Pensions share a similar concept to the marshmallow study. If a person puts money into a pension, compound interest allows it to grow over time, as do benefits like matching and tax incentives, so the sooner an individual starts their savings the more value they will get for their investment in the long run.
The UK is coming up to a savings crisis. For the first time, retirees will be worse off than the previous generation. Those born in the 1960s and 70s will be the first generation of retirees worse off than their parents, the Institute for Fiscal Studies has previously warned. Auto-enrolment was brought in to help lessen the blow, and so far the policy has been largely successful. But there is still a long way to go.
One down, many to go
To a financial adviser, compound interest is a beautiful thing. It is the ultimate example of delayed gratification – save some money now and essentially get some for free. But, unfortunately, many clients do not understand that and prefer to spend their money in the short term rather than save.
Longevity will compound this problem. As people live longer, they will need more saved to last them into their old age. Low inflation will also pose a great problem for pensions if it continues, as many schemes base their annual increases on inflation figures.
Auto-enrolment has been successful in one sense, but has yet to be in another. While it has helped to increase the number of people with a pension and the total amount of pension contributions, the median amount that people are paying in has declined.
The higher minimum contribution rates that are set to be phased in will help the situation, but by no means solve it. The 8 per cent level will be an improvement but will not result in sufficient retirement savings for all, and may lure many into thinking that they have more saved than they do.
Auto-enrolment came into effect in 2012, so changes to the market have been fast. Since last year’s survey, staging dates have kicked in for all employers with 39 to 59 employees, and select employers with particular reference codes and fewer than 30 employees.
But this year’s data has revealed that some providers are making auto-enrolment more difficult for smaller employers by increasing their minimum requirements for employees per scheme and total annual premiums per scheme. By increasing these requirements, providers may be signalling that they do not want to provide pension coverage to small, usually less established firms.
By the numbers
Basic details of plans in this survey, including the minimum number of employees required, total annual premiums per scheme, and contributions per member, from different providers are shown in Table 1. Some figures are left as a dash to specify that those providers price on a scheme-by-scheme basis, which most commonly occurs when determining the minimum contribution that would be required from each member. This means that employers will have to deal directly with the provider to figure out appropriate requirements for their individual situation.
Providers are having to accommodate clients with few employees as more small employers reach their staging dates. However, some providers have increased the minimum number of employees required for each scheme. In last year’s survey both of Aegon’s plans had no minimum number of employees, but now both require at least five. Friends Life has dramatically increased its requirements, from no minimum in last year’s survey to 50 in the My Money Workplace Retirement Account, and 250 for the My Money Flexible Retirement Account.
This is in contrast to our survey two years ago, the first covering auto-enrolment, when Aegon reduced the minimum number of employees per scheme from five to none. Scottish Widows said last year that, while its pension plan stated a minimum of 20 employees per plan, in certain circumstances it would accept some self-employed individuals.
Minimum total annual premiums have also increased in some cases. Aegon’s have gone up from £1,200 last year to £1,800 this year and Royal London’s plan (Scottish Life in previous year’s surveys) has increased from £1,000 to £1,500. In previous years Friends Life had no minimum requirements, but the My Money Workplace Retirement Account has increased to £60,000 and My Money Flexible Retirement Account has jumped to £300,000.
The bespoke nature of many of these plans should be noted, as scheme details could change depending on the employer. This is especially true as smaller companies reach their staging dates, as larger firms have a better capacity to take on large scale pension commitments than their smaller counterparts, and therefore will have different needs that will need to be met by their provider.
Tony Read, development manager at Aegon, says, “We look at various factors including the size of the employer, expected number of scheme members, the type of industry the employer is in, the average likely term of contributions to retirement, the possibility of the scheme receiving transfers in, the average expected monthly contribution, and whether any significant increase in membership can be expected over the short-to-medium term owing to auto-enrolment.”
