We recently interviewed 50 public and private sector stakeholders, corporate pension and retirement organizations, and asset managers, and asked: can we reach better outcomes by reimagining pension investment and governance?
Collectively, these represent more than US$10 trillion in assets under management (AUM). Several key observations emerged from the survey:
- The importance of social security, pension and retirement providers
- Gaps in pension governance, operational maturity, investment risk and operating models
- Challenges of increased stakeholder, regulatory and service provider scrutiny
- Technology and lower returns driving pension investment
Respondents’ diversity regarding assets, liabilities and stakeholders reveal varying levels of “exposure” to change. Drivers include asset growth, lower returns and increased market volatility, coupled with higher investment risk taking and global diversification in new markets and asset classes.
Governments, regulators and boards must ask: Are our frameworks and capabilities commensurate and aligned to the new world and to our roles as fiduciaries for the financial and retirement well-being of millions — as managers of pension and retirement assets and as long-term investors?
Providers are sandwiched between governments and regulators, and beneficiaries and customers. The shift to customer centricity, defined contributions and the requirement for member action means that both stakeholder groups should be fully aligned.
We frame 10 hypotheses that are supported by EY analysis and interpretation, based on global client experiences.
1. Governance structures are not aligned with size and complexity — 41% agree
We recommend that stakeholders review and align their governance maturity and frameworks. Assessing and driving this maturity is achieved through leadership and accountability, coupled with strategic ambition, incentives and stakeholder engagement. Supporting transparency and disclosure is pivotal to enable policymakers, regulators and other stakeholders to make informed decisions. It is also paramount to retaining the long-term sustainability of asset and liability solutions and promises, as well as underlying social contracts.
2. Operational maturity is not aligned with size and complexity — 34% agree
The shift to customer centricity (with members responsible for their own decisions) makes organizational maturity paramount to meet expectations, sustain delivery and empower customers to make informed decisions about their financial well-being. A tailored balanced “scorecard” is a useful tool to define stakeholder expectations, ask the tough questions and embark on transformation programs. We recommend that government, policymakers, providers, members and employers align their focus on organizational maturity to size, complexity, importance and behavior. This will enable efficient, effective and sustainable delivery of government policy and customer expectations.
3. Investment governance and operations are lagging — 30% agree
Substantially more robust analysis and provider action is needed to meet stakeholder expectations. It is still too little and too late when we compare the research results with recent regulatory reports, public scrutiny or the activities of professional asset managers. The size of the potential benefits and risks for all stakeholders warrant utmost agility, scrutiny and maturity to protect members’ interests and investment outcomes. We encourage all pension and retirement providers to systematically and holistically review their investment governance frameworks and solutions across their entire investment value chain.
4. Investment risk, governance and solutions are not aligned — 63% disagree
We recommend that pension and retirement providers adopt the highest level of investment risk management maturity, integrating investment risk management into a professional enterprise risk management framework. This reflects the fiduciary role that protects members’ financial well-being. It aligns to an increasing demand for corporate governance and risk management that many providers deploy to their investees. Governments, regulators, members, employers and the public must support the ultimate protection of members’ retirement outcomes, in which investment outcomes play an increasingly pivotal role. A systematic framework that covers all internal and external components and stakeholders is essential to support public confidence.
5. Investment operations and operating models need recalibration — 42% agree
We recommend conducting a systematic root-to-branch review. This shows stakeholders and members that organizations take their fiduciary responsibility seriously, and pinpoints their strategic and operational readiness to deliver sustainable investment outcomes. Review steps are similar across all organizations, but findings, decisions and actions will differ. EY’s investment operating model development process provides a structured framework for a systematic and critical analysis. We expect the outcome of such a process will put organizations in a better position to deliver a sustainable, predictable and, transparent pension and retirement system.
6. Member and public scrutiny and fee pressure are driving insourcing — 42% agree
We recommend that fundamental considerations to further insource — or outsource — investment management be conducted thoroughly. The insourcing decision must include: risk appetite and governance, aligning operating models to overall business and investment strategy, and building the necessary business and IT capabilities to support investment. A commonly neglected aspect in the insourcing debate: how can providers align their new investment and operational risk and risk appetite with that of their beneficiaries and relevant key stakeholders? Typically, beneficiaries expected external asset managers to deliver investment outcomes based on providers’ selection and oversight. In the new world, providers are becoming “asset managers,” often without historic track records.
7. Low returns and fees elevate pressure on cost to invest — 76% agree
As providers adjust their outcome expectations in a lower-return environment, they must remain transparent with customers and clearly communicate return expectations. Scenario planning and stress testing the impact are pivotal to restore confidence and long-term sustainability. Answering the questions posed above must be based on a comprehensive and thorough understanding of asset ownership costs, an explicit business and investment strategy and risk appetite, and a clear vision of how the provider delivers the expected long-term investment and beneficiary outcomes. Tough decisions may be necessary to ensure the financial well-being of millions.
8. Lower returns are driving more investment into alternative asset classes — 69% agree
Alternative asset classes are highly attractive for pension and retirement providers, many of whom are growing their businesses through traditional or insource managers or shared alternative models. In our view, alternative asset class exposure helps increase long-term investment outcomes and financial well-being. But, excess returns and a common longer investment horizon require excess risk appetite, vigilance, governance and organizational capabilities. Increasing alternative asset exposure may act as a catalyst for many providers to fundamentally transform their governance and organizations, as well as increase transparency within communications.
9. Scrutiny challenges partner and outcome management — 72% agree
Many providers rely heavily on an outsourced third-party delivery model. While boards or trustees can outsource their responsibility to deliver, accountability remains with the organization and board. Regulatory recognition of the outsourced model and built-in conflict of interest between members, providers and external commercial interests in many countries is crucial. We recommend that providers review their frameworks to manage service providers and investment managers, including controlling investments, offering clear service level arrangements and creating a board service provider committee to discharge obligations.
10. Technology is creating organizational challenges for providers — 67% agree
Most providers embrace the importance of technology in the delivery of sustainable investment outcomes. But, policy and regulatory design and focus must align with the new world, too. This will more holistically set expectations and support sustainable delivery of investment and member outcomes. We recommend that providers develop a level of investment technology maturity that aligns to the new world. A sustainable, effective and efficient evolution must be based on long-term pension and retirement systems and reforms, investment strategies and operating models, as well as adequate technology architecture.