The worst kept secret in the world of pensions is that with the shift from DB to DC pension, employees just cannot either understand or engage with them. Employees appreciate the company match and tax saving elements, but find it difficult to make any analytical choices around their pensions and tend to remain in the default fund. They also have little confidence around the ultimate retirement pot there are likely to receive at the end of the savings cycle.
As an industry, we recognise the seismic shifts in the employee financial landscape that have caused the change. However, the way forward to rectify this situation will require significant changes in how we currently support this important employee benefit. We need to make pensions simpler, continue to offer strong governance structures, embed pension within the broader employee reward package and start educating employees as to how pensions work and the benefits of taking an active interest in the choices we offer them.
Am I bovvered?
HR and finance directors across the country complain about the lack of engagement employees have with their pension schemes. We know that our DC members do not contribute enough; 95% of them drop straight into the default option and most contemporary research indicates that members neither value their pension nor expect it to meet their retirement needs. This attitude is reflected across psychographic and demographic groups. The situation is leading to HR and finance professionals wondering why they themselves should be bothered. Wouldn’t it just make more sense to shut the current arrangement down and place their employee retirement savings into NEST?
Reports on the demise of pensions are greatly exaggerated
Clearly pensions are here to stay, at least within our lifetime. It will take decades to wind up the large number of final salary schemes in existence, even those which have already closed to future accrual. We also have a significant percentage of these final salary schemes still open to both current members and future employees.
The Government and industry leaders realise that pensions are the best way to ensure retirement savings across the workforce and continue to support them with developments such as tax exemptions, matched contributions and auto-enrolment. This, of course, means that a minimum of 8% of salary costs are going to be invested into the pension scheme (within the appropriate bands). Quality pension schemes will have even higher contribution rates.
This is a large slice of operational costs for most UK organisations and will compound itself over the years. Pension provision will therefore continue to be scrutinised at the most senior levels of industry and government and is not likely to become redundant just yet.
Into the valley of death
Earlier this year, Buck brought together a think tank of pension professionals, a number of academics and leading HR thinkers, to analyse the issues involved and possible solutions. The conclusions showed the current situation to be dire – the group believed that the pensions industry is facing an accelerated decline and we will need to work hard to make it relevant again. This article explores some of the issues and possible solutions discussed by the group.
I don’t believe it
We fear that pensions are sinking amongst the benefits mix in terms of desirability and relevance. People are changing jobs more often and find that the small pots of money they have spread out over multiple companies do not add up to any significant retirement pot.
Employees see pensions as a high-risk investment. They do not understand what experience trustees bring to the table, or the options offered by the scheme, nor do they trust that the sponsor behind the scheme will be in existence when they retire.
They claim that the Government compounds the problem by frequently changing the rules; capping pension contributions, moving to CPI increases and tinkering with the taxation benefits of a pension.
But their biggest frustration is with the communication around the scheme. It is often difficult to find, incomprehensible and does not help them understand how the pension scheme works.
All change!
The think tank identified three main areas to focus on so that we can remedy this situation, particularly in respect of DC arrangements:
- Choice architecture
- Embedding pension within a broader reward framework
- Education, education, education.
Choice architecture
We need to build our pension processes around making the right decisions easy for the average member. The Government and the pensions industry appear to agree that the best way to ensure that large swathes of the UK population are covered financially for retirement is through auto-enrolment. There is also a mood in the industry to push this all the way to compulsion. There still appear to be concerns regarding the adequacy of the contribution rates, the age of commencement of participation and gaps in employment. However, auto-enrolment will go a long way toward increasing pension coverage.
Ensuring that the default option is fit for purpose is an important second step. Multiple default options for different psychographic and demographic groups can clearly be useful. The ability to modify the default options over time based on member profile and environmental factors would be even more beneficial. The industry recognises this as a significant concern and we can look forward to a growing number of solutions coming to market over the next couple of years.
The group also believed that we need to explore other areas of choice architecture. For example, making the pension scheme more accessible using web technology, making it easier to make choices, and improving the quality of the financial education we offer.
Embed pensions within the broader reward framework
The group was unanimous in agreeing that pension schemes needed to integrate themselves within the broader reward framework. The prevailing process still expects an employee to go to one website for their pension, another for their shares and a third for their ‘flexible benefits’. Some benefits can be controlled via a web page, whereas others require slips of paper and telephone calls. Employees expect an integrated experience, and technology allows us to meet this need. Employees should be able to go to a single website to access DB, DC, GPP, share options, ISA, flex and salary information. This will ensure that the pension arrangement is integrated within the wider reward package and receives more attention, due to repeated visits to the site.
Education, education, education
A compelling method of enabling choice architecture is communication and education. The legal view is finally changing with respect to this. The HR and pension lawyers I have spoken to recently, agree that we need to improve the communication and education around our pension schemes. Employees do not read the communication we currently send out and modellers have limited interest. Employees are used to Google, Facebook and You Tube as communication tools and we need to match this functionality to keep their interest.
We therefore need to use peer statistics, web-based forums and streaming video to improve employee understanding of how their pension schemes work, the options available and expected results. This will help bring pension communication on par with the communication available around other available employee benefits.
Employees are able to investigate other savings options relatively easily such as shares, ISAs, high interest bonds and property. However, there is no publicly available information on the pension scheme, and companies are realising that it is their duty to provide this in a format that meets their employees’ learning styles. There are a number of companies which have already started down this path with excellent results. At Buck, we have a recent example of increasing membership of a DC scheme by 40% using an innovative communication initiative.
Conclusion
Overall, the results of the think tank discussions painted a worse picture than we expected. However, we believe that there are clear opportunities to redress the situation. What is encouraging is that there is a broad-based consensus that changes need to be made, as well as on the general direction of these changes. Our recommendations – choice architecture, embedding pension within a broader reward framework and improved education – are easy to make. The challenge is in the detail as to how exactly to implement them.
For further information on the work we are doing in this area, please email me at girishmenezes@hotmail.com
