As head of international operations for Danish pension fund ATP, Morten Nilsson was a bit like the Maytag repairman, the idle employee of U.S. advertising lore. ATP was a giant in its home market, managing the retirement assets of most of Denmark’s working population, but it had no international presence. In 2005, Nilsson began talking with top management about ways to expand into other markets, but he struggled to find the right opportunity.
Then, in 2009, Nilsson happened to spot an advertisement for a pension administrator in the Economist. The British government was preparing to launch a low-cost pension scheme, dubbed the National Employment Savings Trust Corp. (NEST), as part of a wide-ranging overhaul of the U.K. retirement system, and it needed someone to keep the scheme’s books. The country’s Pensions Act 2008 aimed to extend pension plans to millions of uncovered workers by mandating that companies offer plans and automatically enroll employees in them. ATP’s proficiency at pension administration is legendary; the company spent six months studying the possibility of contracting its services to NEST. But eventually Nilsson and his colleagues embraced a more ambitious strategy: They would compete directly with NEST and other British pension providers. After all, they thought, ATP had won world renown for its pension model, which provided sophisticated asset management to the mass market at a modest cost. And the Brits have long been happy to import the best of what their European neighbors have to offer — wine and cheese from France, fashion from Italy , luxury automobiles from Germany.
The idea of extending pension coverage to the country’s entire working population is great, but “you have to make sure people are in good funds,” Nilsson tells Institutional Investor. “We thought we could make it really simple and easy on the employer side and easy on the employee. We would guide them through and give them a quality product based on ATP.”
The Danish outfit created a U.K. subsidiary, named NOW: Pensions, and tapped Nilsson as its CEO. In May 2010, Nilsson moved to London, opening a small office on the ground floor of a building on Dover Street in the city’s West End. Starting with just one employee — chief relationship officer Catherine Scott, a hire from Hermes Fund Managers — he began building a Danish-style pension business for the Brits. His first order of business: persuading pension gurus from the U.K.’s labor, employer, actuarial and political arenas to join the board of NOW: Pensions’ multiemployer trust. One of Nilsson’s first recruits, former U.K. government actuary Chris Daykin, was only too happy to join the Danes in their mission of making near-universal pension coverage a reality. “There would be a huge gap for employers who didn’t have plans or couldn’t set up plans and didn’t like insurance-based plans,” Daykin observes.
At first, Nilsson worried that the phone wouldn’t ring, notwithstanding the firm’s telemarketing and advertising aimed at investment intermediaries. But ring it did thanks to the dogged work of his fledgling staff. In December 2011, NOW: Pensions signed its first client, Retail Data Partnership, a small (19-employee) supplier of electronic point-of-sale systems to retailers, based in Stamford, Lincolnshire, in central England. Other companies soon followed, including ISS, a 45,000-employee subsidiary of a Danish facilities management company, and Blue Arrow, a recruitment company with more than 200 offices and service centers. By the end of February, just 18 months after the pension law’s auto-enrollment provision came into effect, NOW: Pensions had signed up 1,700 employers and 250,000 members — nearly 10 percent of the newly created U.K. pension market.
ATP’s success is striking, but the Danish fund is hardly alone. Pension fund providers have moved quickly to capitalize on the U.K. reforms, which are being implemented in stages. The law required companies with 120,000 or more employees to adopt auto-enrollment plans beginning in October 2012. By the end of that year, 17 large companies, most of which already had defined benefit or defined contribution plans for some of their employees, had adopted auto-enrollment plans for uncovered workers. The pension obligation is being extended progressively to smaller and smaller companies through 2016. Last year some 4,000 employers, mostly small and medium-size enterprises, had to open auto-enrollment programs for employees without pension coverage. This year will see by far the biggest expansion yet, with some 40,000 new auto-enrollment plans expected to be created.
“The competition is intense,” explains Nigel Aston, head of U.K. defined contribution for State Street Global Advisors, a 20-year veteran of the pension industry. “All of a sudden, the acceleration of general activity is unprecedented.”
