Pension megatrends in the US and UK – Q&A
Pension megatrends in the US and UK – Q&A
Last week we arranged a private dinner engagement in Sandton and a luncheon in Cape Town with the heads of two of the largest retirement funds in the world. Fellow fiduciaries, Mark Fawcett, CIO of National Employment Savings Trust (NEST) and Sonja Kellen, Global Director of Pensions for Microsoft from the US, shared fascinating insights from either side of “the pond”. Amongst some of the highlights were innovation in member engagement and communication, and leveraging behavioural finance to ensure better outcomes for their members.
What are the most innovative things you’ve implemented in your roles?
Sonja Kellen: A good example is auto-enrolment in our pension plan. In the US, auto-enrolment has become very popular and endorsed by legislation, but it didn’t fit with our population well. The problem is that people were often enrolled at a too low savings rate (6%), which they would then take as an endorsement of the correct savings rate. In fact, the right savings rate should have been a lot higher (10% or more). Therefore, we partnered with our Plan recordkeeper and created ‘Easy Enrol’ to create a new plan from scratch, conducting a lot of research, testing and applying behavioural science in framing it up. We discovered that whatever you put first in your menu of options would most likely be picked. So we put the highest percentage contributions first. We also tested to see how high we could make the savings rates with auto-enrolment before people would start dropping off. After putting up 12, 10 and 8% up first, two-thirds-thirds of members chose a 12% savings rate, simply because we put it first.
With three simple clicks, members could select their savings rate, set up annual increases and choose target-date funds appropriate for their age, etc. So people enrolled faster and saved much more than before. The results have been amazing! It is interesting that people who are opting out are doing so to save at the higher rate not the lower rate. Gathering the data was a big part of our innovation; ‘big data’ is absolutely critical to us.
Mark Fawcett: For us, behavioural economics is a strong underpin for auto-enrolment. We made it emotionally harder for people to opt out, for example, by asking “Are you worried you can afford this? Why don’t you try for a while and then stop at any point?” Calculations indicate that we reduced the opt-out rate by as much as 25 to 30% as a result of two simple behavioural nudges: loss aversion and procrastination, working closely with a leading behavioural economist.
We also started talking to people in simple language. We never use the word ‘pension’: we prefer to call it retirement income. We introduced a phrase book so that we could try to talk in simple English and not jargon. Where necessary, we would explain terms such as annuitisation. This really transformed the conversation with our customers completely.
In the UK, the latest trend is lifetime ISA, a product, which allows you to save for both a deposit on a house and a pension. We recognise that this requires two different investment strategies: short term and long term. Our idea at NEST develops this further.. When you’re auto-enrolled and start saving, initially half your contributions go to a short-term savings vehicle (rainy day or emergency fund) and the other half goes to a pension saving vehicle. But if you have an emergency, you can raid your rainy day fund, draw down your emergency cash, and then when you start saving again, you can top up your rainy day fund again. But all along you keep contributing to your pension fund. So you manage short and long term savings needs through one product, with certain tax incentives.
Looking forward, where is the next big innovation?
Mark Fawcett: At NEST, the big question is how to give people a retirement income for life? Annuitization is not compulsory in the UK anymore, so we need retirement income products that work, don’t require a lot of engagement or complex decisions, and give you an income for the rest of your life. At NEST, we are working on a hybrid product with a low-touch drawdown combined with longevity protection and blending the two. Minimal contact is required from members’. In the previous model, you would have to go to a financial advisor and pay 500 pounds for the advice, possibly every year, which erodes the potential income.
Sonja Kellen: Admittedly, we have a different take on annuities in the US and are still getting there. We make saving easier for people, but we could be better at educating them on how to set up an annuity (they still have to go to a financial advisor). We need innovation from our service providers, we need to annuitize more simply or create annuity-like income streams for people.
A lot has been written about the lack of member engagement globally. Your thoughts?
