Slow take-up for new approach
Two years after Norway introduced its long-awaited legislation to encourage the take up of defined contribution (DC) occupational pension plans, pension providers, asset managers and consultants are still waiting for the market to take off.
The enabling legislation was supposed to light the fuse of DC plans by making them as tax-favourable as defined benefit (DB) plans. However, the legislation has proved to be a damp squib. None of the large corporate pension schemes have switched from a DB scheme to DC in response to the new laws. Furthermore, the take-up by small and medium sized companies without occupational pension funds has been slower than expected.
Initially hopes were high. Some 60% people in the private sector, around 900,000 people, do not belong to an occupational pension plan. So when the new DC became law on 1 January 2001 the DC plans were seen as a new market for insurers, banks, brokers, unit trust managers and asset managers.
However, Norway is a country that has traditionally been more comfortable with DB, and the legislation betrays the fact that the legislators’ hearts were not fully in the task of drafting a DC alternative.
Caspar Holter, a partner in the consultancy Pensjons & Finans, says the real problem has been a lack of political will. “The lawmakers didn’t want DC. So they more or less copied the DB plan and much of the regulation was exactly the same as the DB plan. They focused solely on the insured and built the whole network of structure of law based on that. As a result, the DC regulation is very much similar to life insurance regulation, very tightly regulated to protect the insured.”
Pål Lillevold, an actuary at consultancy Aktuarene, says that initial expectations were pitched too high. “The new DC is a fairly slow moving market, and substantially below expectations. Probably the providers and also the legislators had an expectation that there was going to be a huge wave of new plans being established quite rapidly, which in hindsight is a very naïve perspective.”
One problem is that the legislation is clumsy. Lillevold identifies one important deficiency: the DC plan does not have a mechanism to take account of past service. “The fact that you are unable to exclude older employers from membership means that you are forced to have members in the plan who have irritatingly low pension levels, and would probably be better off not being members.”
However, after pressure from the insurance industry, many of the more inflexible features of the legislation were modified. Erik Garaas, managing director of GN Asset Management, the asset management arm of the Gjensidige insurance group, was a representative for the investment community on the committee that drafted the legislation.
“When it was established it was laid down that you should have either a DB or a DC. You had to close down a DB to establish a DC. That was what the politicians at that time accepted. We argued for the possibility of having a combination of DB and DC, or two parallel systems. And after a great deal of lobbying it was allowed.”
However, the life insurers have an ambivalent view of the new DC legislation, says Holter. “The life insurance industry is afraid of cannibalism, so they want to ring-fence the DB plans they manage. They are eager to get new mandates in the DC area but not at the cost of the DB plans because they see that that is where the money is. So far the assets of DC schemes are insignificant.”
Holter suggests that the market will be driven, not by the insurers but by the unit trust industry. “They will be the main promoters of DC plans because they have a good marketing contact with the smaller companies.”
Another channel will be the insurance brokers who have already taken a large share of the general accident market, he suggests. “They transferred their marketing knowledge and contacts with the smaller companies from general insurance into life insurance. And 100% of their recommendations will be DC because it is the only scheme they understand.”
The growing weight of DB pension liabilities on Norwegian companies’ balance sheets could also provide added impetus to DC schemes. Norway has had a domestic accounting standard since 1994, which is similar to international accounting standards IAS 19 and FAS 87. So, from an accounting point of view, there should already be an incentive to switch from DB to DC. However, with lower equity exposure than other European pension plans, and healthier reserves, corporate pension schemes have not so far felt the heat of international accounting standards.
But this situation could change. Åsmund Paulsen, head of global equity products at DnB Asset Management, says: “The fact that the companies now have huge liabilities where they yesterday had surplus cash, might just be a very important catalyst and might lead to something we haven’t seen yet – DB schemes being replaced by DC schemes.”
This is likely to be resisted by employees, he adds: “The employees that benefited from the DB scheme and had the protection of the employer when it came to annual returns and counterparty risk, will obviously nowadays not voluntarily let go of this benefit. Three years ago, many may have been tempted to have an unlimited upside and jump on to any DC scheme. Nowadays that is not automatically so.”
However, labour unions are now more prepared to accept DC schemes as an alternative to DB schemes in their campaign to include pensions in the round of collectively negotiated pay and conditions. They recognise that smaller companies are more likely to choose DC rather than DB schemes. Oystein Nilsson, a sociologist with the Norwegian Federation of Trade Unions (LO) says: “LO inclines towards defined benefit because this guarantees workers a certain amount. But we accept that many smaller companies will want DC because it is easier and cheaper to administer.”
Another stimulus is likely to be the work of the committee on the future of the Norwegian pensions system set up by the ministry of finance in April 2001. The committee, which is due to publish its final report in October next year, issued a preliminary report in September . This outlined two different two different paths for the development of a new pensions system:
One path is the modernisation of the present system (the state-run national insurance scheme, NIS) with a closer link between income and the accumulation of pension rights. Such a scheme would partly be financed through different types of funds, which could include DC plans.
Lillevold suggests that DC will win ground eventually. “Long term there will be a gradual steady increase of DC plans, primarily form employers that do not yet have a pension fund. But also we will see employers convert from DB to DC which is what we are seeing internationally – and the concerns of the international market place are the same as here – expenses, cost control, accounting.”
Finally, the progress of the European pensions directive could that could emphasise the role of the DC plan is the pensions directive Currently pensions plans in Norway fall under the Third Life Directive.
Caspar Holter says the directive would force Norway to make a distinction between the regulation of life insurance and occupational pensions – something it has so far failed to do. “If we are to comply with EU regulations we have to split up the regulations between life insurance product and pensions products. This would totally change the laws and regulations in Norway, and that would be quite exciting.”
One of the effects of such a distinction would be to place DC schemes firmly in the camp of institutions of occupational retirement provision (IORPs). This would open DC plans up to the more flexible investment rules of the prudent man principle. The new DC legislation has been a step forward for investment choice in Norway. This would take it a step further.