Common problems - different solutions
In the UK right now, all public sector pension schemes are basically in the same kind of review process, says Chris Hull, principal at Mercer Human Resource Consulting.
"They're all responding to both financial and political pressure," he says. "The challenge is how these schemes are going to change…against the background of the difficulties in the private sector." The demands that are now put on costs and benefits will have to be married up, he says.
"More and more, the public sector schemes are starting to look like the gilt edging on public sector employment," says Hull. "If you are a taxpayer… and you are finding your employer changing your pension scheme, you might have some questions to ask. It (the need for change in public sector pensions) is not just financial, but political as well."
In Germany, the main challenge facing the civil servants pension scheme - Versorgungsanstalt des Bundes und der Länder (VBL) - is dealing with the evolving method by which the plan is financed, says VBL spokesman Percy Bischoff.
"There are some areas where the system is pay-as-you-go (PAYG), others where it is completely capitalised and some where it is in a transition phase from the former to the latter," he says. "Financing is a very important subject which is keeping us fully occupied," he says.
In those parts of the VBL scheme where benefits are financed along PAYG lines, the difficulties are the same ones as those faced by the state pension system; the liabilities are high, and there are fears that contributions will not cover them in future. Under current demographic circumstances, where the number of those in employment nationally is stagnating or even falling, a solution has to be found, says Bischoff. Either contributions have to be stepped up or the benefits have to be altered to fit them.
In the pensions reform of 2001 in Germany, the tendency was to reduce benefits rather than increase contributions, a change to be made gradually.
Another major issue for the VBL is the supplementary pillar of pension provision it has introduced. Alongside the compulsory pension provision it administers for its civil servant members, and within the framework of supplementary provision, there is a now a voluntary scheme that members can pay into.
"We are now expanding this," says Bischoff. "It has been set up on a fully-funded basis and contributions attract tax relief."
Earlier this year, the VBL board changed its organisational structure, merging the departments dealing with the compulsory occupational pension scheme and the supplementary voluntary provision.
One reason for bringing the two departments together was to provide improved advice from a single source, VBL said, citing an earlier client questionnaire which showed that competent and comprehensive advice was seen as increasingly important. The re-organisation should yield initial results by the end of this year, it said.
In the UK, the main public sector pension schemes are the civil service pension scheme, the National Health Service scheme, the teachers' pension scheme and the Local Government Pension Scheme (LGPS).
The first three of these are funded on a PAYG basis, while the LGPS, which is made up of 99 regional pension funds with 3.5m members, is at least 70-80% funded, although all of the regional funds have deficits, says Bart Huby, partner and head of the public sector outsourcing group at consultants Lane Clark & Peacock
"They are now much more expensive and more valuable to employees than when they were first put in place," he says, given longevity trends and the fall in gilt yields. When the schemes first started, they were reckoning on paying out for an average of 12 years per retired member, but that length of time has now doubled.
According to the timescale set for the overhaul of the LGPS, details should be negotiated and in place within the coming year, says Hull.
There is resistance to changes in public sector pension schemes, says Huby, but most of this is coming from individual members rather than the trade unions themselves. "The pensions experts within the unions do realise that change is necessary; it's the members who are the most vociferous opponents," he says.
But in other European countries where organised labour has traditionally had more power to oppose government, changes may be much tougher to force through. In France, for example, trade unions have threatened to call a national strike in response to a promise by presidential candidate Nicolas Sarkozy that he will reform the comparatively generous public sector pension schemes if he wins next year's election.
The asset allocation of the local government pension schemes are quite heavily weighted towards equities, says Huby. Because their employer covenant is seen as more robust than that of most private sector schemes, the committees of the schemes are able to have a fairly long recovery period, he says.
Now more than ever, retirement plans in the public sector are having to find new ways to cater for members' needs. And though this might sound like a euphemism for cutting benefits, it need not necessarily be.
Dutch pensions giant ABP, the civil servants scheme which has more than 2.5m members including pensioners and deferred pensioners, is introducing flexible pensions, says ABP's Marcel Vleugels.
"Firstly, people will be able to choose when they retire," he says. As far as the pension scheme is concerned, this can be at any age between 60 and 70. There are 120 moments when they can leave, he says, and they can opt to leave work only partially - taking part-time work for a period.
The scheme also makes it possible for members to swap the widow's pension benefit for extra old-age pension for the member. While in the Netherlands, the state pension is paid from age 65, ABP members retiring before this can ask ABP to provide them with additional income during the gap they find themselves in.
During the first few years of retirement, members can receive up to 25% additional pension which could be needed if, for example, they are still repaying a mortgage or have children whose studies need financing, says Vleugels.
"This means there is a huge variety of things for members to choose from," he says. Communication with members has always been important, says Vleugels, but now it is more so. ABP already has online facilities for members to look up the level of pension they would receive if they opted to retire at a specific point.
The benefits side of the scheme has been revamped as a result of legislation in the Netherlands which stopped early retirement benefits, he says. "Something else had to be invented; we had to do something to keep the system modern," he says. Members have individual circumstances and make different choices; some prefer to save more while others opt to spend more, he says.
Danish public authority pension fund ATP has assets of more than e40bn. Faced with the dual challenge of low capital market yields and an ageing population to cater for, the heavyweight fund has undergone a complete restructuring of its investments.
"The big thing we have been working on within the last year or so has been changing the fund from being a benchmark-orientated fund to an absolute return investment fund," says chief investment officer Bjarne Graven Larsen.
The fund has now been split into two parts: one aiming for alpha, while the other targets beta. "The challenge is to get high returns no matter what market conditions are," he says.
ATP's investment restructuring took place as a three-step procedure, he says. The first was to hedge the fund's nominal liabilities 100%, the second was to start taking investment risk in order to secure high real returns, and the third was - within the beta portfolio - to create the highest possible diversification in order to get the market premiums out of each different asset class.
"We structured the pension fund in quite a different way from before… with the aim of getting the highest possible future returns for the members," he says.
Taking into account the longevity risk and inflation risk, the fund formulated an absolute return target. The total profit and loss would have to be large enough to allow the pension fund to grow as considered necessary. "We should have a large positive figure on the P+L that would allow us to increase liabilities," says Graven Larsen
ATP calculated that the longevity risk equates to an ongoing annual increase in liabilities of DKR4bn (€0.53bn); on top of this the effects of inflation are reckoned to add a further DKR6-7bn. So the fund has now quantified what it needs to meet future liabilities, however, this does mean achieving around DKR10bn crowns from its investments every year on top of the risk-free return.
Achieving returns of that level is certainly a challenge, says Graven Larsen. "In the long term, it's a relatively tough target with market conditions…" he says. "If we behave wisely, with the alpha portfolio and the beta portfolio, we will succeed."