As people the world over live longer, healthier lives the debate around the design and funding of pension fund schemes shows no sign of subsiding, writes RisCura’s Investment Research Analyst, Fran Troskie.
In 2014, then-UK Pensions Minister, Steve Webb, (in)famously advised pensioners to buy Lamborghinis. Despite the uproar at the time, his intention was not for a sports car-driving, middle-aged hoard (after all, 60 is the new 40) to descend on British roads, nor was it to encourage reckless or frivolous spending. Instead, his comments conveyed the increasingly prevalent view that individuals should be able to make their own decisions on how to spend their pension pots, with little interference from government. A longer healthier life is not much fun if we have no discretion as to our standard of living.
Webb was essentially referring to the move from Defined Benefit (DB) to Defined Contribution (DC) pension plans – a transition made by South Africa ahead of its many developed and developing peers.
However, while DB and DC schemes help to pave the way to retirement, DC vehicles come with an “ejector seat” leaving the post-retirement options for members somewhat unclear. It would be wise for members of DC schemes to consider alternatives for the road to retirement.
Too much choice
Let’s start by looking at the life-stage model of the retirement journey. On joining the formal labour market, employees face a myriad of choices.
It is like buying a car. Imagine a showroom with a fair amount of choice on display. At various times in the working journey, employees venture onto the showroom-floor to select suitable options for saving for and getting to retirement.
Members make these choices when joining a firm, starting to save for retirement, choosing to join a scheme (becoming a member) and deciding to retire. Many DC plans feature a life-stage model of retirement funding, which matches present risk-profiles with future funding needs. This means there are clear points at which members move from one life-stage and structured solution to another, but the plan ends at retirement.
This predetermined end-date has led cynics to believe that the move from DB to DC allows governments and employers to dodge a demographic bullet — an evergreen/open-ended plan for an ageing population would result in unsustainable pension liabilities. The opposing view, shared by Mr Webb, lauds the move away from the traditionally patriarchal and prescriptive DB model. But, are members really equipped in the DC case?
Another option for the journey
What if, at the outset, members are offered an alternative to the current plans — a bus ticket to take them along their retirement saving journey without an “ejector seat”.
Members secure a seat once a pass is bought, but with choices along the way. There is room for flexibility and the bus can accommodate an extended life-stage model (i.e. post retirement). As the road and the scenery change, the driver changes gears and adapts his speed and the journey remains smooth. Members can, of course, change seats or change routes, but are not forced to make this decision and the bus does not stop altogether at retirement.
Using this bus-journey analogy, an in-fund annuity option, governed along the same premise and by the same fiduciaries as the more traditional life-stage model, makes for a seamless transition from a pre- to post-retirement solution. An in-fund annuity, similar to an alternative DB product, is an end-to-end service. Clever mechanics by actuaries, consultants and financial advisers can create solutions other than traditional financial service providers’ vanilla annuities.
Existing pension plan providers and employers, like large transport companies, have efficiencies of scale and scope, the ability to leverage off existing service-level agreements, negotiating clout with service providers and an effective support scaffolding for administration of payments and benefits. This means that they can create feasible and cost-effective bespoke options. Like a bus company, smaller feeder buses (products) can access more remote destinations or accommodate special needs’ passengers. Dependent on cost and how sophisticated the market becomes, these are likely to be opt-in options. The road trip therefore need not end at retirement and the initial vehicle selection can in fact eliminate the need for multiple decisions. Members automatically remain in their seat on the bus for a smooth ride through their sunset years.
It is time to rethink the best way to get members where they need to be. Thank you Mr Webb, but I’ll take the bus.
Investment Research Analyst, RisCura
*This article originally appeared in Today’s Trustee on 24 August 2017
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