Why the DC/DB mix is ‘best’
Responsible and socially minded employers will have to operate
a mixed defined contribution (DC)/defined benefit (DB) 2nd pillar system, according to Daniel Chable, chief actuary of the Nestlé group, based in Vevey. “This is particularly true for large corporations, public sector organisations and some collective occupational pension schemes,” said Chable at the annual Swiss Pension Forum 2000 organised by Buck Consultants last month in Geneva.
Chable said that the first pillar systems, which are mainly on a DB basis, are coming under pressure. “In emerging countries you will see mainly DC systems or situations of changing from DB to DC,” he said.
Chable underlined several factors affecting the second pillar: “Legislation is becoming more complex and there is a growing complication of accounting requirements for DB plans.
“We see an acceleration of business combinations, mergers and spin-offs. Employment and salary conditions are more and more volatile as more employees are hired on a temporary basis or for specific projects. Plan sponsors want to control costs in particularly in terms of representatives in payroll and simple administration. They also want employees to perceive plans as a substantial fringe benefit to salaries,” said Chable.
“Members want value for money, in the sense that their invested contributions are supposed to give them a varied and substantial increase in benefits and flexible plans. They want more individualism and less solidarity.”
Financial markets are becoming more efficient in terms of returns and legislation seems to be more receptive to the third pillar which is emerging as a DC alternative to the second pillar . “Given all this, the obvious conclusion would be: ‘Change to DC, and do it quickly’,” he said. “DC plans, on a year to year basis, remain quite credible because real return on investments have exceeded inflation. But if you look at the American scene you could see a number of cases that have been brought to court by employees suing employers or investment consultants who supposedly had not informed them correctly the choice of investment.” He added: “ You have to bear in mind that there are still significant portions of employees, specially thosewith lower salaries who really depend on DB plans.” So, a mixed DC/DB plan would be the best solution, in his view.
The need for taking strategic decisions in planning pension schemes was also discussed at the seminar. Mike McShee of Buck Consultants in Geneva said: “You don’t have to make strategic decisions about your pension fund everyday, but sometimes you do. On occasions you have to think if it is time for you to change from DB to DC or if you have to increase the benefits in your pension fund or to equalise conditions for men and women. Some of these things are very big questions and some are smaller, but all of them are strategic questions,” he said.“Employers operate in competitive markets for their products but also for their employees.
“Flexibility is still a new concept, but employees are more and more concerned about improving the returns of their investment,” said Jalila Susini of Buck Consultants. When a flexible approach is taken, employees have to understand that they will be responsible for their decisions, so a commitment to education and training is essential for this approach to be effective.
“We have four different possibilities for flexibility: investment choice, level of contribution, voluntary contribution and level of death and retirement benefits. It has to be seen as a complement to a normal basic plan and not at all as something that is going to cut down benefits,” she said.
The implications of the EMU in the pension industry were also part of the discussion. Norbert Rössler, managing director of Buck Heissmann Europe in Wiesbaden, Germany said: “The EMU countries represent completely different economies. The GNP per capita, for instance, varies from E 35,000 in Luxembourg to less than E 9,000 in Portugal.”
There are also dramatic differences in productivity levels and unemployment rates.”
Rössler commented that if tax discrimination within the EU disappear s and a pan-European pension system come into force, the free transfer of capital with tax deduction to this pan-European plan would be guaranteed and member states would have to adapt their domestic national regulations to the new situation but “this will take time”. “It is true that the single currency is affecting the market, but we do not see signs of significant convergence for the near future.”