FTSE 100 Defined contribution pension scheme survey results 2013

Transcription

1 FTSE 1 Defined contribution pension scheme survey results 213

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3 FTSE 1 Defined contribution pension scheme 213 survey results Contents Foreword 5 Executive summary 6 Pensions landscape 8 Enrolment and contributions 14 Investment 18 Wider benefits 24 Auto-enrolment the human story 26 About the survey 3 Further information 31

4 Thank you We would like to thank all of those companies that took the time and effort to participate in the 213 survey. Without your responses we would be unable to produce this report. We would also like to thank the hard work of Amy May (University of Leeds), Karin Shields (University of Leeds) and Serafín Frache (University of London) in researching and collecting the data for this year s survey. In addition, we would like to extend our thanks to Jonathan Gardner, Tanya Swanepoel, David Mitchell and Hemal Patel (all of Towers Watson) for their efforts in analysing and compiling this report. 4 towerswatson.com

5 Foreword Once again, we are delighted that the report is based on data from over 9% of the FTSE 1. While this is our ninth edition, this is the first report since employers have been legally required to automatically enrol their employees into a workplace pension. This is probably the biggest pensions change for a generation and has dramatically changed the pension landscape for employers, employees and providers. We have therefore taken the opportunity to refresh and refocus both the survey and the report. We have looked at contribution designs in greater detail, and have uncovered two very different schools of thought in defined contribution (DC) design. In investment, we shed some light on the difference in practices between contract- and trust-based plans. DC is already the dominant form of future pension provision and if the rate of closure of defined benefit (DB) schemes seen in the recent past continued, then in a decade s time there would be no FTSE 1 employers who offer DB to longer standing employees. Indeed, as this report was being drafted, two FTSE 1 hard closure consultations were in the public domain, with DC being the preferred option for the future. So with both auto-enrolment and DB closures driving expansion of members and assets, DC is set to explode in significance. At this critical juncture, we investigate what auto-enrolling does to take-up rates, we look at whether existing investment approaches are fit-for-purpose and we explore the topical issue of charges. For the first time, we have looked at the human impact of this survey. DC pension designs are not just dry tables of information, they are the key to millions of people s retirement futures. So we have taken a look at the levels of pension that might result for two employees. In DC, we can add to the sum of future human happiness. Consider this report a pulse check on how happy or otherwise we are all going to be in a few years time. Will Aitken Senior Consultant FTSE 1 defined contribution pension scheme 213 survey results 5

6 Executive summary We found that employers offer an average contribution of around 1%; charges average.36% and automatic enrolment typically delivers 9% plus take up. Those are just the headlines, let us dig a little deeper. Auto-enrolment has prompted FTSE 1 employers to review everything from contributions to the vehicles they use to provide DC pensions and the investment strategies on offer. Main fi ndings Increase in DB hard closures The closure of DB schemes to future accrual continues. If the current pace of closure continues, all of the current DB schemes open to future accrual will be closed in as little as 1 years. Almost all FTSE 1 employers will enrol new hires into a DC scheme. This has left the number of active DB members increasingly in a minority in an average FTSE 1 employer, offering DC to new hires, non-members now outnumber DB members. Charges continue to fall Despite unprecedented noise around charges, we fi nd that the average FTSE 1 DC scheme offers relatively low charges (.36%). This compares favourably with NEST s charges, which are often cited as a benchmark. Some employers treat former employees differently one in five operates a different charging structure for deferred members (typically higher). Non-joiners DB members Two schools of thought on contribution structures Even against a backdrop of harsh economic times, average DC contribution rates continue to grow. We have broken down contribution designs into two groups flat contributions with and without matching and find that average contributions within those two groups are very different: Flat contributions without matching average 11% in total. Flat contributions with matching average 16.6% in total. However, under the matching approach employees need to pay more to get the full employer contribution. Salary/grade-related contribution structures are increasing; driven by auto-enrolment. Fewer DB members than pension non-joiners in the average FTSE 1 employer offering DC to new hires At the current rate of change, all DB schemes open to future accrual will be closed within 1 years 6 towerswatson.com

7 1 in 5 schemes charge deferred members more Impact of auto-enrolment 5% of FTSE 1 employers are already auto-enrolling their employees many before they legally have to. Amongst employers who auto-enrol employees, take-up rates are typically in excess of 9%. 213 sees the emergence of the master trust which now accounts for 5% of DC schemes for new employees. 9%+ Typical take-up where employers auto-enrol Some schemes have introduced two-phase lifecycle approaches, typically where an initial equity-based portfolio begins to switch into a more diversifi ed growth portfolio, say 2 years prior to retirement, before moving into bonds 1 years out. The most common switching period for the lifecycle strategies is to start 1 years from retirement, although we are starting to see the emergence of a longer switching period as long as 2 years. Wider benefits Despite providers investing heavily in corporate wealth platforms, only one in seven employers offer employees the choice to flex pension contributions into other forms of saving. A quarter of respondents do not currently provide an annuity broking service and few have plans to introduce either retirement counselling sessions or pre-retirement guides. Vehicle drives investment approach Members of contract-based schemes have more funds to choose from but are less likely to make a choice. A higher proportion of contract-based scheme members invest in the default investment option than their trust-based counterparts. Trust-based schemes are three times more likely to use active management in their default fund compared with contract-based schemes. There is a wide spread in terms of the number of funds schemes offer to their members. Most trust-based schemes offer between fi ve and 15 options, while the most common offering in contract-based schemes is more than 5 funds. 4 in 5 members invest in the default fund FTSE 1 defined contribution pension scheme 213 survey results 7

