need to be clear, rigorous, and tangible. Each local plan will be able to prove whether it meets the requirements of these clear principles. The UK’s Pensions Regulator put a great deal of effort into proposing effective principles for high-quality DC design, and we have drawn upon their work and others’ in the suggestions that we include in the following.
Suggestions for Core DC Plan Guiding Principles
■ Principle 1: Plans should be designed to target appropriate outcomes, for example, replace 50 percent of final pay throughout retirement.
■ Principle 2: Plans should identify, evaluate, monitor, and manage key DC risks, for example, volatility, potential loss (value at risk), inflation, and longevity.
■ Principle 3: Plans should have a clear governance framework to implement a global retirement benefits philosophy, with clear and transparent accountabilities and responsibilities.
■ Principle 4: Plans should provide ongoing governance, regulatory oversight, and investment training to plan fiduciaries necessary to competently fulfill their duties.
■ Principle 5: Plan design, investments, service providers, and fees should be reviewed annually by the organization’s global DC plan oversight body or other designated bodies.
■ Principle 6: Plans should seek recordkeepers that provide timely, accurate, and comprehensive records as well as appropriate disclosure on error resolution, fees, and services.
■ Principle 7: Plan member communications should educate and guide participants toward informed retirement planning and investment decisions.
Having established the overarching philosophy for retirement program design, and the core guiding principles that guide every plan, organizations next need to consider local factors and finalize the retirement benefit objectives for each plan.
This is the point at which most companies recognize that a one-size-fits-all approach to DC design probably will not work. For plans operating in more than one market, understanding the local labor market demands for each country in which the organization is operating is critical. No matter how many markets a plan serves, organizations need a clear view of the design of first pillar or first source Social Security benefits and the resulting income replacement targets, the competitive landscape benchmarked against other employers competing for the same talent pool, and statutory requirements. These and other considerations will help each plan to define its specific retirement benefits objectives.
Please note we are not suggesting that for multinational organizations, every plan within the organization should have similar objectives, or have the same design or providers. Rather, we would expect to see retirement benefit objectives that are philosophically consistent across all plans, and with the same core principles underpinning their design.
We believe that organizations that have not established the core objectives for each local plan risk a great deal. Without objectives, measuring the local plan’s success – and therefore measuring return on investment for pension costs that affect the financial performance of the entire company – is virtually impossible.
Once objectives are set at the local level, most organizations find the design and investment structures underpinning each local plan are broadly similar, again excepting for local market nuances (for example, providers or legal restrictions).
The first two steps of the five-step process require high-quality and clear communication across all the retirement benefits teams within an organization. Adhering to the core philosophies and guiding principles would be challenging without effective monitoring, along with engagement of senior leadership and broader stakeholders. Organizations should periodically revisit their guiding principles and objectives to ensure they evolve to meet the changing objectives of the corporation itself, alongside the needs of its employees. To achieve this, organizations should create a governance oversight structure that taps into the expertise of both in-house and retained investment, benefits, and other experts. The oversight structure establishes and evolves the guiding principles and philosophy for DC design, engaging key stakeholders throughout the organization. Critically, the structure allows for monitoring the plans for adherence to those core principles and for measuring the success of each plan relative to its objectives.
To effectively monitor DC efforts, organizations should establish clear success metrics. Since most DC plans aim to provide retirement income replacement, a percentage of final pay may be an appropriate success metric. Such a metric may be used internally to evaluate the plans; it need not be communicated to participants for fear they may construe the objective as a promise. Without clear objectives and the means to demonstrably measure progress against them, any retirement benefits program will be effectively “flying blind.”
The final step in the process will be to assess and manage key implementation considerations that will underpin the final plan designs. These will include recordkeeper and custodian capabilities among many other considerations.
In July/August 2011, Judy Mares, at the time Chief Investment Officer of Alliant Techsystems Inc. (ATK), shared in a PIMCO DC Dialogue the five guiding principles that they established to guide the plan changes. She explained the following:
To start, we established a set of five guiding principles to help our policy committee as they thought about the plan design.
■ First, we decided that we wanted to continue to deliver retirement benefits consistent with the company’s business objective of providing employees with a solid foundation for retirement income.
■ Second, we wanted to encourage and facilitate our participants’ establishment of a final income replacement rate based on personal facts and circumstances and desired retirement income.
■ Third, we needed to continue to educate participants about the factors that influence retirement income adequacy, such as cost-of-living increases, medical costs, longevity – the various factors that are key to the development of a financially successful retirement.
■ Fourth, we sought to offer a plan design and fund lineup that seek to minimize the negative effects of participant behavior. We looked at as many behavioral finance studies as we could get our hands on, and certainly that body of literature suggests that we should imbed structures in the plan that are more opt-out than opt-in.
■ Fifth, we strove to implement a plan fee and expense methodology that’s understandable, transparent and reasonably applied across all participants. We could see that the Department of Labor was moving in that direction. But equally important was the sense that individuals could be better consumers when they know what things cost. Fee transparency helps people understand that component of decision making.
Finally, we presented these principles to our policy committee and gained approval. Then we started to look at the plan design, asking how the plan design addresses these principles, and whether we should think about doing things differently.
PIMCO PRINCIPLES FOR DC PLAN SUCCESS: BUILDING AND PRESERVING PURCHASING POWER
A key tenet of PIMCO’s own DC principles is that success is defined as “building and preserving purchasing power to meet retirement income needs for the majority of participants, regardless of the prevailing economic environment.” This definition has a subtle but incredibly important undertone, namely that the average outcome for participants is not enough on its own as an objective. Instead, as shown in Figure 1.1, the distribution of those outcomes across participants is critical. Think of it as a principle: Avoiding failure for some is as important as marginal gains for the majority. Said another way, we seek good outcomes for all plan participants. This principle requires a success metric (and accordingly an objective threshold to be defined) for avoiding failure, not just for achieving success. In