Not as easy as it sounds
For any multinational considering moving to DC in Europe, it is important to understand the environment in each country, as it is most unlikely that sophisticated US 401K-type DC plans will be possible.
The European DC market is still developing, in terms of concept, employee acceptance and the tax regime. Largely because of very generous first-pillar state pensions, there has been little need in many countries to consider funded pensions at all, let alone DC pensions. With insurance products generally predominant and with little or no legal framework in some countries, there is sometimes minimal market understanding of the DC concept. The move to second pillar funding will be a boost but it is not clear that DC will necessarily go down the Anglo-Saxon route.
Most multinationals today have a range of pension plans in place, so any move to DC will be a slow and evolutionary process. Where a company has moved to DC there are key management issues to be addressed. Some of these are not receiving sufficient attention, others are new to us here in Europe as most of the experience is American. Let me mention a few of the main ones.
To begin with, it is particularly important from a fiduciary point of view, as the employee now bears the investment risk, that the selection of the investment manager or insurance company, the investment vehicles and the administration supplier, should be rigorous and comprehensive. All suppliers should be monitored and carefully tracked to ensure they deliver what was expected.
One worry is lack of transparency and slowness in reporting by insurance companies, which makes effective and timely member communications difficult. Another worry is on the question of communications. It is mandatory with DC plans that employee communications are both thorough and understandable - be they in the Anglo-Saxon model or the insurance company model. In developing its strategy the personnel department needs to appreciate that countries differ considerably in investment awareness and understanding. With personnel departments reduced in size, who is taking up the slack? Lastly comes the whole question of the DC board’s role and responsibilities. For example, under DC, there is a potential conflict between the board’s fiduciary investment role and the reasonable wish of members to choose their own investment strategy. Failure to focus on any of the above issues might give rise to possible future legal claims, making it critical that DC boards demonstrate complete professionalism to plan members .
So how might some of thesepossible long-term (fiduciary) risks best be minimised? Here are a few suggestions :
q Ensure there is an active trustee board with sufficient executive involvement. The board must closely and continuously monitor the appropriateness of its DC fund products.
q Limit the number of investment funds, but the choices must be reasonable. Consider a lifestyle fund option.
q Consider eliminating manager risk by using only passive funds.
q Ensure comprehensive and understandable communications. These must be complemented by an administrative system with good links into the fund manager, enabling the members to have easy access to their personal accounts.
q Employee communications should encourage additional personal savings.
q Ensure asset security and carefully assess insurance company credit risk.
q Make the plan’s bye-laws as explicit as possible
q Always seek the advice of a specialist lawyer!
So the message is this. Don’t think that a move from DB to DC reduces management time and responsibility. This may be the case in some areas, but it is significantly increased in others. The importance of focusing on fiduciary responsibilities cannot be overstated.
In conclusion, I should like to highlight concerns on the implementation of DC from a European perspective. The first is a really fundamental one, which I call annuity risk”, where members do not have any timing flexibility when converting their DC pot into a lifetime annuity, but are at the mercy of interest rates at the date of retirement. The Canadians appear to have resolved this by allowing the annuity decision to be delayed well after retirement age.The second concern is the insurance company issues revolving around lack of data and transparency and the insistence, sometimes, on having the annuity taken with their company. Third is the practice in some countries of allowing the whole DC pot to be taken as a lump sum at retirement, thus defeating the object of ensuring long-term provision of pensions. The fourth concern is the board member fiduciary risks. And finally, the most frequently asked question is: “Will DC deliver an adequate pension, or one that is in any way comparable with a DB pension?” This is doubtful, if you consider just the contribution rate statistics of DC versus DB. So greater third-pillar funding seems the key.”