8 Pensions landscape Over the next few years more current DB members will find themselves in unfamiliar DC territory. Meanwhile, auto-enrolment will bring a large and varied population into pensions for the first time, many of them unwittingly. This expansion has increasingly put DC schemes under the spotlight. Not least the topical question of whether members are paying too much in charges - our survey shows that these are lower than some might expect. Will Aitken, Senior Consultant Figure 1. Pension schemes for new hires 92% DC scheme 8% Non-DC scheme 3% 2% 2% 1% Cash balance DB/DC hybrid Career average Final salary * Figures correct at January 213. Changes announced but not yet implemented are not yet incorporated. Figure 1 shows that DC remains the pension vehicle of choice, although some DB schemes remain intact ahead of auto-enrolment. Generally, new hires of FTSE 1 employers will find themselves enrolled into a DC scheme, although a few industry sectors, most notably energy and retail, still offer some form of DB pension benefit. The reasons for continuing to offer DB schemes where much of the competition has moved to DC will vary between employers. These may include a two-year vesting period for pensions or the need to provide a higher level of pension benefit to attract the top employees. In some industries, regulators permit pension costs to be passed on to consumers, meaning that the commercial pressures that have forced other DB closures simply do not exist. Those non-dc schemes include a number of risk sharing arrangements, some along the lines of Minister of State for Pensions, Steve Webb s defined ambition. However, it is clear that at the present time, risk sharing schemes exist very much at the margins of pension provision. Nearly 7 fold Increase in proportion of hard closed DB schemes in FTSE 1 employers 8 towerswatson.com

9 The closure of DB schemes to future accrual continues at a steady pace as shown in Figure 2. While offering DB to new hires is now very much a minority approach, DB accrual for existing members is dropping but continues to persist with 58% of employers offering DC for new joiners and DB for longer standing employees (down from 74% in 21). However, the trend is quite clearly towards hard closure of schemes to future DB accrual. At the current pace of change, all DB schemes currently open to future accrual will be closed over the next decade. No two DB closures are ever quite the same. Many closures stem from financial pressures the need to ensure deficits are not added to, the need to bring risk under control and the need to restrain pension costs. In short, DB provision typically costs more than DC. Figure 2. Percentage of FTSE 1 employers who only offer DC to employees Percentage of schemes DC now the only option for all employees Only ever offered DC In the past year, we have seen a number of closures on the basis of providing equality across employee benefit groups. It becomes increasingly hard to justify leaving DB schemes open when it is only a small proportion of the workforce that benefit. As new hires and non-members are gradually enrolled 58% into DC schemes, DB members will quickly find themselves in a very much diminishing minority, and hard closures based on an equality of pension cost may gather pace. Figure 3 illustrates the point with the average FTSE 1 employer reporting DB members in the minority. At the current pace of change all DB schemes currently open to future accrual could be closed in the next decade. Figure 3. Average workforce of a FTSE 1 employer with a DC scheme of employees in DC schemes 58% DC members 18% DB/hybrid members 24% Non-joiners An average FTSE 1 employer with a DC scheme has 58% of their workforce in a DC scheme, 18% in a DB/hybrid and 24% not in a pension scheme at all. FTSE 1 defined contribution pension scheme 213 survey results 9

