Your Pension Section Council recently sponsored the second Retirement 20/20 conference, entitled “Aligning Roles with Skills.” The conference followed an exciting year for the council as the discussions and results of the 2006 conference were featured in industry and national publications. Almost 70 participants from the U.S. and Canada, including actuaries, academics, attorneys, plan sponsors, public policy professionals, investment managers and others, met in Washington, DC in September to debate how best to design roles for three key stakeholders (employers, society, and markets) in 21st century retirement systems.
How the 2007 Conference Came Out of the 2006 Conference
The first step in 2006 was to consider what the new retirement system needed to achieve. The first conference considered individuals, employers, society, and markets as each having a role in the retirement system. For each stakeholder, participants were asked three key questions:
- Who has what needs?
- Who can bear what risk?
- Who can play what role?
Six key themes emerged from the 2006 conference. The six themes focused on how retirement systems (the combination of social insurance, private plans, and individual savings) should work as a whole. The system:
- Should be designed to self-adjust
- Should align stakeholders’ roles with their skills
- Should consider new norms for work and retirement, and the role of the normative retirement age
- Should be better aligned with markets
- Should clarify the role of the employer
- Will not succeed, in the U.S., without improvements in the health and long-term care systems
The six themes are explored in depth in the 2006 conference report, which can be found at www.retirement2020.soa.org.
The seed for the 2007 conference was found in one of the 2006 headlines: aligning roles with skills. Participants at the 2006 conference discussed the fact that individuals aren’t the best suited for retirement planning or deciding how to invest retirement assets, and an employer’s goal in business usually isn’t to operate a pension plan. This misalignment of roles with skills creates problems in today’s retirement system.
For 2007, we set out to determine what the optimal roles are for our various stakeholders. Defining these roles properly is critical for the success of the system. The right role would be one which uses each stakeholder’s knowledge and talents optimally. So, market experts would work in the markets, and employers could focus on their core business. Defining the stakeholder roles is also necessary before beginning to design the new features of the new retirement system.
The 2007 Conference
So for 2007, we focused on role definition. Particularly:
- Which stakeholder is best suited to take on what role?
- How do you allocate roles based on stakeholder skills?
- How do these role assignments affect other stakeholders?
Roles were considered for three of our stakeholders:
- Society. Society in this case is society at large: all citizens and particularly all taxpayers who have to pay the cost of any retirement system designed. In this case, government (including politicians) acts as an agent or representative of taxpayers/society. Taxpayers include current taxpayers and future taxpayers, those who may end up paying for unfunded mandates. Society as a whole is often concerned with issues of intergenerational balance (more money spent on retirees means less money to spend on children and infrastructure) and the redistribution of wealth (social insurance systems, such as U.S. Social Security and CPP/QPP often pay progressive benefits, where wealthier taxpayers receive less money relative to their earnings or contributions than less wealthy taxpayers.)
- Markets. Capital markets are where the accumulation and decumulation of wealth takes place. For purposes of our discussion, markets include financial intermediaries (e.g., insurers, mutual funds) who take the raw product of the capital markets and turn them into solutions for individuals and groups. Markets are a key to the success of the new retirement system. They can reduce the cost of retirement risks by providing the proper hedges (e.g., longevity bonds).
- Employers. Employers play a key role in today’s retirement system, as the sponsors of defined benefit and defined contribution plans, in both the U.S. and Canada. Employers also have motivations that may drive them to want to sponsor retirement plans – as a tool to help attract, retain, motivate, and eventually retire their workforce.
The conference was organized into three “panels.” Each panel began with expert speakers, chosen to present diverse views of the issue, who introduced the topic. After the panel introduction, the participants broke into four pre-assigned working groups to discuss the issue in more depth. A spokesperson then reported the consensus (or lack thereof) of their group back to the full conference. We then moved on to the next panel, which proceeded through the same phases. At the end of the two days, conference participants were given the opportunity to vote for their favorite themes (those that they felt were the most important) from all of those that emerged out of the discussions. The balance of this article will focus on the key themes that emerged.
