The great pensions switch continues
December 2016

The changes that have taken place in pension provision across the Western world in recent decades represent nothing less than a revolution. The continuing switch away from the traditional defined benefits (DB) model to a defined contributions (DC) approach has gathered momentum to the point at which it is unstoppable. Says Ben Jenkins, global head of transition management at Northern Trust in Chicago:

"We're solidly in the age of the defined contribution pension: estimates by the Washington DC-based Employee Benefit Research Institute suggest that as of 2013 private sector workers in the United States of America were 16 times more likely to have only a DC retirement plan rather than a DB pension."

Since 1979, significant changes have occurred in the kind of employment-based retirement plan that workers participate in, says the Institute; its figures show clearly that DB plans have declined, while DC plans have grown.

In 2013, some 45 percent of private-sector wage and salary workers participated in an employment-based retirement plan. The composition of this participation comprised 33 percent DC only, 2 percent DB only and 11 percent both DC and DB.

Further highlighting the problems with which the industry has been struggling is the UK's Pensions and Lifetime Savings Association's (PLSA) 42nd Annual Survey, published on 7 December 2016. Its findings highlight that costs for operating DB schemes have increased by 37 percent in one year.

Since 2015, the mean running cost of DB schemes has increased by 37 percent from 400 to 546 per member. Smaller schemes, with 5,000 or fewer members, have seen the greatest rise in running costs with an average increase of 63 percent, to 787 per member.

Joanne Segars, Chief Executive, Pensions and Lifetime Savings Association, said: "Our analysis highlights a continuing problem for DB schemes. Higher operating costs, especially for smaller schemes, combined with widening deficit levels mean DB schemes are under pressure as never before. We can't ignore the resulting risk to members' benefits for all but the most strongly funded schemes and for these members the risk is they will lose 15-20 percent of their benefits.

"Our DB Taskforce is currently collaborating across the pensions sector to develop recommendations on how we can change the industry to improve outcomes for members and schemes. Our Annual Survey clearly shows that the running costs of a DB scheme are considerable for all schemes – and even greater for smaller schemes. With over 6,000 private sector DB schemes in the UK the Taskforce will explore the potential of scheme consolidation to deliver better value to scheme members and sponsors."

DC schemes continue to grow in the UK, fuelled by the success of automatic enrolment. Master trusts have played a significant role in automatic enrolment and between June 2015 and June 2016, master trusts enrolled an estimated 1.8 million new members.

Within UK DC schemes, says the PLSA, the average employee contribution rates remain at 4.2 percent (the same as 2015) and employer contribution rates sit at 7.9 percent (8.0 percent in 2015). Savers continue to benefit from low charges, with the average annual management charge of 0.4 percent as it has been for a number of years.

The latest high-profile example of the long-established trend that is the switch from DB to DC saw Indian industrial conglomerate Tata declare its intention to close the old British Steel pension fund in the UK. Continuing travel in that direction means that the former will inevitably one day make like the Cheshire Cat of Lewis Carroll's Alice in Wonderland. DB pension plans in those countries where the trend is most stoutly entrenched will gradually disappear, leaving perhaps only a grin behind on the faces of sponsoring employers.



Revolution breeds revolution

This revolution has introduced new complexity into the investment world. The very nature of DC compared with DB means that the process and structure of the plan vehicles have shifted and will continue to evolve. Asset allocation will take on a different complexion. Those responsible for ensuring that DC contributors have something to show at the end of their working lives will be compelled to move further along the risk-reward spectrum. This will see them increasingly replacing traditional favourites such as bonds and developed market equities with investments in private equity, hedge funds, real estate and so-called emerging markets.

This, in turn, makes the world and everyday work still more exciting for transition management specialists. These practitioners of what is still seen by some as a dark art, are often unsung heroes who can turn their hand to transitioning a DC portfolio into and out of just about any asset class or geography that a putative client might care to think of, with minimal leakage.