10 Figure 4. Number of DC plans offered to new hires 81% Single scheme offered 19% Multiple schemes offered 3% 3% 7% 6% According to service According to date According to business unit Other Around one in five of FTSE 1 employers utilise more than one DC scheme as illustrated in Figure 4. There have always been a variety of reasons why an employer might do this for example, it may operate different schemes for different business units, may not have standardised pension provision across legacy organisations, may have switched to a contract-based scheme only for new employees, or chosen to operate a corporate self-invested personal pension alongside the main scheme. However, there is anecdotal evidence that automatic enrolment is providing organisations with new reasons to operate more than one DC scheme. Automatic enrolment and multiple pension schemes Automatic enrolment means that employers have to provide pensions for categories of employees who may previously have been excluded from pension provision. This can include some contractors and short-term workers as well as permanent employees who would otherwise not have been eligible or would have been subject to a waiting period before being eligible to join the employer s pension scheme. Employees who have started receiving pension benefits from the company scheme but have continued to work also need to be given access to new contributions under the new rules. One of the questions that employers have grappled with when preparing for automatic enrolment has been whether to establish a different arrangement for their auto-enrolled population rather than change the profile or rules of their existing scheme. As explored later in this report, employers who have previously made pensions available on an opt-in basis should expect auto-enrolment to improve take-up significantly where this was previously low. If employers anticipate paying pension contributions for more people, an obvious question is how the cost of this will be absorbed or passed on to employees. In some cases, part of the answer will be to enrol new members at less generous contribution rates than were previously available either just during their earliest period of service or on a permanent basis. This can involve providing their pensions through a different vehicle. While this is not explicit levelling down (as existing members do not have their contributions affected) over time, this will lead to lower average contributions. In the same way that DB members now form a progressively smaller share of the workforce after DB schemes have closed to new entrants, old DC members may also become a minority as time progresses where employers choose to spread their pension budget more thinly. The possibility of contributions to DC schemes decreasing at a member level has always been a potential side-effect of auto-enrolment. 1 towerswatson.com

11 Figure 5. Total value of assets in DC schemes Percentage of schemes Scheme assets worth over 4 million have more than doubled from 5% to 11% since 212. DC schemes continue to grow ahead of auto-enrolment and 4% of DC schemes are now valued at over 1 billion , 4 1,1 or more Assets ( million) Percentage of schemes Figure 6. Total value of annual DC pension contributions Schemes with contributions of more than 25 million Figure 1. Type of scheme offered to new have employees increased 9% since 21, from 13% to 22%. We expect this growth to accelerate further as auto-enrolment takes effect or more Contributions ( million) In 27/28 only 6% of FTSE 1 DC schemes were worth more than 2 million. By 213 this figure had trebled to 18%. Figure 2. Significance of DC relative to overall pension provision FTSE 1 defined contribution pension scheme 213 survey results 11

12 The number of salary/grade-related scheme designs has almost doubled in popularity since 212 and now account for 11% of designs against 6% previously. However, age-related designs have fallen by over a half to only 4% of schemes, down from 9% in 212. As recently as 25, 25% of DC designs were age-related. Similarly, flat-rate designs with no matching have almost halved in use, down to 15% of designs from 27% in 212 as illustrated in Figure 7. We believe that the increase of salary/graderelated designs is almost entirely the result of the pressures of auto-enrolment. Pension scheme non-members have tended to be lower earners and offering lower earners a less generous scheme mitigates some costs, coupled with their lesser ability/willingness to actually pay contributions. Matching designs (often a flat core contribution with matching options on top) continue to be very popular as they permit an employer to direct pension contributions (and therefore costs) to those employees who most value them. Figure 7. How contribution rates are determined 54% Flat rate with matching 15% Flat rate no matching 11% Salary/grade-related 8% Service-related 4% Age-related 8% Other Salary/grade-related contribution structures have almost doubled over the last year from 6% to 11%. Flat-rate with matching continues to dominate. We believe that the emergence of salary/grade-related designs is almost entirely the result of the pressures of auto-enrolment. 12 towerswatson.com

13 Charges In 74% of schemes, the annual management charge (AMC) in the default fund is no more than.4% of the member s account balance. The average AMC is.36%. This is a long way below the 1% charge cap that eventually applies in stakeholder schemes, never mind the 1.5% cap that applies during a saver s first 1 years of membership. None of the schemes surveyed apply charges that would breach these limits. The National Employment Savings Trust (NEST) combines a.3% AMC with a 1.8% charge on contributions, which NEST says is broadly equivalent to an AMC of.5%. NEST s charges are becoming a benchmark against which commentators measure those in other schemes. While smaller employers may frequently find NEST s costs more than competitive, the survey indicates that those with enough scheme members to exercise significant buying power have often been able to secure lower charges for their employees. In some cases, what members have to pay will also have been reduced by employers deciding to pick up some of the cost. The 74% of schemes with an AMC of.4% or less compares with 53% in 212. This chimes with our recent experience, as we believe pressure on charges has mostly been downwards. In recent years, we have seen many schemes negotiate keener terms for their members. As Figure 8 shows, the most common AMC met by members in the default fund of trust-based schemes is.2%. In contract-based schemes, the most common AMC is.3%. The average AMCs are.37% and.33% in contract and trust-based schemes respectively. As recently as 21, the average contract-based scheme had charges.2% a year higher than the average trust, but the difference in charges is closing. Of course, whether charges represent good value depends not only on what members are paying but also on what they are paying for. More sophisticated investment strategies cost more to implement but it is as important to seek a better balance of risk and return in DC schemes where investment performance directly affects member outcomes (particularly compared to DB schemes where employers must make good any losses). Policymakers will understandably want to ensure that no more than necessary is deducted from members retirement savings but a charge cap could prove a blunt instrument if it stifled innovation. Figure 8 shows charges for employees currently paying contributions. Of the employers surveyed, 19% operate a different charging structure for deferred members (ex employees) that is likely to involve those members paying more. A further 3% enforce transfers out. The Government s plans for pension pots to follow members from job to job may effectively end active member discounts / deferred member penalties : when ex-employees pension pots are less likely to stick around, these charge structures will generate less revenue for providers and some may seek to renegotiate terms (higher prices) for contributing members as a consequence. Figure 8. Annual management charges for the default fund met by members Percentage of schemes Contract-based Trust-based Annual management charge (Percentage) FTSE 1 defined contribution pension scheme 213 survey results 13