As of the end of February, the auto-enrollment system had captured 3 million new members. The big winner to date among providers is government-run NEST, which has enrolled 1 million members. Other large players include People’s Pension, a plan created by the Building and Civil Engineering Benefit Schemes, a multiemployer pension for construction workers, which has signed up some 500,000 members.
This year’s expansion of auto enrollment will increase the opportunities for providers — and challenge them as well. The government expects that pension reform will cover as many as 10 million workers by the time the law is fully implemented, in 2018; savings by those workers could total £11 billion ($18.3 billion) a year, according to the U.K. Department of Work & Pensions. That’s potentially lucrative business, but many of these people work for small companies, making it harder for providers to reach them. Is there enough provider capacity and expertise to offer solid benefits? Will smaller employers be able to grapple with the added demands on their time? Right now there are more questions than answers.
“We will have a capacity crunch that will test all of us,” Nilsson says. “A substantial number of companies will come in very late.”
The demands on employers to establish new retirement savings programs, communicate with their workers, find good providers with well-conceived investment plans and set up the enrollment process have been very challenging, to say the least. “It’s a bureaucratic nightmare,” observes SSgA’s Aston. “If plans are going to be effectively mandatory, you can’t have bad or expensive plans.”
Yet Nilsson is confident that ATP’s model and those of other providers are up to the challenge. “It’s changing rapidly, improving quite rapidly,” he says, pointing to significant downward pressure on costs and better investment solutions. “New players like us and NEST are setting new standards.”
LIKE MANY OTHERS AROUND THE WORLD, the U.K. pension system has faced growing pressure over the past two decades. Accounting changes have made pension liabilities a big balance-sheet issue, prompting many employers to close their defined benefit pensions to new employees and off-load their obligations. The transfer of pension risks to insurance companies hit an all-time high of £6.9 billion last year, four times the level of 2006, according to Frank Oldham, global leader of defined benefit risk management for consulting firm Mercer in London. Longevity risk-swap arrangements, a type of insurance contract that hedges against employee longevity, also hit a record high.
Defined contribution schemes had grown over the years, but many of them were complex, expensive structures with opaque fees and costly intermediaries. They left many workers uncovered, either because companies didn’t offer a plan or because employees declined to sign up for it. Before the 2012 launch of automatic enrollment, the U.K. had some 200,000 different pension schemes — many of them one-off plans sold by insurance or mutual fund companies to small employers — yet a majority of the private sector workforce had no pension plan. The situation had become untenable.
The government of former prime minister Tony Blair had taken a stab at pension reform in 2001 by requiring employers to offer retirement savings plans, but the law didn’t oblige companies to contribute to those plans. Most plans were contract-based, with individuals expected to manage their own assets. Fees were capped at a lofty 1.5 percent of assets for the first ten years, with the promise of a decrease to 1 percent. Expensive, confusing and lacking an incentive for workers to sign up, the program fell flat.
Retirement savings plan coverage fell from 7.9 million privately employed workers, or 55 percent of the total, in 2003 to 5.8 million, or 42 percent, in 2011, according to the Pensions Regulator. Membership in employer-sponsored defined benefit schemes plunged even more dramatically over that period, from 24 percent of the private sector workforce to just 8.4 percent.
At the same time the private retirement system was deteriorating, the state pension, established in 1948 as a safety net, was having problems of its own. Similar to Social Security in the U.S. and pay-as-you-go government retirement systems across Europe, the U.K. system provides some of the worst benefits. Currently, the maximum full state pension is £110.15 a week, or about £5,727 a year.
To address the broader issue of retirement income security, the government in 2002 created the Pensions Commission, chaired by Lord Adair Turner, a pillar of the British academic and business establishment who would later head the Financial Services Authority. In 2005 the commission came out with recommendations that led to the pensions acts of 2007 and 2008. The first one reformed the state pension, removing certain inequalities, such as the treatment of women and other caregivers’ time out of the workplace, and progressively raised the retirement age to slow the growth of future liabilities.
