Europe's pensions patchwork has changed enormously in the last 10 years. A decade ago the dominant pattern featured state-provided PAYG supplemented by defined benefit (DB) occupational pensions. The threat posed by ageing populations was largely ignored; the crisis of funding shortfalls lay in the future. Since then there has been a landslide of change, dictated by financial necessity and regulation. The story of European pensions over the last 10 years has been a struggle for viability.

Despite efforts in every country to scale back their previously over-generous pensions, the state is still a generous provider. An accountant retiring today in Spain would expect the government to provide over 80% of retirement income; an Italian counterpart would receive 75%. By contrast, the average UK retiring professional gets a meagre 12% of income from the government, while the figure in the Netherlands is 20%. Taxpayers in Germany, France and Belgium pick up the tab for 35%, 43% and 47% respectively. Clearly the European retirement landscape is not level ground.

The biggest change has been a general switch from defined benefit (DB) to defined contribution (DC) schemes, but with companies operating both types side by side. DB is the general model throughout Europe for existing employees - Spain being the exception. Contractual commitment and the potential need for trustee and member assent for any change ensure that these cash-hungry plans keep rolling on. In the UK, for example, two-thirds of employers still provide current employees with traditional final salary pension plans. European employers and schemes often now offer new recruits some form of DC plan, which fixes the level of cost to the company and avoids the large element of risk that accompanies DB plans.

For historical reasons, the Netherlands has resisted the general trend. Some 48% of employers provide a career average revalued plan to both existing staff and new recruits. The pension picture here has evolved slowly and typically involves changes in the structure of benefits rather than in costs, stemming from the need for agreement from works councils, which, unsurprisingly, are reluctant to accept less beneficial terms for future employees.

The scale of pressure on companies to move away from DB and into DC schemes becomes evident when comparing the different levels of payroll cost of pensions for existing employees and new recruits. In both Germany and the UK the cost for new recruits is considerably less. In the UK, companies typically pay between 12.5% and 20% of their payroll costs into pensions for existing employees, compared to a sum between 4-8% for new recruits. In Germany, two-thirds of employers contribute less than 4% of payroll costs to pensions for new recruits, as against 40% of companies paying less than 4% for existing employees. In the Netherlands, the cost of funding is almost the same for all employees.

Across Europe, the main change in pension provision for current employees is a reduction in the value of benefits. In the UK, 58% of employers who made changes have increased the level of contribution expected from employees. Nearly two-thirds of German companies have altered their scheme details for calculating pension payments, dropping the final salary basis in favour of a career average plan. In the Netherlands, 38% of companies have introduced a life-cycle scheme. The exception in Europe is Spain, which enjoys a markedly different pension climate to the rest of Europe. There, 18% of employers actually increased their DC contributions.

 

cross Europe in the last five years, most companies have launched a new pension plan, nearly always DC but with local flavours - in the Netherlands there are life-cycle plans and collective DC, while German companies offer DC-like cash balance plans. In Germany conventional wisdom says that employers cannot alter legacy pension plans. In fact, with agreement, they can. German labour law allows for amendments to plans at a group level, where the changes give benefits to employees as a group that are at least as favourable as the old plan. In exceptional cases, for example where the employer is in financial difficulties, benefits can even be cut.

Germany has seen an important change in funding methods. Before, German employers accrued book reserves on the balance sheet. More than 40% of German companies (but 90% of the Dax 30) have set up an external funding vehicle - either a contractual trust agreement (CTA) or Pensionsfonds. Often a combination of financing vehicles is utilised; for instance a CTA is a mechanism designed largely to get pension funding off the balance sheet.

The main influence on pension change in the future will be legislation, age discrimination laws in particular. The original EU framework directive introducing this ban has led to legislation in each member country. Rather than offering specific protection for older workers, though, the EU directive requires equal treatment of all workers regardless of age. In fact, most cases brought under age discrimination laws are by younger workers seeking parity with older colleagues. The directive has profound implications for pensions because length of service - a strong proxy for age - drives them. Unfortunately the directive was not careful or clever enough to avoid presenting employers with a headache. There is no specific exemption for DB plans or for age-related DC plans.

Worse, each country has produced its own version of age discrimination laws, enforcing the directive in line with national interpretation, leaving companies with a patchwork of laws. The main issue is that because there is no central or national body to pre-approve pension arrangements for compliance with age discrimination law, companies may find that cases decided by tribunals and courts in subsequent years in other EU countries may outlaw aspects of an employer's pension policy. So companies need to adopt a consistent approach; the best option is to ensure that pension policy complies with the principles of the directive.

Cross-border - if not pan-European - pension funds are set to attract more attention. So far they have been viewed as a fine idea, but not really of great interest. Previous objections that cross-border pension funds are prevented by tax barriers have been dispelled by a test case in Denmark. There are almost 50 cross-border funds in place in Europe, around 10 of them since the EU directive was implemented.

Moreover, a recent Towers Perrin survey of more than 400 companies in six EU countries found that a quarter of European participants thought they would follow the road towards multinational funds. As companies open operations across Europe, especially in new EU countries, it makes little sense to start small-scale pension plans in each of, for example, Estonia, Latvia, Slovakia and Slovenia. A far better idea is to set up one fund that complies with laws in all countries and reap the economy of scale.

So far, cross-border schemes are few in number, but this will grow rapidly as companies embrace new EU markets more closely and age discrimination laws start to bite.

In coming years we can generally expect to see companies continuing to cut the cost of DB commitments and DC scheme membership will grow as employees change jobs. The good old DB days of bountiful returns, fund surpluses and contribution holidays will never return.

But the seismic upheavals of the last decade are for the most part behind us. Pensions can return to their real job: to attract employees, to offer security after work, to encourage loyalty. Research still suggests that employees do not value pensions as a benefit anywhere near as they should, given the cost to employers. As a final prediction, in the future there will be an even sharper focus on the communication and branding around the company pension scheme.

For a full copy of the ‘European Pension Trends 2007' survey please contact Emma Mayes emma.mayes@towersperrin.com

Paul Kelly is senior consultant at Towers Perrin

 

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