many peo- ple would be shocked to see how much the value of their pension has fluctuated in the last six months in particular," she says. You could therefore argue that people's apathy towards their pension protects them from panicking about their savings when the stock market fluctuates. Why do providers offer this type of default strategy? Rutland says: "Because it's cost effective. Putting everyone into this type of strategy means that everyone can invest in the same way as others who are the same age as them. Each provider can simply make changes to one portfolio. The cost of providing advice to every single investor in each group scheme would be prohibitive." But as more people endeavour to live sus- tainably, attention might turn to the actual contents of their pension pot. In Australia, Dr Bronwyn King, an oncologist, famously persuaded Australian pension funds to divest from tobacco. "The majority of default funds, including lifestyle strategies, will be invested in 'tradi- tional' investments such as shares in oil and gas companies, tobacco and armaments," says Rutland. "Traditional investments don't usually consider the carbon footprint of the underlying companies or the govern- ance of the business and its supply chain. "While a lot of opportunities to invest in ethical, ESG [environmental, social and governance] or positive impact portfolios are becoming more and more available on the wider market, workplace pensions are behind the curve." With increasing awareness, the tables could turn if people begin to take more con- trol of their pension, changing funds en masse. In the UK, campaigns like Make My Money Matter by Comic Relief's Richard Cur- tis, could contribute to bringing ESG invest- ing to a mainstream audience by asking what is your pension invested in? But any form of pension activism has to be balanced with peo- ple's need for financial literacy and advice. How can the industry find a happy bal- ance between apathy and activist invest- ing? Kate Smith, head of pensions at Aegon, says: "Nowadays, individuals have to shoul- der much more responsibility for funding their retirement than ever before, so getting people properly engaged as early as possible in their working life is key. "We want to see more savers engaged with their pensions, including reviewing their investment choices and monitoring investment performance. This is a good thing for providers and savers. Currently, fewer than one in five UK workers say they have used an investment-risk tool to find out how much risk they are comfortable with when investing in their pension." She notes that while many provid- ers allow savers to carry out online fund switches, free of charge, few savers take advantage of this. The majority remain invested in the default fund, out of choice or apathy. "In reality, we think it's highly unlikely that savers will en masse make numerous investment fund switches," Smith adds. "And doing so will not neces- sarily lead to good member outcomes." For now, apathy and a lack of transpar- ency are still endemic in pensions, despite years of attempts to improve engagement. As Lady Altmann concludes: "Improve- ments have been achieved, but only very slowly. I believe the industry should face up to this challenge and help its customers understand and engage with pensions." I N V E S T M E N T S Nest was set up by the government to ensure every UK employer could offer a workplace pension to their employees when auto-enrolment was introduced. It now has more than 9.3 million members and one in three of the working population is expected to have a Nest retirement pot by the late-2020s. "Our view is that engagement is a necessary tool in helping our members achieve better outcomes in retirement," says Eve Read, Nest's director of business delivery. She argues that a combination of efforts is required. "We issue regular communications on topics that matter to members, which will be personalised to their own situation as much as possible," Read says. "For some individuals, the way to create engagement is to make it real for them, such as sharing how Nest is committed to tackling climate change, but for others it might be highlighting that they could build their pension pot faster by maximising tax savings or employer-matched contributions." She says greater engagement could help pension schemes gain insights such as their members' desired retirement age or retirement income. "However, the biggest challenge of a very active model would be that members may then engage in highly complex decisions without fully understanding the profound impact these might have on their financial future. So, when we communicate with our members, we have to think really carefully about what we want them to think, feel and do, so we don't inadvertently drive behaviours that might undermine their long-term goals," Read concludes. Driving engagement BARRIERS TO ENG AGEMENT Top five challenges companies face when engaging employees with pensions CBI/Aegon 2018 1 in 3 people know what their pensions are worth 1 in 3 don't know whether their pension is invested in the stock market 29% know how much money they'll need in retirement Hargreaves Lansdown 2020 I believe the industry should face up to this challenge and help its customers understand and engage with pensions Employees putting off saving 61% Employees' lack of awareness of importance of retirement saving 59% Employees opting to divert money due to financial pressures or into other savings 59% Employees' lack of understanding of the pension scheme 45% Employees' lack of understanding of state pension 42% Peter Cade via Getty Images OVID-19 has refocused defined benefit (DB) pension schemes on their individual approaches to integrated risk management. The novel coronavirus has forced stakeholders to look closely at their asset allocation, their longevity forecasts and the support available from the sponsor- ing company. As a result, there has been substantial media coverage dedicated to the chal- lenges faced by DB schemes, along with reams of commentary on how trustees are navigating the turmoil. Some may have