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A new report on the sustainability of the UK’s pension system urges that public sector defined benefit (DB) plans should be closed and replaced with defined contribution (DC) schemes by the end of the decade.

The report, Self-sufficiency is the key – Addressing the public sector pensions challenge was published by the Centre for Policy Studies, a Conservative party think tank. It suggests that all public sector workers earning over £10,000 a year be encouraged to enroll in the National Employment Savings Trust (NEST).

In the report, Michael Johnson, a former JP Morgan investment banker and consultant at Towers Watson, argues that public sector pensions are unaffordable, unsustainable and unfair, likening the current situation to a Madoff-style pyramid, collapsing under the pressures of underfunding and demographic change.

He suggested that all currently unfunded pensions, such as the National Health Service’s pension fund, should be closed by 2020 and replaced with nominal DC schemes.

The government should take advantage of the imminent retirement of baby boomers to phase in new DC retirement offerings as replacements for the aging workforce are hired, he said.

“Moving to a DC basis would have to be on an unfunded basis, i.e. notional DC,” the report said. “There would be no underlying assets, and contributions would continue to flow to the Treasury to be available to pay pensions in payment.”

To address the lack of underlying assets, a system of indexation should be developed, the report says. “In the interests of simplicity and transparency, the government should seed the accounts with index-linked gilts (issued on a cashless basis) in an amount that reflects the annual increase in the state’s liability,” it says.

However, the report stresses that the scheme would not be linked to longevity expectations, allowing the government to avoid additional longevity risk. Members wishing to pursue an investment strategy outside of simple gilt [British Treasury obligations] exposure would be allowed to do so, but at their own risk, with the government’s sole obligation being the servicing of the gilts.

A more cautious approach would see a shift to career-average pensions, with a salary cap in place, with NEST and the notional DC scheme described above providing additional retirement income.

© 2011 RIJ Publishing LLC. All rights reserved.

Britain’s National Employers Savings Trust Corporation, or NEST, is hiring UBS, State Street and BlackRock to manage portions of the money in the state-sponsored, employer-based defined contribution plan set up by the Department of Work and Pensions.   

Five investment “mandates” were confirmed. UBS has won the mandate for passive global equities with its Life World Equity Tracker, which tracks the FTSE All World Developed Index. State Street will manage UK Gilts in its fund that tracks the the FTSE Actuaries UK Gilts All Stocks Index. State Street also picked up another fixed income mandate when it was picked to offer UK Index-Linked Gilts (ILG) through its UK ILG Over 5 Years Index Fund.

In the last two of the announced mandates, BlackRock’s Aquila Cash Fund and Life Market Advantage fund will offer cash and diversified beta funds, respectively. The Life Market Advantage fund aims to deliver returns similar to a 60% equity/40% bond fund over the long term, but with less risk.   

NEST CEO Tim Jones said infrastructure is now in place to test the organization’s systems.

 © 2011 RIJ Publishing LLC. All rights reserved.

New fee disclosure regulations for retirement plan service providers will not be put into effect until January 1, 2012, the Employee Benefits Security Administration (EBSA) announced. ERISA Section 408(b)(2) had been scheduled to take effect July 16, 2011.

“We now believe plans and plan service providers would benefit from an extension of the rules applicability date,” said assistant Labor Secretary Phyllis Borzi said in a statement.

The regulations will require the disclosure of direct and indirect compensation to service providers who receive $1,000 or more in compensation and who provide fiduciary or registered investment advice, offer investment options in connection with brokerage or recordkeeping services, or receive indirect compensation from the plan, EBSA said.

The rules require plans to report legal and accounting fees separately, and to describe the fees that participants must pay to borrow from their plan or to have a qualified domestic relations order processed.

The earliest version of the regulations, which were part of the Pension Protection Act of 2006 and was scheduled to take effect in early 2009. That version rejected by the Obama Administration, which wanted tougher safeguards against high fees and conflicts of interests in the sales of investments to retirement plans. 

