Mercer recently completed its 2009 Global Defined Contribution Survey, covering a wide range of topics related to defined contribution (DC) trends in 33 countries across Continental Europe, Asia Pacific, Latin America, the US and the UK. The breadth and depth of this survey make it unique in the industry, with more than 1,500 responses received, including over 300 from multinationals. The survey is extensive and reveals several interesting insights. We focus here on four key areas: approaches and objectives, reactions to the financial crisis, investing, and plan management.

Approaches and objectives

When asked to self-identify their approaches to DC management, most plan sponsors across geographies chose the “facilitator” role. This is characterized by the phrase “We will provide a market-standard DC plan and education to enable employees to make adequate provision for themselves.”

One could read this data as an unfortunate erosion of paternalistic care for members. On the other hand, facilitation may in fact be the ideal philosophical outlook for a modern DC plan sponsor. DC schemes have been very effective at shifting risk and responsibility to members. However, one could argue that they have not been very effective at providing members with the support they need to properly plan for retirement. As long as plan sponsors view their “facilitation” roles as providing more robust member education and decision support, we would view this as good news for members and DC schemes in general.

We also asked respondents to indicate their reasons for sponsoring DC plans.

The top three responses represent an interesting frame across social and business motivations, and can be viewed as spanning a spectrum between business and social motivations.

Enterprises are increasingly viewing their DC schemes as business tools subject to the same ROI standards as other investments. However, there remains a strong set of social motivations for continuing to provide schemes for employees. While this trend can cause friction with social partners and the occasional cynical press article, it can also lead to a healthy balance.  Mercer recommends that enterprises embrace this trend by reassessing their objectives in offering DC schemes and mapping these goals onto effectiveness measures that can be tracked year over year.

Reactions to the financial crisis

As the survey was fielded in the midst of a severe financial downturn, it was important to assess the impact of the crisis on DC plans. Employers were asked about recent and anticipated changes to their DC contribution levels. 

A large majority (86 percent) of employers have decided not to make changes to their DC contribution levels over the next 12 months. A small proportion (9 percent) had already implemented a permanent or temporary decrease or suspension in DC contributions at the time of the survey, with an additional 5 percent considering suspension or decrease over the coming 12 months. These results are consistent with two other surveys Mercer conducted over the last year. (See “Leading through Unprecedented Times” on mercer.com).

The results signal employers’ ongoing commitment to funding their DC schemes. Of course, in some countries DC fund levels are less flexible. However, the results were consistent across countries such as the US, Canada, the UK and Hong Kong.

As noted above, Mercer attributes this commitment to providing DC plans to two key motivational factors: 

We also asked employers about their members’ reactions to the crisis. Measured globally, the top three reactions were:

• Asked about DC plan investment performance (49 percent)
• Changed their personal DC plan asset allocation (41 percent)
• No reaction (39 percent)

The same top three responses persist for Canada, the UK, Europe x-UK, and Asia Pacific. The US reported the following top three responses:

• Changed their personal DC plan asset allocation (60 percent)
• Decreased or stopped voluntary contributions (42 percent)
• Asked about DC plan investment performance (39 percent)

Member inquiries about investment performance are understandable. Given the magnitude of asset erosion, global uncertainty and wide media coverage, members are in need of information, and they go first to their employers for answers.

The prevalence of asset allocation changes by employees, as reported by their employers, is not surprising. While general market data from service providers – in particular, from the US – indicate a trend toward inaction by the majority of employees, it would be expected that some DC members would change their allocations to try to actively manage their way through the crisis. The survey did not gather detailed data on the underlying asset class changes, so it remains unclear if the changes that were made were sensible or panicked reactions, or something in between. 

The fact that over a third of sponsors indicated that their employees have had no reaction to the financial crisis is interesting. Not only was “no reaction” among the top three responses globally, it ranked as the most prevalent response in the UK (58 percent) and Latin America (57 percent). An optimistic reader of the data might conclude that these members had been educated on risk and long-term investment principles and, therefore, are calmly riding out the storm. However, other indicators in the survey point to a different conclusion. When asked to rank the risk sources in their schemes, plan sponsors identified the following top three issues:

• Sufficiency of member communication and education (63 percent)
• Market and investment risks (60 percent)
• Poor member decision making (40 percent)

Clearly, employers are concerned that members do not fully understand the risks or possibly even their ownership of those risks. Seen through that lens, perhaps we can infer that the high occurrence of “no reaction” reveals a disconnect between members’ understanding of risk and their actual ownership of it.

There is, however, good news, too. Employers overwhelmingly indicate that plans are in place to improve member communication and education going forward. This was identified as the most common area of planned changes. Improved member decision support is proof positive that employers take their roles as facilitators seriously, even as they move away from the more paternalistic approach of the past. DC schemes are effective at shifting risk and responsibility to members. There now appears to be a healthy trend toward a desire to provide members with the tools they need to manage those risks and responsibilities.

Investing

The economic downturn has influenced members and sponsors around the world. Not surprisingly, one of the greatest challenges facing sponsors is poor investment returns (just under 60 percent). However, what is a little surprising, particularly given when this survey was sent out, is that limited member understanding is seen as being even a greater challenge (just over 60 percent). We see this as good news. Experience and behavioral finance research support the view that members struggle with financial decisions. Sponsors should address the issue, and the survey results seem to indicate a trend in that direction.

