Handling the DC challenge

Gary Smith, senior consultant at Watson Wyatt, analyses the growing demand for DC in Europe

Maturity of the various European pensions markets vary significantly. While a number of countries, like the United Kingdom and the Netherlands, have substantial, well developed pensions markets, there are several countries in which the industry is relatively underdeveloped.

One feature that is consistent though across these different pensions markets of Europe is the growing interest in, and emergence of, defined contribution (DC) pension provision by employers. Indeed a significant number of multinational employers now have a global policy to only operate DC plans wherever they offer their employees retiremeHungary, Pont savings provision anywhere around the world.

The relative size and importance, however, of DC pensions compared to defined benefit (DB) provision does vary considerably between countries. While DB will still generally dominate DC in terms of pension fund assets, the real emerging influence of DC can be seen by examining plan membership. On this measure, DC is the main form of pension provision for around half of the main pensions markets across Europe. In the Czech Republic, land and the Slovak Republic it could be argued that there is actually no funded alternative to DC (although unfunded DB arrangements do exist). But in countries like Belgium, Germany and the Netherlands, around 95 per cent of pension fund members are still in DB pension schemes.

So, with this growth of DC, how are employers generally tackling the emerging issues and risks and to what extent are they managing those risks?

Global experience of DC so far has identified a number of significant issues and concerns. In many countries, the proportion of employees joining the plan can be very low and the general level of savings can be woefully inadequate to realistically provide an acceptable level of income in retirement. In fact a real danger to employers is that many employees will have a much higher expectation of benefits than reality will deliver and many of these disappointed and disgruntled employees are very likely to blame their employers and even potentially seek compensation from them.

In addition to this lack of employee engagement and likely under delivery against expectations, more and more media attention is being focused at the, generally poor, levels of customer service being delivered to society by, so-called service providers - particularly in the financial services arena.

So should employers be concerned?
There are really two clear reasons why employers should be concerned and, in my experience, while there are always some exceptions, the majority of employers do not think that DC stands for Don't Care and furthermore do not want employees and scheme members to think that they do.

Firstly, employers often make a non-trivial financial commitment in providing employee pensions and so it makes sound commercial sense to ensure this investment gives a good level of return to the employer. Any hitches or bad experiences in the scheme's operation can easily undermine and devalue the employer's pension investment in the eyes of the employee.

Secondly, risk management is an integral part of corporate life these days, and pensions are no different. Undertaking a risk assessment exercise in any DC pension arrangement will identify a long list of potential risk areas ranging from general financial and HR business risks through to risks associated with the scheme's administration, investment and member communication.

The commitment and management focus given to DC plans in many European countries is very low. In many countries, even key decisions about which providers to use are not given the attention they deserve. In several countries, local operations often believe that they do not need to give their DC plan any management time. Unfortunately, these employers are working under a misapprehension. And actually taking control and steering your DC plan along the highway to success doesn't have to mean a huge expense and time commitment.

We are beginning to see, however, growing concerns at many multinational companies about this lack of oversight at local level and these companies are beginning to implement a sound structure and control framework around their various local plans.

Adopting a structured approach to monitoring and managing a scheme's operations seems a small price to pay for safeguarding, and maximising the return on the organisationÕs financial commitment as well as minimising and managing an organisation's risks and minimising the potential for, what could too easily lead to, significant damage or financial liability.