Global research undertaken by our firm indicates that there is an almost universal trend towards defined contribution (DC) plans in employer-sponsored provision. The table summarises our estimates of how the markets will change in the principal European countries.
The trend is clear – without exception, the market penetration for DC plans is expected to grow. The reasons behind this well-evidenced growth are often cited as:
q The new employment relationship – many employer-sponsored retirement plans were designed to meet the needs of the traditional long-serving, permanent, full-time employee. In recent years, there has been a substantial growth in part-time, casual and contract employment and this has not been restricted to the “Anglo-Saxon” countries. The defined benefit (DB) concept is difficult to adapt to these circumstances and a benefit based on salary at, or close to, retirement can appear to have little relevance to employees expecting to stay with their employer for only a short period.
q Risk tolerance – with DC plans the contributions are set, and the risk that eventual benefits will fall short of intended levels passes to the employee. This is an incentive for the employer to switch to DC.
q Control – in many countries national governments are moving to increase employees’ involvement in the management of corporate retirement arrangements. That relinquishment of control is unpalatable to many companies, and DC plans are seen as being more consistent with employee control than DB plans.
q Complex regulatory frameworks – governments continue to interest themselves in the regulation and provision of employee retirement benefits. Compliance with regulations on vesting, taxation, indexing and portability is usually more complex in DB plans than in DC plans.
q Perceived value – in many circumstances, despite an employer’s best efforts, employees may have difficulty in appreciating how expensive and therefore valuable is the DB plan provided by their employer. DC plans, with regular communication of understandable concepts such as the current account valuation may be seen as being more effective in increasing the perception of value to the employee. In US terms, “the bang for the buck” is greater with DC than DB.
q Absolute cost – some employers will undoubtedly view a switch to DC as an opportunity to reduce costs.
Some of the influences on US corporate employers are not generally translatable to Europe. These would also include “empowerment of employees”, a focus on total remuneration packages and placing of a higher value on flexibility for the employee. However, the extent to which such concepts are of significance within the more “social” European environment is questionable.
There is one specifically European point that will concentrate the minds of finance directors in certain countries. As a direct result of the euro, interest rates have declined across the Euro-zone, making the tariff or cartel interest rates used by insurance companies to determine annuity prices in a number of countries unsustainable. As interest rates decline, the cost of purchasing annuities increases. The cost of purchasing a pension for a new employee in Belgium, for instance, will have increased by around 20% as a result of tariff changes.
For insured DB plans in Belgium, France and the Netherlands, for example, these tariff or cartel changes have started to make their effect felt, although there will often be a delay before the full effects are seen. Nevertheless, in a lower interest rate environment, the cost of promising pensions will increase, and as a consequence so will the incentive to switch to a DC approach.
The main factors quoted above are likely primarily to influence the groups of countries where employer-sponsored DB plans are already established as one of the main planks of retirement provision. These would include Belgium, Ireland, the Netherlands and the UK.
However, the main influence in many countries in the growth in employer-sponsored DC schemes is good old-fashioned state direction. In many countries, particularly those struggling to reduce the reliance on state pension systems, the state is actively promoting DC plans and not providing employers with a choice in the matter. Typically these countries are in Central Europe or the Mediterranean. A few examples will provide evidence of this trend:
q Czech Republic – legislation encourages DC plans as it is entirely focused on personal pensions
q Greece – new legislation limits deductibility of employer contributions to insured supplementary plans (DB, DC and risk benefits) to the lesser of 5% of annual salary or Drs150,000 per employee. Not surprisingly DC plans are growing in popularity.
q Hungary, Italy and Spain – legislation strongly encourages DC plans as it sets contribution-related limits, not benefit limits, for plans to be tax-qualified.
In countries that are still making the transition towards Western free market economies, the influence of the World Bank and its broad preference for the Chilean DC model should not be underestimated.
There are thus some very clear issues specific to Europe which are helping to drive the growth of DC plans and eventually DC plans may prove to be more suitable to form the basis of a pan-European fund than their DB counterparts. The need for consensus and the strong workers’ rights in many European countries may mean that the speed with which plans were converted from DB to DC in the US may not be repeated in Europe. However, new plans being established are almost always DC in nature and they now have a dominant position in the European market.
Paul Kelly is a European partner with William M Mercer

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