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OECD report warns of income 'lottery' for future retirees

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  • OECD report warns of income 'lottery' for future retirees

EUROPE - Future retirees can expect dramatic fluctuations in defined contribution (DC) scheme payouts unless they adopt investment strategies that lessen the impact of market shocks, according to the Organisation for Economic Co-operation and Development (OECD).

A recent OECD report - Assessing Default Investment Strategies in Defined Contribution Pension Plans - analysed the impact of different pension investment strategies on how much people actually received when they retired.

The report warned that, without modifying portfolios to lessen the effects of a market collapse, significant disparities in retirement income could occur between members of a cohort with similar profiles.

For example, an individual who saved 5% of salary over 40 years and invested in an all-US equity portfolio could have expected an income of 100% of final salary had they retired in 2000.

That same individual, however, would have received less than half that had he or she retired three years after the dotcom crash, according to the OECD.

The report’s authors - Pablo Antolin, Stephanie Payet and Juan Yermo - said there were no ‘one-size-fits-all’ default investment options, since no single strategy dominates in all simulations.

However, some strategies - such as those with low exposure to equities, or those with overly high exposure to equities - generally prove inefficient over the longer term, they said.

The report found the best-performing glide path for lifecycle strategies maintained a constant exposure to equities during most of the accumulation period, switching to bonds in the last decade before retirement.

Such strategies provide the best improvement in benefits relative to a fixed portfolio strategy with a similar risk profile, especially when contribution periods are short (fewer than 20 years) and when shocks to equity markets occur just before retirement.

Further, dynamic multi-shape investment strategies - which regularly adjust their portfolio based on past performance to reach a predefined benchmark - show the best replacement rates for investment strategies in scenarios that simulate extreme market conditions.

The report concluded regulators may find lifecycle strategies easier to explain to the public and therefore be more suitable as a default.

However, it acknowledged that some sophisticated investors would prefer more dynamic strategies.

“Regulators need to pay more attention to the regulation of DC plans,” Yermo said.

“Policymakers need to provide guidance on the design of DC default options after a careful evaluation of retirement income needs, taking into account the overall design and benefit risk in the pension system.

“While some countries have default strategies in place, such as mandatory pension funds in Latin America and central eastern Europe, the default choice is often far from optimal from a pensioner’s perspective.”
 

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