Hybrid pension funds must have a “balanced” governance structure in place to ensure no one group of beneficiaries is penalised, the latest paper by the 300 Club has said.
David Villa, a member of the group of investment professionals seeking to improve the investment landscape, argued that the hybrid approach of blending defined benefit (DB) and defined contribution (DC) was preferable to “going off the defined contribution cliff”.
Villa – CIO at the State of Wisconsin Investment Board (SWIB), which reformed to offer employees of the US state hybrid benefits – insisted governance was a crucial risk when determining pension outcomes.
“Governance decisions are ultimately equivalent to a change in return and can contribute significantly to volatility of outcomes,” he argued.
In his paper, ‘The Third Way: A hybrid model for pensions’, he claims that if the governance model is not designed properly, then one group of beneficiaries risks losing out at the expense of another.
“Both the DB and DC models lack the countervailing force provided by risk sharing,” he writes.
He argues that the model used by SWIB, which manages assets worth $91bn (€74.8bn), was easily copied by other providers by offering a minimum benefit guarantee and any gains made above the level split between sponsor and member.
“The risk sharing aspects of this design have profound implications for the governance of the system,” he says. “Interests are not aligned in DB or DC structures.
“In the hybrid structure, risk is shared, and the alignment of interest that results contributes to a virtuous cycle of governance.”
Villa argues in favour of the benefits of any hybrid approach.
“Society,” he writes, “would also be better off if we could avoid going off the defined contribution cliff, wherein financially unsophisticated individuals take on large risks that significantly change their wealth in retirement if they get it wrong.”