As the rest of the pensions world contemplates a move away from defined benefit investing, Australia, in its upturned fashion, is considering how to offer its members an actual pension.
Defined benefit (DB) funds account for 70 per cent of the world’s pension funds, according to Towers Watson. Furthermore in the largest five markets excluding Australia, which are the US, Japan, UK, Canada and the Netherlands, defined benefit funds make up 57 per cent, 98 per cent, 61 per cent, 96 per cent and 93 per cent, respectively.
Australia, which sits between Canada and the Netherlands as the fifth largest pension market in the world, has a split completely in reverse, with 81 per cent defined contribution (DC).
This means that the Australian industry has a lot to learn from other countries as it, not so gracefully, tries to solve the disconnect between the accumulation and decumulation phases of its DC schemes.
Policy makers and industry participants in the Netherlands have been spending the past year or so contemplating a move towards a “defined ambition” structure.
And in the US, jurisdictions that have traditionally offered DB public pension structures, including Alaska, Kentucky and Michigan, are looking at introducing DC funds, or hybrids, for new members.
A recent paper by APG, which manages the assets of the giant €426 billion ABP, looks at combining the best elements of DB to a DC structure by replicating real deferred annuities.
Finding a solution to the Australian dilemma will involve a change of thinking by funds. The DC structure is essentially a savings account, and as such is dominated by wealth management thinking.
Defined benefit, on the other hand, is a fully integrated product and is an insurance or risk-based offering.
Whole-life income
The paper’s author, APG-intern Jens van Egmond, says the study rests on the premise that people want income over their whole life.
“A real annuity is the best way to achieve that and you can only get that in a defined benefit scheme,” he says.
Stefan Lundbergh, head of the innovation centre at APG, says DC funds are essentially wealth management or active management solutions. “That makes it easy to communicate that your wealth is growing,” Lundbergh says. “A real pension solution delivers future cash flows, of which the net present value is much more volatile than just wealth accumulation. That’s a very difficult thing to communicate.”
