The Organisation for Economic Co-operation and Development (OECD) is warning that defined contribution (DC) plan members are at risk of fluctuations in retirement income unless default strategies are adopted that blunt the impact of market shocks.
In a working paper, Assessing Default Investment Strategies in Defined Contribution Pension Plans, the OECD explains that the specific glide path of lifecycle strategies and introduction of dynamic features in default design affect retirement income outcomes.
The report found that strategies featuring excessively low or high exposure to equities (less than 10% and more than 80%) generally proved inefficient compared to lifecycle strategies that feature exposure to risky assets before switching to safer fixed income products in the last decade of accumulation.
It states that while the strategic asset allocation is the main determinant of the level of volatility of pension benefits, well-designed lifecycle strategies can “help protect pension benefits from extreme negative outcomes without jeopardizing high replacement rates for the average generation.”
As a result, it is important to conduct modeling that takes into account risk aversion, human capital and other sources of retirement income.
“Through such models, plan sponsors, providers and policymakers can identify optimal asset allocations for representative individuals and hence design suitable default investment strategies with specific weights for each asset class.”
Read the OECD report here.
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