The 2008 act established a comprehensive framework designed to bring the entire U.K. workforce — or close to it — into retirement savings plans, enshrining automatic enrollment as its defining feature. The idea was that every employer would be required to sponsor a pension scheme. Employees are enrolled automatically but given three months to opt out. The plans are funded initially by employee contributions of 1 percent of pay and a 1 percent match by employers. Contributions will rise gradually through 2018, when employees will contribute 4 percent and employers will chip in 3 percent. The addition of an existing 1 percent tax deduction for employee contributions will bring the total annual savings rate to 8 percent.
The act drew heavily on the work of two U.S. behavioral economists: Shlomo Benartzi of the University of California, Los Angeles’s Anderson School of Management and Richard Thaler of the University of Chicago’s Booth School of Business. In early 2004, Benartzi and Thaler published a paper titled “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving,” in which they contended that people suffer from inertia and tend to put off long-term decisions such as investing for their retirement. People need outside intervention to prod them to increase their savings rate gradually over time, the authors said. The U.K. government ran a number of pilot schemes with willing employers and found that the idea worked. “Start small; ratchet it up; keep going,” explains Adrian Boulding, pension strategy director for Legal & General Group, a London-based insurer that is one of the U.K.’s largest investment managers for pension funds.
Before the introduction of auto enrollment, the government conducted an impact assessment and estimated that the program would yield a 25 percent opt-out rate. Legal & General did its own assessment and predicted the opt-out rate would be 35 percent. Yet since auto enrollment’s introduction in October 2012, only 10 percent of employees have chosen to opt out. “It’s the triumph of behavioral science,” crows Boulding. “We’re over the moon on this.”
Others are a bit skeptical, pointing out that the early results have come from the largest employers. Big, blue-chip employers in the FTSE 100 Index, some of which still offer traditional defined benefit pensions and actively promote retirement saving, have been supportive of auto enrollment. “As we get more smaller employers, there will be more opt-outs because employees won’t have the reassurance of their employers telling them it’s a good thing,” predicts SSgA’s Aston. Wages tend to be lower among smaller companies, and many of these employees need every bit of their paychecks to meet their bills.
The auto-enrollment program stops short of compulsory participation; many feel this was necessary to get the law passed. Any employees who opt out are automatically enrolled again after three years and given a fresh opportunity to opt out.
WHILE THE BRITISH WERE struggling to overhaul their retirement system, the Danes were honing a model that combines near-universal coverage, top-notch asset management and low-cost administration. How good is it? The Danish system, which requires participation by virtually all companies and employees, ranked No. 1 in last year’s Melbourne Mercer Global Pension Index, and Denmark was the only country of 20 ranked to receive an A grade. The Netherlands and Australia followed closely with grades of B+. The U.K. managed a B, and the U.S. scored a C grade along with Poland, France and Brazil.
Established in 1964, ATP operates a hybrid defined benefit–defined contribution arrangement similar to the Dutch retirement model. Called a risk-sharing collective defined contribution scheme, it provides some income guarantees and offers additional benefits when the investment portfolio goes above a 120 percent funding level. ATP enjoys the benefits of scale that come with market dominance: It manages 593 billion kroner ($110 billion) in pooled retirement assets for 4.7 million people at some 160,000 Danish employers. A simple administrative model helps keep costs very low.
In addition to its good design, ATP can boast annualized investment returns of 12.3 percent over the past ten years. By comparison, the California Public Employees’ Retirement System posted average annual returns of 6.5 percent during that period, and Stichting Pensioenfonds ABP, the largest Dutch pension fund, reported annual returns of 6.8 percent between 2003 and 2013. The Danes’ track record is one of the biggest selling points that NOW: Pensions makes in the U.K. The company is formally targeting a more modest 3 percent return over cash over a rolling five-year period.
ATP takes a risk-based approach rather than allocating assets to traditional categories such as equities or fixed income. The company uses five risk categories: rates, credit, equities, inflation and commodities.
