Have the shifting sands from Defined Benefit schemes to Defined Contribution schemes eroded the role of actuaries?
Not long ago, the annual ‘Actuarial Report’ carried probably as much weight as the Annual Financial Report for most major companies offering a Defined Benefit (“DB”) scheme, not only pension funds. The day the report was released carried significance for most executives as it formed an integral part of their KPIs for the year. As such, the role of the Actuary was held in high regard, with most employees having an appreciation of the occupation, even if it was only to the extent that the Actuary’s work would have a significant impact on their own performance review for the year.
Fast forward to today and you can hardly identify an Actuary at a Defined Contribution (“DC”) fund, or at least in the traditional sense. In Australia this shift from DB to DC was exacerbated and accelerated by changes in accounting standards; requiring more information to be captured on the balance sheet, the introduction of the Superannuation Guarantee (“SG”) legislation as well as an increase in job mobility. In fact, there were approximately the same number of Actuaries in the mid 1990’s working in life insurance and superannuation in Australia, compared to today where only 7% of Actuaries work in superannuation in Australia.
The Actuaries that do work for DC funds tend to be associated with insurance related offerings or are those who have honed their asset management skills to carve out some form of investment management function, which is not necessarily because of their Actuarial skillset. Did the purpose of the superannuation system change as a result of the transition from DB to DC? If not, what caused Actuaries to become so irrelevant in pension funds?
The purpose of the system
The purpose of the superannuation system has always been to provide an income in retirement. Historically, an income in retirement was delivered through DB funds, usually based on some form of final salary. This should not be confused with the quasi lump sum DB schemes still on offer these days. The original intent of the DB structure resulted in the balance of costs (therefore all the risks) vesting with the employer. Due to the impediment on most companies’ solvency position, not to mention affordability, the majority of companies decided to close these schemes and instead transferred the risks to the individual (who are often far less equipped to manage these risks themselves) through the establishment of DC funds. What is probably more ironic is that the DB fund closures were largely driven by the Actuaries in the organisations, as they were the ones raising the risks to the companies in the balance sheets (in addition to the changes in accounting standards and introduction of SG legislation). However, with the closure of DB schemes the ‘prescribed’ role and influence of the Actuaries diminished as the ‘liability’ was no longer seen as being an integral part of the objective.
The focus in DC schemes therefore shifted away from providing a retirement income and instead to wealth accumulation, paying little regard (if any) to the ‘liability’ the household continues to face. Despite the fact that the purpose of the system remained unchanged, Actuaries lost their prominence and prescribed roles as pension provision became an ‘investment management’ problem and an ‘asset-only’ league table game. Just looking at the most recent Productivity Commission supplementary report on investment performance, success is still being defined as wealth accumulation and net returns. Where is risk in the conversation, not to mention the risk to an individual’s retirement outcome?
Considering the individual’s risks
The change in funding mechanism from DB to DC did not change the purpose of the superannuation system. Similarly, the risks, have not changed, but instead have only been transferred to the individual. Actuaries are well trained to manage these for companies and funds but have not risen to the challenge to do the same for individuals. Instead, Actuaries have taken a back seat in the DC world and left individuals exposed to the mercy of the rest of the superannuation industry. Considering how the industry defines what constitutes a ‘Balanced fund’ leaves one to wonder whether the industry is likely to align its own objectives with that of the individual and actually inform individuals about risk.
“The superannuation industry seems to have little interest in genuinely informing individuals about risk”
Individuals are in a weak position to assess and compare the risks inherent in their superannuation investments. 2018 saw a number of questionable practices being brought to light by the Royal Commission. However, it has done little in addressing what has been and continues to be measured and rewarded in the industry. Success is still being defined as short-term ‘asset-only’ peer-relative rolling time-weighted investment performance. This only partly resembles what actually impacts individuals’ retirement outcomes and the risks individuals face.
When framing the challenge as a retirement income objective, the risks an individual face are much more complex than only the volatility of the daily marked-to-market unit price. Instead individuals are exposed to a number of other risks such as inflation, real rates, longevity, legislation, sequence of returns, reinvestment, consumption needs, adequacy and outcome certainty to name a few.
Whenever risk is being put forward, the argument gets made that it is too hard to define the risks an individual face. However, we (as Actuaries) are the first to publicly say that ‘We are the leading professionals in finding ways to manage risk’. Historically, our profession would have jumped at the opportunity to solve the impossible. In fact, in 1693 our profession’s predecessors developed an approach to construct a life table and how to use such a table to calculate the purchase price of an annuity. This was done without any of the computing power we have readily available to us these days.
“We are the leading professionals in finding ways to manage risk”
Instead of taking a leading role in DC superannuation, we seem to be skirting around the edges. Why are Actuaries not prominent in helping funds develop risk management strategies for individuals? Why are funds defining the objective as asset-only and ignoring what really matters and impacts on individuals? Why is the main solution ‘advice’? Why are Actuaries not prominent in managing DC funds like they were in managing DB funds, when the objectives and risks are the same?
Don’t get me wrong, there are a handful of pensions Actuaries who are trying to drive change and do have an impact. The most recent Retirement Income Disclosure Consultant Paper issued by Treasury as well as the Australian Government Actuary’s (AGA) Technical paper is a step in the right direction, albeit not perfect. Other good examples are Accurium’s initiatives in the SMSF space, Rice Warner’s market insights and research initiatives as well as Challenger’s calculators.
The role of actuaries
The transition from DB to DC only changed the funding mechanism, however the purpose actually remained the same. The (proposed legislated) primary objective for the DC superannuation system is ‘to provide income in retirement to substitute or supplement the Age Pension’. The objective is therefore not to provide an uncertain lump sum accumulated up to retirement, but instead to target a more certain retirement income.
The Actuary’s role in DC schemes to deliver this objective has been limited to date and only a select few are really driving change to achieve this. The profession needs to re-establish itself as a key contributor to designing and delivering solutions that serve the individual’s best interest and the actual objective of the system. Others have seen the potential and value that we could bring, so why don’t we take up the challenge? The Actuarial skillset was once synonymous with pension provision, why don’t we become that once again!
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by Andrew Ngai