Panel 1 – Role of Society
This panel opened the conference. The speakers were Malcolm Hamilton (Mercer) and Virginia Reno (National Academy of Social Insurance), and the moderator was Anne Button. Malcolm and Virginia presented an overview of how and how well the social insurance systems are working in Canada and the U.S. Their presentation was followed by a discussion of the proper role of society in providing retirement security and a debate regarding the role society should take with respect to retirement savings. Conference participants then considered these questions, as well as whether society should protect people if they are forced to retire before they planned and whether society should encourage individuals to work longer.
The primary conclusion of conference participants was that the role of society is to provide structure to the retirement system. This comes about primarily through three main roles:
- Help individuals make right decisions
- Set some guidelines about what “ought” to happen
- Provide consumer protection
One goal of society with regards to the retirement system is that it wants to ensure that today’s workers save enough that they aren’t a burden on tomorrow’s taxpayers. Society, when focusing on the roles of helping individuals make the right decisions and setting guidelines about what “ought” to happen, could achieve this particular goal by doing the following:
- Encourage lifetime income (annuitization). First, conference participants felt the basic social insurance benefits ought to be structured as lifetime income, and they should maintain their progressive element. Participants discussed whether flat-dollar benefits were better, however introducing negative incentives for individual behavior and the surrounding bureaucracy around means-testing was thought to outweigh any potential savings. Secondly, as a rule, society should mandate or encourage the annuitization of retirement savings. It could do this by mandating or encouraging the annuitization of a portion of savings (e.g., up to a dollar level or percentage of pay). Note that this could be done through tax mechanisms: annuitization could be tax-favored, or not annuitizing could carry tax penalties.
- Accumulation of retirement wealth. Conference participants felt that society should take an active role in helping individuals accumulate funds for retirement. This could be done in several ways. One way would be for society (the government) to mandate a minimum level of savings and encourage more savings (e.g., through tax policy). Another way this could happen would be to set up a mandatory second-tier program that would exist in addition to the social insurance system (Social Security in the U.S., CPP/QPP/OAS in Canada). This second-tier system might be thought of as a mandatory “pension” plan which employers or individuals could elect to opt out of. This idea was revisited and developed more fully in the role of the employer discussions.
- Oversight. Society has a responsibility to set the rules and regulations, to provide oversight to the system. This occurs in several ways. First, society provides basic oversight for consumer protection. Secondly, it encourages some degree of standardization to allow consumer comparability. Finally, in providing oversight, the government also needs to “get out of the way” to allow and encourage evolution. The example noted most often was removing barriers to phased retirement and later retirement that could help encourage new patterns of work and retirement in an individual’s later life.
Two last observations that arose from the discussions on the role of society:
- Participants felt strongly that society should not set any direction regarding retirement age. Some people have argued that society ought to be encouraging later retirement, particularly for knowledge workers, as this will help to avert the “retirement crisis” by keeping people in the workforce longer (paying taxes into the social insurance system without yet collecting benefits). Conference participants felt that society should neither encourage nor discourage earlier or later retirement.
- Participants felt that society should have an actual retirement policy, not just a tax policy. Tax policy is certainly one way to influence the behavior of individuals. But, conference participants noted again and again the need for oversight, standardization of products, and education of participants – three potential goals of society that are unrelated to tax policy.
Panel 2 – Role of Markets
The panel on the role of the markets opened with a lively discussion from Keith Ambachtsheer (KPA Advisory Services) and Zvi Bodie (University of Boston), moderated by Bob North. The panelists discussed the imbalance between the markets and the very sophisticated individuals who work in the markets, and the individuals who need the markets to help them manage their retirement risks. This is partly due to a lack of symmetric information (market makers and financial intermediaries have more information than users of the market, particularly unsophisticated users such as individuals). Do you fix that asymmetry by using buying cooperatives (unsophisticated individuals band together to hire an agent who understands the markets) or do you offer guarantees (consumers don’t have to understand how the car is put together because it comes with a manufacturer’s warranty)? In identifying a solution, one must consider that buying collectives may not achieve what is desired if their agents don’t have the proper incentives.
