Video: New Thinking About Retirement Risk Sharing

The above talk was given by Peter Shena, Executive Vice President and Chief Pension Officer of the Ontario Pension Board, at the 2014 Pension Research Council Conference.

Shena speaks about “creative, progressive risk-share models” implemented in some European countries that go beyond defined-benefit or defined-contribution plans. He also talks about his concerns about the sponsor’s role in these plans.

Do Pension Plans Give Retirees a False Sense of Retirement Security?

broken piggy bank over pile of one dollar bills

At one time, pensions were seen as the safest, most secure stream of retirement income. But the security of pension benefits is no longer rock-solid. That raises the question: do pensions give retirees a false sense of retirement security?

Economist Allison Schrager explores the idea:

Until recently, a pension benefit seemed as good as money in the bank. Companies or governments set aside money for employees’ retirements; the sponsors were on the hook for funding the promised benefits appropriately. In recent years, it has become clear that most pension plans are falling short, but accrued benefits normally aren’t cut unless the plan, or employer, is on the verge of bankruptcy—high-profile examples include airline and steel companies. Public pension benefits appear even safer, because they are guaranteed by state constitutions.

By comparison, 401(k) and other defined contribution plans seem much less reliable. They require employees to decide, individually, to set aside money for retirement and to invest it appropriately over the course of 30 or so years. Research suggests that people are remarkably bad at both: About 20 percent of eligible employees don’t participate in their 401(k) plan. Those who do save too little, and many choose investments that underperform the market, charge high investment fees, or both.

It turns out that pension plan sponsors, and the politicians who oversee them, are just as fallible as workaday employees. We all prefer to spend more today and deal with the future when it comes. Pension plans have done this for years by promising generous benefits without a clear plan to pay for them. When pressed, they may simply raise their performance expectations or choose more risky investments in search of higher returns. Neither is a legitimate solution. In theory, regulators should keep pension plan sponsors in check. In practice, the rules regulators must enforce tend to indulge, or even encourage, risky behavior.

Because pension plans seem so dependable, workers do in fact depend on them and save less outside their plans. According to the 2013 Survey of Consumer Finances, people between ages 55 and 65 with pensions have, on average, $60,000 in financial assets. Households with other kinds of retirement savings accounts have $160,000. It’s true that defined benefit pensions are worth more than the difference, but not if the benefit is cut.

As the new legislation makes clear, pension plans can kick the can down the road for only so long. Defined contribution plans have their problems, but a tremendous effort has been made to educate workers about the importance of participating. (Even if the education campaign has been the product of asset managers who make money when more people participate, it’s still valuable.) Almost half of 401(k) plans now automatically enroll employees, which has increased participation and encouraged investment in low-cost index funds. And now it looks like a generous 401(k) plan with sensible, low-cost investment options may turn out to be less risky than a poorly managed pension plan, not least of all because workers know exactly what the risks are.

Read the entire column here.


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Private Equity Likely to Target 401(k)s As Next Big Capital Source

401k jar

According to a survey released Monday, nearly 90 percent of institutional investors believe that defined-contribution (DC) plans are firmly in the cross-hairs of private equity firms.

Reported by Investments and Pensions Europe:

Coller Capital’s latest quarterly Global Private Equity Barometer suggests the world’s limited partner (LP) community is almost unanimous in its expectation that defined contribution (DC) pension schemes will become a source of private equity capital over the next five years.

The findings, based on the private equity secondaries specialist’s survey of 114 investors worldwide, also show growing enthusiasm for private equity in general, and buy-and-build and private credit in particular – despite some concern over what the exit environment for private assets might look like in 3-5 years’ time.

Almost nine out of 10 investors see DC providing private equity capital within five years, with 27% of European LPs believing DC schemes will provide “significant” capital to the asset class.

Stephen Ziff, a partner at Coller Capital, said: “The backdrop to the finding about DC assets going into private equity is one of more capital in general moving into alternatives, and private equity in particular.

“But in addition there has been a shift in the pensions landscape over the past several years, and GPs are certainly looking for new sources of capital. The industry is slowly starting to get to grips with the challenges, to varying degrees – particularly features of DC investments like liquidity and daily pricing.”

The survey interviewed a representative sample of institutional investors, including pension funds and endowments, based across the globe.