The phasing out or transition of DB plans throws up a lot of complex questions about how to execute initial pension plan conversions and mergers and those that subsequently take place within the DC sphere. Says Mr Jenkins: "You need to be a mile wide and a mile deep in terms of knowledge and expertise if you are to switch successfully from executing simple transitions into handling multi-asset multi-disciplinary multi-geography assignments. With potentially dozens of balls in the air at the same time, you need to be good at everything. We have a transition currently in progress which has six different plans trading at the same time with 30 to 40 different managers. DC transitioning will test your ability as a risk and project manager."

Not just anyone can do it, he avers. "You need a back story, a history of being in the business, a track record. Your team needs to be intellectually curious, ready not only to ask the right questions but to identify the answers that will help to minimize liability to risk and react to changing conditions."

Illustrating the variety that is an essential feature of his work, the quickest transition in which he has played a role took two days from the client giving the formal authorization to completion, while the longest spread over almost a year from start to finish.

"The two-day transition was unique," he explains. "The client was fully invested and woke up one morning to discover the entire team looking after its assets had been lifted out overnight. They contacted me and, as Northern Trust was the custodian, we were able to fast-track the process.

"Generally speaking, though, the days when you could do everything in a short timeframe are gone. While the majority of DB transitions could be done in a single trading day, DC transitions take longer to plan and execute, as they have a lot of moving parts. It is not just trading in itself you have to worry about, but also managing cash in and out and checking trades. If you are a Chief Investment Officer at a DC plan you don't want to do it too often. Generally, clients don't use our services more than once every 12-18 months."

Successful DC transition in a nutshell

Hire a transition manager early: For a typical DB plan's asset restructuring, the transition manager is usually engaged shortly before the start of the event. A DC transition, however, will require considerably more planning and coordination.

Co-ordinate quickly: Communication between all parties involved in the restructuring will be critical in the days leading up to the event and during the transition itself.

Formulate an action plan and prepare a timeline: a timeline of the event should be completed at least one month prior to the start of the event.

Prepare a liquidity plan: The transition plan must include a strategy to provide sufficient liquidity to accommodate participant activity.

Be prepared for every eventuality: unexpected stuff will happen.

Source: DC Plan Transition white paper by Northern Trust

Ben Jenkins Global Head, Transition Management, Northern Trust




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The changes that have taken place in pension provision across the Western world in recent decades represent nothing less than a revolution. The continuing switch away from the traditional defined benefits (DB) model to a defined contributions (DC) approach has gathered momentum to the point at which it is unstoppable. Says Ben Jenkins, global head of transition management at Northern Trust in Chicago:

"We're solidly in the age of the defined contribution pension: estimates by the Washington DC-based Employee Benefit Research Institute suggest that as of 2013 private sector workers in the United States of America were 16 times more likely to have only a DC retirement plan rather than a DB pension."

Since 1979, significant changes have occurred in the kind of employment-based retirement plan that workers participate in, says the Institute; its figures show clearly that DB plans have declined, while DC plans have grown.

In 2013, some 45 percent of private-sector wage and salary workers participated in an employment-based retirement plan. The composition of this participation comprised 33 percent DC only, 2 percent DB only and 11 percent both DC and DB.

Further highlighting the problems with which the industry has been struggling is the UK's Pensions and Lifetime Savings Association's (PLSA) 42nd Annual Survey, published on 7 December 2016. Its findings highlight that costs for operating DB schemes have increased by 37 percent in one year.

Since 2015, the mean running cost of DB schemes has increased by 37 percent from 400 to 546 per member. Smaller schemes, with 5,000 or fewer members, have seen the greatest rise in running costs with an average increase of 63 percent, to 787 per member.

Joanne Segars, Chief Executive, Pensions and Lifetime Savings Association, said: "Our analysis highlights a continuing problem for DB schemes. Higher operating costs, especially for smaller schemes, combined with widening deficit levels mean DB schemes are under pressure as never before. We can't ignore the resulting risk to members' benefits for all but the most strongly funded schemes and for these members the risk is they will lose 15-20 percent of their benefits.

"Our DB Taskforce is currently collaborating across the pensions sector to develop recommendations on how we can change the industry to improve outcomes for members and schemes. Our Annual Survey clearly shows that the running costs of a DB scheme are considerable for all schemes – and even greater for smaller schemes. With over 6,000 private sector DB schemes in the UK the Taskforce will explore the potential of scheme consolidation to deliver better value to scheme members and sponsors."

