The UK has moved to try to get its retirement savings crisis under control by introducing auto-enrolment. But what lessons can the nation learn from the approach other countries have taken?
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- Too much investment choice can confuse employees.
- A mandatory defined contribution (DC) environment with centralised administration can help keep pension charges low.
- A move to collective DC plans from defined benefit (DB) schemes in the UK would not be a gradual change.
Ian Neale, director of legislative specialist Aries, says the big message from Australia is that employees do not miss what they have never had. The country’s superannuation system is based around a compulsory employer contribution of 9.25% from employees’ salaries, which will rise to 12% by 2019-20.
“A further attraction for employees is that, on retirement, the benefits are, within limits, entirely tax-free,” says Neale.
Martin Palmer, head of proposition, corporate benefits at Friends Life, says another notable lesson from Australia is that employees start to engage with their pension more once their pot becomes a significant amount.
But he warns of the dangers of employees accumulating lots of small pots with different employers. “In Australia, the effect of compulsory pension savings and high job churn has led to millions of lost accounts,” he says.
Keep charges down
Good outcomes in the defined contribution (DC) world hinge on charges as well as contribution rates. Anne Bennett, consultant in the retirement resource group at Mercer, says: “High charges over a member’s lifetime can make a very significant difference to the funds available at retirement.”
Bennett points to Denmark and Sweden as examples of countries where costs have been held down by a combination of regulation and economies of scale. “Part of the Swedish system is based on mandatory personal DC accounts, to which all employees contribute 2.5% of salary,” she says. “Centralised and automated administration keeps costs low, as does the ability of the central agency to negotiate with investment managers directly on fees.”
Too much choice
The system in South Africa, where many employer DC funds date back to the 1990s, offers a glimpse into the challenges the UK will face. Petri Greeff, director at RisCura, says employees can be bamboozled by having too much choice. “A ’safe’ investment decision could doom people to a cold-baked future when retiring,” he adds.
In the longer term, Greef believes UK schemes will have to offer risk-profiled investment options that take members’ ages into account. “A simple but important lesson from South Africa is that too much choice is not a good thing, and don’t over-engineer investment options,” he says.
Reform annuity system
Like the UK, Chile has a mandatory DC environment and also shares the problem of poor annuity conversion rates because of high charges. Philip Smith, head of DC and wealth at Buck Consultants, says the solution there was to cap commissions payable to brokers and introduce an electronic consultation-and-offer system to help employees approaching retirement to search for thebest annuity and income drawdown options.
“It has resulted in a pretty good annuity market,” says Smith. “If you look at the value a pensioner gets from an annuity in Chile and compare it with the UK, Chilean pensioners get greater value.”
Other initiatives have also helped, including a more efficient market for insurance companies holding index-linked debt and a requirement for married employees to purchase joint annuities.
Collective DC plans
Finally, a different model altogether. The use of collective defined contribution (CDC) plans, in which contributions are based on a fixed formula, is well established in the Netherlands, and received UK government support from pensions minister Steve Webb in January 2013.
Wichert Hoekert, consultant at Towers Watson, says: “This is often phrased as defined contribution from the sponsor’s perspective, but defined benefit from the member’s.”
Such a set-up could be introduced in the UK, but it would not be straightforward, says Hoekert. “It has to be understood that, in the Netherlands, benefits were to some extent already flexible because indexation has typically been conditional and benefit reductions have been possible as a last resort,” he says.
“Any transition from DB to CDC in the Netherlands would be a more gradual change than would be the case in the UK.”