Going beyond DB vs DC for the ultimate pension

One constructive consequence of the global financial crisis, according to the director of the Rotman International Centre for Pension Management, Keith Ambachtsheer, is the exposure of defined benefit and defined contribution scheme designs as inadequate. Amanda White spoke to him about alternative pension models and the most cost-effective delivery mechanism.

The turbulence in markets has been a catalyst for some navel gazing in the global pension market, which has the two-fold effect of re-examining pension design and the institutional elements that need to be in place to deliver cost efficiency, according to Keith Ambachtsheer, director of the Rotman International Centre for Pension Management (ICPM).

“I hope that what comes out of this cycle of market turbulence is that the defined contribution versus defined benefit debate diminishes into a discussion of what the best system should look like.”

And there is an awakening of that question, according to Ambachtsheer, who points to pension funds, government and regulators in Canada, Australia and The Netherlands which are all regarding optimal pension plan design with some seriousness.

The answer will depend, to some extent, on local considerations, and how various countries deal with how to develop to the best pension systems will be one of the questions posed at the ICPM conference, which will be held in Toronto in June.

ICPM aims to be the bridge between investment academics and practitioners, and has 23 research partners in the US, Europe, Asia and Australia, mostly made up of large pension funds including the Australian Future Fund, PGGM, Mn Services, OMERS, the Washington State Investment Board, Nomura Research Institute, USS and the Ontario Teachers Pension Plan.

“The opportunity the financial crisis has created is that the old approaches are faulty, but it needs everyone to get together,” Ambachtsheer says. “Everyone has their own hammer and thinks theirs is the best, but it requires integrative thinking.”

In Ambachtsheer’s view, the optimal pension system is a target-benefit approach, and he has developed a proposal for a Canada Supplementary Pension Plan, which combines the best of both defined benefit and defined contribution plans.

It has three basic tenets: a retirement savings accumulation/decumulation formula likely to generate adequate, affordable post-work lifetime payment streams; complete workforce coverage and job-to-job portability across Canada; and pension delivery by institutions that are transparent and cost-effective, and operate solely in the best interests of the people they are meant to serve.

Ambachtsheer is widely recognised for his out-of-the-box thinking on pension governance, finance and investment issues. He founded his own firm, KPA Advisory in 1985, and was also one of the founders of CEM Benchmarking, which benchmarks investment and administration services of more than 500 pension funds globally.

Now the ICPM and CEM are collaborating to analyse the data and some preliminary results that raise some interesting inferences regarding the cost-effective delivery of pensions.

“The financial crisis has highlighted there have to be effective institutional elements in place to deliver the goods cost efficiently, which raises questions of scale, governance, and insourcing versus outsourcing.”

On average, according to his research, a 10-times increase in membership size is associated with a $108 drop in benefit administration costs per member. Similarly, in the investment database, on average, a 10-times increase in the dollar value of the funds is statistically associated with a 0.17 percentage point drop in total investment costs.

In addition, size not only gives funds a cost advantage, it also gives a performance advantage because the larger funds typically invest more in private equity and alternatives assets, with a larger overall allocation to passive management.

But just how big is big enough?  It’s a question that is also up for debate. The chief executive of the Ontario Municipal Employees Retirement System, Michael Nobrega, was recently quoted as saying his fund with $44 billion was not big enough to deliver the quality and depth of governance, investment skills and risk management expertise its members need and deserve.

According to Ambachtsheer, who says any fund under $20 billion is too small, the reality that scale produces better outcomes for members should be reflected in the public policy and strategic plans of pension funds.