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OPDU
Report 26 October 2009
Bulletin Board
Defaulting on the default option
Malcolm McLean OBE In the course of dealing with dispute cases TPAS advisors and
staff are used to seeing a wide range of different complaints from
members of pension schemes.
One recent complaint which did surprise us a bit, however, came
from a man I shall call Jack Briggs (not his real name) who wanted
to complain about having been put in an “active lifestyle” fund.
Apparently he had joined a defined contribution (DC) pension scheme
and had not indicated a preference for any of the investment funds
on offer. In consequence he had been put in the default option which
had been set up as a lifestyling arrangement.
So, what was Jack complaining about? He said it was because in
his view he didn’t have a very active lifestyle and he objected,
therefore, to being put in a fund carrying that name. Jack said that
in a typical day he got up in a morning, had his breakfast, drove to
his office, sat at his desk, had his lunch, sat at his desk, drove
home, had his tea, watched television and went to bed.
“Does that sound to you like an active lifestyle?”, he asked.
“Of course not”, was the reply “but it doesn’t actually mean you
yourself have to follow an active lifestyle. It is more about the
type of investments that you are in at different stages of your life
and minimising risk as you approach retirement.”
“Well why didn’t you say that in the first place”, came back the
predictable response.
There are two points I could make from our experience with Jack
Briggs.
The first is, as I have observed on many occasions in the past,
that we really must stop using jargon when dealing with the general
public. Words and phrases like accrual, franking, protected rights
and so on will not have any meaning for the average person. Even
worse is the form of jargon which uses everyday language and sounds
like it should mean something but in fact means something else.
Lifestyling comes into that category as does a trivial pension
(which could be in value as much as £17,500, hardly trivial). Other
examples would include crystallisation (is that the art of
glassmaking?), an annuity (is that a payment that can only be made
annually?) and the Barber window (is that the outside of a
hairdresser’s shop?).
I have seen all these expressions used without explanation in
correspondence with scheme members and frankly you cannot be
surprised if people are bemused or like Jack get the wrong end of
the stick.
My second point relates to the use of the default option and the
hidden dangers in it. I am told that about 90% of DC members are
enrolled in default options and the majority of those will have some
form of life-styling. So there is nothing unusual or wrong in Jack
ending up in that type of arrangement. But my fear is that Jack and
others like him might not fully understand the mechanics of how it
is going to work – that he will probably start off 100% invested in
equities and then at some point perhaps 10 or 5 years away from
retirement his funds will be automatic-ally moved gradually into
less volatile investments such as bonds or cash. But what about if
somewhere down the line he changes his retirement plans – brings
them forward or puts them back? How would that work? What about if
at the very point where his money is being moved out of equities the
stock market has just dropped to an historic low? Would that really
be the right time to move but then if the process is an automatic
one would anyone take that into account and/or be asking Jack how he
feels about it?
The number of DC members now in lifestyle default strategies
highlights the importance of getting both the design and the
profiling right. Lifestyling is often the answer in dealing with
market turbulence but it can backfire.
I believe it behoves all schemes and their advisors to review the
arrangements to make sure they are working for the majority of their
members. Of particular importance will be the communication strategy
– what are members told and when, how are they consulted before a
switch is made, and what attempts are made to check the continuing
validity of the member’s retirement intentions?
I do not think that schemes can distance themselves completely
from the consequences of the process going wrong, particularly if
they have done nothing to satisfy themselves on how it is working.
Not to do so is effectively them defaulting on the default option
they have elected to use.
People like Jack depend on their chosen scheme to do their best
for him. That is not asking too much, surely, or be a task beyond
the collective wisdom of the trustees, consultants and investment
managers involved.
Jack’s non-active lifestyle may be a problem for him if only he
would realise it. His pension scheme ought not to be.
Malcolm McLean OBE
Chief Executive
Pensions Advisory Service
020 7630 2270
Malcolm.Mclean@pensionsadvisoryservice.org.uk
www.pensionsadvisoryservice.org.uk
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