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Default Fund

Main article: Funding

The default fund is provided by the employer (the scheme trustee) to employees who do not actively choose the scheme. In other words, employees are automatically assigned to join a default fund if they don't select any. Typically, it is a lifestyle fund, which represents an investment in preparation for a specific retirement outcome (reducing the purchase of an annuity) rather than a traditional investment designed to increase pension savings. However, the default fund plan chosen by the employer may not be suitable for every employee.

A default fund, also known as a guaranteed fund, is a separate fund from a central clearing counterparty (CCP) and is funded by multiple parties to guard against default.

History

Stakeholder pension schemes were introduced in the UK in April 2001. The plan aims to improve pensions for low - and middle-income people. The plan is essentially a pension scheme on a defined-contribution (DC) basis. Providers are generally members of employers, unions, financial services companies, etc. It has a lower contractual minimum contribution (20), and there is no penalty for reducing or ceasing the contribution, or even for transferring the fund to another arrangement, and the total fund expense must be controlled at less than 1% per year. At the same time, in order for members to make no clear choice of public funds, each scheme should provide a default fund.

It is found from a large amount of literature that most members of the pension plan passively accept the default fund in the plan. For instance, Choi et al. (2002) found evidence from the United States that members are more willing to accept default plans with characteristics of investment funds and payment rates, even if they can choose not to participate. Between 42% and 71% of members accept default rates, and between 48% and 81% of plan assets are invested in default funds, usually money market funds. Participants in the UK had similar tendencies. 80% of participants in the DC scheme accepted the default fund (Bridgeland, 2002).

Stakeholder Default Fund Data

In the UK, there is a law that says DC plans must be registered with the Occupational pension Regulatory Authority for publicity purposes. As of June 2004, there were 35 different plans, excluding those that did not meet the requirements. The following data were collected from these schemes:

Table 1

Table 1 shows the range of default funds in lifestyle and fund types. More than half offer "balanced management" funds. Typically, 50 to 60 per cent is invested in UK equities, 20 to 30 per cent in overseas equities and 10 to 20 per cent in bonds, with advanced investments up to 5 per cent. With the exception of two funds that have adopted passive management, other balanced active management has adopted an active approach. In addition, 13 schemes offer default funds of all-stock funds (seven in the UK and six globally). Seventy per cent of global funds are UK equities, with the rest overseas. In addition, most of these funds are passively managed. The remaining three options are profit-making funds and actively managed, with an average underlying asset allocation of 50 per cent UK equities, 40 per cent fixed interest rates and 10 per cent overseas.

Table 1 - Stakeholder Pension Scheme Default Funds by Type

	Total	Actively Managed	Passively Managed	Lifestyle Default	Lifestyle Option	No Lifestyle
Balanced Managed	19	17	2	5	4	10
Global Equity	6	1	5	6	0	0
UK Equity	7	1	6	6	1	0
With-profits	3	3	0	0	2	1
Total	35	22	13	17	7	11
Notes: See text for a full description of each fund type

Table 2

Of the 35 eligible plans, 17 had automatic lifestyle asset conversions by default, and seven offered lifestyle investments. The rest did not offer lifestyle at all. Table 2 shows the scope of stakeholder lifestyle arrangements for different categories. In addition, lifestyle is part of the default plan, and the highest proportion is the initial asset allocation. For instance, six of the seven 100% equity investment strategies are in default, and there is no default in the profit strategy. This may be feasible because funds with low equity weightings offer relative protection against market volatility.

Table 2 - Stakeholder Pension Scheme Default Lifestyle Profiles

Years to Retirement When Lifestyle Switch Starts
Final Year Allocation	3	4	5	8	10	Total
75% Bonds 25% Cash	-	-	10	2	2	14
100% Bonds	-	-	-	-	1	1
100% Cash	1	1	-	-	-	2
Total	1	1	10	2	3	17
Notes: This table only includes schemes where a lifestyle profile is part of the scheme default arrangements.

The Implementation Principle of Default Fund

The implementation of the default fund must follow the following principles:

• Those involved in the supervision of the fund must be experienced enough to control its implementation in the future. It's easy to make mistakes if the employer (or trustee) doesn't have enough knowledge and experience. Therefore, employers should stick to a simple and suitable type of choice when choosing a default fund strategy, and hold professionals accountable.
• Default funds should be designed to take into account the occupation, wealth, contribution capacity and retirement status of savers. That's because there are uncontrollable factors that could lead to retirement, such as health problems or layoffs at companies. Therefore, the design of default fund should consider the possibility of these situations and make corresponding countermeasures.
• The implementation of the default fund needs to follow the flexibility to protect the interests of those who invest in the sub-fund and allow participants to choose to withdraw from the fund. In other words, the management of the default fund should adjust the fund according to the ability of the manager, the regulatory system, the investment thinking and the behavior change of the members.
• In order to avoid conflicts of interest, the employer (or the trustee) shall not be directly responsible for the investment decisions of the fund in default when setting targets and supervising the fund in default.
• Providers of default funds should provide investors with more options to choose funds that are better suited to their circumstances.
• Pay more attention to members who will be out of retirement for a long time, as they may not be able to make the best financial choices for retirement.
• We need to maintain fair asset accumulation and investment.