Mark Fawcett: Pensions are typically perceived to be boring, so we don’t expect people to engage willingly on the subject. The main questions we ask are: Are you saving enough for retirement and do you know when you want to retire? In addition, what are the life events that get you to start thinking about retirement? We keep our engagement very basic to avoid complexity and are not actively engaging our members yet.
With regard to member communication, we focus on using plain and simple English to engage members better. We make our website look more interesting (like Amazon) not like a boring pensions website, and it is designed to be user-friendly. Risk is a horrible word for most people – they tend to catastrophize and think they’re going to lose all their money. So we’re careful about the terminology we use; we frame words in the positive when we talk about investing and risk. We make it real and tangible.
Sonja Kellen: Financial wellness is the big buzzword at the moment in the US, particularly in the DC space. These are some of the things we’ve done differently:
- We have started tying a financial action to an incentive (there are incentives attached to a health wellness check-up, such as biometric screening, flu shots, etc. get). Now we’ve added a financial check-up to the mix, so this together with health check-up will get you your incentives (only 50$). It is astounding to see that people will take action even with a small incentive! We got 50% engagement in the first year through this initiative. This financial check-up tool (which we deployed with Willis Towers Watson) tells members which age they will become financially independent based on current activities.
- We have incorporated behavioural science into email campaigns. Two years ago, we started personalising messages using individual data, framed up with loss aversion and saying “You’re leaving 324$ on the table, you should be maxing up”. We recommend taking one specific action members need to take, using data. We divided members into 13 different groups, based on behaviours and where they are on their savings journey. We then customised different messages per group. Inertia is a big challenge to overcome and it is especially challenging to get older members to start looking at their savings.
What are your thoughts on outsourced CIO or delegated investment services?
Mark Fawcett: To be honest, because our fund is so large it doesn’t make sense for us. It is more cost effective to do it in-house. Outsourced fiduciary management is effective but only in smaller funds. Investment consultants also need to be able to manage any potential conflict of interests.
Sonja Kellen: Litigation is huge in the US, so we do believe in the value of outsourcing the fiduciary duty. Having said that, we do not absolve ourselves of the legal risk altogether, but we do need help to make the ultimate fiduciary decisions. For many investment committee members, it is not their day job, so outsourcing could have advantages. But as we’re a big 15 billion dollar plan, it doesn’t really work for us.
What are the hot topics in the US and UK at the moment?
Sonja Kellen: The big thing for us is around fiduciary conflict of interest. We are trying to apply fiduciary standards that sponsors have always had to uphold, and ensure broad uptake so that everyone acts in the best interests of their clients.
Mark Fawcett: In the UK, the big question is: are pensions still relevant? Contextually, there has been a shift towards changing tax incentives, ISA lifetime savings (long and short-term savings), etc. There is a lot of uncertainty about whether pension savings is a good idea. I believe we just need to get people to start saving on a regular basis and promote the worthiness of saving.
Member administrators / record-keepers needs to be on top of their game to achieve their funds’ goals. How do you manage this relationship?
Mark Fawcett: We outsource to TCS, who are used to dealing with large numbers of members (as one of the largest pension schemes in the UK, we have 3½ million members and rising). But this is the hardest part, keeping records accurately, and not to be underestimated!
Sonja Kellen: We see our record-keepers as a very important extension to our team and are the first point of contact when something goes wrong. Our web interface is the preferred means however, so we try to get that right first time. It is a huge investment in their technology to get it right, and a major component of our overall benefit to our employees. This is very challenging. Technology must allow seamless integration. Tools must also feel personalised; data fields must be hidden but streamlined across a dozen vendors and member participants. It is critical to have the right partners involved here. Lost email addresses, unclaimed benefits, etc. are all an issue.
Sustainable investing: how important is that in your investment philosophy?
Mark Fawcett: Sustainability is critical for us. A critical part of manager selection is their approach to ESG integration. We make sure it is part of our evaluation criteria, even with passive strategies. We have an ESG customised index too (in EM equities). We care about ESG risks because they are good for our investments, not because it is a good thing to do. How you treat workers, shareholders and the environment leads to better returns, and is a virtuous cycle.
