How far do you go?

It is widely acknowledged that the level of contributions from both employers and employees to defined contribution schemes is too often far short of what it needs to be.

Employers have a dilemma not only as to what they themselves should contribute but how they encourage employees to do so also. There is a level of contradiction in the market that could well have employers who are eager to do the right thing scratching their heads. The two key areas concern what constitutes an acceptable level and what employers are allowed to do about it.

According to the National Association of Pension Funds in its latest annual pensions Survey, employers operating DC schemes are, on average, contributing 7pc of pensionable pay, this being more than double the minimum 3pc the new personal accounts system due in 2012 will require. This perhaps says more about the minimum contribution required under personal accounts than it does about encouraging levels in DC schemes today. But the NAPF does point out that 9pc of employers contributed 10pc or more.

Standard Life brand development manager (corporate benefits) Ian Buchan recommends a satisfactory DC contribution as a percentage of the employee's salary that is half their age.

He says: "If employees are aged 30 they should have a 15pc contribution; if they are 40 they should be looking at 20pc. This can be a mix of employee and employer contributions. But there is a gap: generally employees are not contributing anything like that level."

Barely adequate
When it comes to whether employers are making sufficient contributions to defined contribution schemes, the short answer is some are and some aren't.

Punter Southall principal Steve Charlton says: "There are many employers out there making perfectly adequate contributions and encouraging their employees to do so as well. They are also putting a lot of effort into making sure members are aware of the level of potential benefits and if there is a shortfall that they need to do something about it.

"Then there are other employers who are funding at far below adequate levels. This may be because they haven't got the cash to do it, or because frankly pensions are not important in their industry. But overall you have to say the level of employer contributions is probably below that requried to rovide an adequate level of funding for everyone."�

Then there is the level of contributions that employees are making. Charlton says there is also an irony in it actually being a problem when employers are generous with their contributions.

He says: "Bizarrely the most dangerous attitude is where employers are making adequate contributions and employees think they don't have to. It is an extension of 'the state will look after me'� to 'the employer will look after me'. Even some of those employers with good schemes could find themselves with employees experiencing problems in retirement."

When generous company contributions lead to staff reducing theirs, one has to wonder just how much hand-holding the employer has to do. But when it comes to encouraging employees to join company DC schemes and contribute adequately, should it be the employers' job to do that?

Hymans Robertson senior investment consultant Mark Jaffray says most employers that he comes across tend to be very responsible in their outlook to their employees.

But he says: "I do not see it wholly as the employer's responsibility to ensure their employees are contributing adequately to their pension provision. But this is a key benefit employers offer their employees, often worth 5-20pc of their total remuneration package. Employers have some responsibility to ensure employees are aware of it. And most employees will look to their employers to guide them in the pensions area."

Whose retirement is it anyway?
Employees however, says Jaffray, must take a significant amount of personal responsibility for how much they are contributing and whether this will be adequate. Employees will have different needs from their pensions in retirement based on their family circumstances, their wealth outside their pensions and how long they expect to be retired.

"While an employer can offer access to a pensions vehicle, as well as access to information and offer to contribute to it, it is not the employer's responsibility to ensure that employees have adequate resources to finance their retirement," concludes Jaffray.

Then there is the issue surrounding the fine line between providing employees with information on the pension scheme available to them and advising them.

In January the NAPF reported that 87pc of DC experts believed employees look to their employer to help them understand how much to save and in which funds to invest. The problem for employers is while they need to communicate all the information that employees need regarding their pensions, employers must also ensure they are not straying into the area of regulated advice.

As NAPF chief executive Joanne Segars said at the time: "Employees do not just want standard information, they want in-depth information, much of which could be bordering on regulated advice. The skills of the employer have to be widened to judge the difference. It can be a fine line, but for the employer it is a crucial legal and regulatory line."

Jaffray acknowledges the provision of advice to members is still a difficult area. Most people would benefit from seeking independent financial advice more generally, he says and particularly in relation to their pension provision, but only a small proportion of the general population accesses financial advice regularly.

He adds: "Some companies provide access to financial advice as part of their flexible benefits package. Others offer employees access to advice via their pension provider. Others, with the help of their advisers, are using strategies to promote education and awareness to help their employees with the decisions they need to make concerning their pension plan."

Towry Law practice manager, employee benefits division, John Sansone says it is very dangerous for employers to overstep the mark when advising employees.

He says: "We are finding employers are happy to make sure there is a good communication programme in place. Once they have given people information and made them aware of what their options are, that is where their duty ends. Then it is up to the employees to take up the information they have and if they need advice on investment choices they source it themselves."�

Some employers with deeper pockets may pay for advisers to come in and advise staff on their options. Product providers with good IT investment profiling tools can also steer staff through the impact of contributions and investment choices, on a one-to-one basis. Then all the employer has to provide perhaps is the time in the day for employees to do this.

