Changes in multinationals’ approach to employee benefits (EB) are strongly affecting the work of traditional insurers, according to a report by London-based consultancy First Consulting*.
Although EB is still a neglected area in most multinational companies the findings of this study show that this picture is changing fast. The typical international EB department has usually been dramatically understaffed, and had limited knowledge of foreign EB arrangements and limited involvement in decision-making and little cost awareness.
However, moves towards greater harmonisation at a European level and increased cost pressures are forcing multinationals to review their policies towards EB, thus bringing huge changes for the EB departments themselves but also for pension products providers, who will have to change the nature of their business in order to maintain their current market share.
The first change for insurers is the increasing focus on fund management which will be the key area in EB provision, forcing them to acquire fund management skills and establish a well-recognised fund management brand. This is quite a complex task and early developments in the US during the last decade suggest that insurers will find it very difficult to maintain their place in the market.
Also, the shift from defined benefit (DB) to defined contribution (DC) will bring major modifications. According to the report, the timing and scale of this change is still uncertain and if the stock market boom continues allowing multinationals running DB schemes to enjoy large surpluses in their pension funds, it will take a long time for DC schemes to really take off. “If the current long- lasting bull market would come to an end, the trend towards DC may be speeded up,” the report says.
However, and taking into account that this trend will affect each European country in a different way, both managers and administrators of pension schemes should start preparing themselves for the new range of products required in a DC environment. Multinationals will reduce the use of bundled products and buy services separately, thus decreasing the demand for traditional insured pension products.
The move from insured pensions to pension funds, the different forms of risk sharing with local insurers and the increasing using network pooling, will have significant implications for EB providers who will have to struggle to become competitive on all fronts or focus their business on a reduced range of products.
The report also underlines that the use of commission-based brokers will be reduced. “The traditional broker relationships are already coming under scrutiny as more and more multinational companies start questioning the value added by brokers as part of their drive towards greater efficiency,” the report says. “As this trend strengthens brokers will have to find alternative sources of revenue as their traditional commission income is drying.”
In terms of regulatory reform, the study states that “the pension fund market is the one market still relatively unaffected by the creation of the European single market”. However, this is starting to change as cross-border pensions and pooling of pension assets are becoming more important for multinationals. “Estimates in the industry suggest that pan-European pension schemes – pooling administration, assets and liabilities across several countries – could lead to up to1% higher returns on fund assets calculated for a multinational with approximately E3bn in pension assets,” the report says. This would mean a reduction of annual pension contributions of around 20%.
Although the pension reform at an European level has still a long way to go, and a pan-European pension scheme won’t be a reality in the short term, the report highlights that intermediary steps such as partial pooling of administration an assets, are already possible. At the time the interviews were conducted, it was unclear how many multinationals were taking this approach, as regulatory issues are very complex and EB managers at multinationals are not always aware of the different options available.
Nevertherless, the increasing attention and publicity given to the EU pension reform is not always clear. The report comments that sometimes consultants and lawyers promote conferences and press coverage about developments which are not always very significant, which makes it difficult to distinguish what is mere hype from what really are important regulatory developments.
The study recommends providers of EB-related services to present themselves as being well-positioned for the eventual arrival of the pan-European pension, which might impress consultants and therefore facilitate gaining market share.
National pension reforms are also altering the EB scene all over Europe and companies seem to be concerned that they might be expected to pick up a larger share of the pension costs, thus increasing the interest in EB issues again. The Spanish law requiring companies to externalise their pension liabilities has resulted in a new market for pension funds in the country, just as the introduction of stakeholder pensions in the UK has urged managers to offer lower costs, flexibility and more efficiency.
Also in the UK, and in other countries like Sweden and Italy, recent reforms allow individuals to decide how their pension assets are going to be invested and who the fund manager is going to be. This new type of pension product, sometimes called ‘instividual’ products because they are organised by an institution but with the providers being chosen by individuals, will constitute great opportunities for pension providers. The new opportunities will also bring new challenges for brokers and consultants, which will have to find different approaches in order to be successful in the new EB environment. Brokers will suffer as multinationals try to cut out intermediaries to reduce costs and consultants will see they actuarial income reduced by the gradual shift from DB to DC pension schemes.
But the worst affected will be the traditional insured products providers that will have to set up new sales strategies and distribution channels for their products as the business they have been focusing on is gradually loosing importance, with the added threat of newcomers breaking into the European market.
“At the same time, the rewards for those who get it right are likely to be substantial as these ‘instividual’ products are widely predicted to be one of the main growth areas in financial services,” the report says.
The report is based on interviews with EB managers at international companies and providers of EB-related services across Europe, as well as with lawyers and representatives of the European Commission. This research was complemented with studies on insurance, pensions and fund management previously undertaken by the group.
*European employee benefits: insurers under seige. Report by First Consulting in London