Creating most effective strategies for old age
One of the great attractions of a defined contribution scheme for an employer is that the investment risk is borne by the employees and the plan provider takes the main responsibility for administration, communication and compliance.
There is then a temptation for companies who have a defined contribution scheme to take a “hands off” approach to retirement plan management.
This approach puts a strong onus on the employees, both in terms of choosing appropriate investment funds and keeping track of performance and fees over time.
Employees could, of course, seek independent advice to help them with this process. However, in reality, this is very uncommon and, as a result, globally many employees end up simply going with the default investment option which may or may not be suitable for their individual needs.
This is part of the reason for the very high proportion of Korean employees who invest their defined contribution balances in short-term, low risk investments. For example, over 70 percent of defined contribution assets are invested in one year principal and interest guaranteed products such as term deposits which are generally the default option. (Regulatory restrictions on the options that can be made available to defined contribution members have also contributed to the allocation to principal and interested guaranteed products.) This will directly impact on the eventual benefits that employees receive.
The “hands off” approach often ends up with employers getting poor value for their retirement contributions. As these contributions typically amount to around 10percent of salary cost, this represents a lost opportunity for the employer, particularly given the evidence that Koreans are worried more than ever about their retirement savings. Indeed, Towers Watson’s 2012 Global Workforce Study showed that only 28 percent of employees feel that they are financially prepared for 15 years of life after retirement, which is well below the global average. This has consequences not only for employee motivation but also for labor force mobility - for example, the expected retirement age has increased for 38 percent of employees covered by the Survey over the past three years compared to just 16 percent of employees who now expect to retire earlier than before.
In this context, we believe that companies have a very important role to play in the management of a defined contribution retirement plan.
In the case of a defined benefit plan, the stakes are even higher for the company given that it is on the hook for making up any investment shortfall. Despite this, the evidence does not suggest that governance processes are any stronger for defined benefit schemes in Korea and, in our experience, investment strategy decisions are often made without setting clear long-term objectives or carrying out detailed analysis of the options and possible longer term consequences.
It is not surprising, therefore, to find that well over 90 percent of defined benefit assets are invested in short-term, low risk products. In our view, by following this approach, companies may be missing a golden opportunity to significantly reduce their long-term costs and risks by better matching the investment strategy to the liabilities.
We find that while many companies in Korea see the benefit of introducing a governance process, they are worried that it will be cumbersome and add to the workload of an already overstretched HR team. The good news is that governance can be as simple or as complex as required, depending on what is appropriate for each company and its employees.
The first step in setting up a governance plan is to set objectives, which should be both operational (for example, to receive an efficient and transparent service from the plan providers and to ensure the plan is run in line with legislative requirements) and strategic (for example, to provide benefits which are appreciated by the employees and support the company’s wider HR objectives around attraction and retention).
Having set the objectives, the next step is to identify the risks faced in achieving them. A risk register is a common and effective way of doing this. Similarly, decisions should be made on how to measure success and key performance indicators established which can be monitored to assess plan performance.
All of these activities should be outcome-based, focusing on the retirement outcomes the employees require and are likely to receive. Likewise, it is important that the governance process recognises that the objectives in relation to investment growth and risk tolerance vary enormously from individual to individual.
Therefore, in order to create the most effective investment and engagement strategies, companies need to segment and profile their employees. Employee perception surveys are also a very effective way to measure and improve engagement.
Regular performance monitoring is then essential to ensure that the objectives are being achieved. At the simplest level, this could be a six monthly or even annual governance report covering performance and outlook for the investment managers and plan providers. At a more sophisticated level this could extend to quarterly reports (the norm in the United States), including analysis of communication materials, employee feedback and benefit competiveness.
This can be pulled together to form a documented governance plan, including a year planner for the plan management.
Finally, consideration should be given to roles and responsibilities in the governance framework. As retirement benefits straddle the HR and finance sides of the company, both areas should be represented in the governance process. A strong case can also be made for getting employees directly involved ― after all this is all about delivering their retirement benefits.
Christian Olsen is a director of Benefits Consulting, Towers Watson Korea.