Of course the employer does need to have a measure of commitment to their scheme and the extent to which they want to provide for staff. Sansone says the process starts with the employer's aspirations and commitment and then moves on to the design of the plan.

He says: "If employers start with a matching contribution scale, that can have quite an effect on how much employees pay. If you have a contribution structure whereby everyone gets an arbitrary 5pc contribution, and then for every 1pc extra the employee puts in the employer will match with 1pc up to say another 5pc, what that says to the employee is that the employer is as serious about retirement funding as they are."�

Thereafter, it is important for both employers and employees to continue the engagement process, reviewing regularly what they are contributing, how that relates to their salary and any salary increases and how their pension fund is performing.

Market impact
At the start of the year there was much focus on the impact of stock market volatility on pension funds. Mercer pointed out that as markets closed on January 22, the effect of market movements on the UK's largest company pension schemes left them showing an aggregate deficit of £13bn, compared to a deficit of £25bn on January 21.

The actuaries pointed out that: "As company pension funds invest for the long term, the current market volatility should be of limited concern to well-managed pension funds that accept measured amounts of exposure to equity volatility as part of a robust financial strategy."�

But Mercer investment consultant Simon Pearse says: "The impact on defined contribution schemes members could be more significant. Without a benefit guarantee from their employer, they bear the risks of any downturn in investment performance, and so a market fall is more evident in terms of reduced fund levels. However, members should already be taking a long-term view of their investments and not be tempted to make any quick decisions to move away from their plan strategy, without sufficient justification. Any decision on a change in asset allocation should be made for the long term, taking advice as necessary."

What is important he added was that individuals regularly review their investment options and decisions and their long-term strategy.

Jaffray admits it is very difficult to assess whether employees are making the right contribution and investment decisions.
He says: "œAll employees' needs are different, the level of wealth they have outside their pension scheme will differ, so a contribution rate for one member may be inadequate for another member. We have undertaken a number of exercises with our clients with the objective of increasing employee awareness of their pension plan, to achieve better engagement with employees, for example, re-launching the pension literature, changing the investment options, employee seminars and appointment of new pension providers."�

For one of Jaffray's clients the objective was to ensure members understood the investment options within the pension scheme and to encourage members to make active decisions.

He explains: "While a high level of switch activity does not necessarily mean appropriate investment decisions are being made, it does at least indicate a level of engagement with those decisions."�

Leading a horse to water...
No employer can press-gang employees to join or stay in a scheme or make them contribute to it. But they can address the issues that may make employees reluctant to contribute. Too many bad press stories about the security of occupational pensions and the restrictions around accessing pension funds may impact on employee's enthusiasm.

As Sansone says: "With an occupational trust-based scheme it comes down to the strength and solvency of the employer and the promise to protect that trust arrangement. There is not a great deal of protection in law for trust-based DC plans. If you are a member of a group personal pension or stakeholder plan in the workplace governed by the FSA, the Financial Services Compensation Scheme protects 95pc of their assets in case an insurer goes bust."�

Sansone says a measured approach is needed towards communicating all this, but with the message around security of the pension assets themselves there is an argument for diversification through non-pension assets.

He says: "We tell employees to use a pensions plan as much as they reasonably can because it is a tax-efficient way of making long-term provision. However they may need a more balanced and diversified approach to wealth accumulation. There are other savings vehicles out there, so why not have a more combined strategy that looks more holistically at long-term provision rather than pigeonhole yourself to a pension plan?"�

Buchan says employers themselves can be more creative in what options they give staff saving for retirement.

He says: "Increasing retirement savings does not mean increasing contributions to a pension scheme. You can increase retirement savings in many ways and depending on age and stage of life individuals may want to save outside of pension restrictions. What we will see more of in the future is employers who want to be seen as employers of choice offering a much wider range of savings vehicles that can be more suitable to their employees at every stage in their lifestyle."�

Buchan gives the example of student debt. "A 22-year-old employee straight from university with £15,000 worth of debt probably can't afford 3pc to join the scheme and therefore would miss out on 6pc of employer contributions. Instead the employer could agree to use that 6pc to help to pay that student debt, for five years, provided they see the employee committed to paying it off as well. That could be more beneficial for retirement savings than putting it in a pension fund."�

The problem for the industry, in Buchan's view, is that the UK appetite for fully understanding the finer details of investment is just not there, evident in the numbers of employees drifting into default funds without actively choosing that route.

He says: "A huge focus should be placed on the default fund. Contributions are one thing but investment returns can have a very significant impact on the resulting pension. There is a significant demand for a more sophisticated default fund to take as much advantage of growth as possible while underpinning that with as many safety nets as possible.

There is a movement to apply the liability-driven investment approach taken by some defined benefit schemes to DC to marry perhaps 80pc of the growth with only 20pc of the risk."

Employers, pension providers and financial advisers have a win-win situation in front of them if they can creatively address employee's apathy or ignorance of the importance of making adequate contributions to their schemes. But it will take commitment all round.