Designing a Defined Contribution Pension Plan? What can you learn from Commercial Aircraft Designers?
David Blake, A.J.G Cairns and Kevin Dowd
Why are pension plans not designed in the same way as commercial aircraft? At first sight, this might seem a very strange question to ask. It is, however, also a very instructive one. Given the astounding success of aircraft design over the last century, we suggest that designers of DC pension plans have much to learn from aircraft designers.
There are many similarities between a DC pension plan and an aircraft journey. The strategic investment strategy of a pension plan is analogous to the aircraft. The aircraft operator is analogous to the pension plan provider. The contributions into a pension plan are analogous to the aircraft’s fuel. The climb stage of an aircraft’s journey is analogous to the accumulation stage of a pension plan, and the aircraft’s descent stage is analogous to the pension plan’s decumulation stage. The pension fund achieving its target outcome successfully is analogous to safe arrival at the destination. The market timing or tactical asset allocation decisions of the fund manager are analogous to the actions of the pilot in managing the progress of the flight. Sponsoring employers, pension trustees and regulators are analogous to air traffic controllers.
There are of course also significant differences, but these are themselves highly instructive:
First, there is no uncertainty about the destination of an airline journey and the passenger cannot change his mind once the journey has started or alter the route to be taken. By contrast, with a pension plan, the destination of the journey (how much pension is desired in retirement), the anticipated length of the journey (the time until the member retires) and the route to be taken (the investment strategy) are generally much less clearly formulated when the pension plan journey begins, and can be easily changed afterwards.
Second, the time horizon with an airline journey is also much shorter, typically a few hours, compared with the 70-year or so journey of a pension plan. Aircraft designers must get the design right before the aircraft ever takes off. By contrast, the designers of pension plans will have long since departed the scene by the time the member discovers whether his plan was well designed or not: the pensions that their plan members actually receive are not their concern.
Third, airline passengers know that they need to get to the airport by a certain time if they want to catch their plane and reach their destination in time. On the other hand, the much longer journey of a pension plan offers plenty of opportunities to delay the journey’s start and consequently end up with a lower pension by the time the retirement date arrives.
Fourthly, there is also virtually no danger of an aircraft having insufficient fuel to reach its destination. And, of course, it is very obvious with a commercial airline flight that no improvement in fuel efficiency can compensate for insufficient fuel to reach the destination. Similarly, no increase in investment risk can compensate for fundamentally inadequate contributions if a particular target pension outcome is desired.
A fifth instructive difference relates to the relationship between the climb and descent stages of an aircraft journey, on the one hand, and the accumulation and descent stages of a DC pension plan, on the other. Whereas the climb and descent stages of an aircraft journey make up a seamless whole, there is an almost complete lack of integration of the accumulation and decumulation stages in the current design of DC pension plans.
And finally, there is the difference between the competency of the passenger and that of the pension plan member. The passenger only needs to know where he wants to go and the airline and flight to book, and can therefore be treated as an intelligent consumer who knows what he is doing. Unfortunately, many pension consumers are clearly not well-informed, and there may be a role for some kind of guide or supervisor to act on behalf of pension plan members as a surrogate ‘intelligent consumer’. This role might be filled by pension trustees, sponsoring employers or (maybe) regulators.