DC lessons from across the globe

U.K.
What, Exactly, Are We Buying?
Henry Tapper, business development director for U.K.-based First Actuarial, says one lesson employers can learn from the U.K.’s DC model is its failure to provide good value for money for pensioners.

“Since no one has been able to define what good value for money looks like, there has been no gold standard set to which plans can aspire, nor any minimum standards that plans must reach,” explains Tapper. “Consequently, the quality of provision has varied enormously.”

Tapper says the problems start with the fund managers, who typically fail to properly disclose the costs of running a fund, thanks to layers of intermediation that obscure investment costs. That’s because of the U.K.’s disclosure requirements are less strenuous compared to the U.S. and other parts of Europe, Tapper adds.

Next, because of the U.K. market’s bundled nature—where employers buy recordkeeping, investment management and investment administration in a package priced with a single Annual Management Charge fee—workplace pension providers don’t ask for this information and add to the problem by imposing new costs while wrapping the funds. This makes the layer of undisclosed costs variable—and these costs aren’t understood and disclosed to consumers or advisors, Tapper explains.

Then there are the financial advisors, for whom Tapper reserves his harshest assessment, unapologetically saying that while these advisors should be asking the difficult questions, they’re either too incompetent or unmotivated to do so. He says these advisors, who are employed either by trustees set up by employers of the plans or by employers themselves, should be probing the controls that are in place to ensure the expenses incurred by the fund’s trading are properly measured and monitored.

This means employers can’t establish how much they’re paying, or even what they’re paying for.

Tapper says he’s seen situations where a quoted management charge is within the authorized cap of 0.75% per year, but the unquoted costs charged to the fund exceed 5% annually. These costs, he says, are wrapped in complex investment structures often involving private equity or structured products (where a derivative, typically, is in place to control the return on the fund, such as a guaranteed protection in the form of a cap on growth and a collar on losses) or infrastructure products targeting growth assumptions unlikely to be achieved. Hidden costs prevent the instrument from producing the anticipated growth, and they can be measured as the lag on performance not disclosed but felt, he adds.

On top of this, Tapper says, the industry has misjudged the ability of ordinary people to understand and manage their pensions. “People have been left to their own devices by advisors who were paid to distribute and had no incentive to handhold through the lifetime of these plans,” he explains. “Add to this a failure to engage with risk and a lack of appreciation of the specialist skills needed to govern DC, and you have a toxic mix.”

U.S.
Stop the Pension Bleed
For our neighbours to the south, pension bleed, which describes how money is flowing out of U.S. 401(k) pension plans, is a problem. Unlike Canadian plans, which are typically locked in, the U.S. allows people to easily withdraw money from their 401(k)s.

“The modern 401(k) pension plan is really doing double duty,” explains David Laibson, professor of economics at Harvard University. “Not only is it acting as a retirement savings plan, but it’s also become an ATM of sorts for Americans who want to use the funds before retirement.”

Laibson says if the U.S. were redesigning the 401(k) plan from the ground up, it would do well to introduce better laws to prevent pension bleed. But the laws aren’t there, so it’s time to look at how to stop the premature withdrawals under the existing structure.

A knee-jerk reaction might be to stop people taking money from their retirement funds, but Laibson says that’s not the answer.

“I don’t believe we should stop people taking money from their pension fund,” says Laibson. “Rather, we have to come up with innovative ways to get more funds into the system.”

He says employers can do more to help their employees save for both long-term retirement and short-run rainy day goals. One way is to raise contribution rates using strategies such as autoenrollment and auto-escalation. Another approach might be to redesign the system and how people think about savings by introducing payroll deductions for both retirement accounts and rainy day savings accounts. Why should people be left to choose between one or the other? Instead, create a system that makes it easy for employees to do both.

“In an ideal world, legislators would recognize there is a problem and come up with solutions on their own,” says Laibson. “But it’s not happening, and I don’t think we need to sit around and wait for government to solve this problem. Employers can move ahead and address it.”

Still, Laibson admits the first step is to get employers to recognize there’s a problem. He says that, on average, for every dollar going into retirement plans for those 55 years of age and under, 40 cents is bleeding back out.

Does that mean half the population is doomed at retirement? Not necessarily, says Laibson, but it does suggest many retirees may face a serious hit to their quality of life.

“Pension bleed is a problem in the U.S. that needs to be fixed,” he says. “Unfortunately, how—and when—we’re going to fix it still remains an open question.”

Australia
Compulsory Contributions Are Challenging
The move from DB to DC pension plans is well under way in Australia, with a February 2015 Towers Watson survey showing that DC, now totalling more than $2 trillion in assets, accounts for 85% of the country’s pension assets. In large part, this is thanks to Australia’s superannuation savings plan, which mandates employers to contribute 9.5% of an employee’s salary to the retirement fund.

Janice Sengupta, chief investment officer and head of the Aon Master Trust with Aon Hewitt Australia, says compulsory contributions are great because it means everyone has at least some money for retirement. But, she warns, there’s a downside.

Sengupta, who also lived in Canada for a number of years, is astounded at the difference in how Canadians and Australians view retirement savings, based primarily on whether or not pension contributions are compulsory.

“In Canada, when RRSP time comes around, there’s a certain buzz and excitement that goes with it,” she says. “It’s certainly not like that in Australia, where employees are forced to give up a portion of their income toward retirement. It’s interesting: Australians tend to view compulsory contributions as more of a tax than a benefit.”

Sengupta says Australians are now debating whether they should be allowed to take money out of their superannuation pension plan for major expenses such as buying a home. The argument, she says, is “it’s my money and I want to be able to place it where I need it.”

Sengupta says it’s a valid point since money probably could be used productively at certain stages of a person’s life for purposes aligned with a secure retirement, such as buying a house.

Still, despite automatic contributions, employee engagement remains an overall challenge. Sengupta says most employees end up going with the employer’s default fund choice. That is one challenge, but there’s another.

In 2014, Japan had only 2.8% of DC assets

The Netherlands had 5.1% of DC assets

— Towers Watson’s 2015 Global Pension Asset Study

“There’s a unique psychological factor that automatic contributions introduced,” she explains. “Our challenge is overall engagement, yes, but it’s also to answer the question of how we get people to view superannuation pension savings as a positive opportunity and not as a burden.”

Engagement Is the Talk of the Town
While de-risking has been the buzzword in Canada over the last few years, Ian Struthers, partner and investment practice leader with Aon Hewitt Canada, says there is now more of a focus on outcome; that is, plan designers want to ensure employees have enough money to retire. And, he says, a lot of that comes back to employee engagement, something else that’s been discussed over the last few years.

“Talking about outcome and whether the employee will have enough to retire [on] has led to a few similar conversations,” says Struthers. “The questions being asked are things like how can we better engage employees to become more involved in planning for their retirements? How do we grow contribution rates? And, in terms of investments, how do we encourage a wide asset allocation mix while minimizing risk and maximizing returns?”

Tony Palermo is a freelance writer based in Lombardy, Ont.

Get a PDF of this article.