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Knoxville Voters Approve All 5 Pension Measures on Ballot


There were five separate pension measures on the Knoxville ballot yesterday – and voters approved all five by a large margin.

The measures weren’t as far-reaching as more controversial reform initiatives such as Phoenix’s Proposition 487.

But they still introduce changes to Knoxville’s retirement system. Among the changes: more investment options for workers covered by the city’s defined-contribution plans and the appointment of finance and accounting experts to the city’s pension board.

The five measured, explained by WBIR:

No. 1: Better clarifies some terms and is essentially nothing more than housekeeping and cleaning up language.

No. 2: Gives city leaders the authority to consider granting retirees the option to take a single lump payment when they retire rather than receiving monthly payments. Note that it doesn’t automatically grant officials the option, but rather the chance to study whether they want to do it.

No. 3: Could lead to those employees covered under a contribution plan (think: 401K) to have a say in how their dollars are invested. Or at least there could be more options than what the city currently sets aside for them.

No. 4: This amendment…says that only the retiree’s spouse would be eligible for his/her retirement benefits. Right now, children and grandchildren can get them.

No. 5: This amendment…would add two new spots to the pension board. The new members would have to have expertise in finance and accounting, they would have to be city residents and they could not be city employees or folks who receive pensions from city employees.

The specific language of the measures can be found here.


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The Effect of Age On Portfolio Choices

Graph With Stacks Of Coins

Does a person’s willingness to hold risky assets diminish as they grow older and get closer to retirement? How does aging affect portfolio choices?

A paper published in the October issue of the Journal of Pension Economics and Finance aims to tackle those questions.

The authors analyzed administrative data from an Italian defined-contribution plan spanning 2002-08. Here’s what they found:

We studied investors’ portfolio choices in a very simple real-world setup. Some results prove quite robust across all the empirical exercises we performed. In particular, we found a pronounced tendency to choose safer portfolios as people age. This effect is still there after controlling for several demographic factors, for time effects, and for the sub-fund chosen in the previous period. This result is broadly in line with other micro-evidence from the US market, and is consistent with models of life-cycle rational portfolio allocation.


The effect of age is more pronounced in the last years of the sample. This might be due to the fact that investors learn form the experience of their colleagues. Indeed, in our sample there have been periods of disappointing stock market performance. Having seen that people who retired during these bear market periods have been severely hit might have pushed investors toward a more active behaviour. A better understanding of this form of learning appears to be an interesting issue for further research.

But not all plan participants reduced risk as they approached retirement. From the paper:

Not all elderly people in our sample reduced their exposure to risk. Looking at the ones present in the sample from the start, it turns out that more than 30% of the elderly workers who were exposed to stock market risk in 2002 were still exposed to it in 2008. As the stock market events of the last decade show, an elderly worker taking risk on the stock market could pay a high price if stocks fall. This evidence suggests that life cycle funds could be a valuable instrument, given that they automatically bring all the participants toward less risky allocations as they get near to retirement (Viceira, 2007). In the Chilean system, for example, a lifecycle fund is the default option for all the workers. Moreover, the riskiest sub-funds are closed to individuals older than a certain age.

The authors also found that job position and education are factors that play into people’s risk choices:

People with a higher position tend to take more risks. This tallies with previous empirical analyses and can be consistent with optimal portfolio allocation. We also found that education has no clear impact on portfolio choices, even if it slightly increases the likelihood of switching for those in the zero-shares sub-funds. The weakness of this effect could be due to the easy set up provided by the fund, and/or to strong social interaction effects, in which the financial skills of the educated employees who make up most of our sample also benefit the few uneducated participants.

Read the entire paper, titled “the effect of age on portfolio choices: evidence from an Italian pension fund”, here.


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Fact Check: Would Phoenix’s Pension Proposal Really Cost $350 Million?

Entering Arizona sign

In just two weeks, Phoenix residents will head to the ballot boxes to vote on Proposition 487, the controversial pension reform measure that would shift new hires into a 401(k)-type system.

Recently, a group opposing the law made a bold claim:

“Prop. 487 will cost Phoenix taxpayers more than $350 million over the next 20 years.”

But is it true?

