As a result, the European DC landscape is multi-faceted. For example, while the shift toward DC is well advanced in countries such as the United Kingdom and Italy, the Netherlands and Germany are still overwhelmingly DB countries. Individual investment choice and individual accounts exist in some countries, while in others there is no investment choice, but instead minimum-return guarantees.

Going forward, there are two crucial questions. Will the trend toward DC in Europe continue? And what will European DC plans look like in the future?

A new study by Allianz Global Investors in cooperation with the Centre for European Economic Research (ZEW) sheds light on these issues. Instead of looking into the haze of a crystal ball, the study took a different and structured approach.

THE COMPREHENSIVE SURVEY was conducted of people with a profound knowledge of pension issues, including people from pension funds, academia, consultancies, regulators, associations and financial institutions. The focus was their assessment of developments in the next five years. Aggregating these views delivers a picture of the future that captures the best estimates possible today.

Geographically, the survey focused on the most important European pension markets: France, Germany, Italy, the Netherlands, Switzerland and the United Kingdom. Among European pension experts there is broad consensus that occupational DC schemes will continue to grow. An overwhelming majority (88% on average) of the 216 experts surveyed expect this and agree, with the exception of many in France, that a shift from DB to DC is in fact occurring. This trend is considered so powerful that in almost all countries the expectation is that DC will dominate the respective pension markets in the future, although the Netherlands will remain an exception.

THE DRIVING FORCE behind the trend seems to be cost considerations on the part of employers. However, this relates not so much to cost reduction. Rather, it relates to cost calculability, which is seen as the crucial driver. A second major factor is the reduction of investment risk exposure. The importance of investment risk exposure has been brutally demonstrated by the financial crisis. The crisis is certain to impact the development of DC plans and funded pensions in general, but how exactly is less clear.

According to the European pension experts who were surveyed, there are two main consequences. First, the crisis will accelerate the shift from DB to DC, according to more than 60% of respondents. Second, the crisis will increase the importance of protection mechanisms in DC plans.

Protection mechanisms can refer to formal investment guarantees, to investments in less risky assets or to investment approaches that have built-in risk-managing strategies. This last approach, which includes life-cycle, outcome-oriented or inflation-protected investment strategies, received the greatest support in the survey. A vast majority of experts (76% on average) in most countries expect this kind of protection element to be strengthened within plans. DC plans are there to accumulate assets for retirement. But they also have crucial implications for the payout phase of pensions. They pose a question unknown in a DB world: How should people spend and invest their money in retirement given the twin goals of having agreeable sunset years and not running out of money?

Across Europe, surveyed experts consider lump-sum payments an inappropriate solution during the payout phase. There is also limited approval for mandatory annuitization (22%), while more than 60% of respondents consider inflation-indexed annuities a desirable solution.

THE EMERGENCE OF Pan-European pensions has often been predicted. However progress has been limited so far. Many pension specialists view future progress toward a pan-European market skeptically. They are split in almost equal camps regarding the question as to whether there will be such a market within the next 10 years. Many believe that this market will only develop after social, labor and tax laws are further reformed.

Whether these required changes will occur is unclear. While optimists (42%) outweigh pessimists (39%), many do not have a clear attitude on the matter. A clearer picture emerges regarding the drivers and future-plan designs. The demand for European cross-border schemes is likely to come mainly from large multinationals. If such plans materialize, an overwhelming majority of experts (82%) would expect them to be defined contribution in nature.

Expert assessments can, of course, be fallible, but they offer a solid and well-founded snapshot on what to expect from the future. One main message is that the financial crisis has not undermined the general trend toward DC – quite the contrary – but that the requirements for effective DC plans are changing.

What the crisis has brought to the fore is the issue of protection in DC plans and how to achieve it. This is high on the agenda and likely to remain there. The proper design of these protection mechanisms will become one of the key goals for financial innovation in the pensions and asset management industry.

Published by PROJECT M in November 2009

(Illustration: Andy Martin/heartagency)