DC schemes continue to grow in the UK, fuelled by the success of automatic enrolment. Master trusts have played a significant role in automatic enrolment and between June 2015 and June 2016, master trusts enrolled an estimated 1.8 million new members.

Within UK DC schemes, says the PLSA, the average employee contribution rates remain at 4.2 percent (the same as 2015) and employer contribution rates sit at 7.9 percent (8.0 percent in 2015). Savers continue to benefit from low charges, with the average annual management charge of 0.4 percent as it has been for a number of years.

The latest high-profile example of the long-established trend that is the switch from DB to DC saw Indian industrial conglomerate Tata declare its intention to close the old British Steel pension fund in the UK. Continuing travel in that direction means that the former will inevitably one day make like the Cheshire Cat of Lewis Carroll's Alice in Wonderland. DB pension plans in those countries where the trend is most stoutly entrenched will gradually disappear, leaving perhaps only a grin behind on the faces of sponsoring employers.



Revolution breeds revolution

This revolution has introduced new complexity into the investment world. The very nature of DC compared with DB means that the process and structure of the plan vehicles have shifted and will continue to evolve. Asset allocation will take on a different complexion. Those responsible for ensuring that DC contributors have something to show at the end of their working lives will be compelled to move further along the risk-reward spectrum. This will see them increasingly replacing traditional favourites such as bonds and developed market equities with investments in private equity, hedge funds, real estate and so-called emerging markets.

This, in turn, makes the world and everyday work still more exciting for transition management specialists. These practitioners of what is still seen by some as a dark art, are often unsung heroes who can turn their hand to transitioning a DC portfolio into and out of just about any asset class or geography that a putative client might care to think of, with minimal leakage.

The phasing out or transition of DB plans throws up a lot of complex questions about how to execute initial pension plan conversions and mergers and those that subsequently take place within the DC sphere. Says Mr Jenkins: "You need to be a mile wide and a mile deep in terms of knowledge and expertise if you are to switch successfully from executing simple transitions into handling multi-asset multi-disciplinary multi-geography assignments. With potentially dozens of balls in the air at the same time, you need to be good at everything. We have a transition currently in progress which has six different plans trading at the same time with 30 to 40 different managers. DC transitioning will test your ability as a risk and project manager."

Not just anyone can do it, he avers. "You need a back story, a history of being in the business, a track record. Your team needs to be intellectually curious, ready not only to ask the right questions but to identify the answers that will help to minimize liability to risk and react to changing conditions."

Illustrating the variety that is an essential feature of his work, the quickest transition in which he has played a role took two days from the client giving the formal authorization to completion, while the longest spread over almost a year from start to finish.

"The two-day transition was unique," he explains. "The client was fully invested and woke up one morning to discover the entire team looking after its assets had been lifted out overnight. They contacted me and, as Northern Trust was the custodian, we were able to fast-track the process.

"Generally speaking, though, the days when you could do everything in a short timeframe are gone. While the majority of DB transitions could be done in a single trading day, DC transitions take longer to plan and execute, as they have a lot of moving parts. It is not just trading in itself you have to worry about, but also managing cash in and out and checking trades. If you are a Chief Investment Officer at a DC plan you don't want to do it too often. Generally, clients don't use our services more than once every 12-18 months."

Successful DC transition in a nutshell

Hire a transition manager early: For a typical DB plan's asset restructuring, the transition manager is usually engaged shortly before the start of the event. A DC transition, however, will require considerably more planning and coordination.

Co-ordinate quickly: Communication between all parties involved in the restructuring will be critical in the days leading up to the event and during the transition itself.

Formulate an action plan and prepare a timeline: a timeline of the event should be completed at least one month prior to the start of the event.

Prepare a liquidity plan: The transition plan must include a strategy to provide sufficient liquidity to accommodate participant activity.

Be prepared for every eventuality: unexpected stuff will happen.

Source: DC Plan Transition white paper by Northern Trust

Ben Jenkins Global Head, Transition Management, Northern Trust




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