The OECD has identified for some time the growing importance of Defined Contribution (DC) pension schemes.
There has been a major shift globally away from Defined Benefit (DB) schemes to DC, such as KiwiSaver here in New Zealand.
As a result, the individual has become increasingly responsible for investment decisions, for which they are generally not well equipped to make. This has been likened to a “financial climate change” by the World Economic Forum
The OECD has undertaken a review of DC potential drawbacks and how to incorporate them into regulatory frameworks to protect members. This led to the formation of a Core Principles of Private Pension Regulation.
In addition, the OECD Roadmap for the Good Design of DC Pension Plan made several recommendations.
Off interest to me, from the perspective of designing investment solutions, were the following:
- Ensure the design of DC pension plans is internally coherent between the accumulation and pay-out phases and with the overall pension system.
- Consider establishing default life-cycle investment strategies as a default option to protect people close to retirement against extreme negative outcomes.
- For the pay-out phase, encourage annuitisation as a protection against longevity risk.
The OECD made a number of other recommendations which also have merit and they are provided below.
The OECD Core Principles of Private Pension Regulation emphasised that the objective is to generate retirement income.
Importantly, investment strategies should be aligned with this objective and implement sound risk management practices such as diversification and asset-liability matching.
“These should be appropriately employed in order to achieve the best outcome for the plan members and beneficiaries” (Guidelines 4.1).
Interestingly, these principles should apply not only to KiwiSaver, but to any forms of voluntary savings plans and mandatory arrangements.
The emphasis on generating retirement income and coherency between accumulation and pay-out phase (de-cumulation) are important concepts.
In my mind, a greater focus should be placed on generating income in retirement at the later stages of the retirement accumulation phase i.e. at least 10-15 years out from retirement. This is achieved by using asset-liability matching techniques as recommended by the OECD. The investment knowledge is available now to achieve this.
This reflects that the goal of most modern investment Products is to accumulate wealth and risk is defined as volatility of capital. Although these are important concepts, and depending on the size of the Pool, the focus on accumulated wealth my not lead to the generation of a stable and sufficient level of income in retirement.
This is a key learning out of Australia as they near the end of the “accumulation” phase of their superannuation system.
The central point is, without a greater focus on generating Income in retirement during the accumulation phase the variation of income in retirement will likely be higher.
Therefore, it is important to have coherency between the accumulation and pay-out phase of retirement.
I have Posted previously on the concept of placing a greater focus on retirement income as the investment goal (as recommended by the OECD). The argument for such a goal is well presented by Noble Memorial Prize in Economic Sciences Professor Robert Merton.
Professor Merton highlights that for retirement, income matters, and not the value of Accumulated Wealth.
He also argues that variability of retirement income is a better measure of risk rather than variability of capital.
It is appropriate to consider the OCED recommendations at a time that the New Zealand Government are reviewing the Kiwisaver Default Provider arrangements.
This Review is being undertaken by the Ministry of Business, Innovation & Employment (MBIE) and submissions are due 18 September 2019.
This GoodReturns article provides some context.
It is also important to note that there is a paradigm shift underway within the wealth management industry. The industry is evolving, new and improved products are being introduced to the markets in other jurisdictions.
New and innovative financial products are disrupting traditional markets by offering alternative ways to receive retirement income. The new approaches combine existing products in new and different ways. While they do not always provide guaranteed lifetime income, the innovations nevertheless can give savers options and features that annuities do not provide.
For example, Managed Payout Funds in the USA are a major alternative to an annuity. These Funds are designed to produce a relatively consistent level of annual income but that does not guarantee that outcome. They are similar in some respects to Target Date Funds (TDFs) but have a different objective.
More robust investment solutions are being developed to meet the retirement income challenge, they also display Flexicurity. EDHEC Risk Institute provides a sound framework for the development of Robust Investment Solution and the need for more appropriate investment solutions.
Increasingly the robust solution is a Goal-Based investment solution coupled with longevity annuities that begin to make payments when the owner reaches an advanced age (e.g. 80) as a means to manage longevity risk.
The future also entails an increasing level of customisation. This reflects that saving for retirement is an individual experience requiring much more tailoring of the investment solution than is commonly available now. Different investors have different goals.
The investment techniques and approaches are available now to better customise investment solutions in relation to the conservative allocations within ones portfolio so as to generate a level of income to meet retirement goals.
Likewise, the allocation to risky assets (e.g. equities) should also be based on individual goals and circumstances.
The risky asset allocation should not be based on age alone, other factors such as assets outside of Super, other forms of income, and tolerance for risk in meeting aspiration retirement goals for example should also be considered.
In summary, the retirement investment solution needs be customised and focus on generating a sufficient and stable stream of replacement income. This goal needs to be considered over the accumulation phase, such that hedging of future income requirements is undertaken prior to retirement (LDI). Focusing purely on an accumulated capital value and management of market risk alone may lead to insufficient replacement of income in retirement, greater variation of income in retirement, and/or other inefficient trade-offs are made during retirement.
Importantly the investment management focus is not on beating a market index, arguing about fees (albeit they are important), the focus is on how the Investment Solution is tracking relative to the “individuals” retirement goals.
Please see my Disclosure Statement
Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.
The OECD also recommends:
- Encourage people to enrol, to contribute and contribute for long periods.
- Improve the design of incentives to save for retirement, particularly where participation and contributions to DC pension plans are voluntary.
- Promote low-cost retirement savings instruments.
- Establish appropriate default investment strategies, while also providing choice between investment options with different risk profile and investment horizon.
- Promote the supply of annuities and cost-efficient competition in the annuity market.
- Develop appropriate information and risk-hedging instruments to facilitate dealing with longevity risk.
- Ensure effective communication and address financial illiteracy and lack of awareness.
9 thoughts on “KiwiSaver and OECD Pension Scheme Recommendations”
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