Asset managers and private markets are ill equipped to provide the defined contribution (DC) products that match savers lifestyle and retirement needs, experts have warned.

David Blake, professor at Cass Business School, and Stefan Lundbergh, non-executive director at AP4, said DC savers’ requirements were far off current offerings across Europe.

Speaking at the OECD Roundtable on Long-term Investing in Paris, Blake, head of the Pensions Institute in London, said mathematical analysis showed the optimal decumulation for DC savers was phased annuitisation.

This was based on the idea that a member’s human capital, their ability earn a greater salary, was classed as an asset in the fund.

This means, if a younger member expects earnings to increase, he could use human capital to replace his bond holdings and take greater risk with equities.

As the member ages, the fund would take on more bonds and then exchange these for annuities as human capital continues to decrease.

Blake also lamented the lack of matching assets to back U-shaped annuities and said this had significant implications on DC schemes’ ability to invest long term.

U-shaped annuities provide a high level of income in initial retirement, before falling to match a dwindling lifestyle, and then increasing again to cover long-term care costs.

This creates the need for pension plans and annuity-like products and cashflows to be provided outside of the insurance industry, Blake said.

Commenting on the changes announced to the UK retirement system, which remove the need for single and compulsory annuitisation, he said there remained a risk providers would not seize the opportunity to provide the right products.

“New fund managers coming into the UK that do not have experience of the decumulation market do not understand the risks and will treat this as a new opportunity to manage assets and maximise returns, without realising what the pension plan has to do,” Blake said.

He warned that the UK might shift into a US-style 4% system, where DC plans annually drawdown 4% but run significant risk of not accounting for longevity.

“With two groups of people [consumers and asset managers] not understanding the risks and not delivering products that deliver these cashflows, DC is the last thing in town, and it could be discredited,” he said. 

Lundbergh, meanwhile, said he personally did not believe the market was capable of delivering an adequate solution to DC requirements.

“If you just leave it to the market, you will get an asset management product,” he said.

He said any solution would require government intervention, particularly in markets lacking the “social partner” structure.

“The little thing we need is the understanding from the regulators on how to fix the markets so it works,” he said. “You need to add something to get market to function better.

“Investing is a means to an end. If you have a great design on your pension retirement product, then investment is the way to achieve that.

“A lot of the new DC products are contract-based and a retail model, and it is very difficult to adjust this model to [David Blake’s model].”

The National Employment Savings Trust (NEST), the DC master trust backed by the UK government, recently launched a consultation on its future investment and decumulation design given the Budget changes.

As part of this, NEST said it would study the possibilities of combining annuities and income-drawdown products internally, as well as collective DC.

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