Steering a careful path between DB and DC
The time is right for a pension revolution, contends Keith Ambachtsheer in his latest book, Pension Revolution: A Solution to the Pensions Crisis, just published worldwide by John Wiley & Sons. This intriguing book reviews the problems facing pensions provisions internationally and presents a coherent solution.
Ambachtsheer's career positions him at the intersection of academia and industry. As principal of Toronto-based KPA Advisory Services, Ambachtsheer has provided strategic advice on governance, finance, and investment. He is also a founder of the Rotman International Centre for Pension Management (ICPM) at the University of Toronto. His book examines current pension provision in the light of the latest research and finds it lacking in many areas.
Ambachtsheer's inspiration throughout is Peter Drucker, and particularly his 1976 book, The Unseen Revolution: How Pension Fund Socialism Came to America. Ambachtsheer finds Drucker's unequivocal warnings issued 30 years ago have gone unheeded. But he also maintains that we are reaching "tipping point" conditions, when pension fund reform is inevitable. To that end, he provides a solution that is a departure from the accepted DB and DC models
Ambachtsheer's premise is beguilingly simple and clear. There is consensus internationally that occupational pension schemes in most countries in the developed world are in a desperate condition and are unlikely to meet the needs of their subscribers unless they are overhauled dramatically. He asserts that the solution to the problem already exists and has been implemented and tested, but what is lacking is the leadership to drive the necessary change.
The solution is what Ambachtsheer calls TOPS - the optimal pension system - "a cure that is both revolutionary and thoroughly practical at the same time," he writes. The Pension Revolution addresses the difficulty in finding a solution that does not replicate the existing problems inherent to DB and DC plans. "…A cure must avoid the collective risk-bearing traps that eventually turn DB plans into multi-stakeholder fist fights or ‘musical chairs' risk-shifting games… the cure must also effectively deal with the human foibles, agency, and longevity risk baggage attached to traditional DC arrangements," writes Ambachtsheer.
TOPS covers all these bases. To address the problem of human irrationality when it comes to financial decision-making, TOPS is based on auto-enrolment and "auto-pilot" mechanisms for dynamic readjustment, linking investment policy to the individual participant's age for lifelong planning. It also deals with longevity risk by including the purchase of deferred annuities. These annuities are managed in according with insurance company principles, thus avoiding the fights over the ownership of balance sheet surpluses and deficits that bedevil DB plans.
Appropriate governance, an ongoing challenge around the world, is crucial to TOPS schemes. "TOPS arrangements are run by arm's-length, expert pension co-ops in order to manage the inherent conflicts and too-high costs the for-profit financial services industry brings to the table," Ambachtsheer explains.
This tension between the interests of the beneficiaries and the self-interest of the financial services industry is a major problem facing the traditional pension model. "You have to create a situation in which the financial services firms
behave in the interest of the beneficiaries - you have to manage from the inside out," Ambachtsheer says. "Once you change the rules, there will still be opportunities for outside service providers, but on different terms."
While TOPS is Ambachtsheer's own conceptualisation of the solution, he points out that there are successful real-life examples of pension provision, independently arrived at, that strikingly resemble his TOPS programme.
One case in point is the Netherlands. The new regime implemented there after the pension regulator initiated a wide-ranging review and revision of pensions provision reflects many of the concerns that underlie TOPS. "The Netherlands saw a radical change in the nature of the pensions promises," says Ambachtsheer. "They are now contingent promises - contingent on the ability to pay."
In Australia, too, where a pension scheme was created de novo, there are many similarities with TOPS. Ambachtsheer notes that now, 15 or 16 years into the process, lump sums are being generated and in response the authorities are building an annuitisation process in a key TOPS element.
"The Dutch and the Australians lead the way in enforcing high workforce coverage, encouraging high contribution rates, and designing auto-pilot savings-investment processes," Ambachtsheer writes. They also "lead in the creation of large, arm's-length single-purpose co-ops to manage their pension arrangements." This can be compared with North America, where material pension components … are political tainted or company sponsor-ed, and mutual fund managed."
In the UK, the recommendations of the Turner Commission "look a lot like TOPS," Ambachtsheer told IPE, in the use of the life cycle model, in the "autopilot dimension and in the recognition of agency issues. When you use the best available research to define pensions provision, this is what you come up with," he said.
North America is not entirely devoid of examples of good practice. Ambachtsheer notes that in the US, TIAA-CREF - also admired in his time by Drucker, who was a pleased beneficiary of monthly cheques - runs in many ways on TOPS principles, particularly in the incorporation of life annuities, which shows that within a pension system, individual accumulation can live alongside an annuity dimension.
Incorporating both accumulation and annuities, TOPS achieves a level of transparency greater than DB plans, asserts Ambachtsheer. "What goes on inside a DB plan, nobody, not even the actuaries, really understand. TOPS is a more sustainable, transparent model."
And for an example of sound governance, the Ontario Teachers' Pension Plan (OTPP) is notable. The OTPP was established in 1990 and is co-sponsored by the government of Ontario and the Ontario Teachers' Federation, both of which appoint the board of directors. The make-up of the board is crucial. "The board cannot just be representative of stakeholder groups," stresses Ambachtsheer. "You need an overlay of the necessary skill and experience set. At the OTPP, the board collectively has the necessary skills and experience to oversee a $100bn (€76.9bn) fund, he says.
"The classical antithesis to this is the bread and circus atmosphere at CalPERS, with politicians standing on the board grandstanding," he notes.
Another reason for the success of the OTPP is that the board understands the difference between governance and management and delegates management to a strong and well remunerated leader. "This clarity between what are governance versus management responsibilities… contrasts sharply with what we see in many other pension and endowment fund organisations," Ambachtsheer writes.
So the models for best practice in
pension funds exist, according to TOPS principles, and the opportunities to implement change exist. In the corporate sector, Ambachtsheer points out that "changes in pension accounting will provide further impetus to the closing of traditional DB plans there".
While the largest corporations have the scale and resources to create TOPS schemes for themselves, the rest of the sector will have to rely on intermediaries. "The logical intermediary to fill this void is the for-profit financial services industry. However, an important book theme is the fundamental conflict between the financial services industry's for-profit mind-set and the retirement income aspirations of workers," Ambachtsheer writes.
In order to mediate this conflict, Ambachtsheer advocates the establishment of "knowledgeable bargaining and monitoring processes acting the in workers' best interests," possibly along the Australian model of pension plans based on industry and geographical groupings.
In the public sector, the tipping point may well stem from "the proper valuation and cost allocation of the guarantees embedded in industry/public sector DB plans" but whistle-blowers, like the Dutch regulator who started the pension revolution in that country, have yet to emerge. Ambachtsheer points at certain signs indicating that the tipping point in the public sector was near.
"There is no single shot that we can fire today to launch and win a single massive global pension revolution. There are, however, a number of promising local skirmishes taking place in various places across the global," he writes. Right now, the pace of change may be more suggestive of evolution than revolution, but the nature of the changes afoot are certainly revolutionary.