Abstract
We propose a new methodology for the smart design of the default investment fund(s) in occupational defined contribution pension schemes based on the observable characteristics of scheme members. Using a unique dataset of member risk attitudes and characteristics from a survey of a large UK pension scheme, we apply factor analysis to identify single factors for risk aversion, risk capacity and ethical investment preferences, and then apply cluster analysis to these factors to identify two distinct groups of members across age cohorts. We find membership of these clusters depends on a number of personal characteristics, with the principal differentiating feature being that one group had previously engaged with the pension scheme, while the other had not. These identified characteristics can be utilised in the design of smart default funds, including appropriate engagement strategies.
Highlights
Around the world, occupational pension schemes are shifting from defined benefit (DB) to defined contribution (DC) with im plications for scheme governance (OECD, 2009)
Recall that the DB section continues to operate as the main pension scheme for individuals earning up to £55,000, so that many individuals completing the Universities Superannuation Scheme (USS) survey might not be expected to immediately participate in the new additional DC scheme (USS Investment Builder), unless they make additional voluntary contributions (AVCs) which attract matching contributions from the employer up to 1% of salary
Based on the literature review of the possible candidate characteristics used in the design of smart default funds, we will be able to answer the following questions for our data sample: (1) Do risk aversion, risk capacity, ethical investment considerations, match intentions and whether participants have previously engaged with USS by making AVCs vary by gender, age, tenure, salary/wealth and job type, and if so, do they help in determining whether USS members fall into distinct clusters and justify having more than one default fund? (2) Are USS members more or less risk averse than members of the national pop ulation, and if so, should they be offered a more or less conservative default investment fund than the national population?
Summary
Occupational pension schemes are shifting from defined benefit (DB) to defined contribution (DC) with im plications for scheme governance (OECD, 2009). The two groups are not distinct across the two clustering techniques that we use, there is still a significant overlap and again the two groups largely separate according to their degree of prior engagement These findings support the strategy subsequently adopted by USS: a single age-dependent lifestyle default fund designed primarily for those members that have not previously engaged with USS and a range of self-select funds which are likely to be taken up by some of those scheme members who have previously engaged. The key empirical contributions of our paper are to use cluster analysis to identify groups of USS scheme members with similar risk attitudes and risk capacities, to examine whether individuals in these groups exhibit particular demographic and personal charac teristics, and to determine whether the groups are sufficiently distinctive to justify having more than one default investment fund. The survey ques tionnaire emailed to USS members is reproduced as an Appendix
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