How to Build the Best DC Plan (the JP Morgan Way)

JP Morgan Asset Management’s Paul Sweeting has taken experiences from around the world and come up with the ultimate defined contribution plan blueprint.

(January 28, 2014) — The world’s best defined contribution (DC) fund would be a combination of Denmark’s ATP, Switzerland’s occupational benefits system, and the Chilean advanced life delayed annuities, according to JP Morgan Asset Management.

Paul Sweeting, head of strategy for Europe at the firm, has spent the past few months analysing DC funds from around the world in the hope of finding transferable models which could be used to create the ultimate DC pension.

While each model has been designed to fit the specific parameters of their demographics and regulations, there were many aspects which could be transported, he found.

The best format, Sweeting decided, was for a combination of drawdown funds and collective annuitisation in large-scale, multiemployer pension funds.

There are two levels suggested for the basis of a DC fund: a basic level and a supplementary level. The basic level would borrow heavily from ATP’s system, and includes the following features:

1) A contribution based on a fixed percentage of earnings, 80% of which should be paid into a matching fund to ultimately provide a collective deferred annuity;

2) The matching fund should invest in assets which have cash flows that match annuity payments;

3) The remaining 20% should be invested in a growth fund which would go towards paying the collective current annuities and covering any falls in the matching fund due to longevity increases;

4) This growth fund would not be guaranteed, but it would have to be completely exhausted before any benefit payments could be cut; and finally

5) Actuarial adjustments could be used to increase the retirement age if longevity increases resulted in the growth fund being used more to fight that problem than to fill any shortfall in the matching fund

Importantly, the choice of whether to defer their annuity or take the current collective one would be down to the individual.

For the supplementary level, Sweeting borrows from the Swiss occupational pensions system and Chile’s advanced life delayed annuities.

Unlike the basic level, 80% of contributions would go into a target date fund intended to convert to a decumulation fund at retirement, 16% of the contributions would be paid into a matching fund that would be channelled into the advanced life delayed annuities, and 4% would go into the growth fund.

“This approach would allow investors to take more risk with assets at the basic level, but would convert the decumulation challenge from an open-ended problem to one with a fixed endpoint,” Sweeting wrote.

“Furthermore, because the advanced life delayed annuities would be collectively provided, they would not attract the significant capital requirements associated with the policies provided by insurance companies.”

The payback for all of this is that the ultimate guarantee behind pension funds would be lost, Sweeting said, but the growth fund should provide a significant cushion against an economic disaster affecting pension payments.

The full paper, which also includes analysis of the UK’s proposed defined ambition idea and further investigation of how a drawdown fund should be created, can be found here.

Related Content: DC Participants Record Little Investment Responsibility and DC: The Next Frontier for Fiduciary Management