Giles Archibald talks to Alex Beveridge about the difficulties and choices faced by companies across the world when considering adequate pension provision
Giles Archibald: Firstly ageing: people are living longer and staying in education for longer.
In the past, people typically came out of education before age 20, entered the workforce and then went on working until 65 - and then lived for another ten years. Now, so many of our students are staying in education until 25, and many are taking gap years.
Also, the average age of retirement is actually less than 65. Then in retirement, because of the continuous improvement in mortality, on average people are expected to live till 85. People born today in Japan, for example, have a life expectancy of over 90.
So what we are moving toward is a life in thirds: a third in education, a third in work, and a third in retirement. How do we pay for all of this?
Alex Beveridge: Does this make the old models of defined benefit (DB) unsustainable?
Giles Archibald: Yes, particularly when you have the old economies in relative decline. When these plans were put together in the 1970s, life expectancy was a lot shorter, you had higher interest rates, and the US and Europe dominated the industrial production in the world. They did not face competition from lower cost economies. Now you have this tremendous cost pressure.
Alex Beveridge: How do you see countries coping with these changes?
Giles Archibald: Well, first of all, social security provision has to face up to reality. A lot of countries have generous social security - Italy and Greece for example. These countries now realise they are not able to sustain this.
They have seen the writing on the wall and now ask themselves how they can reduce benefits in a way which is politically acceptable? Well, the answer to that is incrementally.
What we're are also seeing is the inevitable rise in retirement age. People can expect to have to work longer in order to collect social security.
Added to the decline in social security and the raising of the retirement age, we now also have the new accounting standards and the reduction in interest rates.
All of this shows companies how volatile their pensions expenses and liabilities are. So we have both the desire to get out of defined benefit plans and the realisation that a true protection plan is too expensive. This volatility plus the desire to reduce benefits has led to a significant move to defined contribution (DC) almost everywhere. Exceptions are rare, for example, Canada and the Philippines are perhaps such exceptions.
Alex Beveridge: What will be the impact of this?
Giles Archibald: DC plans have tended to have far lower cost than the DB plans they replace . It is not as if companies had a DB plan in the UK which was costing , say, 18% of salary then put in a DC plan which cost the same. On average it is half. So while companies have not said they are increasing retirement age, they are effectively doing this by moving to DC and reducing prospective benefits. In addition, if the company is only contributing , say, 9% on your behalf, unless you invest in the same things DB plans are invested in, it is possible to argue that you are not even replicating half of what DB plans return.
So, you have a generational discontinuity. We have the lucky generation, of which I am a part, and then those who will have to work a lot longer.
Alex Beveridge: What are your views on the changes in accounting standards?
Giles Archibald: It goes against all the ingrained actuarial thinking, which is that you don't recognise losses and gains immediately. You smooth them out because you know the market is in flux, so you don't want to have to take all your gains immediately or have to show all your losses immediately. They will be smoothed out over time, which has been shown to be the case.
The problem is people want more transparency; they say if that is where the market is now, then that is how you should value it.
The inevitable consequence is less DB, and so the push for more transparency inevitably means the employee will end up less well off.
Alex Beveridge: What about the Dutch system of collective defined contribution, could that offer an alternative?
Giles Archibald: There are some weaknesses to that system, and time will tell. When the stress comes and the amount of money being put into these programmes is not enough, will companies be under pressure to put more money in? I think the jury is still out.
There are halfway houses which people are looking at. For example, pooling the longevity risk, but we are not seeing a great deal of interest in them.
Alex Beveridge: So this is not a hot topic for multinationals?
Giles Archibald: It is almost as if there is a corporate call along the lines of: "We have got get out of this DB plan - what are other people doing?" "Well other people are getting out and going into DC, so let's do that too." Also, we're not experiencing much pressure from employees because, by and large, the people who are affected are the young, who are not so engaged with pensions.
Alex Beveridge: Will that change in the next 15 to 20 years?
Giles Archibald: I think companies are going to have to face up to the fact they will either have to provide more or accept an older workforce. They won't easily be able to manage people out of the workforce.
If someone reaches 62 and does not have enough to retire, they are not going to retire. It will be expensive to force them to. Indeed some companies which need the experience of older employees may not want them to retire.
If people are more active at 62 than they were 20 years ago, can they go on working till they are 70? We have someone running for the president of the US who is over 70. That's a pretty demanding job. It does seem that the vitality of people has improved. The problem is that we may have created an expectation that everyone will have this wonderful holiday of retirement.
Alex Beveridge: What is the state of multinational pension provision in emerging markets?
Giles Archibald: Brazil has a more mature market for pensions and multinationals there generally will have some kind of retirement plan.
In China, most of the firms tend to concentrate benefits around medical and life. The legislation is still new in China to allow for retirement programmes.
We would expect that in five years' time, most Chinese multinationals would have some sort of DC scheme.
Russia is probably a step behind China, but we expect to see that market maturing because of the very low level of social security.
India, on the other hand, is a country where there has been retirement provision for a long time. It is certainly a country where we would expect multinationals to have some sort of plan.
Alex Beveridge: Pension pooling is increasingly talked about as the route many multinationals will take. What has been your experience of this?
Giles Archibald: I know of very few companies which have a pan-European pension plan. The legislation is there and you can do it, but it is pretty limited right now.
To unlock this opportunity, there needs to be some bundled providers, people who can offer administration [and] investment across multiple markets. That has been a little slow in developing.
Alex Beveridge: What are Mercer's ambitions in this area?
Giles Archibald: We have already spent some time researching our clients' needs and reviewing the various regulatory issues, and are developing pan-European pension offerings with supporting investment, operations and governance advice. We would expect to have a package of options ready by the end of the year.
Alex Beveridge: How would this work in practice?
Giles Archibald: By having one central location for the plan, but with different country sections, as these would need regulatory approval in each individual country. So, for example, you would have a Spanish section approved in Spain and an Irish section approved in Ireland.
The assets would then be effectively pooled so that a company could offer, say, six funds. Members of their pan-European pension fund could then invest in any of the six funds regardless of which country they are from. This approach clearly makes most sense with a DC plan , and we believe is attractive to many multinationals.
Giles Archibald is global leader for international consulting within Mercer's retirement business
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