Plan design facing demographic, investment challenges

Changes are occurring on both the defined contribution and defined benefit side globally, from new plans that have been introduced to capture non-enrolled workers, to new payout calculations that account for longer life expectancies of plan participants, speakers detailed at Pensions & Investments' Global Future of Retirement conference.

The National Employment Savings Trust Corp., London, in 2012 began auto enrolling U.K. workers without a retirement plan in defined contribution plans, said Mark Fawcett, chief investment officer.

NEST, the U.K.'s £475 million ($738 million) national defined contribution system, uses behavioral economics to persuade workers to remain in the plan, which offers an opt-out feature, Mr. Fawcett said.

“Are you happy to lose out on money from your employer?” one of its e-mails asks, noting that employees who contribute to the pension plan receive free money from their employer in the form of matching contributions.

Another e-mail, citing the plan's low deductions, tries to reassure participants that the plan won't put a big dent in their budget.

Only 8% of participants opt out, he said. NEST originally anticipated an opt-out rate of 20% to 30%.

But Mr. Fawcett also noted it was important to not go too far with a message, and consider the ethics of using behavioral economics.

NEST's target-date funds, chosen by more than 98% of participants, also take less investment risk when people are in their 20s than when they are older.

“This goes against all conventional wisdom,” Mr. Fawcett said.

“When your pot is very small and when you're 22 years old and know very little about the world, it doesn't matter how much risk you take, because your pot is too small. It really matters when you're 35, 45 and 55.”

But younger people are especially disturbed by excessive volatility, he said.

Mr. Fawcett said the plan is covering 2 million workers, but that number is expected to double as more workers become eligible.

Under the law that created NEST, the plan is enrolling workers gradually, with largest firms the first to participate.

He said by 2017, NEST and other private pension schemes that compete with it for those without pension benefits should be covering about 11 million employees.

In another panel, plan executives debated how to best manage longevity risk as plan participants live longer.

Plans in the U.S. and the U.K., for example, are transferring that risk in buyouts, swaps, buy-ins or lump-sum payments to participants. Administrators also are adding alternatives to improve investment results.

Olga Fuentes, the deputy chairman of regulation at the Superintendent of Pensions in Chile, said both increases in the retirement age and the contribution rate of participants might be needed.

Ms. Fuentes said executives at Chile's mandatory defined contribution system are looking at increased fees for employees and employers, as well as financial education to increase awareness of the need to save. She also said the system is exploring the concept of having participants buy annuities before retirement age.

On another panel, Olivia Mitchell, professor of insurance and risk management and director of the Pension Research Center at the Wharton School of the University of Pennsylvania, noted that the environment for incorporating annuities into defined contribution plans remains uncertain.

Ms. Mitchell said challenges from annuities include investment risk, income risk, capital market volatility, longevity risk and inflation risk.

While the shift from defined benefit plans, particularly in the U.S., was a topic among speakers at different panels, others touted the health of their state plans.

Officials at two of the U.S.' largest defined benefit plans, in Florida and North Carolina, noted their plans have been able to maintain a relatively high funded status because of strong investment returns in the past few years. And in the case of North Carolina, its Legislature made a commitment to make up funding shortfalls with additional dollars.

Schorr Johnson, communications manager for North Carolina Treasurer Janet Cowell, the sole trustee for the North Carolina Retirement System, said the $90 billion plan is 94.8% funded, the second-highest ratio in the nation.

Mr. Johnson said the ability to maintain high funding has been enhanced because the pension fund pays no cost-of-living increases to retirees without investment gains. Even then, he said, any COLA benefit must be approved by the pension system's board of trustees and the state Legislature.

The board of trustees recommended a one percentage point COLA increase for the 2014 calendar year, but the Legislature has yet to take up the matter.

North Carolina is a right-to-work state. With unions less powerful, state officials have the ability to restrict benefits when necessary without a political fight, Mr. Johnson said.

Ashbel C. “Ash” Williams, executive director and chief investment officer of the Florida State Board of Administration, Tallahassee, which is the administrator of the $150.4 billion Florida Retirement System, said Florida is also a right-to-work state. Benefits have been adjusted when lawmakers felt it necessary, but have stayed relatively stable in recent years, he said.

Some lawmakers have championed plans to reduce or eliminate defined benefits for state workers, sparking battles in the Florida Legislature in the last two years. But according to published reports, the retirement system's relatively strong funding ratio prompted lawmakers to drop those efforts.

FSBA statistics show a current funding ratio of 86.6%. That's down from before the financial crisis when funded levels exceeded 110%, but it is still relatively strong compared with other state plans.

Mr. Williams said a strong part of the story in Florida has been the growth of the state defined contribution plan, which has helped supplement the defined benefit plan. He said it has grown to more than $9 billion since it was started in the fiscal year that ended June 30, 2004.

Defined benefit retirement plans are thriving in other parts of the world. Statistics presented by consulting firm Towers Watson show retirement assets in Japan, the Netherlands, U.K. and Canada were almost entirely still invested in defined benefit plans at the end of 2014.

In the U.S., however, overall DB assets continued a long-term decline: 48% of retirement assets were in DB plans vs. 52% in DC plans at the end of 2014.

James Comtois and Robert Steyer contributed to this story.