(This is post 6 of 7 on the 2016 Thinking Ahead Institute global roundtable, held in London on 2 and 3 November. The theme of the event was “Fuller measurement, broader integration, better decisions”)
The session began with attendees noting that the introduction of new pension freedoms had focused attention on DC members’ expectations for post-retirement income provision. Whilst annuities provided certainty of income they were generally still perceived to offer poor value and limited flexibility, while not matching the income needs of retirees (for example insufficient spouse pension, inflation protection, etc). It was also noted that while there have been failures in the retirement product market, there were also failures in the demand side, in that people felt ill-equipped to make the right choices. The group then looked at NEST’s proposed solution for post-retirement DC income provision. The solution aims to meet the needs of its membership by providing increased flexibility in the early post-retirement stages, leading to increased certainty in later stages. A few key overarching principles were discussed, including the importance of pension providers maximising the utility of members’ pension pots so that they are exhausted over an individual’s lifetime, with the level of income being determined by the provider.
The group discussed various elements of the design such as monthly payments used to protect against longevity risk, a cash element which served as a ‘rainy day’ fund and a drawdown element used to provide income, cash bonuses in the event of favourable market conditions and a level annuity in later stages of retirement with the trustees providing governance and oversight of the design. Strong communication with the member also played a vital role in successful pension design.
The attendees turned their attention to a transformational change project which aimed to create fit-for-purpose DC pension design with appropriate governance, engagement and longevity protection. While approximately 75% of members in South Africa sit within the DC system (excluding government employees), estimated income replacement at retirement was low (with actual replacement ratios of around 22%) signalling a looming DC pension crisis. As a result, the DC industry in South Africa was seen as ripe for disruption. There were however several hurdles to be overcome before there could be change (such as poor competition between pension funds, inadequate regulation and insufficient good governance). A more holistic approach was needed, with the participating employer and the trustees working together to form a clear understanding of the requirements for successful transformational change.
Transformational change was necessary along three key dimensions, namely: best-in-class governance structure and organisational design; a more holistic approach to ALM design and risk management; and re-thinking member engagement. A new generation DC solution required better integration between investment, insurance and wealth management functions. Specifically, looking at holistic ALM design and risk management, the group discussed a number of levers to be managed covering contributions, investment returns, costs, allowed withdrawals from funds, retirement age, and annuitisation.
The attendees noted the importance of having strong decision-making frameworks in place to deliver effective future DC design and the work by Clark and Urwin (2008) was highlighted in outlining various models that could be used for ‘best-in-class’ governance. The session concluded by the group noting the importance of setting goals to reduce the DC shortfall (such as encouraging higher levels of contributions, and introducing mandatory preservation during before a minimum age) and increasing governance budgets to improve replacement ratios.