Need to know:
- Diversified default funds have protected most defined contribution (DC) pension scheme members and, for younger employees, market falls can be an opportunity to buy into investments at a lower price.
- The Covid-19 (Coronavirus) job retention scheme has limitations and members who opt out can destabilise other employee benefit arrangements.
- As credit spreads widen, there are opportunities in the buyout market.
Stock markets have fallen around 25% since January, a worrying scenario for pension scheme sponsors and their members. Fortunately, most defined contribution (DC) scheme members are in default funds that are diversified, investing not only in equities but in low-risk bonds and other less volatile assets.
In addition, many default funds use lifestyle strategies that reduce equity exposure for members approaching retirement, to minimise vulnerability to sudden drops in the market, and this will have provided a degree of protection for these members. Nonetheless, employees facing retirement will be worst hit as their funds will still have shrunk, at a time they cannot make up the money, and when annuity rates offer poor value.
Retirement choices
The 2015 pension freedoms offering people flexibility over when they start taking a retirement income are helpful. Steven Cameron, pensions director at Aegon, says: “They can choose to remain invested, drawing an income, rather than buying an annuity. While there is no guarantee around if and when fund values and annuity rates will bounce back, we’d encourage individuals about to retire to seek advice. Some might decide to defer locking into an annuity at this time, instead using ‘income drawdown’ to take an income from their pension. Importantly, they have the option to buy an annuity with their remaining pension pot at any future point in time.”
Some employees may ask to work longer, perhaps on a part-time basis, and under The Equality Act 2010, cannot be forced to retire.
For younger employees, the pandemic could, ultimately, have little impact on their retirement pots as stock markets have always recovered from such shocks. Refinitiv Data has crunched the data on market crashes since 1969, and the average time to make up lost ground was 648 days, while the longest recovery period was four years, after the 2007 financial crash. Indeed, for younger members, the slump represents an opportunity because their pension contributions can now buy investments at a discounted price.
Employee communication
Many schemes will be getting ready to issue annual member statements and will need to communicate the impact of market falls on pension savings. David Bird, head of proposition development for LifeSight at Willis Towers Watson, says: “Different members have differing levels of engagement in the investment process and so different messages are required. The biggest group by far is the defaulters who won’t make a decision, but may be concerned, so what we need to communicate to them is mainly reassurance.”
Communications should mention that the market falls should be seen in the context of a long bull run, as well as explaining that default funds are designed to be robust for just such events, says Bird.
Employers might also remind members that moving forwards, equity valuations are likely to be cheap, so they should keep up their contributions and even increase them. Jonathan Watts-Lay, director at Wealth at Work, says: “Investors panic and make knee-jerk reactions when the markets drop, such as withdrawing their funds from investments. The fact is, investors know that they are supposed to buy at the bottom and sell at the top, but in the midst of the ‘proverbial bottom’, they often look to protect what assets they have left and subsequently miss the rebound.”
That trustees and employers should consider how individual members might react to headline fund value falls was a central plank of The Pension Regulator’s (TPR) guidance issued in April. Trustees should also review the risks in their portfolios, for example over-exposure to certain sectors, and their governance structures in the event of trustee incapacity, and whether any changes to their provider arrangements are necessary. TPR has also relaxed its reporting requirements so the focus can be placed on essential activities to keep schemes running during the pandemic.
Impact on auto-enrolment contributions
For now, the Department for Work and Pensions (DWP) has confirmed that automatic-enrolment will not be suspended. For employees working normally, nothing has changed but there are special provisions for furloughed employees. As well as claiming assistance under the Coronavirus Job Retention Scheme, employers can claim the employer’s national insurance (NI) contributions and 3% of qualifying earnings for auto-enrolment employer pension contributions.
However, the job retention scheme has limitations where an employer provides pension contributions that exceed the automatic-enrolment minimum. Employers can choose to continue these and to provide top-up salary in addition to the 80% grant, but employer NI and automatic-enrolment contributions on any top-up salary will not be funded through this scheme, nor will any automatic-enrolment contributions above the minimum mandatory employer contribution.
Jeremy Milton, principal, financial wellbeing leader (DC and individual wealth) at Mercer, says: “For [employers] not accessing [the Coromavirus job retention scheme], or for those that do and have higher levels of contributions paid to their qualifying schemes, there will still be a continuing cash flow strain, even with support. Employers could look to reduce contributions below the rate set out in scheme rules or current terms, but in most cases would need to go through a minimum 60-day consultation process, before such changes could be implemented.”
Employees usually have a right to cease contributions and end their membership, and often have the option of reducing contributions or taking a contribution holiday. Employers can respond appropriately to member-initiated requests but should take care they are not perceived to be inducing a worker to reduce or opt-out.
Lynda Whitney, partner at Aon, says: “A simple change the government could make is to allow employers to publicise the opt-out option to furloughed employees. Currently, there is significant fear of this risking falling foul of being an ‘inducement’ to opt-out. The long term impact could be managed by an automatic opt-in if they cease to be on furlough.”
Impact on other employee benefits
Problems can also arise because other employee benefits are sometimes inextricably linked to pension scheme membership or pay definitions, although such integrated arrangements have become less common.
Alan Emberson, director, workplace solutions at Punter Southall Aspire, gives the example of how a large number of furloughed employees at a client firm asked to suspend pension contributions, impacting the life assurance and income protection schemes which are dependent upon active membership of the pension scheme itself.
“Not only does this create a short-term issue of a shortfall in cover for staff if they suspend pension contributions but when a member decides to restart pension contributions, underwriting may be required before they are re-accepted for cover, exclusions may be applied and, in the worst-case scenario, cover could be declined,” he explains.
“It could also result in an increase in premium for the employer. If employers are content for benefit coverage to reduce, reflecting employees’ revised earnings, most policies contain a clause requiring notification where significant changes to the membership and cover levels occur.”
Defined benefit pensions
Defined benefit (DB) pension schemes will also be trying to understand the impact Covid-19 will have on their funding positions and covenant-related considerations, and indirectly, on the sponsoring employer’s ability to pay future deficit contributions.
The Pensions Regulator had announced that employers can access a three-month pension contribution holiday over the Covid-19 disruption period. “I do expect some employers with DB schemes which are under strain to approach trustees with requests to defer deficit contributions or cease accrual,” says Whitney. “This short-term relief for the employer is reasonable for the trustees to consider where the pain is also being shared with all other stakeholders, for example, no dividends are being paid.”
Meanwhile, a number of pension schemes are looking at current opportunities in the buyout market. Stephen Purves, partner at Aon, Risk Settlement Group, says: "For those that are well-hedged and have low-risk investment strategies in place, there are definite opportunities to de-risk into bulk annuities as credit spreads widen and insurer premiums look comparatively more attractive, even against a backdrop of potentially heavier mortality rates.”
