“The Gold Star DC Pension Plan” – awaiting conception! | AgeWage: Making your money work as hard as you do

That good chap Jonathan Stapleton who runs mags for Incisive has asked me for my view on what makes for a gold star DC pension scheme. I’ve submitted 150 words which I hope will find their way into a future edition of Workplace Savings and Benefits;

A gold star DC plan is one that delivers its promise to its sponsors. The plan converts regular contribution into a string of regular payments called a pension and a gold standard plan is one that does this effeciently. Efficiency means “no friction” (low charges, easy contributions and prompt payments in decumulation). Gold Star also means “value” delivering market-beating performance , smoothed investment returns in drawdown and convenient interfaces for the sponsors (both employer and member)

“Gold Star” shouldn’t be defined in terms of sponsor contributions. The level of sponsorship is to do with the sponsor’s covenant – not the plan .The plan should encourage sustained contributions from sponsors by delivering efficiency and value.

A gold star pension plan achieves sustained support from sponsors so that it can make payments throughout retirement . A gold star plan ensures money does not run out either through annuitisation or through self-insurance.

I’m with the Americans in not using the word “scheme”, it’s not a word that has positive connotations elsewhere and “plan” is much better.

As I have a blog, I have the luxury of expanding whereas others, submitting their ideas may not (if you are offering Jon your thoughts – (or if you aren’t!)- perhaps you can put them in the comments boxes below

The big idea

Most quality standards on this subject – in particular the PLSA’s PQM – make the chief criteria for a good DC Pension Plan, the contribution of the sponsors (member and employer). This has caused the PQM to become a badge for a club of well heeled employers who can afford a reward strategy whether 10%+ of salary goes into a pension. Nice if you are in that position but not much good if you are one of 95% of employers who are not and may never be in that position.

The big idea is this

We can judge pension plans , not by their input but by the quality with which they transfer the input to the output. More specifically, by the quality of the promise made at outset and the pension plan’s ability to deliver on that promise over time.

This is my big picture idea of Value for Money.

Laurence Churchill has got it right as IGC of the Prudential Pension Plan. His benchmark for success is to achieve a set level of return for policyholders (after all costs). If – over time- the plan exceeds this return, it is achieving value for the money the Prudential is taking for managing the plan, if – over time – it isn’t – it isn’t! It is that simple.

The little ideas are these

Dave Brailsford

The Dave Brailsford way to make our cycling team successful was to set it a high level goal- win lots of medals – and then to focus on lots of little things that could be done well or badly , work out what “well” meant and do them well. Together, these little things made champions.

The gold star pension plan has to do all the little things well to achieve the big idea, the big idea is dependent on the little things but the big idea comes first.

Value and efficiency

There are only two ways you can deliver profits to shareholders of a business. The first is to generate revenues and the second is to minimalise costs. The two need to work together and whether we talk of them in pension plan terms as growth and risk control , alpha efficiency or simply value for money, it’s the same thing. I used value and efficiency as they seemed the closest to an engineered process.

Value – as defined by growth comes in two forms – contributions from sponsors and investment growth (above what can be expected from the financial instrument employed).

Value

Pension Plans can get more contributions from sponsors by winning trust that the plan is worth using. Government can help here by giving the plan an even break – tax relief, the kicker of salary sacrifice, pension freedoms and so on. It can also keep sponsors minds on the plan by not introducing rival ideas like workplace ISAs.

People will put more money in when they see the Plan performing well. Unfortunately “well” is often defined as “going up in value” and clearly this can’t happen all the time without being invested in risk-free assets (which don’t help achieve the long term goal of a pension. So education about the long-term goal and the short-term issues of the stock market is part of the value that the Plan managers should be aiming to deliver.

That said, there is more to winning trust than lectures on the equity risk premium!

Fiona Dunsire

Fiona Dunsire – UK CEO of Mercer went on Wake up to Money this morning to tell listeners that the keys to getting people saving into the Gold Standard Pension Plan were to be purchased from UK Mercer. They took the form of individualised video statements where you were told the likely outcomes of your pension and invited to contribute more to make up shortfall. This is of course a very good idea though I suspect one that is beyond the means of all but Mercer clients!

More generally, the Gold Standard Pension Plan can aim to keep members informed of the value and the money being generated and given and taken and they can do so quite cheaply through the proper use of data and technology. It is unusual for this service not to be available, it is unusual for it to be generally used. Gold Standard Pension Plans will get the reporting on the progress of a plan and the models for shortfall calculations in the hands of members in a way that suits the hands of members and the pockets of sponsors.

Investments aligned to expectations

Critical to the delivery of the overall objective – the long term objective to deliver targeted outcomes, is the correct investment strategy. I do not mean the range of investment options but the investment strategy for those who do not want to choose their investment strategy.

I do not think there’s any doubt that the plan needs to be aligned to the investment strategy. If you choose a bond based strategy, you can expect smaller but more certain returns than an equity based strategy. If you want to provide an optimal strategy for everyone – you may want to diversify between the two and even use wider diversifiers. The point is that you should be able to demonstrate that the objectives of the Plan are in line with the strategy of the default investment.

Clearly the investment strategy needs to be aligned not just to the overall objective , but to the specific needs of each member, it must be dynamic to their lifecycles.

A Plan is for life, not just for saving

A DC pension plan that simply provides a cash sum to its participants is not a pension plan at all, it is a tax-incentivised savings plan and is ducking its primary responsibility, to offer participants a lifelong income (known as a pension).

As Pension Plans (Gold Star or not) become more mature, their capacity to provide a pension for life will be more scrutinised. Pension PlayPen is already downgrading a lot of DC schemes that are not taking up this challenge and we expect to see some real innovation in this area. At the moment we don’t see many Gold Star Pension Plans for those trying to spend their pots, we just see Pension Plans passing the buck to third parties.

Those advanced strategies – such as Alliance Bernstein’s Retirement Bridge – are still only half the way there – they still bale out into annuities rather than more ambitiously running scheme pensions, no one has yet tried to replicate the efficiency of DB pensions in payment.

To a large extent this is because DC Plans are suffering a collective failure of nerve, no-one is prepared to insure longevity , nor even establish self-insured mortality pools from the pots of the thousands of participants in some of our bigger plans.