The Danes have tweaked their model slightly for the U.K. market. The portfolio at NOW: Pensions, called the Diversified Growth Fund, takes a similar risk-based approach as the company’s mother fund, and all six of the British subsidiary’s investment staff — including CIO Mads Gosvig, ATP’s former chief risk officer — work alongside ATP’s staff at its headquarters outside Copenhagen. For now, however, the British fund invests only in liquid securities, avoiding any allocations to ATP’s hedge fund, private equity, real estate and infrastructure investments. In addition, the NOW: Pensions fund is denominated in sterling rather than Danish kroner.
Like the ATP portfolio, NOW: Pensions has a modest 35 percent allocation to equities, compared with allocations as high as 80 percent in traditional target date funds offered by many mutual fund and insurance companies. The equities portfolio holds three index future funds — covering the Euro Stoxx 50 Index, the S&P 500 and the Asia-Pacific index of Japan’s Topix. Interest-rate-sensitive securities, including futures on U.K. government bonds, German Bunds and U.S. Treasuries, make up 20 percent of the portfolio. Credit instruments, expressed by exchange-traded funds in European and U.S. high-yield debt and emerging-markets debt, have a 10 percent allocation. The inflation risk class, which invests in U.K. index-linked gilt, U.S. Treasury Inflation-Protected Securities and German index-linked bonds, gets a 25 percent allocation. The remaining 10 percent of the portfolio is invested in commodities, including an oil total return swap and Morgan Stanley’s Radar ex Agriculture & Livestock Commodity Index.
The strategy is pretty simple. NOW: Pensions aims to take the guesswork away from employees who are not investment professionals by offering its single, diversified fund. Costs are very low, consisting of an annual fee of 30 basis points on investments and a £1.50 monthly administration fee. The scheme also contains a glide path to retirement: Ten years before an individual reaches retirement age, the fund puts 25 percent of his assets into a cash bucket and 55 percent into long-dated government bonds, leaving the remaining 20 percent in the diversified growth fund. Employees are required to purchase annuities for their retirement; they are directed to Annuity Direct, an independent consulting firm, for help with the process.
Ian Pither, Dover-based group pensions manager at P&O Ferries, oversees pensions for about half of the company’s 3,100 British employees. (The ferry company also employs Belgian, Dutch, French and Irish workers, some of whom are covered by a variety of pension plans in their home countries.) Before the advent of auto enrollment, P&O offered two plans in the U.K.: a seafarers’ pension and a company-sponsored plan for shore staff. Despite being offered a company match of as much as 5 percent of salary, fewer than 300 of the shore staff participate in the company plan, which is managed by Fidelity Worldwide Investment. Fully 1,600 workers failed to participate in any retirement plan “because they didn’t need to be in one,” Pither says. Such abstention was common among U.K. workers, who were loath to see any of their pay deducted for a future savings plan.
When he was informed in February 2012 that he would need to select a new pension scheme and automatically enroll hundreds of uncovered employees by September 2013, Pither, an actuary by training, felt daunted by the task. “Because of the seafarers and bits and pieces, it’s quite complex,” he explains. “We have people here, there and everywhere.”
Things got even more complicated when Pither started contacting providers. He discovered that P&O could not use NEST, the government-sponsored plan, because the ferry company is based on the Channel Island of Jersey, which is not governed by the U.K. (NEST can collect contributions only from British bank accounts.) Similarly, he found out that insurance company plans can’t contract with individuals outside the U.K. And large financial services companies such as Legal & General didn’t want to do business with P&O because of the complexities of its workforce and small scale. “Because of auto enrollment there is so much business out there, some of them have to draw the line,” Pither explains.
Pither engaged Capita Consulting to help him choose a vendor and eventually settled on NOW: Pensions. He liked the firm’s low cost, its relatively simple auto-enrollment process and the fact that its portfolio was based on ATP’s proven investment model. By December 1, 2013, 580 P&O employees were participating in the NOW: Pensions plan; only 30 chose to opt out.
While Pither was addressing P&O’s auto-enrollment challenge, Oliver Webber was facing the same issue at Swiis UK, a health care recruitment firm.
