Impact of the Perfect Storm
Then, the pension world was shaken by the perfect storm of 2001/2002, which rocked the majority of private pension plans—particularly those in Canada, the U.S. and the U.K. The combination of local funding rules and somewhat new corporate accounting rules caused great pressures on employers’ cash flows and profitability. Many companies that survived divested themselves of the future risk associated with private pension plans by introducing DC plans for their employees.
Following certain highly publicized pension plan closures, which left plan members with less than they were owed, governments were pressured to modify their pension legislation to better protect pension plan participants. The financial community also began to wonder if the existing pension accounting rules—which allowed for smoothing techniques that deferred many losses and obscured companies’ financial statements— were still appropriate.
A few enterprising countries took action even before the perfect storm hit. In the early 1990s, Australia had already decided to move to a mandatory DC system requiring all employers to contribute 9% of employee pay toward retirement (the requirement gradually increased between 1992 and 2002 to reach 9%). This initiative effectively ended DB plans in that country.
The trend to move to DC plans in the U.K. also started well before the perfect storm. The U.K. was one of the true bastions of DB plans. Employees enjoyed generous retirement plans that often replaced more than half of their pay at retirement, which was then indexed to inflation for the rest of their lives. The real cost of these benefits became clear to employers in the 1990s, when funding costs soared in the low-interest environment. Some employers closed their DB plans, replacing them with much less generous DC plans. Following a change in U.K. accounting standards, most employers followed suit. Today, more than 80% of DB plans in the U.K. are closed, and DC plans predominate. Employer contributions now average approximately 8% to 9%, which—while up since the initial conversions—is considerably less generous than the DB plans they replaced. Recent legislation now requires that trustees and employers negotiate the contribution funding schedule. In addition, the U.K. has created a stronger pension authority and introduced a new levy to create a protection fund, in case an underfunded plan should close.
Those governments that weren’t ahead of the wave also got creative. In the Netherlands, DB plans are weathering the arrival of new legislation that adds complexity to plan management— likely because DC plans in the Netherlands must have an age-related scale that mimics DB accruals. The 2007 Pensions Act considerably changed the governance of occupational pension plans, requiring plan sponsors to adapt to numerous other laws and regulations. Among them is the new financial assessment framework consisting of three tests—the minimum test, the solvency test and the continuity test—to determine the ability of pension funds and life insurers to meet their obligations within a particular time horizon. The main consequences for pension funds are more volatile valuation liabilities and higher overall contributions.
Belgium has increased contribution requirements by modifying the actuarial basis on which the minimum funding is established. It went from a solvency test (protecting acquired rights only) to a going-concern test (recognizing a portion of future salary increases). It also created additional roles within the pension committee to ensure compliance with legislation and proper audit of the pension fund.
In Japan, most plans used to be unfunded DB promises, working with a table that would pay out a specified number of months’ pay based on the number of years of service. DC plans are slowly becoming more prevalent since they were first allowed in 2001. Practically all plans, other than retirement allowance plans, must be funded from 2012 on.