EBSA published interim final regulations in July 2010 and received many comments, including suggestions for a summary plan document system to help plan fiduciaries use the cost data, Borzi said.  

© 2011 RIJ Publishing LLC. All rights reserved.

Women in the UK lag far behind men in average pension savings, according to The Telegraph.

British women have a median balance of just £9,100 ($14,620) in their defined contribution “pension pots,” while men have a median balance of £52,800 ($84,820). The discrepancy stems largely from career breaks for child-rearing. Until the early 1990s, employers could ban part-time workers from joining their DC plans, which penalized women in particular.

A pension pot of £9,100 would generate an annual income of just £564 ($906), or less than £11 ($17.70) a week as an annuity, according to Hargreaves Lansdown, the independent financial adviser.

The figures were supplied by the Office for National Statistics in response to a parliamentary question by Rachel Reeves, the shadow pensions minister.

The lack of pensions savings of most women will cause particular problems in the next few years, as women have to wait longer before they receive the state pension, according to critics of government policy.

The State Retirement Age (SRA) for women is being raised from 60 to 65, and then—along with men—being raised to 66 by 2020 under recent plans unveiled by the coalition Government. The age hike comes far sooner than under previous proposals by the Labor government.

An estimated 500,000 women born between September 1953 and March 1955 will have to work at least a year longer than they would have under the previous plans.  

© 2011 RIJ Publishing LLC. All rights reserved.

“Hedge funds are on a tear, and continued aggressive investing is a huge plus for asset prices,” said Vincent Deluard, a vice president of research at TrimTabs.

Hedge funds took in $6.6 billion (0.4% of assets) in December 2010, the sixth straight inflow, according to TrimTabs Investment Research and BarclayHedge.  Industry assets stand at $1.7 trillion, the most since October 2008.

“The December inflow is very bullish for the industry because year-end redemptions typically produce an outflow in December,” said Sol Waksman, founder and President of BarclayHedge.  “We estimate that industry revenue in 2010 clocked in at $53 billion.”

Risk appetite among hedge fund investors is soaring.  Emerging markets funds received $5.8 billion (2.5% of assets) in December, the most since July 2008, while macro funds took in $3.0 billion (2.6% of assets), the most of any hedge fund strategy. Fixed income funds attracted $2.5 billion (1.4% of assets), the eighth straight inflow.

“Macro funds hauled in $13.9 billion last year, which made them the most popular hedge fund strategy of 2010, even though they underperformed the S&P 500 by about 650 basis points,” said Vincent Deluard, Executive Vice President of Research at TrimTabs. “But macro themes have dominated markets, and hedge fund investors count on macro managers to navigate extremely volatile currency markets.  The bulk of last year’s macro inflow hit after the first leg of the European debt crisis erupted in May.”

Funds of hedge funds redeemed $1.3 billion (0.2% of assets) in December, the second straight outflow, and underperformed hedge funds by about 600 basis points in 2010.  Commodity trading advisors (CTAs) received $1.9 billion (0.7% of assets), the ninth inflow in 10 months, as commodity prices gained momentum. Meanwhile, many hedge fund managers have set new high-water marks.

“More than 60% of the managers in our database have recovered from the losses they suffered in 2008,” noted Deluard.  “While the S&P 500 still sits about 8% south of its year-end 2007 level, our Hedge Fund Index is up about 8%. Meanwhile, flows in the past five months rival those of the pre-crisis period. 

© 2011 RIJ Publishing, LLC. All rights reserved.

Dutch pension funds have missed out on more than €145bn ($198bn) in unrealized returns over a 20-year period due to over-investment in risky assets and “lack of expertise,” according to Zembla, a Dutch current affairs TV program.   

Christian Democrat MP Pieter Omtzigt has called for a hearing and debate on the matter in Parliament.

Bureau Bosch, the consulting firm hired by Zembla to analyze Dutch pension fund investment results for the 20-year period ending in 2009, found that Dutch pension funds have allocated ever more to equities since the 1990s, resulting in excessive risk.

