Pension systems everywhere are either struggling to manage the shift from defined benefit (DB) to defined contribution (DC) or contemplating the journey. The UK is among the former. Since 2012 auto-enrolment has added over eight million savers to the DC system. Attention is now turning from the administration of enrolling (what will soon be) 10m people into pensions, to the investment strategies that will grow their money.
Value for money is key. What is it, and how to get it for all these new savers, many of whom have never had a pension before? Regulators have avoided a prescriptive definition but are now demanding answers.
If value for money is the destination, where is the map? Those nations that first adopted DC are a good place to start. So Andy Tarrant of B&CE, a not-for-profit financial services company in the UK, and I commissioned a series of essays written by experts on DC first movers in the Americas (Chile, Mexico, US), Asia (Hong Kong, Singapore, New Zealand), and Europe (Denmark).
Denmark emerges as the global leader. Hardly a surprise. League tables place the Danish pension system on top. But qualitative analysis of its DC pillar is rare. Perhaps because Denmark is small, more ink has been spilled on the ‘Canadian model’, Australian super funds, and the transition in the Netherlands. Yet it is Denmark that has led the way in consistent quality in its second pillar.
It is worth noting that the emphasis on increasing individual engagement in DC systems is not borne out by the Danish experience. The Danish system is complicated to understand because of the interaction between taxation, pensions accrual and pensioner benefits. Individuals often only have a vague notion of what they are due in pension or what their savings amount to once clawbacks are deducted. But this matters less because outcomes are good and confidence in those entrusted with savings is high.
“In Denmark, an exceptional overlap in the values of management, employers and employees offers the necessary ingredients in its recipe for success”
Strongly performing institutions usually have high-quality governance. But this is descriptive rather than explanatory. What is good-quality governance and why do the Danes do it well? Governance is the process by which responsibility, authority, and accountability is allocated among an institution’s decision-makers. It is hard to get right in a pension fund because the interests of sponsors (employers), members (employees), and management (executive) diverge, or are at least perceived to do so. Aligning these interests is crucial. In Denmark, the national culture is characterised by a shared commitment to collective prosperity that brings employers and employees together in long-term partnership across the economy. This togetherness is reflected in Denmark’s standing (and that of the Nordic countries more widely) in global surveys of trust levels among individuals and between individuals and public institutions.
A consensual, long-term focused culture where public institutions are trusted is fertile ground for pension fund governance. In Sweden, these attributes have translated into a long period of stability in pensions policy-making. Since Sweden’s shift to notional DC pension accrual in 1994, an informal parliamentary agreement that no government can change pensions policy without cross-party support has held.
Even more than other labour market institutions, pension funds demand the long view. Well-run pension funds will have good and bad investment years, but chopping and changing approach regularly is an easy way to guarantee underperformance. Denmark avoids this because employers, employees, and management have values similar enough to enable a shared long-term objective and to stay the course. The long-term view is entrenched enough to encompass Danish pension funds’ wide use of derivative-heavy liability-driven investment strategies which, after all, demand constant short-term performance monitoring, metrics and commentary.
Denmark’s success in building long-term focused pension funds, which combine cutting-edge investment techniques with a fiduciary duty, is also a testament to scale. Consolidation is easier to achieve where stakeholders are aligned. Pension fund management is not a cottage industry and in Denmark there are just over 20 sizeable pension funds, compared with 35,000 across the UK’s second pillar. Danish funds have taken the opportunity to bulk up, and achieved payroll scale and the professionalising of their executive function.
Pension fund success in the long term demands a team of skilled investment professionals, often hired from asset management. The in-house investment team can be either small or big, depending on how much insourcing is done; but it needs to be professional. Significant insourcing makes feasible the accessing of higher-cost private market asset classes with attractive long-term return profiles. This is sometimes associated with the Canada model, and involves paying top salaries for talent. The largest Danish fund, ATP , enjoys a dispensation from the state to pay market-rate salaries. Political systems lacking Denmark’s consensus-focused civic institutions are likely to find this approach much more difficult. The temptation to weigh in against pension funds is overwhelming.
Denmark’s funds attract investment management talent; they also allow management to manage, with the board’s role clearly defined as one of oversight (holding management to account on strategy implementation) and stewardship (ensuring that the natural advantages that a pension fund possesses namely a liability structure which nurtures a long-term perspective, certainty of cash flows, tax advantages, advantages of sentiment, scale via contribution rules). The paritarian style, privileging representation of employers and employees over subject matter expertise, has come under pressure in the Netherlands. In Denmark, an exceptional overlap in the values of management, employers and employees offers the necessary ingredients in its recipe for success. That is, second-pillar funds in which the decision-makers at every level care about the members above all else. If it sounds easy, it isn’t. But that’s why all roads lead to Denmark.
Gregg McClymont is head of retirement at Aberdeen Standard Investments and co-editor of Towards a New Pensions Settlement: The International Experience, Vols. I & II (2016, 2018)