A new default for a new era – Is it too soon to say?

With the pensions freedom just around the corner - Emma Jones of Royal London discusses how to prepare your business for the unpredictable.

Since April 2014 I‘ve read a myriad of reports about how people will react to the new pension freedoms coming this year.  But is people’s behaviour that easy to predict?

“Would you like a free doughnut?”

If I took a ‘Family Fortunes’ style poll and asked 100 people this question what do you think most of them would say?   I’d expect most people to say yes – after all what’s the worst that could happen if you accept a free doughnut?  And yet, standing in the queue of a well-known doughnut emporium the other day, I witnessed almost everybody in the queue ahead of me turning down an offer of a free doughnut, fresh from the fryer, to eat while they waited. Maybe they thought it was some kind of a scam? Or perhaps our pre-programmed British response is always to say “No thank you”.  In any case almost everyone said no.  Which just goes to show you really can’t predict what people will do.

And yet, ever since the Chancellor announced his plans for freedom and choice in pensions during last year’s budget statement, the industry has been busily trying to work out what people will do with their savings when they retire – a decision which, I’m sure you’ll agree is much more important than accepting a doughnut. 

And now that the long-awaited date of April 2015 is nearly upon us it seems that every time I open a paper I can read about a new report which says that retiring investors want the secure income they can get from an annuity. Or that they’re all going to blow their entire pot on a Lamborghini.  Or that everyone’s going to go into drawdown.  But the one thing I can guarantee here and now is that you just can’t predict how people will behave.

Managing in the meantime

All this uncertainty makes it very hard for advisers who are setting up new corporate pension schemes, or indeed reviewing existing schemes.  The DWP’s guidance on default funds says that you have to choose a default which is suitable for the membership of the scheme. And that the default investment option should de-risk as the investor approaches retirement. 

But if you don’t know what the scheme members will do when they retire how on earth can you know what investment outcome the default fund should target? 

  • Should you hedge annuity rates?
  • Or target a cash pot to fund all those Lamborghinis?
  • Or simply move from an accumulation portfolio to a drawdown portfolio?

Whichever option you go for it’s worth remembering that the default option will never suit everyone perfectly, so it’s important that it targets the needs of the majority of members, but takes the needs of the minority into account as well.  So, for example, if you go for a drawdown target, you might want to keep the volatility low to provide some protection for people who will take cash and include a reasonable proportion of fixed interest to help hedge annuity rates.

How we can help

Our Governed Range includes a range of off-the-shelf lifestyle strategies which target drawdown, pension and cash and cash outcomes.

Keeping your options open

A flexible solution is going to be helpful in this brave new world. You’ll need to review the appropriateness of whatever default investment you go for from time to time, so it’ll make your life easier if you can change the default easily as and when you need to.  And this includes moving all members invested in the default into your new strategy so that you don’t end up with a two tier scheme with a better default strategy for new joiners.

We’re going to wait and see

Now we’ve done our fair share of head scratching and research to decide what to do with our own default investment option and we’re going to sit tight for now with our Balanced Lifestyle Strategy (Pension and Cash) which targets annuity purchase.  And we already offer lifestyles that target cash or low risk multi asset portfolios, so advisers or individual members can choose a different investment option if our default isn’t right for them. 

We’re not complacent though.  We’re going to improve our annuity target fund and we’ll be launching some new lifestyle options which will target our Governed Retirement Income Portfolios for customers who know that they’re going to go into drawdown.  But we’ll leave any fundamental changes to our default lifestyle strategy for now.  After all, in a few months we’ll have some real experience to refer to and will have far more certainty that any changes we make to our default will be in response to genuine, proven customer needs rather than some educated guess work about our customers’ future actions.

And if and when we do change our default, we will automatically move everyone invested in the default into our new strategy – so rather than running around with switch forms, you can sit back with a cup of tea and a doughnut.

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