As a result, Bosch reported, the two crashes of 2002 and 2008 wouldn’t have had such a devastating impact on the funds if pension funds had stuck with the safer investment strategies of the past.  

Bureau Bosch found that over the period in question Dutch pension funds underperformed the MSCI Europe index, saying that “This underperformance cost nearly €80bn, which amounts to €145bn today if one takes interest and investment returns into account.”

That’s an average loss of €20,000 ($27,300) for each of the Netherlands’ 7.5 million plan participants, Zembla said. 

But consultant Frits Bosch said he never meant to say pension funds should not invest in equities. “In the past, strategic allocations to equities were too high, but this is a tactical game. There are times, such as the present, when fixed income might be riskier than equities. In the short term, it may well be better to invest more in equities.”

On average, Dutch pension funds now allocate 61% to equities, Zembla said. During the 2002 dotcom crisis, Dutch funds lost some €50bn. Their funding ratios dropped from 200% in 1989 to 124% in 2002. The credit crunch of 2008 causes the schemes to lose another €112bn, and the average coverage ratio dropped to just 95%.

Dutch central bank director Joanne Kellermann agreed that the funds “take too much risk.”

According to Zembla, the pension fund industry is wrong in arguing that risky investments keep pensions affordable. Under the more risk-averse asset mix of 1989 (which on average consisted of 10% property, 75% fixed income and just 15% equities) Dutch pension funds would have been €36bn richer today and would have a coverage ratio of 115%, the Bosch report said.

© 2011 RIJ Publishing, LLC. All rights reserved.

Morningstar, Inc. has introduced four new data points for exchange-traded funds (ETFs) that it claims will provide better measures of the total costs and risks associated with investing in individual ETFs.

 Three of the new data points help to quantify the total cost of an ETF by measuring the contributions of an ETF’s portfolio manager to performance and liquidity in the secondary market. The fourth data point measures portfolio concentration in individual sectors or individual securities, Morningstar said in a release.

The new data points are:

• Tracking Error: a measure of how closely an ETF follows its benchmark index on a day-to-day basis. Typically caused by sampling error or incomplete replication of the benchmark portfolio, tracking error can cause an ETF’s performance to deviate dramatically from its index over time. Morningstar is the first in the industry to calculate tracking error on a daily basis.
• Estimated Holding Cost: a measure of cost that takes into account both explicit and indirect expenses and payments, like income to the ETF from lending shares to options traders. This measures long-term deviations from the index excluding intraday volatility.
• Market Impact Cost: a measure of an ETF’s liquidity, by calculating the basis point change in an ETF’s price caused by a $100,000 trade. ETFs with lower liquidity can cost more to buy as large purchases drive up their price.
• Portfolio Concentration: a measure of portfolio concentration in a single or small number of sectors, countries, securities, or credit grades or durations, which can affect investment risk.

Morningstar covers about 98% of the ETF universe, with analyst research reports on more than 400 ETFs and data on approximately 4,500 ETFs. Morningstar has more than 15 ETF analysts globally.

The new data points are available in Morningstar Direct, a web-based global research platform for institutional investors, and through licensed data feeds. The methodology for the new ETF data points can be found at http://global.morningstar.com/ETFdatapoints.

© 2011 RIJ Publishing LLC. All rights reserved.

A Senate bill, S. 267, could require 401(k) plans to tell participants how much monthly retirement income their accounts might generate, National Underwriter reported. The bill was widely discussed last year.

S. 267, the Lifetime Income Disclosure Act bill, was introduced by Sens. Jeff Bingaman, D-NM, Johnny Isakson, R-GA, and Herb Kohl, D-WI. It appears to address some of the concerns of plan providers and plan sponsors. Namely, that they needed a compliant way to express the retirement income potential of a participant’s accumulated savings that would not seem promissory or discouraging to participants.

 Few argue with the rationale for such a disclosure, however.

“The key issue is how to make employees aware of this risk [of running out of money in old age] and how to educate employees about lifetime income issues. The Lifetime Income Disclosure Act would require benefit statements to include the annuity equivalent of an employee’s benefit — a small step, but one that can make a significant difference in beginning to tackle the public policy challenge,” according to a background paper distributed by the Senators’ offices.

