“What you do see is a convergence going on around the world,” he says. “You do see a gravitation towards the U.S. 401(k)model and all of them are at varying points of progress.” In addition, adds O’Brien, more countries are adopting the four pillars of social security, occupational pension plans, personal savings, and employment income. Around the world, private and public pension systems are in the throes of change.
What sets Holland apart is that politicians have recognized the importance of having a strong regulator. “The system has now accepted the reality that you can’t have firm, hard pension guarantees that are based on final earnings and are fully indexed,” says Keith Ambachtsheer, president, KPA Advisory Services Ltd. in Toronto. “It’s too expensive. You’ve got to put flexibility into the benefits.”
In 2002, Holland’s regulator issued a letter to the pension fund industry stating that, in its view, Dutch pension plans had become materially underfunded. It maintained that contribution rates would have to rise considerably, benefit promises would have to be scaled back, or some combination of the two.
“The regulator basically said ‘you need to match everything to market, both assets and liabilities, and if you take mismatched risk, you need to have a risk buffer, to offset that mismatched risk, just as you have in the insurance industry, or the banking industry,’” says Ambachtsheer.
In the July 2005 edition of his newsletter, which provides research and commentary on pension governance, finance, and investments, Ambachtsheer writes that Holland is leading the way for other countries in terms of pension reform. The reasons, he says, are four-fold.
Pension plan membership in Holland is compulsory, pension contracts are in the process of being clarified, with a focus on the nature of the pension promise, and on who the pension promise underwriters are. “Re-engineering efforts have focused on introducing modern financial economics principles into the definition and valuation of contingent pension claims,” he writes. “These developments in turn enhance the prospects that the redefined pension arrangements will be transparent, fair, and sustainable.”
Dutch pension funds are leaders in the global hunt for new investment opportunities and in raising global corporate governance standards.
The pension industry is openly debating pension plan governance. “While there is no consensus yet on the ideal organization design of a Dutch pension fund, the debate is on,” he writes. The ongoing challenge for the Dutch pension system is collective risk-sharing, says Ambachtsheer.
“It’s not obvious just who is providing the guarantee. It’s not the employers, which means it must somehow be shared among all the plan participants, and it’s not clear how,” he says. “The next step is to bifurcate the accumulation of pensions for everybody into two parts. One is a guaranteed part that will act like an insurance company-type annuity. The other part is just an investment account. That’s the final step and that’s what I’m advocating for everyone in the world. The Dutch have made significant progress towards that because they have a regulator who’s prepared to be proactive.”
Sweden is another country that has undertaken significant pension reform. In 1998, the Swedish parliament passed legislation that transformed the country’s social security system to a notional DC plan. It’s financed on a pay-as-you-go basis and replaces a DB plan.
Dr. Annika Sunden, a researcher at Stockholm University in Stockholm, Sweden, says the new system creates a clearer link between workers’ contributions and benefits because it credits the bulk of workers’ payroll taxes to virtual individual accounts(paper accounts with no actual assets). Upon retirement, benefits are determined by the accumulated balance in each account.
“It’s similar to the Canadian system in that most of the retirement income comes from earnings-related benefits,” says Sunden. “There’s a minimum guarantee for people who don’t have enough income-related benefits on their own.”
The payroll tax of 18.5% is split between the employer and the employee. A small portion of the payroll tax, 2.5%, is used to set up individual investment accounts—called premium pensions—with actual assets controlled by employees. The system is set up so that all adjustments that have to take place to ensure financial stability take place on the benefits side, rather than on the contribution side. “When you calculate your benefit at the end, you take the amount in the notional account and divide it by remaining life expectancy,” says Sunden. “As life expectancy increases, the system is set up to automatically account for that. It’s an innovative way of setting it up.”
The funded component(2.5% of earnings up to a ceiling)lets plan members have some control over their pension investments. Workers can choose from over 700 investment funds in Sweden, with the default selection being a global equity fund.
The Premium Pension Authority— the regulator for the funded component of the system—has plans to introduce an automatic rebalancing model by the end of the year in a bid to help apathetic plan members control their investment risk.
The second piece of Sweden’s pension system is comprised of four occupational plans—one each for national government workers, local government workers, salaried workers in the private sector, and hourly wage workers in the private sector. These plans are provided through collective bargaining agreements. Approximately 90% of Sweden’s workforce is covered by one of these occupational plans.
Prior to reforms in the public system, these occupational plans were traditional DB plans. Following the conversion of the public system to DC, the private plans followed suit, either converting completely to DC with individual accounts or introducing DC-style individual accounts while retaining a DB component. “They are really important for people who have earnings above the ceiling because they provide a similar income replacement as the public scheme,” says Sunden.
She says Sweden is one of the few countries to have achieved comprehensive pension reform. “We do have a system that’s financially stable, that’s designed to be financially stable and adjust to variations in financial and demographic developments,” she says. “On the face of it, it’s a very simple system.”
Nevertheless, the system is very difficult for most people to understand. In addition, given that it’s a DC plan, it’s hard for workers to know what their benefits upon retirement are going to be. “We get projections every year in annual account statements but the farther off you are from retirement, the more uncertain it is,” she says. “It puts more requirements on participants.”
Similar to Sweden, Poland significantly reformed its pension system in the late 1990s. It replaced its unsustainable DB system with a new DC-based system. The Polish system now comprises four pillars, two of which are mandatory, two of which are voluntary:
Pillar One(P1)is a stateoperated, mandatory DC plan, funded through a payroll tax to which both employees and employers contribute. It’s accessible after age 60 for women and after age 65 for men.