been tempted to 'latch on' to this constant news stream, or influ- enced to make decisions based on what 'the market' appears to be doing. But for Raj Mody, partner and global head of pensions at PwC, now is the time for trustees and companies to keep a level head, to work closely with other stake- holders and take bold decisions, tailored for their scheme. "There has been a lot of noise which has led to a 'herd mentality' in some parts of the industry," he says. "I feel strongly that there cannot be a one- size-fits-all strategy for the more than 5,000 UK DB schemes. You have to resist the push towards a norm. It may not be right for you." Mody endorses the approach of renowned investor Warren Buffett who famously proclaimed "We don't read other people's opinions. We want to get the facts and then think." The PwC partner says DB pen- sion schemes should take the same approach, only making decisions when they understand the data and options that are relevant to them. Pension trustees tend to agree. "Decisions on the future of pension schemes are complex and nuanced," says Steve Delo, chairman of PAN Trustees. "Just because something is appro- priate for one scheme does not mean it will be effective for another. All schemes have their own quirks and idiosyncra- sies, liability profiles, specific rules, legacy of decisions and ways of work- ing," he explains. Thinking differently Mody has become something of a cham- pion for DB trustees and sponsors making bespoke decisions. He advises a range of companies and trustees, and for the decade until early 2020 worked exten- sively with ITV on its pension scheme. ITV was one of the early adopters for a variety of interventions, championing a more effective relationship between the sponsor, the trustees and members. Christine Jackson, ITV's director of reward and pensions, says the new way of working has only been possible because all stakeholders have developed an enor- mous level of trust. "We believe working together is a better way to think about pensions," she says. She recognises that it is common for media reports to characterise trustees and the sponsoring company as two sides locked in battle, each trying to secure very different outcomes, but says that isn't usually the case. "Most of the time the company and the trustees are not on different sides," she says. "All parties want to improve member security, and they want to do it in a way that doesn't adversely affect the sponsor." ITV has managed its scheme in var- ious, innovative ways over the past decade including completing a longevity swap in 2011, and then in 2018 entering an insurance transaction, both ena- bling it to reduce unwanted risk. Opting for a partial buy-in for one part of the scheme, with different characteristics, meant that it complemented the previ- ous longevity swap. A new approach For Nadeem Ladha, trustee director at 20-20 Trustee Services, pension scheme management has changed and requires more strategy and innovation than it did in the past. "There used to be a time when trus- tees took each actuarial valuation cycle one at a time, and the only variables were the mix of equities and bonds, and the prudence of the actuarial assump- tions," he notes. Ladha thinks we are now at a stage where all schemes must have their own plan to succeed. "Each scheme's jour- ney is likely to be unique, reflecting the difference in maturity, funding and the tools available," he says. The post-COVID world will have seen substantial economic turmoil, so schemes will need to focus increasingly on the needs of their members and not just investing assets, according to Mody. "People have traditionally seen a lia- bility valuation number, and an assets number. Their focus has been on ensur- ing the assets number beats the liabil- ity number over a period of time. And, if it doesn't work, they ask the sponsor for more cash. But that is not the true dynamic," says the PwC partner. Delo at PAN Trustees believes trus- tees and companies need to have a common level of understanding. "This can be critical to properly aligning inter- ests," he warns. "Too often, I have seen parties that should be aligned being at loggerheads because one party has devoted the time to properly understand the issues, and the other hasn't." At the same time, trustees and finance directors should be wary of adviser reports which design their guidance around an interpretation of what the Pensions Regulator wants. "That should sound alarm bells," Mody says. "You cannot run a pension scheme only through a regulatory checklist. The checklist is there for after your deci- sion, not before you have even started thinking about it and understanding your issues." In his experience, diagnosing a scheme's condition with a fresh pair of eyes, and then creating a scheme-spe- cific strategy, will yield better results and over a shorter timeframe. It's a given that the plan of action has to comply with regulations. ITV's Jackson recognises that "there will always be" a desire by some to herd towards a regulatory objective, but she thinks the Pensions Regulator has been extremely forward-thinking in recent years in trying to understand the unique position of schemes across the board. This regulatory position is perhaps indicative of a broader recognition by trustees, scheme managers and finance directors that, through collaboration, they and only they are the ones best placed to serve their members. "The best outcome for mem- bers requires us to work as a team more so than we ever have before," con- cludes Ladha. For more information please visit pwc.co.uk/pensions Designing a winning pension strategy While defined benefit pension schemes have historically been categorised as a tug of war between the sponsoring company and the trustees, things are starting to changeā€¦ Commercial feature C You have to resist the push towards a norm. It may not be right for you LIFE EXPECTANCY Significantly higher than average Higher than average In line with average Significantly lower than average Lower than average Source: PwC analysis

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