Lessons can be learnt from overseas pensions arrangements.
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- Pension schemes across the globe are highly fragmented.
- Rising life expectancy is encouraging governments to provide pension schemes.
- More mature pension regimes are beginning to regulate the structure of default funds.
Global pensions provision is highly fragmented. In western Europe, for example, people look largely to the state rather than to their employer for a pension, while across Africa and in some parts of Asia, the absence of social security has led to continued reliance on the family network for financial support.
More than 80 countries have some kind of social pension, but as life expectancies rise, many nations are encouraging people to take responsibility for their own retirement savings. Countries such as France, Hungary, Poland, Portugal and Germany have introduced private pension saving initiatives, often with tax privileges.
Of course, there are exceptions to the rule and undeveloped countries where life expectancy is lower. In Russia, for example, male life expectancy is 61. In Zimbabwe and Lesotho, where life expectancy is just 38, less than 5% of people have a pension.
But in Japan, life expectancy for women is predicted to exceed 90 by 2050, and social security accounts for one-third of the country’s ¥90 trillion (£672 billion) state budget.
Japanese men typically work until age 70 and women until 67, according to the Organisation for Economic Co-operation and Development (OECD), although the country’s official state pension age is 61, rising to 65 by 2025.
Pensions in Japan
Japan’s social security bill is inflated by the defined benefit (DB) nature of its national pension scheme, Kokumin Nenkin, which contrasts with the cheaper and more flexible defined contribution (DC) arrangements of most provident funds across Asia.
All registered residents of Japan, including foreigners, pay set monthly pension contributions at banks, post offices or convenience stores, and receivea basic pension from age 65 as long as they have paid contributions for 25 years. The benefit is based on the number of years for which employees have paid contributions.
The Netherlands also operates mainly DB arrangements, but unlike most of continental Europe, it boasts a huge occupational pension system covering 90% of Dutch workers, easing pressure on the state purse. The country’s flat-rate public pensions are boosted by these earnings related occupational pensions, into which employees typically pay 4% to 8% of salary.
DB structures have also survived in countries such as Spain, Italy, France and Portugal, where there are industry-wide schemes and strong trade unions.
James Walsh, senior policy adviser, EU and international, at the National Association of Pension Funds (NAPF), applauds the scale of Danish, Dutch and Australian pension funds, which is achieved through just a few very large schemes. “Scale makes for low costs and therefore better returns for the investor and higher-quality governance, so schemes are well run,” he says. “These are features we would like to see imported here.”
Unsurprisingly, newer state-backed schemes tend to be DC with compulsory membership. Such schemes are growing across Asia. Hong Kong’s mandatory provident fund system of approved trusts was introduced in 2000 and covers 98% of relevant staff. Employers, employees and the self-employed contribute 5% of the first £24,000 of salary. Employers choose a provident fund scheme, which is provided by banks, insurance companies, asset managers and trust companies. Existing occupational schemes were allowed to continue if they met certain standards.
Lesson from Hong Kong
What happened next in Hong Kong could provide a salutary lesson for auto-enrolment in the UK. Mark Childs, managing director of the Total Reward Group, says: “After the initial flurry [following the introduction of the mandatory system], many providers retreated and the market was left to the HSBCs and Fidelitys of this world. Normally in mandatory arrangements, there is an initial rush for market share when lots of providers come into the market and go for a land grab, but not long after that, there is often a retreat.”
New Zealand’s Kiwi Saver work-based savings initiative is most similar to the UK’s auto-enrolment regime in that it operates an opt-out system. More than half of New Zealand’s working population is now enrolled in this scheme, which offers a NZ$1,000 (£520) kick-start plus tax incentives, and is provided by a number of private sector companies. Staff can choose to contribute 2%, 4% or 8% of gross salary. People who are self-employed or out of work can also contribute. The fund can also be used as the deposit on a first home.
One of the most comprehensive social security saving systems is Singapore’s Central Provident Fund. Set up in 1955, it has evolved to address not just retirement, but healthcare and home ownership.
Working Singaporeans and their employers make monthly contributions to the fund, which go into individual accounts. For most people, contributions to cover all three services total 36% of salary, of which 16% is from the employer and 20% from the employee. Workers can take their savings at age 55 providing a minimum sum has been set aside to buy a life annuity. Monthly drawdown is then allowed from age 62.
Pension scheme design
Pension scheme design varies considerably between countries, ranging from highly prescribed to flexible. Australia’s lauded state backed system allows a lump sum to be paid on retirement, and members can withdraw funds for specified conditions, such as terminal illness, physical incapacity or financial hardship. Employers pay 9% of an employee’s salary into the superannuation fund.
Such high contribution rates would be difficult to introduce in many other countries. Chris Curry, research director at the Pensions Policy Institute, says: “Australia’s high contributions are possible only because they have been built up over time and there is a culture of collective bargaining. The scheme was first introduced in 1992 after negotiations with the unions for 3% employer contributions in lieu of a pay rise. By 2002 they had risen to 9%, where they have remained for a few years, but by 2020 they will rise to 12%.”
