Edition: Sep - Nov 2014

Does ‘member choice’ add value?

Not necessarily, cautions Old Mutual Corporate Consultants principal consultant Michelle du Toit.

Du Toit . . . trustees’ role

When it comes to benefits and investments, trustees of retirement funds have become accustomed to providing their fund members with choices. While it may please members to be given choices, this approach should be carefully assessed as it may actually be to members’ detriment.

Consider the value of choice

Members who have a multiplicity of choices might make decisions that are not always in their best interests. Choices are often given to members by trustees regarding retirement-fund contribution levels, flexible risk benefits, investment options, retirement decisions and whether to preserve their retirement savings.

The question that should be asked before offering the member an array of choice is whether it adds value to the member’s retirement fund. Choice should encourage members to consider the long-term repercussions of their decisions, but often too much choice allows members to make decisions that negatively impact their retirement fund by eroding their contributions.

Trustees need to look at the value that every choice adds to the member’s retirement fund. Does the choice encourage the member to save more? If the answer is no, then the choice offered may not deliver the best value to the member’s retirement savings.

Member’s mindset

The member’s frame of mind must be considered before offering too many options. This is because, when it comes to options at retirement, members’ decisionmaking is often based on taking the highest current ‘cash’ value.

Choices such as contribution rates of 2,5%, 6%, 7,5% or 10% of one’s salary are usually given to new members. However, if only the option of 10% were presented to the member, would the member still want to choose another contribution rate? Members often want to maximise their take-home pay. Instead, consider removing the choices easiest to make so that the retirement-fund value to the member is enhanced.

Also, upon exiting a fund, preservation has always been a choice offered to the member. Studies show that, if not legislated, members may not necessarily take the option of preservation – especially since the decision-making process is not always based on assessing the long-term benefit of increased savings at retirement.

Default annuities may help

National Treasury’s retirement-reform proposals will address the high cash-out rate of retirement savings upon leaving an employer’s retirement fund and ensure that members do not make incorrect choices that will depletetheir savings. These proposals, with regard to default annuities, will ensure that the majority of members end up with a sensible product that provides retirement income at a low cost.

The default offerings also begin to reduce the level of member choice available. They thereby simplify the offerings, making them more suitable and easier for members to understand.

Targeted communication A targeted communication and education strategy should be put in place by trustees for members to review investment choice. Studies show that, with greater choice, members are likely to be more conservative and will be risk-averse. This is not necessarily best for the individual.

Trustees should weigh up how much time they spend versus their members on reviewing investment-choice options, whether members fully understand high-risk versus low-risk portfolios, and whether the information provided to the member will have a long- or short-term impact.

Adding these choices imposes a huge administrative burden on trustees. If value is not being offered to the retirement fund through the choice offered, then it is best to reconsider the structure of communication to members. In addition, a clear and targeted communication strategy should be deployed to ensure that members understand the risks associated with their choices.

It’s up to trustees to ensure that members have sufficient information to make the choices best for them as individual members. While trustees should ensure that members are given correct advice upon retirement, sometimes this means not giving the member too much choice.

Key questions for trustees before offering choice to members:

  • Are you considering the member’s wants or needs when offering the choice?
  • Does the choice add value to the member’s retirement plan?
  • What is the member’s mindset when making the choices being offered? For example, is the member’s choice to maximise take-home pay or to maximise retirement benefit?
  • Is the appropriate default option in place?
  • Is there an appropriate communication strategy to educate members about the implications of their investment decision?
  • What would happen if this choice were removed, e.g. would the member’s notice change? If not, why have it?
  • What are the costs involved in offering this choice?
  • What are the long-term consequences of making the wrong choice?

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