Finance directors, policy makers and academics already regret the period – right up until the 1990s – in which corporations and governments made what now seem extravagant pension promises to baby boomers.
At that time, the retirement plans of those individuals seemed far enough away to think that the equity risk premium would both send them away happy with a decent pension, maybe even taken early, and that the scheme would be so well funded that the corporate sponsor would be able to take away a surplus.
The early 2000s put paid to this rosy picture of the pension fund as profit centre. That period saw an end to final salary DB in most cases, and the takeoff of average salary DB and individual DC pensions, in the UK and a few other countries, in which the employee takes all the risk.
The Netherlands is undergoing a painful period of readjustment in the form of pension benefit cuts, and DB schemes are largely closed to future accrual in the UK private sector, with a patchy landscape of trust and contract-based DC schemes.
At some point in the next decade, the UK’s £380bn-plus of DC pension investments will probably exceed the £1.1trn of DB assets belonging to schemes that pay the PPF levy.
NEST, the UK’s new auto-enrolment pension fund, expects 80-90% of employees to remain enrolled, while the NAPF’s latest survey (measuring the opinions of people not auto-enrolled) found that 64% said they would stay in their scheme.
Shlomo Benartzi and Richard H Thaler noted over 10 years ago that the asset allocation of individuals in DC pension funds is biased towards the strategies offered in the scheme, representing naive rather than true diversification.
In this issue, we report on the different schools of thought on how to overcome these biases. Some advocate risk management programmes to limit drawdowns and, to this end, NEST members will start with a foundation phase of low-risk asset allocation. Others highlight the need for asset diversification and low costs.
Notably, 50% of respondents to the NAPF’s 2013 workplace pensions survey say they would prefer low-risk asset strategies in return for a guarantee, while research in the Netherlands has also found members to be similarly risk averse. In the UK, the pensions minister has proposed an external fund that would guarantee some measure of security to DC members.
Despite the aversion to loss of DC pension members, risk taking across a broad range of asset categories will clearly be in their best interest.
The implementation of good DC strategies requires time and thought if outcomes for individuals are to be optimal – and if the industry is to avoid further crises of confidence.