The onset of the credit crunch swiftly followed by recession have prompted many industry commentators to declare that the decline of defined benefit (DB) occupational schemes is final and indeed terminal.
However, with efforts to get the government to meet employers halfway on a new set of rules for risk-sharing schemes, an effort that crashed and burned in 2008, the only credible alternative to DB is defined contribution (DC).
But is DC truly the holy grail of pension provision for the country’s employers, tired of being punished for seeking to assist their workers to save for their future?
It is a truth universally acknowledged that an employer with a DB scheme is in want of an exit strategy. And fast.
Apologies to Jane Austen, but if she was in any position to berate my crude subversion of one of her best-known lines, she’d have other worries, particularly as an employer.
The burden of legislation and regulation governing the provision of occupational pension schemes is enough to make the most paternalistic of plan sponsors reconsider the wisdom of their munificence.
Although there is always more than one way to skin a cat, the decision was generally considered to be binary: DC or not DC.
The trouble with DC – and its attractiveness to sponsors – is that investment risk is placed squarely on the shoulders of the member. In the parlance of computing, it is WYSIWYG, or what you see is what you get. Whatever is in the individual’s pot at retirement is what they have to go to market to secure their income.
However, there has been increasing awareness that many DC schemes – although saving money for the sponsors and removing volatile liabilities from their balance sheets – may have been less than beneficial to members.
Simplicity and transparency are of little comfort when you look into your pot and see that it amounts to the square root of bugger all.
The current recession, in addition to the bursting of the tech bubble in 2000, must have had a marked effect on DC funds, particularly for those in default funds – the nature of which means, of course, that the vast majority of DC members are. We will return to the issue of lifestyle later.
Asset allocation
Increased attention from the Pensions Regulator on the governance of DC schemes, including their investment options, has refocused attention on the construction of defaults.
It was for this reason that Pensions Management, in association with market intelligence consultancy PensionDCisions, conducted the DC Default Fund Providers Survey in 2008 (to request a summary report, go to www.pensiondcisions.com and follow the link on the home page).
The results made interesting reading, confirming a number of assumptions about DC provision while challenging others. One key finding was the increased focus on the importance of asset allocation in the design of DC default funds, as opposed to focusing on the value of active management in any particular asset class.
When it comes to asset allocation strategies, there is a wide variety of opinion between providers. Though these solutions might share the default label, they differ significantly in structure, says Graham Mannion, managing director at
PensionDCisions. The impact on retirement outcomes of selecting one solution versus the alternatives available could be very significant.
“We find that there is a clear trend towards providers recommending a greater degree of diversification beyond equities for the growth period relative to what is in place today in many large DC plans,” he adds.
This is a significant development, as they are demonstrating an apparent dawning realisation that giving default investors 100% access to equities is not necessarily the most sensible strategy.
“The conventional wisdom has been that it is okay to put disengaged investors’ money 100% into an equity strategy,” he says, “and the consequences of doing that are quite significant, as we have seen in recent months.”
Derisking strategies
Another divergence in opinion occurs on the subject of derisking. Where providers consider derisking to be an important element and include it in the strategy, there is a wide variety of opinion on when it should commence.
Derisking is a common feature of lifestyle approaches, where funds are switched from ‘risky’ assets (typically 100% equities, split 50/50 between UK and global equities) into ‘safe’ assets (typically gilts or long-dated bonds). In this area, some providers are satisfied that five years is a sufficient derisking horizon, while others now recommend 10 or more years to transition an individual’s account.
“That decision is very significant,” says Mannion, “as a lifestyling approach prior to the equity markets crashing was effective, but after the market adjustment it is potentially not in the best interest of members.
