By Dale Critchley, Workplace Policy Manager, Aviva
While ‘de-risking’ a pension scheme might seem appealing, the relationship between risk and return when it comes to investments means that the consequence of taking less risk is either a lower income in retirement, or a lower income while working, given the need to pay higher contributions to achieve the same outcome. The key is therefore to strike an appropriate balance.
Another approach to de-risking, is the trend in many workplace DC pension defaults in recent years to increase in the amount of investment risk that savers are exposed to when they are younger and have a greater capacity for risk. As members approach retirement, reducing exposure to investment risk remains appropriate, helping to limit the impact of market fluctuations and provide greater certainty over outcomes.
The evolution of retirement income solutions post-pension freedoms means that return- seeking assets remain a feature of many default arrangements, both at and into retirement. The increased use of drawdown means that defaults will more commonly move members into a highly diversified allocation across a range of asset classes and geographies. This can provide schemes and their fund managers with the flexibility to apply tactical asset allocation adjustments where appropriate, to reflect market conditions. Unless a default specifically targets an annuity purchase, de-risking to a mix of cash and bonds isn’t common.
Looking ahead, default retirement solutions are likely to continue evolving. The key challenge is that no single income solution will suit all members. Identifying the most appropriate pathway early—whether that be drawdown, annuity, or a combination—will be central to improving outcomes.
Investment risk is essential to delivering returns, but there are other risks that can managed by the scheme. Longevity risk is an obvious risk in retirement, which can be managed by purchasing an annuity. The key here is to ensure that risk is being shared fairly and that terms reflect a level playing field based on likely longevity. Without underwriting, longevity risk sharing solutions can become a cross-subsidy from those cohorts of members with lower life expectancy to those members who are likely to live longer.
Inflation risk is another consideration, and while inflation protection can be factored into income solutions, it comes at the cost of a lower initial income. While this may be appropriate for some members, it’s unlikely that it will be right for everyone.
There are other risks like sequencing or timing that can be mitigated, and not all risks are to be avoided, but there is one risk that every scheme should seek to reduce – the burden of decision making on the scheme member themselves. Behavioural biases, lack of knowledge, time and capability all conspire to make decision making about pension saving, and especially pension spending, challenging. While Financial Advice remains the gold standard, it’s not accessible for everyone. This is where targeted support, simplified guidance and well-designed default income solutions can play a critical role. By reducing the burden of complex decisions, schemes can help members achieve better outcomes and ultimately have a positive impact on income levels in retirement.
|
