©  Copyright 2002 Rogers Media. The following article first appeared in the January 2002 edition of BENEFITS CANADA magazine.

In most countries, personal and employer plans--equivalent to Canada's registered retirement savings plan (RRSP)--are based on a tax principle in which contributions are tax deductible or tax exempt. Investment earnings are also tax deductible or tax exempt, but benefits are taxable. Things aren't quite as simple in Canada--our $1,000 pension income deduction is a case in point--but the principle is broadly applicable. Within the European Union, there is significant political pressure to move in this direction.

SETTING THE STAGE IN EUROPE
After the Second World War, most European countries instituted generous social security programs to compensate a generation whose savings had been largely wiped out. In the decades following the introduction of these programs, benefits improved steadily, especially the early retirement provisions. Today, the baby boom, combined with increased life expectancy and 50 years of peace and relative prosperity, is placing a huge burden on social security programs.

A study by the Organization for Economic Co-operation and Development shows that in some European countries the average retirement age for males had fallen from over 65 in 1965 to under 60 by 1995, with only one-half of the population in the 55 to 64 age group still working. For most countries, the greatest problems still lie 20 years down the road, and government response has been predictably slow.

The U.K. government has tried to reduce the proportion of retirement income provided by the state. Benefits are increasing for low-income earners, but earnings-related supplements will be reduced and contributory DC arrangements made available to all citizens. Contributions to these plans will be strictly voluntary, and employer contributions will not be required. Funds will be managed by the private sector (banks, insurance companies) but management fees will not be permitted to exceed 1% of assets a year.

Given that management fees for group RRSPs in Canada are commonly in the neighbourhood of 1.5%, this final condition may make operating these plans unattractive. Nevertheless, there is a significant movement in the private sector towards DC plans that offer a range of optional contributions by members and matching employer rates.

In France, pension experts believe that an explosion in private plans is imminent. Until recently, benefits from state-mandated schemes left little need for employer pensions, with the exception of supplementary plans for high-income earners. The program for civil servants offered 70% of final pay. Top-up plans for private sector employees were provided on a book reserve or insured basis. Now, it is expected that the equivalent of trust funds will be approved by private plans in the near future, and that many of these arrangements will be on a DC basis.

In Germany, on the other hand, employer-sponsored defined benefit (DB) pension plans have predominated. Country-wide compulsory insolvency insurance has protected vested benefits and pensions in pay. Although this system has worked well in the past, the prospect of reduced social security benefits has created demand for greater flexibility. To accommodate this demand, a new pension vehicle will likely be introduced to allow for deductible contributions by employers and employees--albeit at low limits. The current expectation is that most will be of a DC nature.

The biggest hurdle to implementing European-wide pension arrangements is the complex patchwork of tax and regulatory systems now in existence. Nevertheless, the introduction of the euro in 12 of the 15 countries will inevitably have a significant impact in the longer term. With employees paid and receiving pensions in the same currency, the pressure for portable pensions and greater uniformity of practice is bound to grow.

LOOKING TO THE FAR EAST
The sweeping social and economic changes taking place in China extend to its social security and private pensions. In the old days, the Communist party looked after its own, providing retirement pensions to members and employees of the state of up to 80% of final earnings. The New Unified Pension System changes all that. This three-pillar approach comprises state programs, employer- and employee-sponsored plans and individual savings. The first two pillars are mandatory.

Although it will take years for the new system to mature, its enormous potential is evident in the intense competition among Western financial institutions to gain a foothold in the market. Undoubtedly, the huge pools of capital which will ultimately be created by this approach are a key inducement for the Chinese government.

In Japan, the aging problem is compounded by low, even negative, economic growth rates. This has led to reductions in social security benefits. At the same time, private sector plans are facing pressures of their own. They are generally book reserved and the impending introduction of new accounting standards--similar to those in Canada--will negatively impact profits and balance sheets. The result has been an increasing trend toward the cancellation of state plans. Legislation permitting tax-favoured DC plans was recently introduced, and it is expected that these plans will flourish in the future.

The Singapore system is unusual in that social security has always been provided on a funded DC basis and private plans have been regarded as superfluous. However, contribution rates have been reduced to increase corporate profits, and the upper earnings limit on which contributions can be made has not been raised for some years. Much of the assets are invested in government-issued securities promoting economic growth over maximizing returns.

In addition, account balances have been made available for house purchase and medical bills. As a result, benefits have fallen short of expectations, and the government is allowing personal pension plans (individual retirement savings arrangements similar to RRSPs) with assets invested in the private sector and tax-deductible contributions. These plans are likely to prove popular despite the fact there is no requirement for employer contributions.

The U.S. social security system has already adapted to the country's changing demographics by deferring the retirement age to 67 as of 2027. A shortage of skilled labour will provide plenty of work for later retirees.

There is still a sizable constituency advocating the conversion of some, or all, of the social security system to the DC model. The conversion of employer plans to the DC approach through 401(k) plans has almost run its course. Falling stock markets over the past 12 months may affect the continued attractiveness of the DC approach, but the impact will largely be determined by how long a recovery takes.

The adoption of DC plans has slowed down in Canada but we still lag behind the U.S. It is surprising that there was so little support for a modification in the Canada/Quebec Pension Plan to include a DC element. But with so many people invested in RRSPs and DC plans, the safety of Old Age Security and CPP may be comforting. Drastic measures are far less necessary here than in Europe because demographic changes will not be as extreme and government-sponsored pensions have never offered much incentive to retire before age 65.

The above countries are all industrialized, affluent and aging--with the exception of China, whose goals are to achieve the first two and whose family planning policy guarantees the third. As a result, it will be a challenge over the next 50 years for all societies and organizations to meet the retirement needs and expectations of their citizens and employees. BC

The Romanow Commission has released its final report on the future of healthcare in Canada.

For Commissioner Romanow's recommendations, click here.

Click here for Senator Michael Kirby's report, "The Health of Canadians – The Federal Role: Recommendations for Reform."