What’s the benefit?
IPE asked three pension services - in Denmark, the UK and the Netherlands - the same question: ‘What are the merits and pitfalls of your benefits models?’ Here are their answers:
Torben Möger Pedersen is CEO of PensionDanmark, which has assets under management of DKK70bn (€9.4bn)
PensionDanmark is a fully funded purely defined contribution scheme, based on collective agreements between trade unions and employers organisations. They set contribution rates through collective bargaining arrangements. They started in the early 1990s at just 0.9% of gross salary, rising to at least 12% in 2009. Employers pay two-thirds.
It will take 40 years for this system to fully mature. A contribution rate of 12% over a whole career should give a retirement income, combining a labour market and state pension, of about two thirds of the pre-retirement salary of a typical blue-collar worker.
In Denmark, we have area-wide collective agreements. Contribution rates in the Danish labour market pensions system range between 12%, for low-wage blue-collar workers, through 18-19% for academics to about 20% in the financial sector. It is important that the compulsory labour market pension schemes do not overcompensate. Instead of saving for a total pension level above two-thirds of their last wage people should rather spend the money during their working life.
As the money goes into individual accounts, from the member’s perspective it is their money and is seen as their largest financial saving outside real estate.
We consider that the end pension will depend on three things: administrative costs, how many of our members become disabled or die pre-retirement and successful investment.
Taking each of those points, we feel an ethical responsibility to keep our costs as low as possible. All members pay an annual flat fee, in 2008 it is DKK387 (€52). That is at the lower end for Danish pension funds and about DKK1,000-1,200 below what is charged by most commercial companies.
Second, we have arranged our insurance coverage for disability, for example, on top of the public insurance coverage. The result is that more than 85% of what is paid in goes for pensions savings.
We have chosen not to have any guarantees on our investment returns, which enables us to focus on achieving high returns.
Our current benchmark allocation is 38.5% in equities, both listed and private equity; about 43% in investment grade bonds, both government and index linked; 6.5% in high-yield and emerging market bonds, 8% in real estate and about 4% in credit and infrastructure funds.
In the coming years we plan to increase our exposure to alternatives - especially infrastructure funds and corporate debt - and reduce our holdings of investment grade fixed income.
Penny Green is the chief executive of the UK’s Superannuation Arrangements of the University of London (SAUL) Trustee Co, which has assets under management of £1.3bn (€1.7bn)
There are a number of factors behind our retention of defined benefit, including employer support for our benefit structure and affordability.
Why is our DB plan affordable when other employers are finding theirs to be unaffordable? It comes down to two fundamentals. First, since the scheme’s inception the trustee has taken a prudent approach to its assumptions - we have very rarely taken credit for returns on equities until they have actually been banked so the discount rates we use are modest with little allowance for equity risk premium. And secondly, when surpluses were revealed, the employers chose not to take contribution holidays but to reserve against future eventualities.
That has meant that even though we are an open DB pension plan our employer contribution rate is 13%. The ongoing cost is around 24-25% of a salary in total and there is an additional employee contribution of 6%, leaving something like 5% to come from the investment returns.
Currently our asset allocation sees 25% in bonds, 13% in absolute return mandates, 5% in property, 5% in what we call high-income equities, so bond-like equities, and the rest is in equities, with a 50:50 split between overseas and the UK.
Costs are as important in the academic sector as for corporates. There is not a finance director in the university sector that would feel insulated against cost demands and the efficiency requirements that a PLC would be subject to, although they may be formulated in a different way. The employers do scrutinise what we are doing.
A number of issues sit around those two factors including a political imperative. SAUL is solely for the non-academic staff. The overwhelming majority of universities in the UK operate at least two pension funds. Academic staff being in the USS and non-academic staff being in a variety of different arrangements.
The university sector as a whole is committed to DB provision for the academic staff, and London University is committed for DB provision for all staff because it has proved to be affordable. My perception is that if it was to move to DC provision for its support staff, but not the academic staff there would be huge employee relations issues that could far outweigh any potential financial benefits.
But having said that my understanding is that there is a group of employer representatives looking at the total benefit provision across the whole of the UK university sector. So future provision may change although if it does I guess this will not be in the short-term.
The advantages of a DB scheme for an employer are that it enables employees to focus on work because they know they don’t have to worry about their pension. And a DB scheme is extremely efficient at managing downturns as, admittedly with additional funding, it can be used in downsizing exercises. And in the event of a death in service it can offer immediate family protection based on salary, and is more efficient than having to insure the benefits in a money purchase scheme where you have to decide what to insure and how to provide it through an insurance policy.
In addition, the employees see it as preventing them from carrying the risk and from a trustee perspective, while the administration of DB is slightly more complex than DB, we are used to it and it requires a completely different mindset from DC.
But there are challenges, clearly there are two huge unknowns that have an impact on funding: longevity and the regulatory risk that sits in a DB scheme. An employer voluntarily chooses to create a benefit structure for an employee and the government says that even though that act is voluntary we are going to interfere and impose conditions, and those conditions change over time.
Jan de Snoo, deputy director of the pension fund of Dutch contracting and construction company Volker Wessels, which has assets under management of €860m
Our scheme is an average salary plan financed by collective defined contribution and, as the name suggests, it is a mixture of defined contribution and defined benefit in that for the member it is a DB scheme but for the sponsor it is a DC scheme. However, there is no guarantee and the reason why it is like a DC scheme for the sponsor is that beyond a requirement to pay the contribution there are no further demands, so the member is carrying all the risks but also receiving all profits.
For the members there are no individual accounts, the assets are pooled and so there is a collective not an individual risk and this in effect reduces the individual risks.
We have one large fund and the members have no investment choices or input. Our strategic asset allocation, although there are always fluctuations in values, is 55% in fixed income and it’s mixed - we participate in a fund that is euro government and non-government bonds; 35% in equities, including global, long-only and hedge funds, which we put under the equities umbrella, and 10% in real estate funds.
The return on the return portfolio was about 5% and the return on the matching portfolio was negative, in line with the return on the pension fund’s liabilities, which is what the matching portfolio is for. The total contribution rate is 25.5% of a member’s pensionable salary, of which the employee pays 6% of a salary and the employer the rest. The level is the result of bargaining between the company and the pension fund.
And this is high enough to deliver a replacement rate that conforms to the market norm. Every year the members built up a pension entitlement of 2.25% of their pensionable salary so if an average member stays with the company for 40 years, for example, at the age of 65 he or she can expect the pension scheme to deliver a replacement rate of 90% of their career-average salary.
Interviews conducted by George Coats