The animation of the panelists spilled out into the working groups, where participants considered how the markets can best be used to hedge retirement risks. They considered whether the informational asymmetry that the panelists discussed could be better handled by focusing on variety or standardization (particularly of products), whether we should focus on designing better solutions for individuals or encouraging increased formation of groups, and how to get all of this done.
Participants concluded that it is very important, when we think about the retirement system, to consider how we use the markets. Structure became a recurring theme, because it was felt that a little bit of additional structure would help the markets work better. Participants saw this structure represented in the following four characteristics of a new retirement system:
- Groups. Markets work best when groups approach the markets. One participant quoted a study where groups (in the form of institutional pension funds) performed at least 200 basis points better than individuals (in the form of mutual funds) when all other factors were controlled for (the difference was largely, but not completely, attributable to fees). Conference participants felt that large groups were best, that groups could be either for-profit or not-for-profit, and that competition among groups was essential. A for-profit/not-for-profit model could mean that you could have government agencies establish groups, as well as insurers and other financial institutions who establish groups that individuals or employers could elect to join. Competition is necessary to ensure that participants experience the best outcomes (groups that have to compete would be more efficient than groups that do not compete).
- Incentives. Agents help groups (and individuals) use the markets better, but agents need proper incentives. Agents in this case can include agents working with a large group (such as investment managers, actuaries, administrators) and agents working with individuals on their retirement plans (such as financial planners). One conference participant works at a public pension plan, and described the principles they use to run their fund (run it like a business, don’t do in-house what they can purchase cheaply, reward employees competitively to maintain talent). The discussion on how to give agents the right incentives to work on behalf of individuals included disclosure of costs/fees of products (both as a dollar amount and a percentage) and a better alignment of agents’ compensation with the interests of the group members (for example, agents’ bonuses increase when group members’ benefits increase).
- Standardization. Conference participants discussed whether market innovation or standardization was necessary, and came to the conclusion that a degree of market standardization was important going forward. Markets need to offer standardized products so consumers can comparison shop. Today, while specialized features on products such as annuities can be very helpful, it’s difficult, if not impossible, for most consumers to determine if the special features add value. The analogy was made to U.S. Medicare Supplement plans, which are standardized into twelve basic designs (made a bit more complicated by the introduction of Part D) to allow price comparison by seniors. One advantage of standardization in the retirement system context would be that middle income consumers who had a relatively small amount to annuitize (say $50,000 to $100,000) would be able to get more for their accumulations, given that standardized products should improve comparability, increase competition, and drive down prices. For these consumers, an additional $10 of monthly benefit would come at a lower price than at present, in the long term, all other things being equal.
Conference participants discussed whether there should be standardized products (e.g., standard form for a life annuity with a 10-year guarantee period) or standardized features (e.g., “guarantee period” option works the same on all annuity forms). Participants clearly felt that standardized products were necessary because standardized features did not clear up enough of the confusion. However, the development of standardized products would not mean that insurers and others could not offer products that were not standardized.
- Innovation. We need to encourage market innovation, particularly in the development of instruments that can hedge retirement risks. Markets have become very efficient at hedging financial risks. For example, the ability to sell mortgages on the secondary market has greatly increased the pool of money available to middle-income consumers for mortgage loans. However, retirement risks are somewhat different than most financial market risks. Pension plans and annuities have long tails on their obligations. We know today that, in the U.S., the supply of long bonds is far outstripped by the potential demand (from pension plans and insurers), and what long bonds do exist don’t match the duration of pension plans and insurer obligations. In addition, systematic longevity risk (the risk that a cohort of individuals will outlive expectations for that cohort) is not a risk that markets can currently hedge. This can make annuitization, in particular, very expensive. Markets must be encouraged to develop the instruments to meet the needs of tomorrow’s retirement system.
