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The worlds of defined benefit (DB) and defined contribution (DC) are colliding, but according to Mitchem—who, as head of the institutional client group at State Street Global Advisors, would know—there are still large differences between the two types of retirement systems.
“Traditionally, when we speak to clients in the DB space we’re really talking to their investment department and to their treasurer. When you think about DC, the range of actors involved tends to shift. It’s not just the CIO and the investment staff that you’re interacting with, it’s the head of benefits, the head of human relations (HR), the head of corporate communications and often the general counsel—so there are many, many more people that are part of the dialogue. I think historically there has been some tension between the HR group and investment staff with regard to the management of the DC plan, but I think that tension is defusing. HR and investment staff are increasingly aligning behind the challenge of creating DC plans that can help participants achieve retirement security. One of the things that I think drove the friction in the past was that in many cases people on the investment side, who were obviously coming from the pension world, really wanted to bring change to the DC plan. They wanted to shake it up. They wanted to make it more institutionally similar to what they had been doing from an investment perspective with the pension. In many senses, HR was reticent to enact too much change because they recognized that any changes to the plan could be disruptive to the end participants.
When we dialogue with plan sponsors in the DC context, we tend to take a very holistic approach to our interactions with them. We talk to them not only about how they’ve structured their plan from a default perspective, but also about auto-enrollment, auto-escalation, participant communications, average savings rates, and loan balances—all these things which really don’t distinctly reside in the investment bucket and have a material impact on the outcome for a DC investor. In the DB context, the conversations are often about specific investment products, investment focused approaches to liability management, or niche investment capabilities.
At its core, the conversations differ in that DC is more holistic and almost always about outcomes. What can plan sponsors bring to the plan which will improve the chances that participants will achieve significant rates of real-income replacement? Ironically, DC led the market in terms of the outcome orientation through the adoption of target date funds which started pre-crisis. We’re now seeing the outcome-oriented approach, less benchmark relative orientation, adopted more broadly in DB.
Success in DC requires a number of things. First of all, it requires participation and contributions—so that has to be part of what the CIO is increasingly managing and thinking about. Secondly, it involves the construction of a well-diversified investment menu. Thirdly, it requires participants to invest with a balanced and well-diversified asset allocation. Those are the three pillars CIOs are most focused on. It represents a shift from the way that most people think about DB, because the funding mechanism isn’t something that the plan sponsor can control. It’s not a corporate decision. It’s an individual decision.
CIOs will spend more time working on DC issues going forward. I’m not sure that the character of the way they interact around the plan will be distinctly different than it is today, but they’ll spend more time with it. In addition to spending more time on the plan, I also think they’ll be able to explore a wider degree of investment solutions for the participant. The breadth of investment product and the level of customization will vary based on plan size and level of open architecture with the largest plans likely to lead the way.
I think that CIOs will probably focus more on the transparency around realized income-replacement ratios over the course of the next 10 years. In the future, CIOs—while still thinking in terms of things like liability-driven investing for their defined benefit plans—will increasingly think about one central problem, and goal: how to get DC plans to a level at which income is sufficient enough to allow for retirement security.”