In the 1990s, Swiis began offering its permanent workers a retirement scheme from Legal & General with a generous 6 percent match, figuring that most of its staff would gladly sign on. “I would have thought it would be 100 percent because it was money for nothing,” says Webber, Swiis’ director of corporate implementation. Yet participation was “surprisingly low,” he explains. As any noncompulsory retirement scheme sponsor knows, Swiis was fortunate to get a 70 percent participation rate from its 230 permanent staff.
With the advent of auto enrollment, Webber had to find a plan to cover the 650 permanent and temporary workers who had no pension coverage. After looking at NEST and NOW: Pensions, Webber went with the Danes. “They’re the most proactive,” he asserts. “They took the largest element of responsibility away from us.”
Today, NOW: Pensions has a staff of more than 70 spread throughout the U.K., handling between 200 and 250 sales calls a week. Three out of four inquiries result in a new client.
The Danes are happy with their entrée into the British pension system, but they could be happier still. Nilsson’s biggest beef was the requirement that workers purchase an annuity with their pension money when they retire — a stipulation that forces retirees to accept meager incomes in today’s low-rate environment. But on March 19, Chancellor of the Exchequer George Osborne dropped a bombshell in his annual budget by announcing that the annuity requirement will be abolished as of April 2015, leaving retirees free to spend their money however they like.
Giving savers more flexibility over their retirement savings is a good thing, Nilsson says, “but by handing them a completely free rein, it feels like the chancellor is throwing the baby out with the bathwater.” Auto-enrolling people into pension plans and then assuming they’ll make smart choices upon retirement “feels somewhat counterintuitive,” he adds. Nilsson believes the U.K. needs new, flexible products for people reaching retirement.
Pressure is building for officials to come up with something that resembles the collective defined contribution scheme operated by the Dutch, the Danes and others, says Henry Tapper, a principal at First Actuarial and founder of the 5,000-member Pension PlayPen affinity group. The government has endorsed the idea in broad outline, calling it defined ambition. Tapper believes NEST will one day run such a scheme: “Our company strongly suggests that.”
In a November 2013 paper, “Collective Pensions in the U.K., Part II,” David Pitt-Watson, an executive fellow at London Business School, teamed up with pension consulting firm Aon Hewitt to model how a British collective defined contribution plan would have performed had it been launched 57 years earlier. The study found that members’ pension pots would have been a whopping 33 percent fuller and had more-predictable outcomes than the current defined contribution system. The paper, sponsored by the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA), was endorsed by the Confederation of British Industry, the Trades Union Congress, the National Association of Pension Funds and the Association of Member Nominated Trustees.
Others support the idea but question whether the country is ready for another pension reform. “I’m very much in favor of shared risk,” says NOW: Pensions trustee Daykin. “We probably missed the trick when we let defined benefit get into heavy water. At that time, we were insisting on a lot of regulations. It all added up to employers’ deciding they didn’t want anything to do with them.”
Sorca Kelly-Scholte, head of client strategy and research for Europe, the Middle East and Africa at Russell Investments, says defined ambition recognizes that employers can’t underwrite a hard-and-fast guarantee of retirement incomes guarantee, but they should aspire to provide greater income security and share the risks with retirees, she says. Employers “would rather walk away and leave it all to the individuals,” she says. “Defined contribution has been very much the poor relation to defined benefit.”
In spite of the obstacles, some observers believe the U.K. will eventually come up with new reforms to allow for a more collective approach to pensions. “There is the political will to get retirement income security right,” says Carl Emmerson, deputy director of the Institute for Fiscal Studies, a London think tank. “We’re not really shy of doing pension reform in the U.K. We’ve done it before, and we’ll do it again.”
That’s music to the ears of Nilsson. “Over time we would like to expand the NOW: Pensions proposition, developing additional product lines in areas where we believe we can add genuine value and offer something better than already exists in the marketplace,” he says. If changes do come, the Danish pension emissaries — having planted their red and white flag in U.K. soil — stand ready to take advantage of them. • •