The terms of compliance

“Under the proposal, defined contribution plans subject to ERISA (such as 401(k) plans) would be required to include ‘annuity equivalents’ on benefit statements provided to employees. An annuity equivalent would be the monthly annuity payment that would be made if the employee’s total account balance were used to buy a life annuity that commenced payments at the plan’s normal retirement age (generally 65).

“The statement would be required to show the monthly annuity payments under both a single life annuity and a qualified joint and survivor annuity (i.e., an annuity with survivor benefits payable for life to the employee’s spouse).

“The annuity equivalents would only be required to be provided once a year, even where quarterly statements are otherwise required. Thus, where quarterly statements are otherwise required, annuity equivalent need only be indexed on one such statement each year.

“Under this proposal, the Department of Labor (“DOL”) would be directed to issue, within a year, assumptions that employers may use in converting a lump sum amount into an annuity equivalent. Accordingly, employers will be able to base their annuity equivalents entirely on clear mechanical assumptions prescribed by the DOL. Of course, to the extent that a participant’s benefit is or may be invested in an annuity contract that guarantees a specified annuity benefit, the DOL shall, to the extent appropriate, permit such specified benefit to be treated as an annuity equivalent.

Avoiding liability

The DOL would further be directed to issue, within a year, a model disclosure that explains (1) the assumptions used to determine the annuity equivalents and (2) the fact that the annuity equivalents provided are only estimates. This model disclosure would include a clear explanation that actual annuity benefits may be materially different from such estimates.

The proposal also provides employers with a clear path to avoid liability: under the proposal, employers and service providers using the model disclosure and following the prescribed assumptions and DOL rules would not have any liability with regard to the provision of annuity equivalents. This exemption from liability would apply to any disclosure of an annuity equivalent that incorporates the explanation from the model disclosure and that is prepared in accordance with the prescribed assumptions and DOL rules. For example, subject to such conditions, the exemption would apply to annuity equivalents available on a website or provided quarterly.

Finally, the proposal does not go into effect until a year after the DOL has issued the guidance needed by employers to implement the new rules.”

Support from ACLI

The American Council of Life Insurers (ACLI), Washington, is supporting the bill.

“Most workers recognize the need to accumulate retirement assets, but many may not think about the need to manage their assets over the course of a retirement that could last 20 or 30 years,” the ACLI says. “Understanding what a lump sum of $100,000 really means in terms of paying the monthly bills will help countless workers in planning for retirement.”

The ACLI cites survey data indicating that many workers say they would save more for retirement if they knew they were saving too little to generate adequate retirement income. In addition to the ACLI, sponsors have support from groups such as AARP, Washington, and the American Society of Pension Professionals & Actuaries, Arlington, Va.

© 2011 RIJ Publishing, LLC. All rights reserved.

Why do so many people undersave for retirement, take on too much debt, and make poor mortgage decisions? Researchers Mitchell, director of the Wharton School’s Pension Research Council and Justine Hastings of Brown University recently sought to determine whether poor decisions were the result of financial illiteracy or inability to defer gratification.

After reviewing responses to a survey in Chile, Mitchell and Hastings determined that both factors play a role, but that inability to defer gratification, or “impatience,” was a bigger influence on the failure to accumulate adequate savings for retirement.

The two researchers looked at the results of the 2009 Social Protection Survey in Chile, during which each participant was asked to play an “Investment Game” for a gift card. In return for filling out a short questionnaire, each participant received a gift card for use at Chile’s largest grocery chain.

Respondents who completed the questionnaire right away would immediately receive a 5,000 peso gift card (US$8). If he or she decided to fill out the questionnaire later and mail it back in a pre-paid, addressed envelope within four weeks, the gift card would be worth more. The higher amount ranged from 6,000–8,000 pesos in 500 peso increments, and respondents who were willing to wait the longest (up to four weeks) got the biggest gift card.   