Sonja Kellen: We don’t have ESG investments delineated to this extent. But when people are interested, we direct them to the relevant broker. We still evaluate the managers we do business with and hold them to a certain standard.
What is the elephant in the room for fiduciaries?
Sonja Kellen: In the US, the lack of savings is the big thing for us; we’re in a savings crisis, particularly since the shift from DB to DC plans. Overall country-wide savings are at record lows, around 4% when we should be in the 5 – 9% range.
What should your investment consultants stop, start and continue?
Sonja Kellen: We get many presentations with generic data, which is difficult to translate into something tangible and relevant. We would advise finding a way to make the those presentations more relevant to the unique company that you’re talking to, by drilling down to the next level and including relevant data.
Mark Fawcett: We don’t use investment consultants because we find it hard to get them to get inside our heads and understand what we want. Our philosophy is to research what our members need and then design products to meet those needs (this runs contrary to the typical financial services model). My advice is think about what meets a specific need for our members rather than just sell products. Try not to shoehorn our requirements into your RFP. Don’t sell me product. Try to understand my specific problems and then try to help me solve them.
Q&A from the audience:
What are your thoughts on robo-advice?
Sonja Kellen: Our version of robo-advice is really an online advice portal based on our specific customised fund line-up. We primarily focus on retirement money and external assets. It is fully integrated into our retirement platform, which makes it unique. Inertia is big, so we help by allowing members to click back and forth seamlessly between advice and the platform.
Mark Fawcett: Robo-advice is emerging in the UK too. We believe it has to be integrated into the retirement plan. Advice has tended to be regulated, so members are given the safe option, along with a heavy implementation fee. We have a long way to go here.
Do you measure the value you add and outcomes?
Mark Fawcett: Yes, we review how we can do it better. Most of value-add lies in asset allocation, so we do that in-house. We monitor the quality of our decisions and feed back to trustees, but it is too early to measure outcomes accurately as NEST is still too young.
Sonja Kellen: Everything we do is measured and we analyse the outcomes derived. We are paid for outcomes not activities. In everything we do, we look at how we impact outcomes. We make sure we understand what we need to do, and if it doesn’t make a difference, we find a new way to do it.
Can you give an indication of asset management and administration fees?
Mark Fawcett: We charge 30 bps for annual charges (total expense ratio plus admin charge). This includes our allocation to active and passive, property, some illiquid, credit and equities.
Sonja Kellen: Our average total expense ratio is a mere 22 bps for members. Ten years ago, it was 745 bps, so we’ve come down significantly, in part thanks to the shifting legal environment which has insisted on transparency in fees. Our asset base has been growing so we can leverage that scale and negotiate down. We have a mix of both active and passive: Passive investment fees range from: 1 – 9 bps, for alternatives it is up to 100 bps, but alternatives represents less than 1% of all assets.
Is that representative of the landscape in your respective countries?
Mark Fawcett: In the UK there is a cap on default funds, at 75 bps. The majority of big plans are 25 – 50 bps.
Sonja Kellen: We give excellent value in the US and have driven costs down significantly for our participants. The average large plan is in the 60 – 70 bps range.
Is AUM is a relevant model for fee calculations?
Sonja Kellen: We question this all the time. When it comes to advice, it should be a flat fee. It is the same amount of work, so it should be a flat fee.
Mark Fawcett: When we started small, it was advantageous to have an AUM fee. But now that we’re bigger, can start to see the relevance of fixed fees. As you get bigger, you can change the model, and align the incentives emotionally and financially.
What is the mix between active and passive?
Mark Fawcett: In our default fund, we have 50% in global equities (passive), 3% in emerging markets (passive and smart beta), 20% in property (active) and credit, which is all active. Broadly speaking, latest calculations show our split as 60% passive, 40% active. We do actively asset allocate, and are more strategic than tactical. We also looking at using a low-carbon index tracking equity fund. A lot can be done in the index tracking space if you design your indices well.
Sonja Kellen: Our split is also 60% passive, 40% active. Our default fund is 100% passive, mostly chosen by members.