The Arizona Republic did some fact checking. They found that the switch to a 401(k)-type system wouldn’t save the city any money initially. In fact, one report claims that the switch would indeed cost the city $350 million:

That [401(k)] provision would not save money, according to the city’s actuary. A report from the financial analysis firm Cheiron states that closing the pension system and replacing it with a 401(k)-style plan would cost the city an estimated $358 million over the first 20 years, assuming the city contributes 5 percent of employees’ pay to the defined-contribution plan.

An analyst for Cheiron and city officials said the move to a 401(k)-style plan itself would cost more initially because Phoenix must pay down its massive unfunded pension liability while funding a new retirement plan.

The city’s pension system for general employees, the City of Phoenix Employees’ Retirement System, is only 64.2 percent funded, meaning it doesn’t have the assets to pay about $1.09 billion in existing liabilities. In other words, the city only has about 64 cents on the dollar to cover all of its long-term payments for current and future retirees.

Phoenix must pay off that pension debt regardless of what voters decide. Prop. 487 wouldn’t decrease the existing unfunded liability, but it would stop the city’s liability from growing, opponents and supporters agree.

But there’s a twist: other aspects of Prop. 487 could offset the previously-mentioned costs. From the Arizona Republic:

Other changes outlined in Prop. 487 could offset that up-front cost of switching to a 401(k)-style plan. If fully implemented, the initiative would save the city a net of at least $325 million over the first 20 years, according to Cheiron’s report.

Two key provisions of Prop. 487 could save money in the first 20 years:

–Make permanent and expand reforms the city has made to combat the practice of “pension spiking,” generally seen as the artificial inflation of a city employee’s income to boost retirement benefits. It would exclude from the pension calculation any compensation beyond base pay and expand the number of years used to determine an employee’s final average salary, a key part of the benefit formula. Those changes could save an estimated $475 million over the first 20 years, Cheiron’s report states.

–Prohibit the city from contributing to more than one retirement account for each city worker, including current employees. Currently, the city contributes to a second retirement plan, known as deferred compensation, on top of most employees’ pensions. Cheiron projects eliminating deferred compensation would save an estimated $208 million.

Consultants for the city have said Prop. 487 could save additional money if those changes are applied to public-safety employees, who are in a separate, state-run pension system. Although the initiative contains intent language saying it doesn’t impact police officers and firefighters, supporters and opponents disagree whether it will be interpreted that way.

Interestingly, city officials have tended to agree that the reform measure would cost the city $350 million over the next 20 years. Officials are also worried about the litigation the proposal could invite if passed by voters.

New York Comptroller Candidates Square Off on Pensions

Thomas P. DiNapoli

The New York State Comptroller serves as the sole trustee of New York’s $176.8 billion retirement system. So it’s not surprising that pensions were among the first issues broached during Wednesday night’s televised debate between the two candidates for Comptroller, incumbent Thomas DiNapoli (D) and newcomer Robert Antonacci (R).

Antonacci voiced several of his gripes with the state’s pension system; he claimed the assumed rate of return was too high and that the system should take on more characteristics of a 401(k)-style plan. From the Democrat and Chronicle:

Antonacci, who since 2007 has served as Onondaga County comptroller, took several opportunities to criticize DiNapoli’s oversight of the system. The pension fund’s assumed rate of return of 7.5 percent, Antonacci said, was too high.

A certified public accountant, Antonacci also said he believes the state should move toward offering defined-contribution retirement plans — what many would think of as a 401k-style plan. State and local-government employees currently receive defined-benefit plans, in which the payout at the time of retirement is determined by a formula and not subject to the whims of the stock market.

“We have to make some fundamental changes to the pension fund, including talking about a defined-contribution plan,” Antonacci said.

DiNapoli disagreed, saying a move to a 401k-style system would hurt working New Yorkers. He touted the performance of the pension fund — which is consistently ranked as one of the best-funded public plans in the country — while acknowledging his office may decide to lower the assumed rate of return in the future.

“Moving to defined contribution would put more and more New Yorkers at risk of not having adequate income in their golden years,” DiNapoli said. “That would be a bad choice for New Yorkers.”

DiNapoli is leading in the polls by 28 percent.


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Kolivakis: Time To Face The “Brutal Truth” About Defined-Contribution Plans

401k jar with one hundred bills inside

Leo Kolivakis, the man behind the Pension Pulse blog, has long been a critic of replacing defined-benefit plans with 401(k)-style plans as a means of reforming public pension systems.

