David Blake: The key problem in the European Union is that pension plans and the pension – the funded pension plans are almost exclusively in three countries in the European Union, that’s the UK, Holland and Ireland.  The other countries don’t have funded pension plans, they rely on state benefits.  These countries are being told that they have to have the same regulatory standards as insurance companies.  And we have a solvency requirement for insurance companies, called Solvency II and it’s based on the same principles as Basel I, Basel II, and Basel III for banks.  In other words, insurance companies have to have solvency capital to make sure that they survive a 100 and 200 year even over the course of the next year.

Our pension plans have not had to have capital requirements.  They relied on what’s called the Strength of the Sponsor Covenant to secure the pension entitlements.  And what we’ve only ever promised or we’ve only ever offered in the UK and other countries is a pension promise; we haven’t offered a pension guarantee, whereas insurance companies offer guarantees.  So you can understand why they will need capital requirements and capital adequacy to back those guarantees in the UK and in our pension plans in the UK there’s no such guarantees, only promises, and the strength of the sponsor covenant has historically been the way by which those pensions have been honored. If companies have to post capital to back their pension promises, this has been calculated to add up to another $600 billion to the pension liabilities of UK companies.  And this is likely to bankrupt them.  So this is a very serious regulatory problem that we face.

Now, in terms of operational risk, there is the risk that corporates can become insolvent, but over the last half a dozen years in the UK, we have had what’s called the Pension Protection Fund.  This is a mandatory insurance company run by the state, but not guaranteed by the state in which companies have to pay levies to bail out the pension obligations of companies that have become insolvent.  And it’s based on the U.S. Pension Benefit Guarantee Corporation. So governments in the UK and elsewhere in Europe are trying to find ways of making the promises more secure, but they’re very much opposed to having capital requirements for companies in terms of their pensions.

In Canada, the situation is rather different.  They have far better funded schemes; they didn’t have the Cult of Equity to the same extent, so they didn’t have the deficits to the same extent.  They have very large schemes in Canada and they’re well-funded schemes.  And they like the Defined Benefit, Final Salary Concept.  And so they are trying in Canada to retain the Final Salary Concept, which is rather unusual for most other countries.

The U.S. led the way out of Defined Benefit schemes into Defined Contribution schemes.... And companies in the U.S. still have deficits because the actuary still underestimated life expectancy, life expectancy is a serious problem in the U.S.   But because in the U.S. you can often choose to take your pension as a lump sum and not as an annuity, the extent of the longevity risk is not as serious for corporates in the U.S., although it’s clearly serious, for individuals.

Healthcare costs are far more important and more significant in the U.S. than they are in, say, the UK.  And we have a recent example, last week with General Motors which reduced its pension liabilities by $26 billion.  And the way they did that was they encouraged their workers to switch from taking a pension to having a lump sum and they also used buy-ins, group buy-ins of annuities with the U.S. company Prudential, U.S. insurance company Prudential, to hedge the longevity risk.  And this is what U.S. companies are doing.

Another country with an interesting, different experience from the UK is Holland.  They have what’s called Collective Defined Contribution schemes.  They are similar in attitude to Canada in trying to maintain a decent pension system for their employees, but they’ve gone the route of Collective Defined Contribution with adjustments in the pension in payment if inflation was higher than anticipated or if longevity increases more than was anticipated.  We’re moving along the DC route, but we’re having much lower contribution rates than Holland and we’re going to end up with much lower pensions than Dutch retirees in 20 years’ time.

Directed & Produced by
Jonathan Fowler and Elizabeth Rodd