By Nico Aspinall
It is most important for trustees to be able to state their objective for managing pension schemes. For trustees of DB schemes the objective (or mission statement) is probably something along the lines of “To pay all the benefits of the scheme without risking excessive reliance on the sponsor”. This is relatively simple to say, and the difficulty for trustees lies in delivering this objective. But trustees of DC schemes face a greater challenge in being able to say what it is they want to achieve, before they even start trying to deliver it.
Should their objective be good returns? A replacement ratio? Understanding or engagement? None of these are “wrong” in that they should all be a part of the objective, but at the same time they don’t quite hit the mark alone.
In our paper “DC Mission: Vision and Action” we propose that trustees of DC pension schemes should be adopting objectives based around delivering the income expectations agreed with members. The objective would need some further elaboration with the Trustees themselves, but importantly, it would align to the intent behind the Code of Practice for Trustees of DC schemes which comes into force in November 2013. The key points for investment managers is that the number of DC clients who think in terms of generating and protecting income in retirement is growing, and as the assets in DC grow and DC members approach retirement, there will be an increasing demand for innovation.
This is very complex as the challenge is individualised and impossible deliver fully without engagement from members. But those are really trustee concerns. Without the right product suite, however, they can only go so far to meet their objectives and the Code of Practice. To support trustee clients better, we would like to see development in two product areas where funds could be more focussed on potential retirement benefits (eg annuity types at particular dates) and offer choices around the level of risk protection or growth of that reference benefit.
The first is annuity matching. Products aimed at individuals close to retirement have grown in sophistication recently, but there is still a space for products aimed at members with a longer term horizon. While there is little point loading actuarial assumptions into portfolio construction (a member will always retain the ability to do something you didn’t expect), we do think products which support an earlier move from capital growth to retirement income would provide missing options and ones which trustees would like to offer. To be “high risk” you can simply invest in the existing pre-retirement products later, but a “low risk” member has to invest in products which have too short a duration and weren’t designed for the purpose.
The second area we would like to see development in is income drawdown. There have been few new products to meet this market despite the increase in the opportunities coming with the coalition’s liberalisation of retirement products. Auto-enrolment has undoubtedly been a distraction for DC schemes and has pulled the resources of trustees away from product design. But now that the big schemes have been through that challenge, be in no doubt that understanding member needs and designing and delivering a better match to members to and through retirement is firmly in their sights. Retaining some income risk post-retirement is something the UK DC market has done very badly up to now. There is a big opportunity for managers to shape innovation in this market and to keep assets invested in funds rather than purchasing annuities.
Trustees are being increasingly asked to manage and communicate the risks and returns around DC income but they have few investment options which give them the choices they need. As DC continues to gather pace, income-focussed products must be the next area of innovation and opportunity.
By Nico Aspinall, head of UK DC investmentconsulting, Towers Watson
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