The Canadian Public Pension Leadership Council released a report last week arguing that converting large public DB pension plans to DC plans would be costly and ineffective. In light of that report, Kolivakis took to his blog to re-explain his aversion to the oft-considered reform tactic. From Pension Pulse:

I’m glad Canada’s large public pension funds got together to fund this new initiative to properly inform the public on why converting public sector defined-benefit plans to private sector defined-contribution plans is a more costly option.

Skeptics will claim that this new association is biased and the findings of this paper support the continuing activities of their organizations. But if you ask me, it’s high time we put a nail in the coffin of defined-contribution plans once and for all. The overwhelming evidence on the benefits of defined-benefit plans is irrefutable, which is why I keep harping on enhancing the CPP for all Canadians regardless of whether they work in the public or private sector.

And while shifting to defined-contribution plans might make perfect rational sense for a private company, the state ends up paying the higher social costs of such a shift. As I recently discussed, trouble is brewing at Canada’s private DB plans, and with the U.S. 10-year Treasury yield sinking to a 16-month low today, I expect public and private pension deficits to swell (if the market crashes, it will be a disaster for all pensions!).

Folks, the next ten years will be very rough. Historic low rates, record inflows into hedge funds, the real possibility of global deflation emanating from Europe, will all impact the returns of public and private assets. In this environment, I can’t underscore how important it will be to be properly diversified and to manage assets and liabilities much more closely.

And if you think defined-contribution plans are the solution, think again. Why? Apart from the fact that they’re more costly because they don’t pool resources and lower fees — or pool investment risk and longevity risk — they are also subject to the vagaries of public markets, which will be very volatile in the decade(s) ahead and won’t offer anything close to the returns of the last 30 years. That much I can guarantee you (just look at the starting point with 10-year U.S. treasury yield at 2.3%, pensions will be lucky to achieve 5 or 6% rate of return objective).

Public pension funds are far from perfect, especially in the United States where the governance is awful and constrains states from properly compensating their public pension fund managers. But if countries are going to get serious about tackling pension poverty once and for all, they will bolster public pensions for all their citizens and introduce proper reforms to ensure the long-term sustainability of these plans.

Finally, if you think shifting public sector DB plans into DC plans will help lower public debt, think again. The social welfare costs of such a shift will completely swamp the short-term reduction in public debt. Only economic imbeciles at right-wing “think tanks” will argue against this but they’re completely and utterly clueless on what we need to improve pension policy for all our citizens.

The brutal truth on defined-contribution plans is they’re more costly and not properly diversified across public and private assets. More importantly, they will exacerbate pension poverty which is why we have to enhance the Canada Pension Plan (CPP) for all Canadians allowing more people to retire in dignity and security. These people will have a guaranteed income during their golden years and thus contribute more to sales taxes, reducing public debt.

Read his entire post on the subject here.


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Changing the Conversation About Pension Reform

conversation bubbles

Keith Ambachtsheer, Director Emeritus of the International Centre for Pension Management at the University of Toronto, wants to change the conversation around pension reform from “dysfunctional” to “constructive”.

In a recent article in the Financial Analysts Journal, Ambachtsheer explains how the reform conversation can be “re-framed” and become more productive. He writes:

The sustainability of traditional public sector defined benefit (DB) plans has become front-page news and the subject of acrimonious debates usually framed in stark terms of DB versus DC (defined contribution). This either/or framing is unhelpful: It simply perpetuates the strongly held views of the defenders and critics of these two opposing pension models. Moving the pension reform yardsticks in the right direction requires that we stop this dysfunctional either/or framing and move on to a more constructive conversation about what we want our pension arrangements to achieve and what that tells us about how to design them.


So, how do I propose to change the conversation about pension reform from dysfunctional to constructive? By reflecting on the implications of five pension design realities:

1. All good pension systems have three common features.

2. All pension systems have embedded risks that must be understood and managed.

3. Some of these risks have an intergenerational dimension.

4. Pension plan sustainability requires intergenerational fairness.

5. Achieving this fairness has plan design implications.

The three design features common to all good pension systems are:

1. inclusiveness—all workers are afforded a fair opportunity to provide for their retirement;

2. fitness-for-purpose—the system is purposefully designed to start paying a target pension for life on a target retirement date; and

3. cost-effectiveness—retirement savings are transformed into pension payments by “value for money” pension organizations.

