Smart DC - de-risking the de-risked By Jacqueline Lommen
The trend towards the wider adoption of defined contribution (DC) pension schemes is gathering steam, and with good reason. Many employers are finding that defined benefit (DB) plans are increasingly unaffordable, and they want to take action by shifting pension risks away from their corporate balance sheets. Some de-risking possibilities already exist within the scope of DB of course – such as by transferring risk through buy-out or buy-in agreements with insurers. But this market is becoming saturated, and as the Solvency II Directive approaches, fewer insurers are either able or willing to take on the longevity risk or financial guarantee. Making a shift from DB to DC offers a great alternative to plan sponsors as it completely de-risks both the employer and the pension trust, putting the onus on the employee, who takes on the risk instead. So the question remains: how do you de-risk the de-risked? If employees are to take on the risks, how should we in the financial services industry protect them?
The transition towards DC – an unavoidable trend Let us first take a look at the main drivers for the shift from DB to DC. The introduction of the International Financial Reporting Standards (IFRS) means pension fund commitments (including deficits) must now run through the sponsor’s P&L, and show up as liabilities on the corporate balance sheet. With DC pension plans this is not the case.
Secondly, the European legislation on solvency buffers is affecting pension trusts. The second installment of regulations by the EU’s Institutions for Occupational Retirement Provision Directive (IORP 2) will lay down stricter rules. So, if DB pension promises made to employees and retirees are to be maintained and not cut, funding shortfalls can only be addressed either by greater contributions from employees, or a direct cash injection by the company. As both employers and employees try to save money as they battle recession and austerity, neither solution is particularly palatable, or sustainable, right now.
Smart DC – The Dutch answer to derisking So what to do? How to best solve the massive funding gap in DB schemes that is hampering overall GDP growth and endangering the financial stability of the Dutch economy? The Dutch are developing an innovative and future-proof DC scheme into which past DB rights can be converted. And this is where ‘Smart DC’ comes in. Making DC ‘smart’ basically touches upon three areas to make sure we can both mitigate the risks, and maximize the potential returns, for employees who go down this road.
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