Protecting members with the ‘Self-Select-Sweep'
Recently I travelled to Kent to see some relatives and ended up spending most of the journey on the motorway. As I drove, I noticed the long trail of cars in the middle lane, snaking down the road in front of me. Occasionally a car would be overtaken in the slow lane, or a car would overtake in the fast lane but generally the cars in the middle lane didn’t move.
This got me thinking, are there similarities between how people drive on motorways and how they invest their DC savings (I know I am sad)? We can think of the middle lane on the motorway as similar to the default investment strategy – these are the options that require the least active management. The slow lane is for people who wish to take less risk and the fast lane for those people who take more risk.
Generally, this works well if we assume the people in the slow lane understand it is going to take longer to get to their destination and the people in the fast lane understand they are likely to get there quicker but there is greater risk in doing so. However, occasionally people can get this wrong and end up in the wrong lane and don’t understand the risks and consequences of their decisions.
The same could be said for members of a DC pension scheme who self-select their investment. Hopefully most of these members understand the risks of the different investment options, but there is a significant proportion of members who also make poor decisions. This has been brought to life recently with the volatility in gilt markets in the second half of 2022, where we saw some funds fall by around 40%. Investigating this issue further, we found that where these funds were offered as self-select options, there appeared to be a minority of members who had made poor decisions, such as young members who had over 80% of their savings invested in these funds. Clearly, these members had not understood the risks of their decision to invest this way. On the bright side, these members have a long time to recoup these losses, and will no doubt be in a better position by the time they get to retirement. The same is not true for older members invested in these funds which saw big losses close to retirement. We know that DC providers have received complaints from some members who didn’t understand the risks of their decisions and have now lost out without any recourse.
In all likelihood, it is quite possible that a proportion of self-select members are not actively monitoring their investments and took a decision a long time ago to invest in the select fund range and have now forgotten about this (or their pension altogether). These unengaged members are at the greatest risk from a poor outcome. In my view, this highlights that most self-select fund ranges are full of risks and should only be used by those with investment knowledge or those taking advice and who are regularly reviewing their investments.
So how can we address this? I strongly believe that more needs to be done to protect those members that have forgotten about their historic self-select investment decisions. I am advocating to see all members in the self-select fund range to receive an opt-in communication after five years of inactivity to confirm they are happy to remain in the self-select fund range. If they don’t respond, then their savings should be transferred to the default strategy. Think of this as a ‘Self-Select-Sweep'. Of course, we don’t want a situation where members are moved to the default and subsequently complain they didn’t receive the communication, so safeguards will need to be built to ensure members receive as much notice as possible. For example, ensuring members receive several chaser communications and allow enough time to pass between each for the member to respond. In addition, details of the self-select-sweep should be clear in member communications.
Now you might say that the default strategy is not the best place for these members which may be true for some members, but this is the same argument that applies to all unengaged members, not just those who are self-selecting. It comes down to deciding what is the least negative option for members, which is invariably the default strategy.
We are never going to avoid all accidents on a motorway and equally not all members will achieve a good outcome from their investments. However, if there is an opportunity to reduce accidents or improve outcomes for more people, then we should take it. Perhaps that’s stretching the analogy too far, but hopefully you get the idea! Self-select investing should be reserved for those who actively manage their investments and more needs to be done to protect members from their own poor decisions that come back to bite them in years to come.