Surely, no rational person would disagree with these three features. So far, so good.

Ambachtsheer goes on to talk about the failings of DB plans in recent years – but says it would be a “tragedy” to scrap them for DC plans:

Remember how we talked ourselves into a “new era” paradigm as the last decade of the 20th century unfolded? As it ended, most DB plan funded ratios were well over 100%. Did we treat these balance sheet surpluses as “rainy day” funds to see the plans through the coming lean years? We did not. Predictably, we spent the surpluses on benefit increases and contribution holidays. After all, was this not a new era of outsized economic growth rates and stock market returns? Was taking on more risk not synonymous with earning even higher returns?

A decade later, we know that the answers to these turn-of-the-century rhetorical questions are no and no. On top of these stark economic realities, red-faced actuaries are now confessing that they have been underestimating increases in retiree longevity for quite some time.

Given the current poor financial condition of many public sector DB plans, it should come as no surprise that people on the far right of the political spectrum want to do away with this type of pension arrangement altogether. Doing so would be a tragedy. I agree with Leech and McNish that none of these weaknesses need be fatal if we repair them now.

But how to repair DB plans? Ambachtsheer offers the idea of defined ambition (DA) plans. He writes:

It seems to me that ditching the dysfunctional DB/DC language is the best way to start these repairs. Political leaders in the United Kingdom, the Netherlands, Denmark, and Australia have already done so. They now speak of defined ambition (DA) pension plans. Vigorous debates on how best to design and implement DA plans are taking place in all four countries.3 In my view, a good DA pension plan has six critical features:

1. A target income-replacement rate—how much postwork income is needed to maintain an adequate standard of living?

2. A target contribution rate—given realistic assumptions about working-life length, longevity, and net real investment returns, how much money needs to be set aside to achieve the pension target?

3. Course correction capabilities—the plan provides regular updates on progress toward targets and offers course correction options when needed.

4. Fully defined property rights and no intergenerational wealth shifting—the plan design is tested for intergenerational fairness and clear property rights.

5. Long-horizon wealth-creation capability—the pension delivery organization can acquire and nurture healthy multi-decade cash flows (e.g., streams of dividends, rents, tolls) through a well-managed long-horizon investment program.

6. Payment-certainty purchase capability—plan members can acquire guaranteed deferred life annuities at a reasonable price.

The entire article, which contains more analysis than excerpted here, can be read here.


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Study: Retirement Savings Have Grown Across All Age Groups Since 2007

sack of one hundred dollar bills, RetirementData shows that nest eggs, on the whole, are smaller these days. But a recent survey suggests a bit of good news: since the financial crisis, median retirement savings across age groups have grown by leaps and bounds.

From the Christian Science Monitor:

Despite all the attention paid to insufficient total savings, median retirement savings among working-age households have grown considerably over the past five years, according to the 15th Annual Retirement Survey from the Transamerica Center for Retirement Studies. The survey tracked median retirement nest eggs among employed American baby boomers, Generation Xers, and Millennials between 2007 and 2014. For each age group, median savings either doubled or tripled within that seven-year span.

“We’ve seen a healthy increase in savings for employed people,” says Catherine Collinson, president of the Transamerica Center for Retirement Studies based in Los Angeles, in a phone interview. The recession, she notes, “set off the alarm bells in a way that they weren’t ringing before and took [saving money] to a new level of urgency, and that’s a good thing. If we look at the national dialogue, it’s difficult to turn on the Internet, TV, or radio without hearing some form of conversation about the need for people to plan and save and think about their loved ones.”

Millennials, perhaps predictably, reported the most robust savings growth of the three groups, more than tripling their savings from $9,000 in 2007 to $32,000 in 2014. Xers, the first of whom will start turning 50 next year, doubled their nest eggs, from $32,000 to $70,000. For boomers, median savings increased from $75,000 to $127,000.

There are a host of reasons for the savings increase. Perhaps the biggest is that in a world where defined-contribution plans are overtaking defined benefit plans, the bullish stock market has been a boon for 401(k)s.


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