14 Enrolment and contributions Where employees are put into pension schemes automatically we continue to find that take-up rates typically exceed 9%. This could have material cost implications for employers yet to auto-enrol. Our survey uncovers two schools of thought in contribution structures. On average, employers put a contribution of about 1% on the table. However, where matching designs are used employees must pay more themselves to get this in full. Rudi Smith, Senior Consultant In spite of the considerable level of detail and prescription within the 212 pension reforms, employers have been left with a lot of choices. Employers have to comply with the minimum requirements to enrol those workers who meet the Government s age and earnings criteria, but they have a choice: do they just do what is required, or go further and enrol more employees (as some do already). Figure 9 shows at the time of the survey 26% of employers still have decisions to make and/or implement, but half of all the employers surveyed already auto-enrol employees. Figure 9. Enrolment policy 24% Auto-enrolment as required by legislation 26% Auto-enrolment not yet in line with legislation 5% Opt-in/voluntarily enrol 5% are already auto-enrolling employees 14 towerswatson.com

15 Figure 1. Approximate proportion of new employees who join the plan Percentage of schemes 8 6 Opt-in Automatic enrolment Members (percentage) Where workers have to choose whether or not to join their plan there is a wide variation in the level of take-up. Figure 1 shows that only 23% of employers have a take-up rate of more than 9%. A key question here revolves around how the option to join the plan is communicated as this will have a direct effect on take-up. In our experience, some employers have made a concerted effort to promote the benefits of their scheme, whereas others have simply made access their plan available without any great fanfare. We have seen more than one employer find that encouragement from its union or employee representative group has led to much higher take-up than would otherwise have been the case. In addition, there is plenty of evidence in behavioural finance to indicate that many individuals make decisions based on what their peer group is doing. Clearly the demographics of the employer will also have an influence for example, take-up tends to be lower amongst part-time, lower paid and transient workers. The right hand side of Figure 1 looks at those who have been auto-enrolled and have not as yet chosen to opt-out of the pension scheme. Based on this, where automatic enrolment is in force, the vast majority of enrollees stay in the scheme until leaving employment. This matches data from our previous survey which indicated that auto-enrolment generates a 9% plus participation rate as a norm. Initial reports of high take-up rates for those employers auto-enrolling for the first time have therefore not come as a surprise. This partly underlines the power of inertia but some of the employees who are auto-enrolled may also be relieved that the first step towards saving for retirement has been taken for them. This is positive news for the Government, since its long-term pension strategy is built on the assumption that most of those who are auto-enrolled will not opt-out. DWP originally assumed that one-third would opt-out. Where auto-enrolment is already in place opt-out rates are significantly lower. However, it is another matter altogether whether the benefits ultimately provided through a combination of State and private pensions will be adequate. FTSE 1 defined contribution pension scheme 213 survey results 15

16 Trust versus contract and a new third way Over recent times we have seen a steady but inexorable shift amongst FTSE 1 employers from trust- to contract-based pension provision, as demonstrated in Figure 11. However, in 213 there has been a new trend; the emergence of the master trust. Interest in master trusts is increasing, with employers looking for a half-way house between the greater fiduciary burden of trust-based schemes and the perceived lower level of governance and responsibility offered by contract-based schemes such as group personal pensions. This has led to a host of new players coming into this market, ranging from insurance companies, financial services firms and independent alternatives to the government-sponsored master trust, NEST. Figure 11 shows that, for the first time in four years, the number of contract-based schemes for respondents has not grown. However, the number of stand-alone trust-based schemes has still reduced, with the gap being filled by master trusts. There have been a small number of large employers who have moved to master trusts. The DC plan design landscape will also have been altered by the number of employers who have chosen to use more than one type of pension vehicle to meet their auto-enrolment duties. It is not uncommon to see FTSE 1 employers segmenting their workforce and using a core scheme (often trust-based) for their longer serving, higher income employees and an alternative contract-based or master trust arrangement for lower earners and transient workers. By definition, FTSE 1 employers are usually large diverse organisations and so it is not surprising to see them adopt different approaches for different groups of employees. For those segments of the workforce where the highest turnover is expected, many employers will see an advantage in utilising pension vehicles like contract-based schemes and master trusts, where the governance responsibility and administration costs do not rest with the employer once the individual s employment has terminated. Looking to the future, it would not be surprising see both master trusts and contract-based schemes increasing their share of the DC market, as employers continue the process of outsourcing responsibility for wider aspects of managing their pension provision to others. However, we still expect a significant proportion of larger employers to retain their own stand-alone trust-based schemes to keep control over their retirement provision vehicle. Master trusts could become, from the employer s perspective, the light touch governance solution, but this is only likely to be the case if the DWP introduces more burdensome governance requirements on the employer for contract-based schemes. The Pensions Regulator has clearly upped its game on oversight of trust-based schemes, including master trusts, and its latest consultation on 31 key features it expects to see in good DC schemes hints at a greater degree of intervention in the governance of all workplace pension schemes. Figure 11. Pension arrangements new members are enrolled into Percentage of all schemes % Contract-based Master trust Trust-based 16 towerswatson.com

