Updated with clarification
Quantitative limits on allocations to equities or other risky investments can be simpler and more effective ways of controlling retirement income risk in defined contribution plans than risk-based measures, such as value at risk, according to a new report by the influential OECD.
In response to investment losses in mandatory DC plans in 2008 of 20% to 25%, countries around the world are looking for ways to lower investment risks for defined contribution participants, according to an advisory report by the Organization for Economic Cooperation and Development, Paris.
Regulations need to fit the unique needs of each country, but the paper's authors said that for the most risk-averse regulators, setting a ceiling of 30% to 40% equities for DC plans has advantages over risk-based regulations, such as minimum returns or a VaR ceiling. However, the report stressed that there is no one right answer, and trade-offs between risk and returns depend on whether other sources of retirement income exist, cultural attitudes on risk aversions and whether participation in DC plans is mandatory.
However, consultants question whether setting allocation ceilings is ever appropriate for DC plans.
“You're setting limitations that may or may not be appropriate for each individual member,” said Helen Dowsey, principal and head of defined contribution consulting at Aon Consulting in London, calling the notion “just a little bit dangerous.”
Pablo Antolin, principal economist in the OECD'S department of financial affairs and one of the paper's co-authors, said that although “there are no specific (legislative) measures out there … all countries are discussing different aspects of regulating DC investments to ensure — at least in default options — some security.”