Schroders Global Strategic Solutions team, led by Lesley-Ann Morgan, is today announcing the findings of its global study into Defined Contribution (DC) Plan Design.
In ‘Lessons Learnt in DC from Around the World', the team investigates the universal commonalities and local distinctions in DC systems, and highlights the key concepts determining success.
and failure. This unique study is designed to guide established plans considering enhancements as well as plan sponsors and governments undertaking new arrangements.
The trend towards DC pension plan provision is growing around the world. In the US, corporate DC plans have overtaken Defined Benefit (DB) plans both in terms of total assets and growth rates[1]. Although the US, Australia and the UK dominate DC markets in terms of their absolute size, DC assets represent a larger proportion of GDP in countries such as Iceland, Chile and Denmark.
Lesley-Ann Morgan, Head of Global Strategic Solutions, comments on the key findings of the report:
"When working with clients globally there were three key reoccurring and universal themes:
1. DC schemes need to be compulsory
"The single biggest factor in determining the success of a DC plan is having sufficient contributions.We believe that this is best obtained by compulsion to overcome the issue of inertia, and we support the concept of auto-enrolment fully.
"Without this compulsion to a reasonable threshold level, take-up rates are poor. For example, in Singapore, Hong Kong, Australia, New Zealand, Sweden - and soon the UK - employees are compelled to contribute to a state or corporate DC plan. However, we believe that contributions in the majority of these countries are still too low given long-term future return expectations. In Australia, where the rate is due to increase progressively to 12 per cent per annum by July 2019, a report by CPA Australia, the nation's largest accounting body, warns that even this may not be high enough for Australians to retire at the current retirement age."
2. DC Schemes need a minimum 15 per cent contribution
"Our research shows that contributions of at least 15 per cent of salary and real investment returns of 3 per cent per annum are the minimum to produce an adequate standard of living in retirement. We looked across the world and if you want a two third salary pension, you need to contribute 15 per cent for 40 years.
"Overwhelmingly we found that plans work best when employers and employees both contribute to the scheme."
3. DC schemes need to follow a real return strategy
"DC funds need to target above inflation returns (at least 3 per cent real). Most DC schemes go for a benchmarked approach with does not always provide real returns. You can't eat relative returns!
"There is significant room for improvement in default design and implementation of default funds. In countries where members are auto-enrolled into DC plans, fiduciary nomination of a default fund is a necessity. A default investment option must be available in the event that the employee does not make an active decision about the fund in which to invest.
"For many years fiduciaries chose to ‘err on the safe side', leading to extensive use of cash or stable value funds. However, in the US the 2006 Pension Protection Act provided protection to fiduciaries using target date funds as default funds by classifying them as Qualified Default Investment Alternatives (QDIAs).
"Target date funds (and their close cousins, lifecycle funds) are now used heavily in the US[2], Canada[3] and the UK[4]. However, we believe that these funds can be improved by using diversification in the growth phase to limit the impact of the periodic losses from pure equity. We would suggest using a diversified ‘inflation plus' or ‘outcome orientated' fund in the growth phase, targeting real returns of 3-5% p.a."
The list of complications could be endless, but generally the solutions already exist - in a diverse world, identifying the right set of keys for each DC market will be fundamental to success. It is our intention that this paper provokes thought and provides a useful reference point for those sponsors setting out to initiate (or update) such retirement provision for their citizens or employees.
For a video of Lesley-Ann Morgan discussing the findings of the Global DC Report please click here.
For a full copy of the report please contact- Estelle Bibby, European Institutional - Tel: +44 (0)20 7658 3431/ estelle.bibby@schroders.com
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