What is the purpose of a pension? I would argue that, while a pension is a vehicle for saving, it is saving with a particular objective – namely to help members meet their consumption needs in retirement. And too often these days this objective is overlooked.
Any individual who plans to retire faces a fundamental discontinuity between their income (which is earned over their working life) and their consumption (which occurs over their entire lifetime). A pension scheme helps to overcome this mismatch. In a DB regime, the ultimate responsibility to provide members’ accrued incomes in retirement rests with the sponsor (or guarantee fund or, potentially, the member if the sponsor is unable to meet its commitments). In a DC context, this responsibility sits squarely with the members. If they fail to spread their wealth effectively, individuals face the prospect of a lean retirement. So, in much the same way that a DB scheme focuses on managing risk for the sponsor, for DC the focus should be on helping the members manage risk, largely through pooling mechanisms. And it is in this respect that DC in many countries appears to be heading in the wrong direction.
Most DC systems (and hence the plans operating within them) concentrate on getting individual members to the point of retirement. For sponsors (employers), there is little incentive to continue to assist employees with their financial planning after retirement. The introduction of pension freedoms in the UK, as one example, has helped cement the disconnect between accumulation and drawdown, so that most DC members, to the extent that they are engaged with their scheme, aren’t provided with the structure or tools to see beyond their retirement date. They regard their pension as a bank account. What’s more, they reach retirement with little idea of how best to meet their complex needs.
There are three further problems. DC schemes have only part of a member’s assets, are only ‘partnered’ with the member for part of their journey, and have only partial information on a member’s risk affinity and post-retirement plans.
So what can be done? For starters, the long-touted solution of pot-follows-member could be more diligently enforced. However, this solution is clunky, in that any information about a member’s future intentions and other assets gleaned by one scheme is likely to be lost in a transfer. A system of unaffiliated schemes which offer a lifetime membership (extending beyond retirement) is likely to be more effective, provided the appropriate governance and accountability arrangements are instituted. But to be truly effective, a credible, low cost post-retirement ‘core option’ that satisfactorily serves the needs of the majority of retirees is critical – ideally coupled with some kind of soft compulsion that steers unengaged members in this direction.
Such an arrangement would be in the national interest, in that it is geared towards post-retirement, whole of life income provision (and hence will limit the number of pensioners who become wards of the state). It is in a PDO’s interests, in that they are now able to fund for a commonly understood post-retirement outcome. And it would be in members’ interests, in that:
A national solution could realise economies of scale and offer pooling mechanisms (mortality, investment pools) that are either profit-loaded or don’t exist in many individual options
Continuity between pre and post-retirement could potentially (depending on the structure of the post-retirement solution) allow members to remain invested in growth assets for longer
Members would come to view their pension as serving the need for which it was intended – to smooth their consumption over their entire lifetime.