Defined contribution (DC) pension plan modelling needs to take into account wider ‘member characteristics’ such as gender, occupation and increases in life expectancy, according to a proposed set of principles for modelling DC pension plans.

The Pensions Institute at Cass Business School is consulting on its newly devised set of 15 principles that aim to improve the modelling of defined contribution (DC) pension plans.

Most DC plans have been described by the institute as “very badly designed” because they are not “modelled properly”.

To address this, the new principles propose modelling DC plans on quantifiable uncertainty; member choices; member characteristics such as occupation and gender; plan charges; longevity risk; integrating the pre- and post-retirement periods; additional sources of income such as the state pension and equity release; extraneous factors such as unemployment risk, activity rates, taxes and entitlements; as well as covering scenario analysis and stress testing; periodic updating of the model and changing assumptions; and model specification and calibration.

Co-author of the principles and director of the Pensions Institute at Cass Business School Professor David Blake said: “Most DC pension plans are currently very badly designed. If a DC plan was well designed, it would be a single, integrated financial product that delivers at reasonable cost to the plan member a pension that provides a high degree of retirement income security. This pension should provide an adequate replacement income for the remaining life of the plan member (and possibly also a partner) and should remove the risk that the member outlives his or her resources. A well-designed plan will therefore be designed from back to front, that is, from desired outputs to required inputs.

“The reason that most DC plans are not well designed is that they are not modelled properly. For example, they do not take account of factors such as the member’s occupation, or the possibility of career breaks for child care reasons, or likely increases in life expectancy over the life of the plan member. The principles of good practice can be applied to develop more reliable and robust models. Projections from the models can then be used to more effectively guide both plan design and member choices”.

The consultation deadline is Friday 31 May. A final version of the modelling principles is due to be published in June.

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