Defining Global Best Practices for Retirement Plans

August 25, 2014 ( – Workers in most developed economies are struggling to address the financial implications of increased longevity and a lack of guaranteed income in retirement.

Businesses and governments have long known that financial pressures are seldom confined to a single economy in a globalized and digitally connected world. The retirement readiness crisis familiar in places like the U.S. and the United Kingdom is no exception, according to new research report from Ernst & Young. As a global challenge, the achievement of true retirement adequacy will likely require coordinated action across borders and economies to solve for the long term.

One upshot of the Ernst & Young report is that today’s most retirement-ready countries have done a better job of rebalancing workers’ expectations as financial realities and resources shift. This is especially important in places where the defined contribution (DC) retirement benefit arrangement takes hold, wherein workers adopt much or all of the longevity and investment risk that is held by employers under more traditional defined benefit (DB) approaches.  

Only with the realization that a long-term retirement income guarantee won’t be in place at the end of the road will workers get more engaged in their retirement planning responsibilities, Ernst & Young says. Retirement systems where this fact is acknowledged within relevant policy are therefore more successful at motivating people to prepare for their own retirement. Countries that have allowed or mandated automatic enrollment in private-sector DC plans, for example, are better positioned to fill the gap left by the widespread freezing and closure of DB plans.

The Ernst & Young report also cites the importance of retirement plan service provider engagement with local financial markets. When local financial markets are interested in and capable of responding to demand from DC plan participants, individuals tend to have more success planning for retirement, the research shows.

An example could be providers’ development of target-date funds (TDFs), which are specifically designed to solve the problem of “participant inertia” on critical actions like rebalancing portfolios and tailoring risk tolerance against an investment time horizon. TDFs are expected to hold as much as half of all U.S. DC retirement plan assets by 2020, according to predictions published by industry research groups including Morningstar and Cerulli Associates, among others. Ernst & Young suggests this could be a positive development for retirement readiness in the U.S. and other countries where problem-solving investment products are popularized.

Researchers suggest policymakers and industry professionals should strive make these products more widely available. This can be accomplished by establishing the appropriate regulatory framework for automatic enrollment and problem-solving investment products and strategies, from TDFs and target-risk funds to managed accounts and lifetime-income annuities.  

The Ernst & Young report further suggests retirement systems perform better when they show some level of acceptance for new regulation, supervision, governance and transparency. Participants benefit from an increased focus on operational excellence and efficiency—especially in the areas of investment fees and plan administration. Successful retirement systems are encouraging the use of technology to bring more simplicity and visualization to complex problems, according to the report. They are also sensitive, especially at the participant-facing level, of being more connected and customer-centric.

The Ernst & Young research contends these best practices are present in varying degrees in different countries. The U.S., for instance, has seen strong penetration of TDFs and other tailored investment products, and has also seen the increasing adoption of automatic enrollment. The nation still trails far behind a few other countries analyzed by the Ernst & Young report, however, due to lower average contribution rates and a reluctance to adopt more aggressive “auto-escalation” of annual participant salary deferrals.

The research goes on to argue that implementing best practices is important for both government and business interests. Governments will naturally benefit from greater levels of financial wellness, especially among their oldest citizens, while solving these challenges remains a significant business opportunity for retirement plan and investment service providers.

Interestingly, all of the 80-plus industry executives from across Europe, the Americas, and the Asia-Pacific region interviewed by Ernst & Young cited a need for immediate political reform to solve pressing challenges. Researchers say they are encouraged by the apparent swell of interest in retirement-related political reform, but given the long lead-time required to receive results from reform and the political sensitivity of “tinkering with benefits levels,” new initiatives will require lasting attention and must be broken down into manageable steps.

Ernst & Young suggests global progress requires equipping individuals to make informed saving and investing decisions based on their own unique circumstances. And because the challenge of long-term financial decisionmaking transcends borders, maximizing things like predictability, service provider professionalism, public confidence and ease of investing will be critical for global retirement readiness.

Researchers use data from the Organization for Economic Cooperation and Development (OECD) to suggest that, among countries with well-developed democratic economies, Australia is perhaps the best prepared overall to provide for its citizens’ retirement income needs.

In the OECD analysis, Australia has a “national pension gap” of just a few percentage points—defined here as the measure of how much people in a given country will have to contribute to voluntary pensions/DC plans to lift overall retirement income replacement ratios to the average of OECD nations, which is about 54% of annual income. Norway and Poland, similarly, show small gaps of just a few percentage points.

By this measure, Mexico may be facing the toughest retirement income crises, according to the E&Y report, with a national pension gap in the ballpark of 50%. The result is particularly challenging for Mexico due to the country’s macroeconomic challenges and wage-related issues. The U.S. has a gap of about 25%—trailed only by Mexico and the United Kingdom among well-developed OECD economies on this measure. Interestingly, the U.S., Mexico and the United Kingdom are all listed by Ernst & Young as high-opportunity markets for retirement plan service providers.

In a separate-but-related report, PIMCO argues that the Australian retirement system is set apart by its mandate that employers must contribute 9.25% of pay to employees’ tax-advantaged retirement accounts. This figure rises to 12% by 2020, according to PIMCO, and is most often directed towards a “superannuation” DC program that does a better job of managing longevity risk than withdrawal strategies offered in the U.S. system, where there is less consensus and support on key spending and decumulation questions.  

PIMCO says the U.K. has taken note of the success of Australia’s system. In fact, between 2012 and 2017, the U.K. is set to phase in a requirement for employers to auto-enroll participants at a rate that will increase to 8% of annual pay, with at least 3% contributed by the employer. The opting-out approach seems to function more effectively in the U.K. and Australia, PIMCO says, where many companies report that vast majorities of members defaulted into plans do not opt out.

In contrast to the U.S., once the money is in the Australian or U.K. systems, participants generally cannot withdraw funds until retirement age, even in the face of economic hardship. Clearly, DC account values will build far more swiftly in the Australian and U.K. systems, PIMCO says, given their higher contribution rates and their firmer control of leakage. American regulators are just beginning to study how to slow leakage from DC plans, PIMCO adds.

Australia also excels on asset allocation, PIMCO says, where balanced allocations stand out for including alternatives such as private equity, real estate and hedge funds.

The Ernst & Young report, which provides extensive breakdowns of the retirement systems in a long list of developed nations and economies, is here. The PIMCO report, which focuses on asset-allocation practices across retirement systems, is here.