Funded pension arrangements, such as defined contribution plans, are playing a growing role in complementing retirement income from public sources worldwide. However, their design needs to be improved, says the Organisation for Economic Cooperation and Development (OECD).
According to the OECD Pensions Outlook 2016 report, the funded pension assets of 13 OECD countries represented more than 50% of the OECD’s gross domestic product last year, an increase from 10 countries in the early 2000s. The funded pension arrangements of seven OECD countries, meanwhile, represented more than 100% of the OECD’s GDP, an increase from four countries in 2000.
According to OECD’s press release, the increased role of funded pension arrangements mostly come from defined contributions and pension arrangements in which there is a direct link between contributions, assets accumulated and pension benefits. However, the OECD warns that while these arrangements have important advantages, they put more of the risk of saving for retirement (for example, investment and longevity risk) and decision-making in the hands of individuals.
“Defined contribution pensions offer some advantages in the current environment of ageing populations, low growth and low interest rates. But as individuals bear more risk and responsibility for managing their retirement finances, we certainly need to focus on improving their design,” OECD secretary-general Angel Gurría says in the report.
Contributors to such pension arrangements have to make important decisions about managing their retirement, including where and how to invest, when to retire and how to allocate their wealth to finance their retirement years.
“In this context, integral components of a policy framework to improve retirement outcomes include the quality, affordability and accessibility of retirement financial advice; availability and sustainability of annuity products that protect individuals from longevity risk; and improvements in financial knowledge,” says the report.
Policymakers need to ensure that people receive financial advice that is appropriate to their needs and that potential conflicts of interest of financial advisers are addressed. “Working together, policymakers and the pension industry need to make sure that policies do not reduce the accessibility and affordability of financial advice — the so-called advice gap — particularly for people with low to moderate wealth. Technology-based advice has the potential to reduce any possible advice gaps.”
Some life annuity products ensure lifelong benefit payments and protect policyholders from the risk of outliving their financial resources. The OECD Roadmap for the Good
Design of Defined Contribution Pension Plans recommends a partial annuitisation of accumulated assets, combining deferred life annuities that protect against longevity risk with drawdown programmes that provide flexibility and choice for individuals.
“However, this requires the sustainability of annuity products and their suitability for consumers. Both can be achieved by having a coherent pension framework to accommodate life annuities, comprehensive product disclosures and a regulatory framework based on principles that allow for flexibility in capital requirements to adjust for changing product designs and that encourage appropriate risk management,” says the OECD.