The experiment revealed three different types of people: the “impatient” who took the lower gift-card amount immediately, the “efficacious deferrers” who chose the later amount and returned the survey for the higher amount, and the “inefficacious deferrers” who opted for the later higher amount but never sent in the questionnaire to activate their cards.

The more impatient respondents were the ones less likely to have saved a lot for retirement. “Our results show that our measure of impatience is a strong predictor of retirement saving and investment in health,” the researchers reported. Financial literacy, though also correlated with accumulated retirement saving, “is a weaker predictor of sensitivity to framing in investment decisions.”

“These results have implications for policymakers interested in enhancing retirement well-being through addressing shortcomings in behavior and economic decision making that may hinder planning, decision making and investments for long-run financial and physical health,” the researchers said.

© 2011 RIJ Publishing LLC. All rights reserved.

In the first deal to hedge against higher life expectancy for a company pension plan’s working members—as opposed to retirees—JP Morgan has taken on £70 million ($113 million) of longevity risk of the Pall UK Pension Fund, Reuters reported. 

The index-based longevity swap with the trustees of the Pall Pension Fund, part of global manufacturer Pall Corp., has a 10-year term. If the life expectancy improves at a greater rate than specified in the contract, the fund receives an insurance payout.

The first longevity risk bond was issued by Swiss Re in December, which passed on $50 million of its own longevity exposure to the capital market in a bond format. 

How does it work? According to a 2008 article in, “In a swap, the pension scheme or annuity provider agrees to pay a fixed sum (based upon the sum–or principal–that the scheme is seeking to protect from erosion by a specific risk) at certain times to the other party, usually an investment bank. In return, at certain times, the scheme will receive a payment that is calculated upon a floating basis. This is the difference between the assumptions used when determining the scheme’s payments, and the actual position of that risk,” said a 2008 article in Engaged Investor magazine.

 “In a longevity swap,” the article continued, “the fixed leg is based on projected mortality rates, while the floating leg is based on subsequently realized mortality rates. If realized mortality rates are lower than projected, the swap involves a net payment to the buyer (i.e., the pension scheme) and, if the swap has been appropriately designed, this will be approximately sufficient to compensate the pension scheme for the additional pension payments it has to make on account of the mortality of its members being lower than anticipated.”

JP Morgan said on Tuesday the Pall swap contract was based on future values of its LifeMetrics longevity index—a toolkit for measuring longevity and mortality risk in England and Wales, United States, Netherlands and Germany.

“Index-based hedges are particularly well suited to hedging the longevity risk of pension plans with significant deferred and active members,” David Epstein, head of longevity structuring at JP Morgan, said.

JP Morgan is the hedge provider and collateral custodian for the deal, which was structured by investment manager Schroder, to cover the British pension scheme liabilities related to about 1,800 members, with assets of  £120 million.

Only a handful of longevity swaps have been formatted to work for a pension scheme in Britain—around £8 billion worth in the past five years, according to specialist insurer Pension Insurance Corporation.  

In the biggest swap so far, German carmaker BMW offloaded £3 billion ($4.6 billion) of risk from its British pension scheme to Deutsche Bank’s insurance subsidiary Abbey Life last December.

Previous longevity deals have focused solely on pension plan members who have already retired, as hedging against increased life expectancy of members still working has been difficult to measure, JP Morgan said.

JP Morgan belongs to the Life & Longevity Markets Association, an organization of investment banks, insurers, brokers and pension providers set up last year to construct capital market instruments to slice longevity risk into tradable portions. Other current members of the LLMA are AVIVA, AXA, Deutsche Bank, Legal & General, Morgan Stanley, Pension Corporation, Prudential PLC, RBS, Swiss Re and UBS.

© 2011 RIJ Publishing LLC. All rights reserved.

GuidedChoice, the provider of investment advice and managed account services for defined-contribution retirement plans, is launching GuidedSpending 2.0, an update of its retirement income advice program.

Reactions from beta testers and early adopters, including a 13,000 participant Fortune 500 company, have been extremely positive and helped shape the final product offering. This is the first online tool of its kind to be offered to all participants within a plan, rather than just as an executive benefit.