One thing was clear from the markets panel discussions: markets need to work better. To some extent, this may happen by changing how we use the markets (using groups and agents), but we also need to make the market work better for the retirement system (some standardization, and more innovation). Defined benefit plans sponsored by employers arose in an era before many of today’s hedging vehicles were developed. We ought to be able to both better exploit what the market is doing today, and also demand more from the markets, as we design better retirement systems.
Panel 3 – Role of the Employer
Rounding out the two-day conference was a panel that explored the role of employers in the retirement system. Panelists Elaine Noel-Bentley (Alberta Local Authorities Pension Plan trustee) and Robert Patrician (Communication Workers of America), with moderator Mike Archer, worked through what role, if any, the employer should have in a retirement system. Their discussion covered points such as whether the employer ought to have a role (yes), whether that role should be mandatory or voluntary, whether the employer role should be to put aside money for employees (capital financing), to provide payroll deductions to the employee’s fund of choice (facilitate savings), to act as a “trusted agent” to determine the best accumulation and decumulation vehicles, and whether the employer should ever be the guarantor of the retirement promise (as they are today in defined benefit plans). And finally, critically, if not the employer, who?
The working groups debated these same questions at length and basically came out agreeing that employers ought to have a role in a retirement system, but that role could look very different from the role they play today. Today, their role in the retirement system is really based on a binary choice: they sponsor a plan (DB or DC) or they don’t. There are some circumstances where they can offer access to a plan (e.g., universities and TIAA-CREF) and some circumstances where they participate in industry-wide plans (e.g., multi-employer plans), but these are limited.
When thinking about the role of the employer, the working groups developed the following possibilities:
- Facilitator. Participants felt that employers should continue to play the role they do well today in terms of facilitating employee savings. Payroll deductions are a powerful tool to help employees prepare painlessly for retirement.
- Educator and trusted advisor. The working groups also focused on the role of the employer as educator and trusted advisor. We know that employees trust their employer to give them unbiased information about retirement accumulations. In addition, the employer can truly be an unbiased agent – the employer realizes no monetary gain from the choice the employee makes, and in fact may be biased to ensure that the employee plans well, which would assist the employer in easing the employee out of employment were this to become necessary or desirable later on.
- Elective employer roles. Other possible employer roles include purchasing agent, distributor of income, and guarantor. As a purchasing agent, the employer might select groups for employees to participate in or investment funds that meet specific retirement targets and provide superior performance at a reasonable fee level. Many employers play the purchasing agent role today with defined contribution plans and other employee benefits. As a distributor of income, the employer would help employees to structure the transition from accumulation of wealth to creation of lifetime income. Employers wouldn’t necessarily guarantee the lifetime income, but they would help structure the choices, such as by setting up preferred arrangements with insurers and other third parties. Finally, the employer could act as guarantor, a role it has played historically in defined benefit plans, whereby the owners of the business (taxpayers for public plans) guarantee some or all of the retirement risks faced by employees. One way this might differ from the traditional defined benefit sponsor role would be that the employer might choose to guarantee part of the risk (e.g., longevity risk) but might pass other risks back to the employee, or hedge them on the markets.
Ironically, by opening up a debate on the appropriate role of the employer, we can begin to entertain the possibility of mandating “second-tier” coverage as one feature of the new retirement system. Second-tier coverage in the U.S. and Canada has been, to date, employer-sponsored pension plans (with the first tier being social insurance). One criticism of the current private employer retirement system is that it has never covered the majority of workers. Small employers in particular are unable to play a role, because the cost and risk of sponsoring a pension plan are simply too much for them to bear.
If there were plan sponsors other than employers, and if the employers’ role could be simply to ensure that a payroll deduction makes it from the employer’s bank account to the plan of choice, then you could mandate participation in the system. We already mandate participation in the social insurance system (with some exceptions), and the employer’s role in its financing and administration (to remit contributions on behalf of itself and its employees). There could be opt-out options for employers (permitting an employer to sponsor its own plan) and/or for employees (permitting employees to elect to contribute to a plan of their choice).
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