Defined contribution (DC) pension plans are shaping up to be the dominant form of retirement savings around the world, but the model’s vulnerability to episodes such as the recent financial crisis must be addressed by fiduciaries in order to restore the trust of plan members, according to a report.
Towers Watson’s Journey well, arrive better report illustrates why employees have felt the full force of investment risks and outlines the actionable items fiduciaries need to focus on.
According to Towers Watson, DC is becoming the future dominant form of retirement savings globally, with DC assets now comprising 42% of global pension assets compared with 32% in 1999. The U.S., Australia and the U.K. are leading DC growth, innovation and best practices, and the trend away from DB is fast becoming universal. The company also suggests that a significant number of multinationals now have global policies of operating only DC plans wherever they offer employees retirement savings provision.
“There is no doubt that being a member, or a fiduciary, of a DC plan is challenging, but more thinking is producing better practices,” says Gary Smith, senior investment consultant with Towers Watson. “Indeed, many DC members now realize they need to better address their own investment risk, while plan fiduciaries are reviewing their investment strategies and default arrangements to redress the balance of risk and return. Against this backdrop, and with much greater awareness of and engagement with the issues, we are confident that a more robust DC proposition is emerging.”
The report considers members’ journeys to retirement and how members should be segmented according to their needs by evaluating lifecycle designs, which alter their exposure to risk as their human capital evolves. It also explores three elements of the investment journey: the benefits of diversity in growth assets, suitable matching assets as retirement approaches and the glide-path design that moves a member from growth to matching assets over time.
Engagement
Historically, DC plans have tended to operate within a relatively low engagement environment, says the report. Members tend to save what they can in the hopes that they will end up with enough money for a comfortable retirement, and little or no consideration is given to members’ ability to take investment risk and the implications for them of doing so. The trick at this juncture is how to develop a higher engagement environment to help members make better-informed investment decisions.
While the concept of journey planning is familiar to DB plan fiduciaries, it is relatively new to their DC brethren. Such planning in a DC environment is most relevant to the individual member, who has tended to focus on the here and now, with little or no time spent on planning his journey to retirement and assessing his progress against that plan. Towers Watson suggests such members could benefit from a more focused approach to their DC journey.
Split personalities
The report finds that DC plan members fall into one of three investment types: true defaulters, who have little interest in their pension savings; guided selectors, who are somewhat financially literate and could be engaged through improved communications; and self selectors, who are financially literate, motivated and engaged in investment choices.
“A really positive development of late is a strong move toward a better understanding of the uniqueness of plan memberships, their objectives and likely behaviour patterns, particularly with respect to investment risk,” says Smith. “This is important for grouping those that will simply follow a default process, those that with guidance are willing and able to make small personalized decisions, and those that are able to manage their own choices. An analysis of a specific plan’s membership, its demographics, its likely outcome requirements and its general tolerance to risk is vital when designing investment strategies—including the default—as well as when agreeing to the member engagement approach.”
In each case, Towers Watson believes the simplest way to help members become more focused in their retirement planning is to set a retirement outcome target. “Better communication helps members own and appreciate what they are saving for,” says the report. “We suggest that fiduciaries should make retirement targets—the ultimate point of building a DC fund—the central theme to their communications. If members do not know what they are aiming for, it is too difficult for them to commit to save or take an interest.”
Download the report here:
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