Copenhagen students win global prize for designing collective DC pension plan

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Their proposal came in response to a challenge set by a group of students under the direction of Sebastien Betermier, a professor of finance at McGill University’s Desautels Faculty of Management. With the challenge inspired by a real-life problem facing the Dutch pension sector, competitors were tasked with designing a CDC plan for the construction sector that would accept members of six defined benefit pension plans.

“The case of the Netherlands is interesting because, even though the Dutch pension system has been consistently ranked among the best in the world, the system has been subject to a growing level of criticism at home,” says Betermier. “Dutch workers and pensioners contribute a very high proportion of income to their pension accounts each year, the majority of which is invested in safe long-term government bonds. These individuals expect to receive a steady and safe stream of pension payouts and therefore do not understand why their payouts have been cut in the last decade as interest rates have decreased.”

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The team’s plan involved keeping contribution rates fairly high and implementing a multi-stage investment strategy. In its first stage, the proposed CDC plan would maintain a low-risk asset mix while establishing a strong governance structure during the complex transition.

“The whole point was to be conservative at first. Just having two plans merge would be challenging enough,” says Sanqvist. “You have guarantees you can’t shift away from.”

In its second stage, as existing DB guarantees are phased out, the fund would transition toward a more aggressive investment strategy with increased allocations toward private equity. In the third stage, the model would shift toward an internally managed asset structure, similar to the design of Canada’s largest pension funds.

“We constructed our risk-taking on the solidarity reserve,” says Sandqvist. “As it builds, so does our ability to take risks. If something goes wrong in the first two years, it goes really wrong. In later years, it is a bit more forgiving.”

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In the real world, problems related to intergenerational risk-sharing have plagued several CDC plans. In producing their alternative model proposal, the winning team was conscious of the needs of both older and younger plan members.

“When I looked at CDC pension plan designs, it was hard to find a non-biased model without prejudice to older or younger members,” says Fierro. “What I do like about CDCs is that you can take on risk as you collect more members.”

According to Betermier, this focus on meeting the needs of different plan members played a big role in securing the team’s victory. Its proposal stood out from the others because it would limit the risk for mature plan members with pre-existing DB benefits secured and improve the outcome for younger plan members eager to generate higher returns through a more aggressive investment approach.

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“The proposed multi-stage strategy, together with the high contribution rate, addresses everyone’s needs and ensures the new plan is resilient to the ultra-low yield environment,” says Betermier. “Other proposals were deemed to be very innovative by judges and, potentially, a better fit for alternative environments where the population is already used to risk-taking inside DC plans. But managing the transition from existing DB plans to new CDC plans in the Netherlands requires a cautious approach that clearly acknowledges the concerns of every stakeholder in the Dutch construction industry.”

While the team’s approach may have helped it stand out in a crowded field, none of its members expected their proposal would do so well. When the students found out they’d been selected for the semi-final, it came as a surprise.

“The thing about case competitions is that you get to be experimental,” says Abrahamsen. “University students have fresh minds. We are making a lot of assumptions and there is no real-world application for our work, but there might be some takeaways that the judges can go forward with.”

Like Abrahamsen, Laasko feels the MPIC and similar competitions can help bring new perspectives to old problems. “I would encourage more students to participate. There is a real possibility of going all the way. Having an open mind is all you really need.”

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