Default funds are nonprofit in many industries, and they follow some or all of the principles. If there is no specific default fund in the agreement, the employer is obliged to provide a superfund to the employee who refuses the default fund. However, this is often a difficult decision for employers, as there is currently no way to weigh whether the common interests of employers and employees are fair. As a result, employers are more likely to buy retail providers' master trusts than industry funds, which are more expensive.

Universal Default Fund

Universal default fund (UDF)is a single default fund backed by the government. It applies to between 6% and 16% of workers and they have no default funds in the industry. Unlike the UDF, which was a safety net for the default bonus system, any worker can join. Compared with the high cost of a retail fund, a properly designed UDF could increase the retirement income of an average wage earner by $100,000. This would help solve the problem of retirement savings for millions of australians.

About 80% of the members of the fund did not choose the investment strategy and thus passively chose the default fund. Surveys suggest that the idea that a default fund is an implicit financial advice is dangerous. UDF provides a safety net for workers who cannot make the best investment choices, especially those with small capital gains, thus guaranteeing australians more decent retirement benefits.

The Function of UDF

• Passive management based on investments in Australian and international equity indices with bonds and cash, rather than active management.

• Age-based equity weightings take into account variable needs over the life cycle

• Set up a reserve fund to eliminate discrepancies in annual returns

• Government-backed annuity products help mitigate financial risks related to increased life expectancy

Because financial services are lucrative, the UDF would be opposed by vested interests such as the retail pension sector. But the UDF is very much in the national interest, because it can actually solve the pension problem.

There are two irreconcilable tasks in the pension industry: protecting members' interests and promoting market competition. Governments have an obligation to protect the savings of members who are unable or unwilling to manage their own investments because pensions have a problem forcing workers to save. Given the need to cut spending on age pensions, the government also needs to ensure that savings are not squandered by bad fund choices, both for the government and for taxpayers. In 2006, the standing committee of the hospital of traditional Chinese medicine stated in financial, economic and public administration that the government also set up a default pension for temporary workers. When they do not choose their pension fund, they automatically join a government-mandated default fund.

Compared with the high-fee eligiblerollover funds (ERFs) system, UDF is incapable of avoiding the central fund's investment strategy of providing reasonable returns to its members. Combining ERFs and lost pensions into a central fund can boost economies of scale and provide a holding point until temporary workers move into full-time work. Because of economies of scale and the absence of market failure, the UDF is likely to charge less than most current ERFs.

Between 2006 and 2008 nearly 1m members withdrew from discounted retail funds to more expensive retail personal finance plans, according to Rice Warner's research on the UK's investment and financial services institute (IFSA). In addition, the average cost of an individual retail fund is 2.5 times that of a large retail enterprise, which is a significant difference. Such reselling can be regulated by prohibiting it, or by requiring members of these retail funds to leave their employers and transfer to the UDF.

Six Criteria for Default Funds

In order to ensure the practicality of the fund in default, the government puts forward six criteria:

• includes ongoing fees and charges and is subject to regulatory caps
• to encourage the flow of funds, entry fees are strictly prohibited
• persistent financial advisory fees or even commissions are strictly prohibited
• provide employers with clearing services that can handle multiple fund payments at the same time
• if contributions are stopped, members should also be allowed to stay in the default fund, rather than deciding to move their assets to more expensive funds or individual plans while they are still in doubt
• automatic follow-up for outstanding payments

Exactly，the government-run UDF meets these criteria and still gives its members good returns.

Suggestions for UDF Design

1.    Passive management. According to the study, only about 10% of fund managers beat the market average, which is lower than expected, because management and transaction costs reduce overall performance. So, the average fund manager is unlikely to outperform the market. The default fund not only has the fund management but also has the other management cost, therefore, the default fund should adopt the passive management investment strategy, because its cost is lower. At the same time, more funds should be invested at home than abroad. Australia, for example, could raise the total cost of a default to 0.5% or 6%, a good contrast to the current average of 1.35%.

2.    A repository of lost and inactive accounts. There are policy issues with the increase in the number of lost and inactive accounts, and the UDF should be the repository for those accounts, thus ensuring that members do not incur the costly expense of eroding account balances. Moving these users to index funds is intuitive and a sensible way to manage pension members who do not actively select them. When they leave their employer and have no other requirements, the original fund should be responsible for transferring the balance to the UDF within a certain period of time.

3.    Offer government-backed pensions.The use of government reserves, which can be leveraged to achieve higher returns without the same risk, is a smoothing system. In addition, it is valuable In the payment phase of an annuity provided by a UDF. Annuities are used to avoid "longevity risk." Under previous pension plans, fixed - expense cuts would not address this risk. However, the portion of an annuity that is backed by a stock investment will yield better returns. For the private sector, most do not offer reasonably priced annuities, but life expectancy is rising fast, by 2.7 months a year over the past century. UDF should be a fund for those who need annuity options.

4.    Other. The trustee of the UDF shall be legally responsible for the effective management of the fund and the corresponding return of the fund. The relevant ratios and indices (Australian and overseas equities, bonds, etc.) should also be recorded in the regulations so that appropriate adjustments can be made in the future. It is also important that the UDF take into account the need for pension funds to provide disability and death coverage.