IPE asked three pension funds how they help members to ensure investment returns are turned into good retirement outcomes
Working to maintain purchasing power
Upon retirement, Industriens members receive three different benefits. There is a one-off payout, called the ‘lump sum payment’, an ‘instalment pension’ that can be paid over 10 to 30 years, and an annuity, called a ‘life-long pension’, which is insurance that guarantees an annuity until death. The lump-sum payment is a small part of the overall savings, as by law members can only save a limited amount in that pot.
Most members get instalment pension payments every month for 10 years, but can choose payments over a period of 15 or 20 years for example, and up to 30 years. We have designed the instalment and life-long payouts in a way that maintains members’ purchasing power over the long term. They can expect payouts to increase annually in absolute terms. We achieve this by calculating each member’s payout profile taking into account variables such as inflation. On the top of that, members continue to receive the ongoing returns on the savings during the payout period.
If we record negative returns during a year, we adjust each member’s profile, which means future pension increases will be lower. Overall, although we do not provide a guaranteed return, we can ensure with a high degree of confidence that members will get increasing payouts.
When calculating our members’ payout profile, we also take into account their age at retirement.
We invest our younger members’ money in order to get the highest average risk-adjusted return in the long run, as they can generally accept a higher degree of volatility. We decrease the risk profile of our older members’ portfolios, but we still maintain an exposure to low-risk, return-generating assets.
Allowing for gradual retirement
Publica members can choose to start receiving a pension prior to the statutory retirement age or retire entirely in one go. They can choose between a one-time, lump-sum payout, a retirement pension only, or a mixture of the two. The level of the pension is calculated by multiplying the individual’s available savings capital by the conversion rate. The latter depends on the technical interest rate and life expectancy. The technical interest rate should be below the expected return.
Publica switched to a DC arrangement in 2008. The conversion rate at 65 was reduced from 5.65% to 5.09% on 1 January 2019, due to lower expected returns and the continuing rise in life expectancy. Publica’s plans take account of changing career paths by, for example, allowing members to reduce the number of hours they work from 58, while continuing to insure their previous salary (calculated on the basis of their previous working hours) until they retire (no later than age 65). This is an optional provision of the law, and pension funds decide whether or not they offer it.
Members can ask Publica to calculate for them the level of a pension, lump sum or mixture of the two they might receive. Publica refrains from offering advice on which might be the best solution, because that could potentially give rise to a legal liability. Publica focuses on explaining the options available but the final choice is entirely a matter for the member.
Focusing on returns
As a default, our members earn a life-long pensions, but they can choose to take out the pension for five years, 10 years and so on. They can also decide when they would like to access their pension.
For individual members, our DB product looks the same as it did 10 years ago, but of course for Alecta and the employers a lot has changed. During the last decade we have increased premiums by over 50% due to increased longevity and lower interest rates.
Before retirement, the strategy for our DC members consists of allocating about 30% to bonds and the rest to equities and alternatives. When members reach retirement, about half of the pension capital is invested in bonds and the rest in other assets. What has changed over the past decade is the expected future return that is used to convert the pension capital to monthly payments and the expected longevity. A decade ago, the expected return was 3.65% in real terms and longevity 20 years from age 65. Today the expected yearly return is 2.15% and expected longevity 22 years from 65. For a retiree at age 65 these changes mean the monthly pension payments is 20% lower. Luckily, the actual return has been good the last 10 years, about 9% per year. Actually, even though we assume longer life expectancy and lower future returns, we are paying out higher pensions than we predicted 10 years ago.
We help our customers by providing comprehensive information on how others have acted when they retire. In particular, five out of 10 take out their pension at age 65, three out of 10 take out their pension after age 65 and seven out of 10 take out their pension for the entire duration of their retirement.
Interviews by Carlo Svaluto Moreolo