Pillar Two(P2)is a statemandated but privately operated DC plan. It’s mandatory and is funded through employee contributions only. Employees choose where the money goes; the employer collects the contributions and forwards them to the selected providers.
Pillar Three(P3)is a registered voluntary DC plan sponsored by the employer. Contributions are tax-deductible by the employer, while investment earnings are taxexempt by the employee. If the plan is offered, it must be available to all employees.
Pillar Four(P3)is a non-registered voluntary DC plan sponsored by the employer. Contributions by the employer are not tax-deductible and the employer has full discretion in determining who can join the plan.
“After I came back from Poland, I said to someone ‘it’s as if they hired a consulting firm and told them to take a year, find the best pension practices from around the world and come back and tell us what our best practices should be,’” says O’Brien of McCain Foods, which has 195 employees in Poland. “And that is, in fact, what they did.
Chile is often cited as a shining example of how pensions can be provided under a private model. In 1981, the country implemented massive reforms to its social security system. Instead of paying a payroll tax, every Chilean worker sends his monthly contribution— between 10% and 20% of wages— to a tax-deferred pension savings account. Contributions are invested in capital markets through private investment managers. When implementing the reforms, workers were given a choice of staying in the old system or switching to the new one. All new employees went into the new system.
While Chile has been relatively successful in changing the way workers view saving for retirement, many other countries don’t have a similar savings mindset. Over the course of history, in some socialist and communist regimes, for instance, employees’ retirement savings have been periodically wiped out by various government actions.
O’Brien cites the example of Argentina, which offered a private Chilean-style social security system.“Then the Argentine government required that more than half of your account had to be held in Argentine state bonds,” he says. “So you had a great model that got destroyed by the investment direction. When Argentina went into default, it defaulted on the bonds, which wiped out the better part of most Argentines’ retirement savings. Now when you try to set up a plan down there, people are not all that excited about an employer’s pension plan.”
Australia, meanwhile, went to mandatory participation in workplace pension plans in 1992. Called the Superannuation Guarantee, it’s a mandatory company-based pension with a contribution rate of 9% of salary.
One of the challenges in Australia is that regulators have never required automatic annuitization of the lump sum upon retirement. “When the system was young, the amounts coming out were not that big so the habit people got into was to take the lump sum and go out and spend it,” says Ambachtsheer. “It’s supposed to be a pension. There’s now a public debate about what should be done to turn the lump sums into pensions.”
Last year, the Australian government introduced new legislation which enables employees to put their contributions either with the money manager selected by their employer, or move it into the retail market with a money manager of their own choice. It remains to be seen whether employees will take advantage of this new option.
“They shouldn’t because they’re going to pay much higher fees but that’s the new wrinkle in the Australian system,” says Ambachtsheer.
According to a survey from Mercer Wealth Solutions in Australia, most plan members are choosing to stay with their current fund. Just under half(49%)of respondents said they were “unlikely to change,” according to the December 2005 Super Switch Index from Mercer Wealth Solutions in Australia. The quarterly index tracks member intention to switch funds. It combines three measures—stated intention to switch, member satisfaction with the current fund, and number of superannuation accounts held—to come up with an overall indicator.
Ambachtsheer says the Australian system is a good one in that it provides a high rate of coverage. In addition, the country has a relatively small number of large pension systems. “It’s based on region or on industry so the whole idea of individual employers sponsoring pension plans has largely gone by the wayside,” he says.
The U.K. has released several significant pension reform papers in recent years. In 2001, the government released the Myners Report, which outlines a series of principles that codify best practices for investment decision-making.
In 2002, the government appointed a three-member Pensions Commission to study the U.K. pension system and make recommendations on how to improve it. Late last year, the Commission released the second part of what’s commonly known as the Turner Report, after the Pensions Commission’s chairman, Adair Turner.
The 2005 Turner Report, called A New Pension Settlement for the Twenty- First Century, proposed the creation of what it calls a National Pension Saving Scheme(NPSS)into which all employees without good existing provisions for pension benefits would be automatically enrolled.
The report dealt only with the part of the workforce not already covered by a workplace pension plan. In Canada, between 50% and 60% of workers are not covered by any type of private pension plan. “There’s debate as to how to set something like this up,” says Ambachtsheer. “They’re visualizing one big system and there’s already debate about the fact that it would get too big, too powerful. But maybe you have three regional systems. I don’t think there’s anything magical about having just one.”
Ambachtsheer maintains that a similar system in Canada could operate at the provincial level or on an industry level. “The energy industry is a classic example,” he says. “We could have the Canadian Energy Pension Plan and have everybody in that industry be a member of one, big, cost-effective, sensible pension plan as opposed to having all kinds of bits and pieces flying around that are not big enough to be cost-effective.”
On May 25, 2006, the U.K. government took further steps. It endorsed a plan to automatically enrol workers into a national pension savings plan. As well, it revealed that it plans to raise the pension age to 66 starting in 2024 and to 68 in 2044. The retirement age is currently 65 for men and 60 for women. Employees, unless they opt out of the plan, would have to contribute 4% of their earnings, with employers contributing 3%.
Will the British pension model— called the most radical in 60 years— fly? Only time will tell.
Andrea Davis is a freelance writer in Guelph, Ont. firstname.lastname@example.org