New generation DC design Jaco van der Walt ICPM, October 2018 Santiago, Chile
DC is evolving from 1.0 to 2.0 and beyond 2 DC1.0 DC2.0 DC3.0 Tax-efficient savings & investment To retirement Retirement income provision Whole of life Integrate accumulation & decumulation Integrated wealth management Whole of life Whole of balance sheet Source: DC Working Group, Thinking Ahead Institute
New generation DC requires an integrated solution 3 Mass customisation Goal-based investing in accumulation Mortality insurance Liability-driven investing in decumulation Investment Insurance Longevity protection Self-help tools Wealth management Guidance Digital interfaces Other assets & debt
Transformational change requires a balancing act 4 Scale Self-help tools Clarity of vision Profit for member Digital interfaces Link to advice Governance & organisational design Board quality Member outcomes Behavioural analytics More affordable annuity Easy preservation & portability Member engagement ALM design Goalbased investing Cost efficiency Fund governance ALM design Member engagement
In DC, governance is a joint responsibility 5 In DB, all decision making and execution is performed by the Fund In DC, the active participation of the member is required, since decision making and execution is a joint effort between the fund and the member Governance in a DC context - a joint responsibility Fund Individual member Design of contribution strategy Design of the decumulation and default investment strategy Design of own choice menu for investments Management of investment portfolios Member engagement Etc. Members need to be assisted with their decision making Choice of contribution rate Choice of investment strategy, if own choice Choice of post-retirement strategy Etc. Member engagement should empower members to manage their choices to reach their retirement income goals
Integrated default ALM design 6 Tracking progress Individual goal True cost of a pension Individual decumulation strategy Funding level Portfolio mix Dynamic adjustment Based on actual choices, fund credit, and member info Based on age, gender, salary, defaults, length of service & prior fund credit Replicating instrument that hedges all the risk High Medium Low Investment strategy Building blocks Drawdown account Goal-based investing Life annuity Accumulation Decumulation
Inputs in the design of the decumulation strategy 7 Retirement goal Behavioural aspects Fund s vision Pension beliefs 10 design principles Member preferences
Decumulation design should align with Fund s vision & pension goal 8 Vision FirstRand Group Retirement Funds Vision To partner with our members in achieving their aspiration of an affordable and secure retirement Pension goal Stable, inflation-protected income for life, maintaining their pre-retirement standard of living
Control for member preferences and behavioural aspects 9 Top 4 member preferences Behavioural aspects Retirees prefer high (rather than lower) income Retirees prefer smooth (rather than volatile) real income stream Retirees do not want to outlive their retirement savings Members place some value on the residual benefit at death Primary concern is running out of money Overestimate early death; underestimate late death Poor understanding of retirement products Loss of cognitive ability post-80 (20% suffer some form of dementia) Low level of trust in advice and financial sector (more trust in employer)
Principles for decumulation design 10 1. Goal should be stable, inflation protected income in retirement, for life 2. Link the solution to spending priorities (essential, desired, aspirational) 3. Secure essential goals, maximise probability of reaching desired goals 4. Solution should be (mass) customised by member specifics (age, gender, income and wealth) 5. Seamless transition from accumulation to decumulation 6. Incorporate member preferences in default design (to be effective for unengaged members) 7. Control for behavioural biases with design features and member engagement 8. Provide tools and information to assist engaged members 9. Design should be transparent, simple and cost effective 10. Delivery preferably via a profit-for-member vehicle
Decumulation design if we had a blank page, in a perfect world 11 Aspirational spending Ad hoc Desired spending Drawdown account (programmed withdrawal) Longevity solution (deferred annuity/mortality pool) Essential spending Strong Pillar 1 (5%+ of GDP) (universal)
Social and market context matters not a blank page 12 Strength of Pillar 1 State old age pension (60) Funded by general tax 1.4% of GDP Means tested Most of our members won t benefit Attitude to collectivisation 1. Pooling for scale to achieve cost benefits 2. Pooling to access more investment opportunities 3. Mortality pooling for early death 4. Longevity pooling 5. Risk sharing to smooth intergenerational returns Labour market dynamics Length of service Attitude to retirement savings Preservation when changing jobs (or leakage) Informal workers Financial market dynamics Large annuity market Deep inflation-linked market Strong insurance sector In-fund annuities are allowed
Decumulation strategy building blocks & individual portfolio strategy 13 Building blocks Individual portfolio strategy Guidance Desired spending Drawdown acct Life annuity Essential spending GATES Based on individual outcomes Mix of building blocks (%)
Decumulation strategy based on individual income needs & wealth 14 Individual portfolio strategy Desired spending Drawdown account <4% Annual drawdown Capital 4.0-4.5% 5.0-5.5% Essential spending 5.5-6.0% GATES Life annuity 6%+ Minimum capital 0% 25% 50% 75% 100% Mix of building blocks (%)
Concluding remarks 15 DC should target retirement income and cover whole of life (DC2.0 model) ALM design, governance and member engagement need to be in balance Consider the Fund s vision, pension beliefs, member preferences and behavioural aspects in setting the design principles for the decumulation strategy Social and market context matters (e.g. strength of pillar 1) Our proposed decumulation design Guided architecture (not default with opt-out) in line with new SA default regulations Two building blocks life annuity and drawdown account Mass customisation of decumulation strategy based on individual member outcomes Mix of life annuity & drawdown account depends on needs-to-wealth at retirement Phasing out of drawdown account before 80 years Offer decumulation strategy in-fund (profit-for-member vehicle)
16 Disclaimer The views expressed in this presentation are those of the author and do not necessarily reflect the views of FirstRand Limited, or any of its entities.