AXA Wealth: Opt in, opt out – what's it all about? – Mike Webb
After years of planning, October 2012 saw the introduction of the pension industry's newest instrument of public policy: auto-enrolment. The idea - an example of what policy advisors call 'nudge theory' - involves the automatic induction of the UK workforce into their respective occupational pension schemes.
Employees will be invited to opt out once the ruling comes in, but the government hopes that a mixture of tax reliefs and employer contributions will be enough to keep people enrolled and saving for their retirement.
But not everyone is clear about what's happening. According to figures in the 'Scottish Widows Workplace Pension Report 2012', 52% of UK employees have no idea about the coming changes. And of those that do, plenty among the so-called squeezed middle will be put off by the thought of even less take-home pay.
"Companies have an obligation to let their staff know what's coming round the corner," says Mike Webb, head of sales at AXA Wealth. "So far, most of the communication has been aimed at the employers because of the changes required to HR, payroll and funding for pension schemes. But the next wave will definitely be at the members themselves."
Crisis, what crisis?
At its heart, auto-enrolment is designed to tackle the savings crisis, one of the UK's most pressing social and political concerns. As things stand, only half the country's current workforce is saving for a pension, according to the National Association of Pension Funds, therefore the remainder are relying on a state pension. That wouldn't be such a problem if people lived only a few years past their retirement.
"People are living far longer than they used to," says Webb.
In the 1970s, the average UK male lived to 66, a year past the standard age of departure. But that number has risen to 86, leaving two full decades of funding to either the individual or the state, something neither can afford to do.
"The government cannot afford to fund that retirement and neither can pension schemes in their current state," Webb adds. "What we're seeing is a shift in responsibility towards the employer and the employee."
Auto-enrolment will not fully resolve the problems associated with the UK's savings culture. Encouraging people to plan for retirement and start the habit of saving is important, but people will still have to scale back the expectations they have of life after work.
"I don't think it's enough to solve the crisis," Webb says. "But saving for the future needs to be raised in the individual's priority set, both for the short term and the long term."
With more than 25 years in the financial services sector, Webb understands the consequences that lie behind the savings gap.
"The pensions industry and government have tried for a long time to convince people to save, without success," he says. "At some point, you have to turn around and say, 'If you won't take responsibility, we will'. With auto-enrolment, the possibility of opting out still exists. Will the government turn around in a few years and make it compulsory? I think almost inevitably."
And that's why he sees auto-enrolment as a step towards full compulsion, already seen in Australia and New Zealand.
As arguably the biggest shake-up the pension industry has seen in the last decade, auto-enrolment presents a number of fiscal and operational challenges for UK businesses. For the time being, these challenges will only apply to large corporates, but full implementation across the board will be phased in over the next five years.
"Companies will have to have to find more money," says Webb. "They'll be required to pay a contribution on behalf of every member, which will rise as time goes on. On top of that, there are costs associated with updating payroll systems and processes. Employers need to find out if their existing systems are up to the task and whether they need upgrading or fully replacing.
"The fiscal and economic problems that exist mean that something will have to give; it could be pay rises, bonuses or something else. These questions are undoubtedly challenging, which is why the government has decided to implement a staging process - giving small businesses with less money and less understanding the chance to move forward positively."
A lot of the questions raised by auto-enrolment involve challenges to fundamental back-office functions like HR and payroll. While employers are starting to understand the issues, many are yet to look at the pension schemes themselves.
"It is also worth noting that while auto-enrolment has only just started to be implemented for the largest schemes in the UK, it is already clear that a further challenge for scheme sponsors and their advisers is that due to capacity issues, they may not be able to secure their first choice of pension solution provider for implementing a new scheme to meet their auto-enrolment requirements," says Webb.
Funds for all seasons
If auto-enrolment is to succeed in getting people to understand the value of their pensions and loosen the pressures on the state, then the construction of funds will be crucial. The financial crisis has shown the vulnerability of many existing pension schemes, with investment returns and equity values tumbling sharply.
What employers use for fund choices has changed significantly since the first defined contribution schemes were set up in the 1980s. While many of these schemes remain strong, many need reviewing and some require changing.
There's now an expectation within the government that providers, employers and trustees can offer funds that will meet the requirements of members. The Department for Work and Pensions (DWP) and The Pensions Regulator (tPR) recently released default fund-design guidelines that they hope will improve the delivery and quality of occupational pension schemes and member outcomes.
"Not everyone will have to build a new pension scheme," Webb says. "What's important is that they ask, 'Is my scheme fit for purpose, and if so, does it meet with the long-term aim of the DWP and tPR?' People who have different requirements, aspirations, time horizons and amounts of money to save need to be catered for. There's no one-size-fits-all utopian fund out there, so it's incumbent on scheme sponsors, trustees and providers to deliver the right solution.
"Also, it all depends on the circumstances of the employer, what they can afford, and whether or not they want to be committed and involved in pension planning. Do they want to meet the minimum guideline standards or use the pension scheme as a key employer differentiator, and ultimately a tool to retain their staff?
"As things stand, the commitment and involvement companies put into their pension schemes vary dramatically," explains Webb. "Some are paternalistic and believe they should be the guiding light. At the other end of the spectrum, the employer sets up the pension scheme and then leaves it down to the employee. Whatever route the employer decides to take, it's crucial that members fully understand what their scheme offers and the value to them, and this will only be achieved through the right levels of communication."
Corporates may have adjusted to the practical challenges they face with auto-enrolment, but many remain in the dark about the ultimate quality of their pension schemes. With policy deadlines looming and the savings crisis coming to the fore, building a fund that suits all parties will prove vital in the years to come.