Need to know:
- Default investment funds are now the norm, and should be regularly reviewed to help ensure they remain fit for purpose and comply with regulation.
- Any review should factor in the profile of the workforce, attitude to risk and likely retirement plans.
- Communicating the findings of a review can help to drive engagement among members.
In years gone by, default funds would be a temporary home for investments before employees who actively engaged with their workplace pensions devised a wider strategy for themselves. But the introduction of pensions auto-enrolment has changed all that. Tim Middleton, a technical consultant at the Pensions Management Institute, says: “Today, a default fund is designed to be a suitable choice for most members on the understanding that few will make a fund-switching choice.”
1. A default fund should be reviewed regularly
Sue Pemberton, head of [defined contribution] DC retail, DC wealth at Xerox HR Services, estimates that around 90% of staff are now invested in default options, raising the need for regular reviews to ensure these remain fit for purpose. “It makes good business sense for those employers that want to attract and retain the best people to ensure that those investing in the default fund receive value for money,” she says.
Indeed, such members often believe the default fund has been selected as one that is appropriate to their needs and feel they lack the knowledge required to deviate, says Karen Bolan, head of engagement at AHC. “This member thinking places a great deal of responsibility on trustees and employers to make sure that they have got the right default funds in place to ensure members get good outcomes from their pension arrangements,” she says.
2. Be aware of the regulatory requirements
Trust-based pension schemes are required to undertake a three-yearly review, says James Monk, head of DC investment at Aon. An annual review is prudent given the requirement of The Pensions Regulator for the chair of trustees to sign a statutory statement confirming that the governance of the scheme conforms to prescribed standards, says Middleton. “One of the topics covered by the statement is the default fund and the extent to which it has been reviewed over the past 12 months,” says Middleton.
Any review would typically be undertaken by a consultant brought in by trustees or the employer, he adds.
3. Assess the membership profile
A key step is to review the needs of both the employer and their membership profile, says Anish Rav, senior DC consultant at Capita Employee Benefits. “[Employers] need to really understand membership needs and risk profiles,” he says. “Only after this analysis is done can the objective of the default fund be set, as well as the benchmarks, to assess whether the objectives are being met.”
Ensuring a default fund strikes the right balance between when members can afford to take risk, mainly in the early stages of their career, and when they cannot is vital. “One of the main issues that we look to manage is return shortfall risk, which is the risk of members not generating sufficient return, and capital market risk resulting in unexpected falls in value,” says Monk.
It is also important to assess the costs of switching to any other fund, and whether this could be expected to make financial sense for members in the long run, Monk adds.
4. Consider employees' retirement plans
An additional element is whether the default fund investment strategy fits with members’ likely attitude to how and when they retire or reduce the hours they work, says Middleton. “Decumulation can now take three forms and may well occur more than once,” he says. “Is the derisking phase sufficiently flexible to cope with all of these contingencies?”
5. Communicate the review findings to employees
It is important that the findings of any review, particularly any changes, are communicated effectively to employees. “This is to help build engagement and educate them in the need to save so that they can afford to retire, as well as obtaining some appreciation of the benefits being offered,” says Pemberton.
