Strengthening the pension proposition

As we review lessons learned in the wake of the recent global financial crisis, it is an opportune time to consider ways to strengthen retirement savings schemes moving forward. This is particularly important as regulators, plan sponsors and participants absorb the impact of the shift from defined benefit (DB) to defined contribution (DC) plans in many major markets. Substantial room exists to improve the governance provisions and rules that apply to both types of schemes — especially the need to better enable DC plans to achieve their plan objectives.

Not only has the number of DC plans increased in the past decade, but many DB schemes have closed to new participants. The rate of DC asset growth has reflected this shift, overtaking the modest annual rise in DB assets in recent years. Despite this overall trend, wide dissimilarities exist. While DC plans in Australia, for example, are becoming the standard, investment decisions in Europe often lie in the hands of plan sponsors.

As a result of the financial downturn, plan assets worldwide suffered substantial declines. Depending on a plan participant’s time horizon, the challenge of rebuilding battered portfolios may be daunting. However, potential regulatory and fiduciary changes could help improve the health of DC plans.

A roadmap for improvement

Even before the crisis, several troubling DC-related issues became apparent, including too many investment choices, wide discrepancies in investor literacy, and low participation levels. Post-crisis, it is clear that fund participants need to acquire a better appreciation of risk, especially when correlated with their own investment objectives. Taken together, these issues provide regulators and plan sponsors with a roadmap of possible improvements to consider.

With DC’s emergence as a dominant player in the pension landscape, regulatory assumptions are beginning to shift. Pre-crisis, pension regulators largely focused on fee structures and cost transparency. While these issues continue to attract attention, they now compete with concerns such as risk management, investor choice, access and management performance.

Enhancing choice and access 

Both investor choice and access are seen as important drivers behind low participation and savings rates, as well as asset allocation issues. A variety of ideas have been tabled to address them. 

The United Kingdom is set to launch one such approach in 2012. Personal Accounts (to be rebranded as NEST this month) is a national, trust-based pension scheme designed to help millions of people on low and moderate incomes — who do not have access to a good-quality workplace pension — save for their retirement. It will feature auto-enrolment and clearly defined savings options. 

Risk management and transparency also play critical roles in affecting investor choice, pension participation and access. Regulators may want to revisit, for example, disclosure requirements, guidelines for trustees and investment advisers, and the quality of investment advice. The UK’s pension regulator is tackling the challenge, in part, with a public campaign focused on investor choice and the potentially constructive role of the employer, while that country’s Financial Services Authority is weighing the question of investment managers’ liability to investors for perceived risk. 

Providing flexibility, incentives to save, useful information geared to savings goals and some measure of risk assurance are considerations that will likely engage regulators to find ways to improve pension plan frameworks, and in particular, DC schemes that are becoming a mainstay of global pension systems. 

Revisiting governance

The shift of responsibility for investment decisions from plan trustees to plan participants draws attention to the question of how — and how much – plan sponsors should assist participants with making informed investment decisions. How can fiduciary oversight improve this picture?

The principal role of DC plan sponsors is to select the retirement options open to participants. Evidence of participants’ experiences with DC plans suggests that fiduciaries may need to become more active in providing both a range of choices and useful information to evaluate them. If so, it may be time to review the guidelines for fiduciary roles, responsibilities and qualifications, which differ worldwide. This is particularly the case where investment options include alternative investments that may call for greater understanding of the risks that plans present. 

Some jurisdictions are moving toward third-party advisory services for plan participants. The UK, for example, has introduced an independent grant-supported service that relies on volunteer advisers. 

The shape of things to come 

Ensuring that DC plans will be able to weather any potential future storms will require action on many fronts. It will be useful to test both new and old assumptions, as well as ensure agreement on the fundamentals. Industry participants such as State Street can play important roles in the discussion, especially as funded retirement provisions around the world grow more complex. As a provider of investment management and investment servicing to $4.4 trillion in pension assets, State Street brings considerable experience to setting global pensions on a firm footing moving forward. Our recent acquisition of Intesa Sanpaolo’s Securities Services in Italy is an example of our commitment to the European pensions, insurance and collective markets. 

Given that these markets are forecast to grow at a rate of almost six percent over the next three years — in addition to factors such as industry consolidation, cost pressures and globalization — there is no doubt that plan sponsors will require solutions that represent best governance practices and those that will result in better retirement outcomes for retiring workers. The lessons learned in the financial crisis offer a valuable opportunity to achieve that objective.