Interestingly, only a third of respondents plan to change their investment options or structure over the next two years. Of those planning changes, the most common expected change is an increase in the number of options offered, followed by an introduction of lifestyle or target date funds.

Number of fund options

As shown in the following chart, the number of funds varies dramatically, depending on the region.

In the US and Australia, fewer than 20 percent of sponsors plan to increase investment options over the next 12 to 24 months. The intent of sponsors to increase investment options is more prevalent in Asia (26 percent) and Latin America (34 percent), both of which currently have fewer fund options in place. 

Mercer supports sponsors’ intentions to improve the DC scheme investment architecture.  However, we caution against a simple increase in the number of choices. Members are often overwhelmed by excessive choice. Sponsors can alleviate that negative side effect by limiting choice to a smaller set of high-quality investments or by reengineering the decision-making process. For example, a scheme might offer three “choice environments” tailored to match the decision-making preferences of investor segments.

Lifecycle funds

The use of lifecycle-type funds as a default option (including target date, target risk and lifestyling) varies by geography. In the US and the UK, over 90 percent of sponsors indicate usage of lifecycle funds. Interestingly, lifecycle investment options are rarely used in Australia (although there has been more interest in the past 12 months). Canada is another region whose usage of lifecycle funds (18 percent) is very low. No respondents from Latin America reported usage of lifecycle funds as a default.

Of the sponsors that confirmed that they have a default investment option, lifecycle funds (including target date, target risk and lifestyling) are the most common instruments, currently used by 67 percent of respondents. And 90 percent percent of sponsors that are considering adding or changing a default option are looking at lifecycle funds. 

Mercer supports the use of lifecycle investments as default options. However, their application can differ by geography, and some countries allow for even more tailored options.

There is no question that DC retirement programs have been affected by the economic crisis. Given the challenges sponsors face with their investment lineup, Mercer suggests that all sponsors regularly undertake three action items to better ensure that participant needs are met, regardless of the future economic environment.

1. Review the appropriateness of target date funds (if offered), glide path and construction methodology, or consider including them in plans (if not offered).
2. Determine how much risk each fund is taking within the plan’s lineup.
3. Consider a tiered investment structure or the “choice environment” concept to improve communication to participants.

Plan management

Recent economic events have brought to the forefront the particular risks associated with multinationals’ DC plans. Sponsors are becoming increasingly aware of the need to manage risks associated with DC plans and to monitor costs more effectively. The survey examined how multinationals currently manage their DC plans and what the goals of plan management will be going forward.

Current global plan management

More multinationals in the survey (44 percent) responded that they manage and oversee their DC plans’ management in a centralized manner than by any other approach. The ways in which companies execute central oversight varies; while some have a single global committee with responsibility, others have multiple global committees or rely solely on one or two individuals in the corporate head office.

Nevertheless, 32 percent of organizations still leave oversight completely up to local management. It is important to note that DC management approaches differ significantly by geography. The most obvious divergences are in Asia and Latin America, where 50 percent of companies manage plans locally. We would expect this given the relative developmental stage of these markets, but believe that they may follow more developed markets in centralizing DC plan management over time.

While some multinationals have central oversight on all aspects of DC plans, most companies are concerned with specific areas of risk. Design is the area in which centralized corporate decision making is most common. Approximately 71 percent of companies make DC design decisions at a global level (some based on recommendations from local management). Another area in which centralized decisions are made is in the selection of providers. Approximately 49 percent of multinationals around the world have central approval of providers. Nevertheless over one-third of companies leave provider decisions completely to local management.

Areas of risk

It is interesting to note that while approximately 36 percent of multinationals leave decisions regarding default/member investment options to local management, sponsors cite market and investment risks as one of their top concerns related to establishing DC plans. The other risks multinationals associate with DC plans are set out below.

Governance going forward

An important question plan sponsors will face on both local and multinational levels is how to minimize risk in a cost-effective manner. Companies no doubt will choose different governance frameworks to suit their organizational cultures and geographic footprints. Over one-third of sponsors (both centralized and decentralized companies) plan to move toward more centralization of DC plan oversight in the next 12 to 24 months. Among those employers that are moving toward central oversight, top reasons for doing so are:

• Risk management (48 percent)
• Economies of scale (44 percent)
• Consistency in benefit design across regions (39 percent)

Companies now recognize the need to manage their DC plans globally in order to minimize risk and obtain efficiencies. It is critical to establish clear authority and responsibility as a first step. Through intentional plan management, sponsors can achieve cost savings and, at the same time, initiate value-added improvements for their employees.

More communication and education needed

Even as plan sponsors take on more of a facilitator role, there are many aspects of plan management, both business and social, that have to be considered in order to keep costs under control and help employees understand the importance of saving for retirement. The financial crisis and the move from DB to DC plans around the world have amplified the need for increased employee communication and education related to the financial risks associated with the investments they are making. Provider risks can be managed through best-in-class governance policies, either global or local. We will see increased use of these lifestyle funds, so sponsors will need to determine the most appropriate ones for their members.   

The 2009 Global DC Survey reveals a number of important insights for DC plan sponsors. Its timing in the context of recent economic turmoil further underscores the survey as a useful tool for sponsors, providers and other participants in the DC supply chain. Mercer took steps to enhance the survey’s value by including benchmarking capabilities. We encourage enterprises to request a copy of the full results and to take advantage of this unique window of time to reassess their plans.