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KPMG LLP (UK

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Investment for Defined Contribution Schemes
DC Market developments • As more companies provide a DC pension scheme for new employees, and as significant money has flowed into these schemes, the market has grown exponentially over the past few years. • This market growth has led to significant innovations in all areas of DC including service delivery, administration, communication and investment choice. • On the investment side, more products have become available and cost efficient for DC pensions, and the capabilities of administrators to tailor and blend together bespoke strategies has increased dramatically. • In particular, alternative investments are being made available and some of the new developments in the DB space – such as Diversified Growth Funds – have also found an application in DC funds. DC pensions delivery • There is an increasing trend in the UK pensions market to move from trust-based DC schemes that sit within a trustee framework to contract-based plans where members have personal control over their plan benefits, investment choices and options at retirement. • Cost efficiency and bundling of services (investment and administration) are key drivers for change in the market. Modern DC plans exploiting the best of what is available in the market can generate material savings for the corporate sponsor. hese T savings can either be used to enhance employee support programmes or to introduce wider benefits. • At the same time, governance is becoming more important in both trust-based and contract-based DC arrangements. Both types of arrangements can create a good framework for oversight of general plan administration and complete flexibility over investment options.

Over the last few years there have been many developments in DC product design that allow for the less costly provision of more efficient DC investment options. We highlight some of the changes and illustrate our latest thinking.
Background • Today most employers have a DC pension scheme in place, often alongside a legacy DB scheme. • While historically the focus of pension fund trustees and corporate HR and finance managers was on effectively managing the DB strategy, we now see an increased focus on the cost-efficient provision of state of the art DC pension arrangements. • A large number of DC pension investment arrangements were set up with simplicity in mind. his usually included an off-theT shelf lifestyle option consisting of a passive equity fund and a limited range of equity and bond funds.

Evaluating DC investment
Same expected replacement ratio

Growth asset = Diversified growth fund Frequency Growth asset = passive equity Note: Sample replacement ratio analysis, for illustration only

0%

25%

50%

75% Replacement ratio

100%

125%

150%

© 2010 KPMG LLP , a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

the most common measure used is the replacement ratio. a UK limited liability partnership. • When modelling replacement ratios. • In our experience. Lifestyle structure 100% Cash fund 80% Cautious Growth Fund can include: 60% • Passive UK Equities • Passive Global Equities 40% • Corporate Bonds • Property • Diversified Growth Fund 20% Matching fund 0% 25+ 20 15 Years to retirement 10 5 0 © 2010 KPMG LLP . • There are additional governance benefits. a replacement ratio of 30% means the pension is expected to be 30% of a member’s final salary. Different lifestyle strategies can then be delivered based on a simplified self-selection process reflecting a cautious. most notably the contributions paid. We therefore believe it is extremely important to have an appropriate default fund option. a Swiss entity. This default should be a lifestyle fund that switches the member out of growth assets over a predetermined period before retirement. such as the “XYZ Pension Scheme Cautious Growth Fund” . . – hanging the de-risking or switching periods will also C impact the spread of expected replacement ratios. • Technical improvements at DC administrators and providers mean that a selection of individual funds can now be blended together and white-labelled as a bespoke new fund. DC Lifestyling – Growth portfolios • There have been significant developments in respect of the structure and composition of the growth / accumulation investments that comprise the early part of a lifestyle strategy. changes to the investment strategy that aim to maintain an expected return but diversify the asset base can materially reduce the dispersion of expected replacement ratios. with a wide spread indicating a larger possibility of lower replacement ratios. • This can help achieve a similar expected return and replacement ratio as for a passive equity strategy. i. All rights reserved. • The expected levels of replacement ratios depend on a number of factors. but with significantly lower expected risk. For example. This is the ratio of the expected pension to the final salary. is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative. a large majority of members do not make an active investment choice in a DC scheme. • It is best practice to encourage choice and investor education through offering more than one lifestyle option. the investment strategy utilised and the time to retirement. • The wider variety of fund options now available and affordable for DC schemes allows a more broad-based growth portfolio to be constructed. • These blended funds make member communication significantly easier and can be used in lifestyle strategies. as it is easier to replace component funds within a blended and white-labelled bespoke fund without complex member record keeping. a lower expected spread of replacement ratios.The Replacement Ratio • When reviewing the effectiveness or success of a DC investment strategy. moderate or aggressive risk appetite. • For more active members that prefer to self select their investment options. This spread is an indicator of risk. DC investment structure • Research has shown that without significant education and communication.e. but this has less effect than the investment strategy itself. we see a trend towards a concentrated core range of funds consisting of a range of different asset classes and investment strategies. it is important to look at the expected value as well as the spread of possible outcomes.

Switching periods and de-risking • Developments at DC administrators have also led to greater flexibility when it comes to switching (or de-risking) out of growth assets into bond assets within a lifestyle strategy. • DC pensions can be effectively delivered through a trustbased or a contract-based structure depending on client circumstances. please contact: Alex Koriath T: 020 7694 1902 E: alexander. logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.koriath@kpmg. a UK limited liability partnership. Although we endeavour to provide accurate and timely information. We believe that there is an opportunity to review DC pension arrangements to make them more efficient.co. the choice of appropriate destination investment vehicle is important.uk www. Printed in the United Kingdom The KPMG name. • In the past this switch typically happened over 5 years before the expected retirement age. There has been tremendous development in the DC pensions sector over the last couple of years. • We see most innovations in designing state of the art lifestyle strategies. In addition there have been developments towards accelerated and other non-linear switching mechanics. KPMG LLP (UK)’s Design Services I RRD-237960 I December 2010. there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. To discuss this further.co. • Switching periods have become more flexible.uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Most benefits detailed in this note are accessible through both structures. he growth of the DC T market has accelerated product development and innovation to a new level. allowing longer switching periods that can be used for a cautious lifestyle approach. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. • We believe that there is an opportunity to review DC pension arrangements to make them more efficient. . All rights reserved. © 2010 KPMG LLP .kpmg. KPMG View • There has been tremendous development in the DC pensions sector over the last couple of years. a Swiss entity. is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative. • When switching out of risky assets as part of a lifestyle strategy. The growth of the DC market has accelerated product development and innovation to a new level. here have been developments in matching funds T that aim to have a low risk and provide a reasonable match for annuity prices.