However, the highest contribution rates can be found in the social security systems of France, Belgium and Spain. For example, Spain’s pension system is financed by a payroll tax on salaries. Employees pay 4.7% of salary and employers the equivalent of 23.6% of an employee’s salary into the scheme.
But the political imperative for pensions is weaker in countries with young demographics. Pensions coverage in India, for example, is less than 25%. Indian state employees are covered by a DC pension plan, but it captures only 12% of the total workforce.
India’s New Pension Scheme, introduced in 2004 for central government staff , was made voluntary for all citizens in 2008, but has attracted just 3.6 million who are prepared to match the 10% of salary paid by employers, that is required by the scheme.
DC fund design
An interesting trend in more mature pension regimes is legislation governing the design of DC funds. In the US, where 60% of the workforce has access to retirement plans, there are two DC schemes to every DB plan. Legislation ensures the default fund takes account of certain characteristics, such as de-risking in line with age.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “Automatic derisking is a good idea in principle, but the world is travelling in the other direction, where individual engagement will become increasingly important.”
There are also arguments in favour of US-style ‘safe harbour’ laws, which absolve employers of responsibility if their pension investments do not perform well, as long as they put in place a qualified default fund alternative. This has given US employers the confidence to move away from cash funds to focus on members’ long-term interests.
Many countries that have privatised part of their social security system, such as Chile, Argentina, Mexico and Slovakia, have made rules about the risk in funds, often creating guaranteed funds, and leaving providers in these markets to compete mainly on service.
The myriad pension schemes across the globe present challenges for employers with staff working abroad, because they need to understand the obligations that operate in different jurisdictions.
Mark Price, principal, international consulting group at Mercer, says: “While most employers prefer to retain their internationally mobile employees in home-country pension schemes, this is not always possible. For complex assignments, employers are more likely to create an international retirement or savings plan, often offshore.
“However, employers should note there may be domestic schemes, either mandatory or provided under collective bargaining agreements, under which expatriates may need to be covered. It may be possible to secure exemptions from such arrangements, but employers should review domestic environments to ensure double coverage does not take place.”
Employers should also consider scheme charges. Paul Kelly, senior international consultant at Towers Watson, says: “The charging structures on schemes can be much higher than retail charges because in many of these jurisdictions there is no disclosure, so it is not clear what the charges really are.”
KBC banks on three-fund pension strategy
Belgium-based KBC Bank has three pension funds: a basic scheme, a plan for senior management and an international scheme.
Its international pension fund, created in 2009, manages a cash balance plan, which is a defined benefit (DB) scheme run like a defined contribution (DC) plan with hypothetical individual employee accounts. The €5 million (£4 million) international fund guarantees an annual return of 5% on all contributions for its 200 expatriate employees.
Edwin Meysmans, director at KBC Global Services, says the plan was set up when the bank started to make acquisitions in eastern Europe, particularly in the Czech Republic, Slovenia, Hungary, Slovakia and Russia.
“To run these operations, we sent a number of senior managers from Belgium to assist the local people and integrate the new bank into the group,” he says. “In the beginning, we would suspend their Belgian pension and make up what they had lost when they came back, but this was difficult because the remuneration package looked quite different from that of local employees, and technically it was difficult to know what to include, such as housing allowance. Another concern was whether tax was deductible on contributions.”
In 2012, KBC paid €97 million (£78 million) in contributions to the basic scheme, based on a 9.82 % rate; €8 million (£6 million) into the senior managers’ scheme, based on a 15% rate; and €1.2 million (£1 million) into the international plan, based on a 10% rate. The funds adopted a liability-driven investment strategy in 2007, hedging their liabilities against interest rate and inflation risk by using a dedicated fund comprising interest-rate swaps with varying durations and 200% leverage.
Meysmans says: “Compared with other Belgian or European funds, we do three things differently: we have no exposure to government bonds, but use interest-rate swaps for hedging liabilities; 20% of our equity exposure is in a low volatility/ minimum-variance strategy; and we invest in real assets other than real estate, such as infrastructure.”
Gabriel Bernardino, chairman, European Insurance and Occupational Pensions Authority
Pan-European pension fund savings
Pan-European pension funds allow retirement benefits to be provided at lower cost. Economies of scale may be achieved by centralising investment management, pension administration and actuarial support. This may benefit employers and employees in terms of lower contributions and higher benefits.
A cross-border pension fund will also bring savings by simplifying governance. Employers will only have to deal with a single board of trustees and supervisory authority. Also, a pan-European fund may enhance the management of the employer’s financial resources, because shortfalls and surpluses may off set each other on a European level.
But the cross-border market is very small, with currently only 84 pension funds.
An important barrier to the functioning of the pensions market is the wide variety of prudential regimes across Europe. The existing EU regime, the Institutions for Occupational Retirement Provision (IORP) directive, takes a minimum harmonisation approach, allowing member states to supplement these with additional prudential rules. It is often difficult to accommodate occupational schemes from other EU countries as national prudential regimes are tailored to the domestic situation.
Another barrier is that pension arrangements must operate as part of each member state’s overall legal system in respect of occupational pensions, for example taxation and social and labour laws.
Among other non-legal and non regulatory obstacles for cross-border schemes are cultural and language barriers.