17 Two different schools of thought on DC design In this year s survey we have focused on the two most popular styles of contribution structures: flat contributions, both without and with matching (Figure 12). We refer to these structures as flat only and flat and matched. Employees who have access to an average flat and matched contribution structure are potentially able to benefit from a higher total level of contribution a total of 16.6% compared to 11% for flat only contribution structures. On the other hand, in the flat only design, an employee typically needs to pay less than 2% to access a contribution of around 9%. In a flat and matched design, 5% to 6% employee contribution might be required in order to maximise the employer s available contribution. The total average employer contributions on offer are not radically different (9.3% in flat only versus 1.2% in flat and matched), but the employee will typically have to do more of the work themselves in a flat and matched design. In the majority of flat and matched designs, the employer will match the employee s contributions on a 1:1 basis, up to a specified limit. Where employers do not simply contribute an extra pound for each pound the employee pays in, higher matches are more common than lower ones. A flat plus matched design provides a greater chance of a meaningful pension, provided that the employee accepts the need to contribute the maximum contribution. However, the typical flat design offers a greater basic employer contribution which might lead to higher ultimate pension for the un-engaged. As a means of funding a retirement, the flat and matched approach offers access to greater overall contributions, and hence, perhaps, a better chance of success. On the other hand, if the aim is to offer equal total reward, irrespective of employee attitudes to pension, the flat only design is arguably better suited. The typical flat design will continue to meet the auto-enrolment minima once they are fully phased in (from 216/17). However, the average flat and matched design will only do so if employees are enrolled at above current average core contribution levels. From our discussions so far with the largest employers, few have chosen to reduce the level of core contributions and matching that is available to employees who already participate in their main DC scheme. Where we have seen changes is in the contribution levels set for new entrants and those who have previously chosen not to join the employer s pension scheme. Even then, this has not been uniform; employers have chosen to segment their workforce between those who are likely to be longer term participants, and those where pension provision is not considered the priority, and contribution levels are often set at or around the current statutory minimum level. Figure 12. Contribution rates Percentage 2 15 Flat only Percentage 2 15 Flat and matched Employee core Employer core Employee match Employer match We have changed the criteria used in previous surveys in the contribution chart above, excluding age, service, grade, salary and other related contribution structures when calculating averages. With auto-enrolment bringing new employees to pension schemes, the average member is likely be younger, have shorter service and be lower paid than previously. Such designs have therefore been removed from this figure for that reason, and because age and service-related designs are increasingly outliers. To allow comparison with previous years, we have recalculated figures back to 21. FTSE 1 defined contribution pension scheme 213 survey results 17