The providers that have increased the minimum levels may be reluctant to deal with smaller employers. Those with few employees may not have systems that are as well established as those of their larger equivalents. Bigger companies may also be more eager to implement the auto-enrolment plan quickly and efficiently, and plan well ahead of their staging date. Smaller employers may be more informal and less organised ahead of time, and lack the knowledge of pension details to set up a scheme properly.
Standard Life was the only provider in the survey to decrease the requirements both for minimum employees per scheme – from five last year to none this – and minimum total annual premiums per scheme – from £120 last year to none this – but only for employers with fewer than 75 lives. Previous conditions still apply to companies with 76 or more employees. The company may have done so to appeal more to smaller employers as they reach their staging dates.
It also made a point to clarify that its annual management charge (AMC) is discounted by at least 0.35 per cent, and up to 0.6 per cent, to ensure that the total expense ratio (TER) is charge cap compliant. Higher discounts may be offered depending on the membership of a particular scheme.
Contract-based schemes are still the most commonly offered with nine this year, compared to four trust-based schemes. The two types of defined contribution scheme differ mainly in the level of control given to the provider over structure and in the way the schemes are managed. Larger companies often prefer trust-based schemes for the fact they they are operated in-house. Contract-based schemes take most of the work out of managing the scheme away from the company. This is often favourable to smaller companies who may not have the time, staff or know-how to have any involvement in the management of the pension scheme as a larger firm would.
The default funds for each scheme, the type of fund it is, associated charges, asset allocation, average returns and other funds that can be swapped in its place are shown in Table 2.
Lifestyle funds remain the most popular option. With these, the farther the individual is from retirement, the riskier the assets the fund invests in, such as equities. As the individual draws closer to retirement age, the funds adjust to safer assets, most often fixed income. This method aims to lock in investment growth over time, while still investing in assets that will provide a return.
Asset allocation in the listed funds have changed surprisingly little, and some not at all, despite changes in the world economy over the past year. Equities have been volatile, due largely to the stock crash in China. The search for yield also continues as returns for many bonds have been lacklustre, and some have even sunk into negative territory.
The asset allocation for some lifestyle funds is difficult to put into a single chart because of the way they change over time, steadily moving into less risky assets. In the case of Standard Life, the Active Plus III Universal Strategic Lifestyle Profile covers the Active Plus III pension fund, the Pre Retirement (Active Plus Universal) pension fund, and the At Retirement (Active Plus Universal) pension fund. The scheme begins fully invested in the Active Plus III pension fund, with a volatility rating of four, when the individual is more than 10 years away from retirement. At nine years to retirement the scheme begins to gradually invest more in the Pre-retirement pension fund, and at four years to go the At Retirement pension fund slowly comes into play until the scheme is fulling invested in it with three months until retirement. The proposition also includes the option to upgrade to Sipp with access to whole of market.
The number of people enrolled in each scheme and companies using each plan are detailed in Table 3. Once again, Nest has experienced a surge in the number of people and companies enrolled, up from 9,200 companies and 1.5m individuals last year to 26,000 companies and 2.3m individuals this year. B&CE remains the second largest auto-enrolment provider with 9,720 companies using the plan and over 1.5m individuals, up from 3,324 companies and 1,054,508 individuals last year.
It is not surprising that Nest remains the biggest player in the auto-enrolment market as it was set up by the government specifically for that purpose. The corporation has a public service obligation to accept any employer who need to meet their auto-enrolment duties, and has therefore been designed for scale.
The average number of employees per scheme and the number of employees in the largest participating company are not disclosed so it is not possible to see whether it is smaller or larger employers that are taking the most advantage of Nest. The scheme’s simplicity and low charges would make it appealing to smaller employers, though employers of any size may be partial towards the perceived security of its links to the government.
Don’t think twice
The point of auto-enrolment is to make old age a little easier by encouraging people to plan ahead and start saving as soon as possible. But, while auto-enrolment should be a positive for most people, there are some circumstances where investing in a pension scheme may not be feasible. Individuals have a one-month window following their enrolment into a workplace pension to leave the scheme
The average opt-out rate of the schemes involved in the survey is about 9 per cent. This is consistent with findings from the Department for Work and Pensions (DWP) which stated the average opt-out rate to be about 9 to 10 per cent, within a range of five to 15 per cent. On the back of these results the DWP halved its overall opt-out rate for the lifetime of auto-enrolment down to 15 per cent from its previous prediction of 30 per cent.