GuidedSpending will be demonstrated in a by-invitation-only webcast for journalists and analysts on Wednesday, 9 February 2011. Chief Architect Harry M. Markowitz, Ph.D., creator of modern portfolio theory (MPT), and Sherrie Grabot, Chief Executive Officer, will explain key features and answer questions.

GuidedSpending was designed to replace the overly simplistic ‘4% rule’ approach long used by financial planners. It addresses the need for an easy way to find a personal answer about the amount of money to withdraw each year in retirement in a way that is both more flexible and more effective. The new tool uses the same sophisticated analytics engine first developed for GuidedSavings, the flagship retirement planning product by GuidedChoice.

“A wise post-retirement policy must steer a course between two dangers: one, running out of money; the other, living too frugally, forgoing conveniences and experiences that the retiree can well afford,” said Dr. Markowitz in a release. “A policy of spending a fixed percent of the retiree’s capital, like the 4% rule—independent of the retiree’s age, wealth, bequest and consumption aspirations, current interest rates, etc.—is likely to eventually run afoul of one or the other of these dangers.”

© 2011 RIJ Publishing LLC. All rights reserved.

To help near-retirement plan participants through the transition from accumulation to income, Fidelity Investments has introduced a new program, mediated by the web and with phone support, called Fidelity Income Strategy Evaluator.

The new program, which Fidelity is rolling out with 200 free, live educational events and seminars at Fidelity branches, worksites and on the Web, was unveiled only two days after Financial Engines announced its Income+ retirement income guidance program (see today’s RIJ cover story) and less than a week before GuidedChoice conducts a webcast on the launch of the second generation of its GuidedSpending program (see news story below). 

Fidelity Income Strategy Evaluator is designed to help investors nearing or early in retirement assess their income needs and structure a portfolio and withdrawal strategy to help ensure their specific sources of retirement income and expenses are aligned throughout retirement.

Participants input estimates of their anticipated income and expenses in retirement, along with information about accounts held outside Fidelity and their current pre-tax income amount and state of tax residence.

The tool takes this information and provides an estimation of monthly income, a suggested “Target Income Mix” (i.e., a combination of investments designed to generate income), an idea of how the client’s portfolio may perform during market ups and downs, a printable report that can be referenced during conversations with Fidelity phone reps about turning savings into income. 

With “Target Income Mix,” Fidelity illustrates the trade-offs of a variety of investment combinations, which may include stocks, bonds, cash and/or annuities, and lets the participant choose.

For solutions, the Evaluator suggests Fidelity and non-Fidelity income and investment products. It helps answer questions like, “How do I turn my savings into a “paycheck” I can receive in retirement?” “How can I maximize my retirement income?” “How can I ensure that my money will last?” and “What’s the potential impact of taxes, inflation and rising health care costs on my savings?”

In addition to the Fidelity Income Strategy Evaluator, and the 200 educational events being hosted across the county and over the Web for the public and Fidelity’s workplace plan participants in February, Fidelity’s income planning program also includes the following components, all free of charge for both Fidelity customers and non customers:

• The Fidelity Guide to Retirement Income Investing (www.fidelity.com/incomeguide) : new online material that includes 13 different interactive modules to help investors learn more about key considerations associated with creating a retirement income plan and selecting an income strategy.
• One-on-one consultations with Fidelity investment professionals.
• A new series of Retirement Income Viewpoints: educational articles with content focusing on three key components related to the income planning process, entitled “Taking On Retirement’s New Normal,” “Smart Strategies for Retirement Income” and “How to Efficiently Turn Savings into Income.”
• Workplace-focused educational resources: Over 25,000 workplace retirement plans where Fidelity is the recordkeeper have adopted the Income Strategy Evaluator. They represent over 10 million participants. Employers have also received a white paper, “Retirement Income Guidance Strategies: Helping Employees Move from Savings to Spending,” and other educational literature.

© 2011 RIJ Publishing LLC. All rights reserved.