18 Investment Default funds remain crucial because a majority of members invest in them. Default fund strategies have evolved differently for contract and trust-based schemes. Trust-based DC schemes feature more active management and contract-based schemes typically offer more fund choices, but contract-based members are less likely to choose to invest outside the default. How much choice is too much? Alistair Byrne, Senior Investment Consultant Default investment option The vast majority of schemes (93%) have a default investment option and nearly all these are lifecycle strategies. The pattern is similar between contract and trust-based schemes. The few schemes that do not yet have a default option will need to offer one if they are going to be used for auto-enrolment. Most schemes accept that a default option is required because evidence suggests that the majority of members do not want to make an active investment choice. The lifecycle approach is well established in the UK and provides a means of managing risk as members approach retirement. Target date funds, which provide a similar risk management approach, but wrapped within a single fund, have yet to become established here, despite strong growth in the US. These may get more traction as NEST, which uses a target date structure, becomes established. Members invested in the default investment option Figure 13 shows most schemes find that the majority of members invest in the default fund, typically 8% or more. The proportion of members investing in the default is higher in contract-based schemes than in trust-based schemes. 77% of contract-based schemes have more than 8% of members invested in the default fund, but the corresponding figure for trust-based schemes is 52%. This is one of a number of differences in the investment experience between trust and contract-based schemes. Contract-based schemes also tend to offer more fund options for members. Despite this availability of greater choice in contract-based schemes, the data suggests that fewer member investment choices are being made. Trustees may be better placed to get employee engagement by choosing a fund range focused on the needs of scheme members, as opposed to standard fund range offerings from contract providers. The high level of use of the default option makes careful design and good governance of the default option essential. It will be increasingly important for trustees and sponsors to review the performance and ongoing suitability of the default option. It seems obvious that the investment needs of, say, retail shop workers, investment bankers and engineers are very different. It therefore seems logical to design investment defaults specifically for scheme populations where appropriate. Default fund use is likely to remain high, with relatively few members inclined to select their own funds. Default fund use may increase as newly auto-enrolled members join the plan, and are less likely to be engaged or experienced in investment choice. Active versus passive Default funds are often passively managed, but a significant minority of defaults now use a mix of active and passive funds, as illustrated in Figure 14. Many trustees and sponsors have been focused on low cost and ease of governance in the default fund. This has led to relatively few schemes where the default is entirely actively managed. Active management is more common in the defaults of trust-based schemes than in contract-based schemes. This is unsurprising given the greater scope (and obligations) for trustees to govern actively managed funds. While low cost passive approaches are likely to continue to play a major role in defaults, the desire for greater diversification is providing more scope for active management. There is an increase in the use of actively managed multi-asset diversified growth funds, as some of the alternative asset classes do not lend themselves well to passive management. We also expect to see growing use of smart beta approaches which lie within the spectrum of active and passive. White-labelled funds and governance committees established in response to the Pensions Regulator s increased focus on DC schemes may yet enable greater use of active management in contract-based schemes. 18 towerswatson.com

19 Figure 13. How many members are invested in the default option? Percentage of schemes Contract-based Trust-based Members of contract-based schemes are less likely to make an active investment choice than their counterparts in trust-based schemes, despite the availability of more investment options Members (Percentage) Figure 14. Management of the default fund Percentage Contract-based Trust-based 62 Trust-based schemes are now three times more likely to use active management than contract-based schemes Active A mix of both Passive Default fund use will increase in schemes used for auto-enrolment. Trustees and scheme sponsors bear important responsibilities for making sure the default fund is suitable for a changing scheme membership. FTSE 1 defined contribution pension scheme 213 survey results 19

20 The growth phase of lifecycle strategies Figure 15. Management of the default fund Contract-based Portfolio at start of growth phase Trust-based Portfolio at start of growth phase 63% Portfolio at end of growth phase (before de-risking phase commences) 59% 68% Portfolio at end of growth phase (before de-risking phase commences) 62% Global equities (which includes UK) UK equities only Managed/balanced fund Diversified growth Other 14% 8% 5% 14% 8% 5% 3% 7% 16% 6% 5% 22% 6% 5% 1% 14% Figure 15 shows the growth phase of lifecycle strategies continues to be dominated by equity investment, but with a growing number of schemes making an allocation to a diversifi ed growth fund (DGF). The designs of lifecycle strategies for trustbased schemes are more diversified, with higher proportions of global rather than UK equities, and higher proportions of the portfolio invested in a DGF. This perhaps reflects a more proactive approach to reviewing defaults among trustees, since DGFs are a relatively recent phenomena. The average weight in a DGF is higher at the end of the growth phase than at the start, suggesting some schemes use a two-phase approach which starts in equities when the member is young and introduces DGF in mid-career. We expect two-phase lifecycle approaches to continue to grow as they can be an effective means to balance higher returns in the early years with risk management later. 2 towerswatson.com

21 Switching period for default fund lifecycle strategies The most common approach for the default fund lifecycle strategies is to start switching 1 years (Figure 16) from retirement, although some schemes have switching periods as long as 2 years. Longer periods of stockmarket volatility and increased uncertainty around when individuals will be able to choose to retire have led to a lengthening of lifecycle switch periods. While five years was once the typical period, 1 is now more common. Figure 16. Switching period of the default fund Contract 25% 8% 58% 9% % 5 years 6-9 years 1 years years 15 years + Trust 21% 6% 56% 2% 15% Switching periods greater than 1 years are less common in contract-based schemes than in trust-based schemes and more contract-based schemes retain five year switching periods. This again points towards contract-based schemes reviewing defaults less frequently that trusts. As recently as 25, fi ve year periods were in the majority, but the trend is towards longer switching periods. 15% of trust-based schemes have a switching period of 15 years or more, while no contract-based schemes that responded have a default fund with a switching period greater than 14 years. Some schemes have introduced two-phase lifecycle approaches, where an initial equity-based portfolio, begins to switch into a more diversifi ed growth portfolio say 2 years prior to retirement, before moving into bonds 1 years out. We expect to see this type of structure becoming more common. Figure 17. Number of lifecycle funds offered Percentage of schemes Contract-based or more Trust-based or more Number of funds Number of lifecycle funds offered More than half of schemes have a single lifecycle strategy, which typically will be the default. However, a growing number report having more than one lifecycle strategy. Notably, 1% of contract-based schemes report no lifecycle option, as illustrated in Figure 17. Some schemes have sought to cater for differing member needs by offering a number of lifecycle strategies that vary by the level of investment risk, or by the target at-retirement asset allocation that is expected to match how members take their benefi ts. Typically, one will be the default and the others are available for members to choose to match their particular needs. In a few schemes, different defaults have been put in place for different sections of the membership in an attempt to cater for variations in characteristics and needs. As more DB schemes close to future accrual, we would expect more schemes to consider whether different lifecycle profiles are required to cater for those who move to the DC plan with significant DB benefits against those whose pension savings are purely DC. FTSE 1 defined contribution pension scheme 213 survey results 21

