Designing a Defined-Contribution Plan: What to Learn from Aircraft Designers

This article uses the framework of designing a commercial aircraft to illustrate how a personal defined-contribution (DC) pension plan should be designed if it is to achieve its objective of delivering an adequate and secure retirement pension. The article’s suggestions are based on similarities between a DC pension plan and an aircraft journey. For example, the strategic investment strategy is analogous to the aircraft, the plan provider is analogous to the aircraft operator, the contributions are analogous to the fuel, and the accumulation and decumulation stages are analogous to the climb and descent stages of the flight. The significant differences that exist between the two concepts are also highly instructive. Why are pension plans not designed in the same way as commercial aircraft? At first blush, this question might seem a strange one to ask. It is also, however, an 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. Many similarities exist between a DC pension plan and an aircraft journey. The strategic investment strategy of a pension plan is analogous to the aircraft. The aircraft’s 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’s achieving its target outcome is analogous to an aircraft’s safe arrival at its destination. The fund manager’s decisions concerning such issues as market timing and tactical asset allocation are analogous to the actions of the pilot in flying the plane. Sponsoring employers, pension trustees, and regulators are analogous to air traffic controllers. Significant differences between aircraft journeys and pension plans also exist, and these differences are highly instructive: No uncertainty exists about the destination of an aircraft journey, and the passengers can alter neither the destination nor the route once the journey has started. In contrast, with a pension plan, the destination of the journey (the desired amount of the pension), the anticipated length of the journey (the time until the member retires), and the route to be taken (the investment strategy) are generally not clearly formulated when the pension plan journey begins and can be easily changed during the journey. The length of an aircraft journey is also much shorter than the journey of a pension plan, which can be 70 years or more. Aircraft designers must get the design correct before the aircraft ever takes off; otherwise, they would soon lose their good reputations, their jobs, or worse. In contrast, the designers of pension plans will have long since departed the scene by the time members discover whether their plans were well designed; the pensions that the plan members actually receive from their plans will not be the plan designers’ problem. Another important difference is that 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. 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 (or even have to delay retirement). There is little danger that an aircraft will have insufficient fuel to reach its destination, but there is considerable danger that pension plan holders will make insufficient contributions to their pension plans. Of course, no improvement in fuel efficiency can compensate for insufficient fuel to reach the destination; similarly, no increase in investment risk can compensate for inadequate contributions if a particular target pension outcome is desired. Another instructive difference exists in the relationship between the climb and descent stages of an aircraft journey and the accumulation and decumulation stages of a DC pension plan. Whereas the climb and descent stages of an aircraft journey make up a seamless whole, an almost complete lack of integration of the accumulation and decumulation stages exists in the current design of DC pension plans. Finally, a difference in competence exists between the airline passenger and the pension plan member. All the passenger needs to know is the destination and the airline and flight to book. The passenger can, therefore, be treated as an intelligent consumer who knows what to do. Unfortunately, many consumers of financial products are clearly not well informed, especially regarding complex long-term products such as pensions. In that regard, a role might exist for a sort of surrogate “intelligent consumer” to act on behalf of pension plan members as a guide or supervisor. This role might be filled by pension trustees, sponsoring employers, or even regulators.