Weaknesses in the private and state pension systems are putting UK businesses at a severe competitive disadvantage in Europe.
Other European pension models have withstood the shocks of the global downturn much better than the UK, putting those companies at a competitive advantage over their UK counterparts.
The European Business Leaders Survey finds that the ways in which pension benefits are delivered are diverse, ranging from fully-funded defined benefit (DB) models in Ireland, the Netherlands and the UK, to the fully-insured and predominantly Defined Contribution (DC) Scandinavian systems. Stark disparities in state pension provisions are also affecting companies’ ability to compete.
Pensions in turmoil
Aon’s survey of its business leaders across Europe in the Q1 2009 paints a picture of how pension benefits provisions have been affected by the financial turmoil. The interviewees were chief executives and senior consultants working in eleven countries with total private pension assets of around €4 trillion.
Paul McGlone, AON’s director of propositions, said: “Employee benefit provision can have a significant impact on a company’s cost base but the extent will vary considerably according to where the company’s pension liabilities are. While volatile securities markets may be a global phenomenon, the way in which this volatility impacts pension scheme sponsors is not. There are winners and losers, with UK business a clear loser.
He added: “The pensions issues are long-term challenges that require careful consideration by governments, regulators and pension scheme stakeholders. The financial crisis has worsened many of these challenges and focused attention on them, but also offers an opportunity to address them.”
The losers
Key findings in the report include:
* The UK, Netherlands and Ireland are the main losers, suffering the biggest competitive disadvantage due to pension liabilities from sponsoring DB pension schemes.
* Companies least affected by the financial turmoil are those whose pension liabilities are based in countries with the most generous state-provided pension benefits, notably Austria, France and Spain, as private sector provision tends to be lower.
* Fully-insured and predominantly DC arrangements in Scandinavian countries have performed relatively well given market conditions but will face challenges over the medium term as conservative investment policies struggle to keep pace with increasing liabilities.
* The Book reserved pension model in Germany and Austria, once regarded as unsustainable, is demonstrating its mettle and now a competitive advantage in capital-constrained conditions.
* Liability calculation methods vary between countries, inhibiting transparency and introducing disparate levels of volatility in pension fund liabilities.
The DB legacy
In terms of competitive disadvantages arising from pension funds affected by the economic turmoil, the Netherlands is the worse hit country in Europe, followed closely by the UK and Ireland. A significant number of companies within these countries sponsor fully-funded DB pension schemes and are under pressure to replenish scheme deficits from earnings or other sources.
The UK has the biggest single pool of pension assets in Europe, exceeding £2 trillion (€2.1 trillion) at the end of 2008, or £33,000 (€35,000) per capita. With around three-quarters of UK pension fund assets held in DB schemes, the UK’s number one pension issue is the funding of DB pension schemes.
McGlone said that with three quarters of UK pension fund assets held in DB schemes, UK companies who have DB pension schemes are at a severe competitive disadvantage to their European peers. “Recession is increasing the pressure on these companies, and those which have already scrapped their DB schemes now hold a competitive advantage over those who haven’t. Of course, the ultimate advantage lies with those that never had such schemes in the first place.”
The clear winners: insured, DC alternative
The least badly affected countries in the study have been the Scandinavians, especially Denmark and Sweden, who have adopted highly regulated insurance-based and predominantly DC pension arrangements. These systems have benefited from the fact that pensions sit on the balance sheets of insurance companies, who are required to keep capital buffers, with the result that they have withstood the pressures of market volatility and not impact directly on sponsors.
However, conservative investment policies in Scandinavian countries will make it harder to recoup portfolio losses and premiums are likely to rise in future.
Generous state pension: the competitive edge
A large and obvious disparity in European pension provision is the difference between state systems, which have had a significant impact on the scope of businesses’ pension arrangements – as a rule, the larger the state benefits the lower the private sector benefits.
In the UK, the state offers a maximum annual benefit of £4,700 (€5,100) to retirees, compared to a maximum €38,000 in Austria. Generous state pensions mean there is much less of a burden on employers to fund pensions, and hence the impact of the financial crisis is lower. In France, pensions assets hardly exist because of highly attractive state earnings-related payments.
“Continuing recession will hasten UK companies’ efforts to reduce their DB liabilities. More schemes will close, both to new members and to future accrual for existing members. Indeed already 80% of companies have already closed to new members and 20% have now also closed to accrual for existing members. We expect this proportion to rise above 50% within three years.
For those UK companies now moving across into DC schemes, the risk now lies heavily with members. As private savings fall due to the economic crisis, state pension provision has an increasing influence on how serious the impact will be to the individual.
"The UK’s low state pension puts UK DC pension scheme members at a disadvantage compared to peers in other countries,” said McClone.