22 More choice, less choosing? As more DB schemes close to future accrual, we would expect more schemes to consider whether different lifecycle profiles are required to cater for those who move to the DC plan with significant DB benefits against those whose pension savings are purely DC. Figure 18 shows there is a wide spread in terms of the number of funds schemes offer to their members. Only 3% of trust-based schemes offer more than 5 options against two-thirds of contract-based schemes. Almost three-quarters of trust-based schemes offer between five and fifteen funds. As noted above, while contract-based schemes offer more choice, the greater use of the default in contract-based schemes tells us that fewer investment choices are being made by members. Trustees are well-placed to define a focused fund range that meets the needs of their members. Partly as a result of the plan sponsor s desire for lower governance contract-based schemes are more likely to offer members the provider s full fund range, which in some cases has hundreds of funds. Core fund range About a third of contract-based schemes offer a core fund range. This perhaps reflects the common availability of a very extensive fund range in contract-based schemes. Which brings with it a baffling array of choice and inevitable member confusion. A restricted core fund range provides a way of offering the majority of members a manageable choice, while still allowing greater choice to more experienced investors. We expect focused fund ranges to continue to grow in favour, meeting the needs of the majority of members. Figure 18. Number of funds offered across the entire fund range Percentage of schemes Contract-based Trust-based 2 17 < < Number of schemes 22 towerswatson.com

23 Investment fund range reviews Almost two-thirds of schemes say they have reviewed the fund range within the last year. All of the trust-based schemes stated they had conducted a review in the last three years, but 16% of contract-based schemes had not done a review for more than three years. We see growing interest in diversified growth funds, and many schemes are also offering members emerging markets funds to tap into faster growing regions of the world. With auto-enrolment creating wider membership, more schemes will also see the need to offer identity funds such as ethical and Shariah-compliant. The Pensions Regulator s draft DC Code of Practice calls for regular review of a scheme s investment options, taking account of any changes in member needs and market conditions. We think an annual review is good practice. White-labelled funds The majority of trust-based schemes use a white-label approach for at least some of their funds. However, such an approach is much less common in contract-based schemes. White-labelling allows the trustee or sponsor to offer funds with a scheme specific name (for example, the XYZ plan global equity fund) and, critically, an ability to change the underlying manager of the fund without disturbing the unit holdings of members. This has benefits in terms of communication and also in future-proofing the funds by allowing manager changes without the need for member consent or creation of legacy funds. However, some trustees have been reluctant to take on the additional governance responsibility of white-labelling. We expect white-labelled funds to continue to grow in use given the advantages they can provide. While trust-based schemes have been the strongest adopters, white-labelled funds also have a role to play in contract-based schemes, and we expect to see more use there. 7% 16% 42% have no default investment options of contract-based schemes last reviewed their fund range more than three years ago of schemes use white-labelled funds We expect focused fund ranges to continue to be in favour, meeting the needs of the majority of members. FTSE 1 defined contribution pension scheme 213 survey results 23

24 Wider benefits A large majority of employers still see pensions as a distinct part of the reward package, not one that can be swapped for other benefits. Yet despite this focus on pension as a form of saving, helping employees make good retirement decisions is not yet universal. David Bird, Senior Consultant Figure 19. Wider benefits Ability to flex pension contributions into other benefits 86% 14% Corporate savings plans 6% 15% 79% Corporate Self Invested Personal Pensions (SIPP) 2% 26% 72% Yes Introduce in next year No Employee choice Offering employees greater choice over how they save for their retirement has been much talked about, particularly by pension providers who in the past few years have invested heavily in building platforms. However, the survey findings suggest that there is little appetite amongst employers for widening choice, as illustrated in Figure 19. It seems that the majority of employers do not want to offer employees the option to divert money from pensions to other uses. This may reflect the tax efficiency of pensions when compared with employers allocating savings to other arrangements (except perhaps sharesave plans) and more recently the compulsion (for employers) to meet the requirement to auto-enrol all employees into a qualifying pension scheme. Our survey does not suggest that employers are queuing up to take action. A lack of clarity around auto-enrolment opt-out inducements is perhaps not helping here. While many employers appreciate that not all employees value pension, some are nervous about permitting employees to cash out of pension for fear of being seen to induce opt-out. 24 towerswatson.com

