The European Pension Challenge Harry Smorenberg CEO – SCC – The Netherlands 1.

The European Pension ChallengeHarry SmorenbergCEO – SCC – The Netherlands

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THE BIG ISSUES

• Pensions on their own will in most cases fail to deliver the ideal income base

• Employers cannot afford more• Employees cannot afford more• Society cannot afford more• Only pensions people think pensions are great

A revolutionary, innovative approach is required2

From “Green Paper” to “White Paper”

• Sustainable balance between work and retirement

• Securing the safety of pensions

• More transparant pensions with better awareness and information

• Strengthening the internal market for workers and pensions

Focus: adequate and sustainable pensions in Europe

3

European Pensions Reality

• Almost every known system for delivering a pension is represented somewhere in Europe

• Historical backgrounds to the various national schemes ensure huge diversity

• Unique challenges:

– The most profound of these is to enable Europe’s pension systems to support Europe’s labor mobility

– Although the EU guarantees its citizens the right to work anywhere in the Union, one still cannot easily port a pension from one EU country to another

– Different systems, different contribution methods, different taxation treatments all combine to make Europe one workplace but still many pension jurisdictions

Display of great variety

Harry Smorenberg - October 2011 4

True Challenges

• Balancing the Pillars

• Shift in Risk

• Ageing Europe

• New Roles & Responsibilities


PillarsPillars

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PILLAR 1. STATE PENSIONS 2. OCCUPATIONAL PENSIONS 3. INDIVIDUAL PENSIONS

Objective • Minimum income

– Reduce or avoid absolute pensioner poverty

• Decent retirement income on top of state pension

• Personalise pension provision

– More flexible: handles periods of unemployment or employment in another country

– Suited to modern “portfolio careers”

Funding • Pay-As-You-Go

– Utilises state taxation powers

– Sensitive to demographics

• Often fully funded

– Sensitive to financial markets

– Risk shared between members of the scheme

• Fully funded

– Sensitive to market levels at encashment and annuity interest rates

– Risk individualised

Solidarity • Very high solidarity

– Compulsory national system

– Contribution according to income

• High solidarity

– Often compulsory (for members or companies)

• Low or no solidarity

– DC only: your pension relies on your own pot

Challenges • Affordability

• Rising pensioner numbers supported by falling workforces

• Complicated interaction with welfare / social security / income support

• Increasingly at odds with the move away from “40-year career”

• Considerable risk and cost burden for employers

• Not optimal for small start-ups or self-employed

• No cohort support: risk is left with those least able to bear it

• Inadequate financial education for the ordinary citizen

• Significant risk of inadequate financial resources at retirement

Balancing the Pillars


Balancing the Pillars

STATE PENSIONS

Dominating First Pillar

• Danger to government budget

• Political decisions; badly adapted to real needs

• Bureaucracy

OCCUPATIONAL PENSIONS

Dominating Second Pillar

• Paternalism

• Problems if companies fail, leaving people unprepared and unprotected

INDIVIDUAL PENSIONS

Dominating Third Pillar

• High costs (management charges, etc.); may even lead to capital destruction

• Under-saving always a threat

SOLUTION

Balance Pillars

• Role for both Defined Benefit (DB) and Defined Contribution (DC)

• DC solution in Europe needs development


Monoculture is dangerous

0,0

0,1

0,2

0,3

0,4

0,5

0,6

0,7

0,8

0,9

1,0

Spain Germany France Italy UK Netherlands Switzerland

State Occupational Private

Problem Solution

Shift in risk

Harry Smorenberg - October 2011 10Shift in risk

5%

33% 39%

95%

67% 61%

Dec 99 Apr 04 Dec 09

DC DB

Split DC* vs. DB Assets Drivers of DC Growth

40%

60%

Closure of DB plans

Organic growth new DC plans

UK pension funds UK pension funds

* Ex personal and stakeholder DC assets. Data source: Mercer (2009), Watson Wyatt (2010).

Continuous shift from DB to DCIn Many Markets, DC is Now the Dominant Retirement Plan Model

Implications of Shift to DC

• Globally, growth of DC assets is outpacing DB

• DC assets now represent 42% of the total pension assets in seven largest markets

• Financial crisis accelerated shift to DC by forcing more companies to close DB schemes

• Value of private pension assets worldwide has declined

• Some challenges facing DC models are due to their origins as supplemental rather than primary retirement savings plans

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Implications of Shift to DC

Many DC participants need more support in selecting their investments

People are not saving enough, investment choices are sometimes inappropriate – poor asset allocations are a major challenge for DC

More information and education is needed to drive participation

Level of participation in DC plans is often too low – active engagement by employers is also necessary to make DC work for participants

Less dialogue with asset management community

Trustees’ fiduciary responsibilities within the DB space mean they lead innovation and are a source of good ideas

Strengthening the DC model also requires regulatory changes

Strengthening regulatory frameworks in many countries to meet exposed vulnerabilities – likely convergence of regulatory approaches to enhance employee participation, investor protection and plan governance

Fiduciary issues to review As the issues facing pensions become more challenging and diverse, there is a need to review fiduciary board membership qualifications to improve risk management

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More innovation in DC

• Plan sponsors, plan providers and regulators must work together to design plans that:– Incentivise people to save– Provide the options necessary to achieve an optimal outcome– Auto enrollment is key feature of DC (with ‘opt out’ option)– Employer-matched contributions (powerful incentive to save !)

• Design of default investment option is key– Growing interest in target-date funds = heavily passive, very transparent,

and comparatively low cost– Research shows that increasing the number of funds reduces 401(k)

participation and leads to poorer choices (TIAA-CREF Institute)– Trend is toward fewer fund options and lower costs, also driven by fee

disclosure requirements and increased fee-related litigation


Towards hybrid DC


New risk sharing arrangements in Europe

- Economizing DB

- Dressing up DC

Conclusion: trend towards (more) hybrid schemes

AgeingAgeing

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20000 15000 10000 5000 0 0 5000 10000 15000 20000

0-45-9

10-1415-1920-24

25-2930-3435-3940-44

45-4950-5455-5960-6465-69

70-7475-7980-8485-89

90+

Males Females

European population (age groups and sex)

2008

2060


Longevity is the greatest pension industry challenge

• DC versus DB means: work longer / save more

• DC contributions have remained significantly and constantly lower than DB contributions

• Big shift in employee / employer behavior and expectations– Performance management– Career paths / training - education– Redundancy terms– Remuneration models

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You don’t get older …you get better !

New Roles


New roles and responsibilities

• Financial literacy– Education (early start with ‘economics’)– Simplicity

• Commitment Financial Service Industry– From budgetting to financial planning’(aggregation)– Consumer protection– Restore and maintain ‘trust’– Increase transparency– Treat clients as partners

• Essentials of solidarity– Commitment to society– Fundamental values


WorkingPopulation

AverageAge

Fertility Rates

PensionCosts

Labour Force


Personal Incentives

• Social and cultural innovation to reinvent retirement• Private retirement provision is essential • Governance issues due to financial illiteracy• Individualization: less loyalty – need for structured

planning • Axes: Income – Health – Pensions (interdependencies) • New class of communications needed• Repositioning of Pensions:

“Managing personal financial continuity continuously;

in balance with a desired life-style”


CONFIDENCE CRISIS?MOST COMMON REASONS GIVEN BY EMPLOYEES FOR NOT JOINING A PENSION SCHEME

• No spare income• My home is my pension• No access• Benefit too far off• Not worth doing• Too complicated• Don’t trust greedy pension/investment firms


TrustTrust


The European Pension Challenge Harry Smorenberg CEO – SCC – The Netherlands 1.

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