Occupational pension schemes are currently being buffeted by storms in the equity markets. In particular, companies providing defined benefit (DB) pensions, who enjoyed pension contribution holidays when stock markets were booming, are now faced with shortfalls in their pension fund assets.
In the Netherlands, pensioners have set up lobby groups to compel companies to top up their depleted funds. In the UK, a growing number of companies are closing their final salary pension plans because they say they cannot afford to fund them – a move that is being strongly opposed by trade unions.
Members of defined contribution (DC) schemes are also seeing the value of their funds cut as equity prices fall, and the value of annuities shrink as bond yields narrow.
The message is clear. Unless total pension contributions are raised, pay-outs will be lower.
In this month’s Off the Record we ask fund managers and administrators how they think the funding of occupational pension schemes can be improved in the current climate – in particular, whether contribution levels should be increased.
Should employers or plan sponsors be expected to contribute more, either in funding or contributions? In a number of European countries, contributions by employers to DC plans are low. In Ireland, the average level of contribution by employers to DC schemes is less than 5%. In the UK, legislation on the new stakeholder pension plans obliges employers to give their employees access to stakeholder schemes but does not oblige them to contribute anything to these schemes.
At the same time, should plan members be expected to contribute more? Should they be prepared to make a more realistic contribution to their DC plans to take account of the new low-growth, low interest environment?
Alternatively, should the pension burden borne by companies who operate DB final salary schemes be reduced? In the UK, the report by Alan Pickering on simplifying occupational pensions suggests that companies may be encouraged to retain their DB schemes if they are no longer obliged to index pensions or to provide survivor benefits.
The verdict of the pension fund managers and administrators who responded to the IPE survey is unequivocal. Both employers and employees must contribute more to ensure adequate pensions. A substantial majority (83%) of the respondents says that generally contributions to occupational pension plans by both employers and employees are too low.
There are country-specific reasons for this. In some countries, private contributions may be squeezed out by contributions to the state pension system. One manager of a French pension fund points out that the chief reason for low voluntary contributions in France was the “high level of employer and employee compulsory social contributions in France”.
In other countries, the adequacy of contribution levels depends on the type of pension scheme. One Danish fund manager points out that “while contributions to DC plans in Denmark are generally too low, contributions to DB plans are not necessarily too low”.
However, there is a consensus that people are contributing too little because of unrealistically high expectations of future returns, based on the experience of the 1980s and 1990s. The manager of a Swedish pension fund says “the expectancy that returns take care of almost everything is very strong. A balanced investment will, over a period of 30 to 40 years, never make a return of more than the average of the return on a mix between bonds and stock. He who gets more should feel lucky”.
A Brussels-based pension fund administrator warns that contributions should take into account the full cost of providing a pension. “Providing pensions is not inexpensive. Contributions should be set at reasonable rates which reflect the desired level of benefits and take into account the age of the member. “
Wider investment choice may also be a solution, she suggests. “Providing sufficient choices of investment funds for members of DC plans can also help to alleviate the strain of volatile investment markets. Investment in equities, however, should not be considered for anything less than the long term.”
One UK manager is blunt about the reasons for low contributions: “For employees it is apathy and lack of communication or understanding and for employers it is because profits come before benefits.”
Overall, there is a strong feeling that employers should do more to improve the pensions provision of their employees. Two thirds of the respondents (67%) think that employers should be compelled to make some contribution their employees’ pension plans.
There is a similar consensus about what proportion of the total contribution employers should be expected to pay. Two thirds of the respondents (66%) take a paritarian view and suggest that employers should pay 50% of the total contribution. The remaining 34% of respondents say the share should be higher, with 8% suggesting 60%, 9% suggesting 66% and an impressive 17% saying that the employer should make the entire contribution.
Companies should not be allowed to make inadequate contributions to a pension fund, respondents suggest. A substantial majority (87%) agree that employers or plan sponsors should be obliged to maintain reasonable levels of contribution to their employees’ pension schemes.
A reasonable level would appear to be around 5%. Most of the respondents (67%) suggest that employers or plan sponsors should contribute between 4% and 6% of an employee’s gross salary. A smaller proportion (25%) say this should be over 6%. Only 8% suggest a level of 3% or below.
A large majority (80%) felt that employers who take contributions holidays should have an obligation to make up any shortfall. Most feel that this is a matter of prudent management rather a prescribed duty.
One administrator of a UK pension fund sums up the views of many: “Markets go up and markets go down. When they go, there are surpluses, benefit improvements and contribution holidays. Hopefully there is also some prudence so that some surplus is reserved against a rainy day. When markets go down there is a need for prudence and higher contributions, especially if sponsors, trustees and advisers do not reserve adequate surplus during the good days.”
However, there is far less certainty about the extent to which the sponsors of pension plans are obliged to protect their members against price inflation. Our respondents were almost evenly divided about this issue with Only a small majority say that 53% say that employers/plan sponsors should be obliged to raise pension benefits in line with consumer price increases. The Pickering report on occupational pension plans in the UK has proposed easing the burden on employers by removing any requirement to provide survivor benefits. This proposal has been strongly opposed by the unions. It also gets little support from our respondents. A clear majority (60%) think that employers should be obliged to provide survivor benefits.
One solution to under-provision may be to make membership and contribution to a second pillar occupational pension scheme compulsory. This idea gains strong support, with 73% in favour of compulsory contributory pension plans.
However, there are limits to this compulsion. Only 32% believe that contributing members of DC pension plans should be obliged to increase their contributions to offset the fall in the value of their funds. Members may choose to do so but they should be allowed to choose not to do so. After all, it is their money that is at risk.