Kris Black, head of pricing at Aviva, says, “Opt-out rates are below our initial expectations. As employers are staged where pension provision is a new employee benefit, this may increase from the current level.
“While we anticipate some parts of the industry may struggle, it is expected that there will be advice and administration propositions that will pick up any extra volume. Early employer engagement is always recommended to ensure successful outcomes.”
As larger companies were the first to implement auto-enrolment these figures are not representative of what opt-out rates as a whole may look like. Staging began with larger companies and is gradually working its way down to smaller employers, the timeline for which is shown in Table 4.
Colin Williams, managing director of workplace benefits at Friends Life, says, “The next few years will be particularly important to the future success of auto-enrolment. We have already begun engaging with clients regarding re-enrolment, and will continue to support these schemes in preparing for their three-year milestone. In addition, employers will need to support the value of the scheme’s benefits – this will help encourage members to continue paying in when contributions increase in 2017 and 2018.
“We believe the industry is reasonably well prepared for the capacity demands. Rather than a volume issue, we see education as the most pressing concern for smaller businesses that will not have in-house pension managers or, indeed, access to financial advice. Making sure small businesses fully understand their duties will be vital to achieving widespread compliance with the rules.”
Too much of a good thing
Although opt-out rates have continued to pleasantly surprise, a capacity crisis could be imminent. Those companies who were the first to implement auto-enrolment are also due to reach their three-year anniversary, at which point those employees who initially opted out will be put back in. Those individuals will have the option to stick with the plan or leave once and for all.
As good as the intentions behind Nest as a government-linked default option were, it may eventually become too popular for its own good. Scott Glasgow, senior market analyst at Royal London, says, “There is a potential for a capacity crisis to hit Nest, who will often be the default provider for employers looking to establish a pension scheme. Commercial pension providers will continue to offer pension schemes on the basis of profitability but, unlike Nest, have no obligation to provide employers a scheme. Commercial providers should therefore be in a better position to manage their pipeline of business to ensure they do not have a capacity issue.”
Re-enrolment and continued staging may prove to be good news for advisers but bad news for smaller companies. The financial advice market is saturated as it is, but add in employers with a lack of pensions knowledge and individuals confused about why they are suddenly enrolled in a pension after they had opted out not so long ago, and a capacity crisis may not be such a stretch. There is a limited number of advisers who can offer advice which gives them the luxury of being able to choose their clients, but that means some will be left in the dark.
As more people are excluded from accessing financial advice, whether because they cannot afford it or because an adviser will not take them on as a client, providers should make their propositions easier to understand. Tony Stenning, managing director at BlackRock and chairman of The Savings and Investments Policy Project (TSIPP), a project run by the Tax Incentivised Savings Association (Tisa) aiming to promote a culture of savings in the UK, says, “It’s on the regulator and government to ensure we get consistency in language.”
Mr Stenning also encouraged providers and the government to use incentives to help encourage people to save for, like further tax incentives and contribution matching policies.
While more people are saving into a pension, the amount they are putting in is not enough and median contribution rates have sunk. Savers will eventually be required to put away 8 per cent of their qualifying earnings, as shown in Table 5, but this may still fall short of the savings gap as many believe this required amount should be closer to 10 to 12 per cent. Lower contribution levels could lull them into a false sense of security, as many believe that as long are they are saving a bit into a workplace pension, it will be enough to last them in their old age, especially when combined with the state pension. But countless studies have shown this not to be the case, and people continue to drastically underestimate how much they need to put away to live comfortably later on.
While still falling short, some savings is better than no savings at all. Providers should welcome business from smaller companies and make marketing material as simple as possible to understand for those who do not have access to financial advice. The market is on its way to meeting the 2018 government requirement for everyone to have a workplace pension, but there is still a long way to go.
