For many people, a pension is a thing of the past — something that may have helped their parents or grandparents, but is unlikely to help them. Outside the public sector, where most workers continue to enjoy a pension plan, pensions are largely viewed as a phenomenon in irreversible decline.
We at Common Wealth disagree. Pensions have been and remain the best way for the vast majority of people to prepare for a financially secure retirement. And although pensions have indeed been in decline, that decline is not inevitable.
The pension is a technology whose value today is as great as ever. But that technology needs a update.
The stakes are high. The need for effective, broadly available retirement security is great and is likely to grow. Many people are not on track to maintain their standard of living. Fiscally constrained governments are cutting back on tax-supported benefits. People are living longer but not necessarily better. Wealth inequality has risen, along with the will to do something about it.
Despite the rising demand for retirement security, much of the private market supply that has emerged to fill the gap left by the decline of pensions has been highly ineffective. Driven by an increasingly profitable financial sector, this supply is dominated by costly, individualized, complex financial “products.” Many of these “products” are often not retirement vehicles at all. They are capital accumulation products, wealth management products, savings plans, investment vehicles.
We could continue following this “financial products” path or carve an alternative path — one that, in our view, is likely to create much more value for tomorrow’s retirees. We need to create modern pensions.
Some people think that if a retirement vehicle is not like your father’s or mother’s pension (an employer-sponsored defined benefit plan — take the General Motors pension plan), then it is not a pension. Such a formalistic, ossified definition of a pension impedes creative thinking. The essence of a pension is not a regulatory category (e.g., ERISA), institution (e.g., employer), plan design (e.g., defined-benefit). It is two simple principles: first, a singular focus on providing retirement security; second, a duty and ability to act solely in the best interests of members. Put differently, pensions are efficient retirement fiduciaries. They excel at one thing: cost-effective conversion of contributions during working years into dependable financial security in retirement.
There is no single mechanism for achieving these goals. In the public sector, more traditional employer-focused, defined-benefit models continue to work very well. In Canada, we have created some leading and much-admired versions of these models, which continue to evolve and improve. But in the private and not-for-profit sectors, an increasingly mobile and “gig” based labour force, combined with increasingly short-lived firms, demand new and innovative models.
A key element of modern pensions is the kind of institution that should initiate and sponsor them. Optimal sponsoring organizations should have longevity, scale, and a mandate to serve members or citizens. This could include labour unions, governments, and certain associations. And although some employers or groups of employers might play a leadership role, the employer-centric model of pensions is increasingly ill-at-ease with contemporary social and economic realities.
Modern pensions should hew to some key principles, many of which are embodied by top public pension plans. They should have a sole focus on delivering retirement security for members. They should take a lifetime approach, factoring in both the accumulation of assets during working years and the decumulation phase, focused on payment of benefits in retirement.
Modern pensions should minimize costs, prioritizing low-cost passive investment management unless they have the rare capability to create after-cost value through active management, and focusing on the aspects of investment management that drive the most value, particularly asset allocation. They should favour simplicity over complexity, including minimizing investment and product choice for members.
Finally, but of primary importance, modern pensions should have robust and transparent governance, including oversight by independent boards who have the obligation, the capability, and the authority to vigorously protect the interest of plan members.
In the Anglo-American world, governments have arguably been first out of the gate in introducing “modern pension” models, as evidenced by the UK’s NEST program, the Ontario Retirement Pension Plan, and the state-sponsored plans springing up in such US jurisdictions as California, Illinois, and Massachusetts. There is much more room for innovation and “managed competition” in this space, including for labour unions and associations to create new vehicles to serve the needs of their current and future members.
If we want to reboot pensions, we need more to create a competitive, well-regulated, and well-governed “market” for modern pensions. It is not enough to depend solely on either government intervention, or pure private-sector innovation. Creating this “market” will require action by all three sectors: the public sector, the private sector, and the third sector. If that multi-sector approach sounds daunting, it has a silver lining: it means that — unlike public policy change, which is decided by a relatively small group of government officials — most pension stakeholders have a chance to make a concrete, direct difference in the realm of modern pensions, either by improving plans for existing members, or by taking action to provide pension coverage for some portion of the millions of people with no workplace pension.
Happily, building a modern pension isn’t putting a man on the moon. In Canada (and elsewhere), we already have the parts; governments, unions, and associations with a history of creating and overseeing strong pension arrangements; low-cost passive investment offerings as well as models for active management that have added after-cost value (e.g., the in-house management of alternatives of some of our leading public plans); governance models that are not only much admired but also have a track record of working; and a regulatory environment that is now paying more attention to issues of coverage, adequacy, and innovation in plan design.
Constructing modern pensions may involve assembling or combining existing parts in new ways. But a perfectly good pension can be created without inventing new parts, provided the architects, engineers, and builders take an integrated approach that brings together plan design, governance, investment, administration, and regulatory issues in a holistic way.
The perfect pension shouldn’t be the enemy of the good pension. Having said that, here are four areas of opportunity for improvement that would help create the conditions for modern pensions that are not just good, but great:
- Decumulation — including the creation of non-lump-sum products that are affordable and understandable
- Alternatives — expand access to affordable alternative asset classes aligned with the interests of members — an offering that could be provided by larger public pension funds
- Technology — an opportunity for simpler, more efficient plan administration
- Regulation — a more nimble, integrated, pro-innovation approach
The promise of modern pensions is enormous: a world where all workers have the opportunity to contribute to to efficient, well-managed, dependable pension vehicles; a well-functioning, well-regulated market for such pensions where a combination of government-, union-, and association-, and multi-employer-sponsored and governed vehicles — well-served by a combination of capable for-profit and non-profit asset managers and administrators — compete to best serve the interests of workers and retirees; and, ultimately, a more equitable, caring society that supports its citizens as they age.
A version of this essay was originally presented at the Conference Board of Canada’s Pension Summit in Toronto on April 13, 2016.