25 Figure 2. At-retirement services Annuity broking service Countdown to retirement guides 4% 39% Retirement counselling sessions 2% 36% 69% 57% 62% 3% 28% Yes Introduce in next year No Guiding employees at retirement Over recent years there has been much attention on the need for members to be provided with access to a robust retirement process and support. So it is perhaps surprising that Figure 2 should reveal that over a quarter of respondents are not providing an annuity broking service and a majority neither have nor plan to introduce either retirement counselling sessions or countdown to retirement guides. With the critical importance of the decisions that members make at retirement and the improvement in the services available to fiduciaries from annuity broking services, it is perhaps even more surprising that there is so much scope for further improvement. What we may be seeing is a gap in the standard of provision of workplace savings arising from the trust/contract division in DC pension provision. We might hypothesise that trustees have taken on board the Pension Regulator s comments on the need for good retirement processes and that employers with contract-based provision need more persuasion to improve their standards. We understand that increasing numbers of enhanced or impaired life annuities are being purchased at retirement. Presumably this is serving to further increase the price of annuities for those in good health. We have seen no material increase in non-annuity options increasing for workplace pensions (such as using income drawdown). Clearly other options are not for everyone and there is every expectation that annuity rates will remain low for the foreseeable future. Nevertheless we might expect more people to be pursuing other ways to provide their retirement income. At this time of historic low-yields from gilts and bonds providing a relatively poor return for annuities we therefore might expect to see an increase in the range of advice made available for members. FTSE 1 defined contribution pension scheme 213 survey results 25

26 Auto-enrolment the human story Jack and Jill We have looked at the overall provision and design of DC pension arrangements, but how does this translate to the employees in these companies? What does this mean for individual members? We have illustrated the impact for employees through the journey of two employees Jack and Jill.* Will Aitken In 23 Jack and Jill are twins. In 23, both were aged 25 and started working together at XYZ plc, a FTSE 1 company. They both received a salary of 3,. If we take a snapshot glance at FTSE 1 pension provision in 23: The average total maximum contribution was around 12%. The majority of employees had to actively request to join the pension arrangement. A five year switching period was the typical approach of lifecycle options. The funds used in the accumulation phase for the majority of lifecycles were global equity funds. When they both started work, Jill decided to join the XYZ plc Pension Scheme, a DC pension arrangement offered by XYZ plc. She opted to utilise the maximum employer contributions available, and selected the default option which was invested 1% in global equities (until five years from retirement when it switched to bonds and cash). The company had decided to adopt an average FTSE 1 contribution structure in 23: Employee core: 2% Additional employee matching: 2% Employer core: 5% Additional employer matching: 3% Jill received a total contribution of 12% per year, of which 8% was paid by XYZ plc. Jack never got around to applying to join the pension scheme, consoling himself with the thought that retirement is a long way away. 23 Jill received a total contribution of 12% per year, of which 8% was paid by XYZ plc. Jack never got around to applying to join the pension scheme, consoling himself with the thought that retirement is a long way away. * Jack and Jill are fictitious. Any resemblance to real persons is purely coincidental. 26 towerswatson.com

27 Now we fast forward to 213 If we now take a snapshot glance at FTSE 1 pension provision in 213: The average total for flat rate contribution structures is 11.% while for flat rate with matching the total average contribution is 16.6%. Due to auto-enrolment, employees do not have to opt-in to join an occupational pension arrangement. A 1 year switching period is now the more typical approach for lifecycle options. There is a shift towards defaults with a global equity and diversified growth fund mix. As a result of auto-enrolment, XYZ plc decided to make a number of changes to the XYZ plc Pension Scheme. For existing members such as Jill, the company decided to change the contribution structure to adopt the average FTSE 1 flat rate with matching contribution structure in 213: Jill This meant that Jill s fund now receives total contributions of 16.6% per year, of which 1.2% is paid by XYZ plc. Investment returns over the ten years that Jill has been a member of the XYZ plc Pension Scheme mean her contributions are now worth around 38,4. Jack As Jack did not join the XYZ plc Pension Scheme back in 23, he is now auto-enrolled into a master trust used by XYZ plc, which has been specifically utilised to address auto-enrolment. The contribution structure for this pension arrangement is: Employee core: 4.5% Employer core: 4.5% This means that Jack s new fund receives total contributions of 9% per year. Employee core: 2.4% Additional employee matching: 4.% Employer core: 5.1% Additional employer matching: 5.1% Jack Jill Date joined a pension scheme 1 February February 23 Fund value as at ,4 Post 213 employer contributions 4.5% 1.2% Post 213 employee contributions 4.5% 6.4% 213 Jill has been a member of the pension scheme for 1 years and Jack is auto-enrolled into a master trust. FTSE 1 defined contribution pension scheme 213 survey results 27