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Wednesday, May 19, 1999 A Look at the DC Market in Europe The following is the first of three reports from the IBC 3rd Annual Defined Contribution Conference held this week in London, England. W hy would a Yank (and one from the West Coast at that) fly to London in the winter and brave the steak-and-kidney pie? To give a succinct answer: the European pension marketplace is undergoing fundamental, structural change that will have lasting impacts upon employers, vendors and employees -- and present new opportunities to U.S. defined contribution vendors. Virtually every element of the traditional European approach to providing retirement income to workers is under review. The issues, solutions, and methodologies for implementation all share characteristics with US-based experiences of the past. But vendor beware -- history, culture, tradition, and regulation do make Europe a considerably different place to do business than in the United States
As in the US, European retirement schemes ("scheme" is the common term for retirement plans over here) and the employers that offer them are faced with a list of trends and variables that cannot be ignored:
Major Similarities & Differences With the U.S.A. While the dramatic success of the U.S. 401(k) experience together with the pressures for full funding of final pay schemes is focusing attention on various defined contribution alternatives, don’t assume that it will be that easy to move your business overseas. Keep in mind that the U.S. DC/401(k) model is not universally, nor even broadly, in use. But more on that later. First, in Europe defined contribution may mean something a little different. Defined contribution plans aren’t necessarily discretionary, they might not be participant-directed and they may not be portable. The hallmarks of current US thinking and offerings are not common in Europe; participant direction, wide investment choice, and comprehensive participant support seem to be the exception, rather than the rule. Remember Back to the Future? Defined contribution plans in many markets are based on a model that we don’t see in the US -- at least in 1999. Instead, the service offering and support systems here look much as they did in the US in the mid 80’s. Missing are the rich, participant-level services offered by large numbers of middle-market TPAs and US-style mutual fund complexes. Insurance companies, actuaries, and money managers hold sway with the bulk of the business. Sponsors frequently make decisions based on the DB model of lowest-cost lifecycle funding expense, rather than the participant service more frequently seen in this country in recent years. Another major difference is the extent to which workers are presented with tax-favored retirement alternatives outside of the plan environment, distributed primarily though commission-paid sales "advisors". More on this in our next installment. Finally, European workers have less exposure to equity investments outside of their plans. In some countries, discretionary income still lags U.S., and the investment experience is one that many covered employees may not have had. Compare this with the love affair of the U.S. mutual fund marketplace of the last 15 years. SERIOUS MONEY As it currently stands, in the next several years, pension assets outside of the U.S. will equal those in the U.S. and the DC portion of those totals will increase proportionally, eventually hitting a projected value of $1.4 trillion in that period. Much of this from new plan establishment in the non-U.S. market. To surveys show this trend clearly: Non-U.S. defined contribution schemes are expected to more than double over the next five years. In an industry survey in the U.K., the National Association of Pension Funds found that 15% of plans offered by larger employers (generally over 1,000 lives) were deferred compensation arrangements. In a similar U.K. survey of smaller employers (generally smaller than 250 lives), the Association of Consulting Actuaries found that fully 60% of such plans were dc in nature. As in the US, smaller employers seem to have difficulty dealing with, funding, or justifying the embedded costs and risks of supporting defined benefit plans. So where is the money and what are the national trends? United Kingdom Basic pension replacement ratio from government system is 47% of income. The system is in pretty good shape, but government policy is promoting contributory DC plans and self-reliance to a degree. There is a wide range of new government and industry-supported initiatives that will change the scene here, but for now, the use of defined benefit plans are still the foundation of this market. Contributions to contributory retirement vehicles are generally tax-deductible and tax-deferred, even after retirement in some cases. Germany Basic pension replacement ratio from government system is 50%, but unlike some other countries, is not fully funded and liabilities outstrip assets. For corporate plans, employers receive a deduction for the accrual of pension liabilities, but not the actual funding of the liability. Their newly introduced contributory scheme (the Sondervermoegen Plan) is not deductible and carries no tax benefits. France Pension replacement ratio is well above European average, at 60% of income. Unfortunately, it does not appear that this level is sustainable in the long term. Italy Very high levels of income replacement, between 50 - 80%. The current structure is seen as unlikely to continue due to funding shortfalls. As mentioned above, too many retirees with too few workers paying into the kitty. Corporate plans are not yet common, but DC plans are coming into play, in some cases through industry, labor or trade groups. It is projected that DC will play a major role in the creation of retirement assets for the Italian labor force. Spain Replacement level around 29%, a sustainable figure for the time being. Defined benefit schemes are being phased out and defined contribution programs are being made mandatory. Elsewhere in Europe, The Netherlands is showing interest in DC plans, though the US model is gaining favor, with a view to flexible investment options and pension provisions. Eastern European states re also moving in this direction through both government action and the vendor marketplace. More change is anticipated, both in velocity and volume as the European Community continues to realize the twin benefits of economic consolidation and a healthy business environment. Ward Harris is Managing Director of McHenry Consulting Group where helps to create and deliver successful products and services. They serve investment/benefit vendors, corporate clients and employee groups. His e-mail address is ward@mchenryconsulting.com. Printed from: MFWire.com/story.asp?s=24889 Copyright 1999, InvestmentWires, Inc. All Rights Reserved |