I never considered a default to be a good thing, except I suppose for the defaulter who stops paying and has some free cash flow. Defaults on contracts nearly destroyed Teljoy, which was the largest service provider of cellphones when the industry was launched in 1994 (and pay as you go hadn’t yet been invented).
But just as bankers set out to generate a liability, pension fund administrators are talking of setting up default pensions. In this context default means unless there is an opt-out the client’s money is channelled into one fund. When people change jobs their default should not be the motor dealership but a preservation fund.
The first two occasions in which I changed jobs, back in the 1990s, I was not informed that a preservation fund was an option and it certainly wasn’t made easy to do anything other than take a cheque as soon as we had cleared our desks.
Default is similar to what is known in the UK and Australia as auto-enrolment, in which people are automatically moved to a fund unless they specify otherwise. The advantage is that members can move into the default option without paying advice fees, and under national treasury’s proposals the investment management fees in default funds would be very thin. Richard Tyler, MD of Simeka Consultants & Actuaries, says the general industry goal is for members to retire with a monthly income of 75% of their preretirement earnings (known in industry jargon as the replacement ratio).
He says a good default product will guide members through various life stages. In the years before retirement the portfolios in life stage portfolios are switched from equities into cash. People seem to like this concept, though there has been research which proves that a negative life stage approach – increasing equity exposure as the client gets older – works even better.
Tyler rightly says that a major problem has been reckless conservatism as members opt for high cash investment options early in their career. He says anyone more than five years from retirement can afford to take quite a lot of risk. He says that even though there is a good chance of a market slump before retirement there is still time to recover. In any case investors in living annuities should have exactly the same portfolio on their last day at work and their first day in retirement. Living annuities require advice, which has to be paid for. But they are a better option than fixed monthly annuities. These look attractive for the first year but inflation erodes them rapidly.
9 January 2013
Stephen CranstonStephen CranstonDefaults on contracts nearly destroyed Teljoy