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As noted by Warren Buffett: “In the business
world, the rear view mirror is always clearer than the
windshield.”
The current market volatility and
changes in local and global economies have brought retirement plans into the
spotlight, revealing the extent of risk to which pension plan sponsors,
wittingly or unwittingly, have been exposed. Undoubtedly, sponsors of defined
benefit (DB) retirement plans are being challenged to question the value of such
plans. Recent research in the UK, prepared by the National Association of
Pension Funds, has found that 25 percent of those DB plans that still accrue
benefits are expected to close. Companies clearly feel the need to reassess the
impact that providing continued retirement benefits will have on cashflow and
future debt burdens.
It’s also likely that the
current environment will offer opportunities to introduce change that may
previously have been resisted. Behavioral economics shows us that individuals
are prone to taking short-term views; we would expect employees concerned about
staying employed to be more acce
pting of the need to adjust their retirement provisions.
However, present conditions don’t affect only DB plans. Members of
defined contribution (DC) plans have witnessed significant declines in the value
of their retirement savings; this is most keenly felt by those close to
retirement age. Many employees now expect to work longer as they cannot afford
to retire. This has consequences for workforce management. As the value of the
more discretionary parts of a rewards package declines, for example, scaling
back on overtime arrangements or incentive payments, the retirement plan and
other benefits become more significant in an employee’s rewards
package.
| We suggest that sponsors
consider four essential perspectives - external, cost and risk,
employee and employer
| Many companies in financial distress are
beginning to take action in response to the economic crisis by closing their DB
plans or by eliminating or reducing their savings plan contributions. It remains
to be seen how widespread this will become. Those companies with a healthier
balance sheet can afford to take a holistic view of the retirement plan and the
added value it creates for employees, rather than respond in a knee-jerk way out
of a desire to control costs or eliminate risk. Regardless of what drives
retirement redesign, we suggest that sponsors consider four essential
perspectives – external, cost and risk, employee, and employer – to clarify
their objectives in offering or amending their retirement provisions. These four
perspectives can be applied more generally to other employee benefits and to the
total rewards package.
Finding the right route
As with any undertaking, it can be difficult to figure
out where to start. The perspectives included in the above graphic are fluid
enough to allow sponsors to use them to reflect their companies’ own aims and
objectives. The same perspectives can be taken into consideration for new plan
designs, for changes to future service benefits and in exploring options for
transitioning benefits.
The external perspective
Without an appropriate consideration of the current and
projected labor market and the competitive environment for retirement programs
in any jurisdiction, the end results may not properly achieve the ambitions of
the project. One of the outputs in considering the external perspective should
be a ranking of how existing retirement plans compare against market norms in
all relevant countries. This is not simply a question of the costs of the plans,
but also the implied levels of risks. It should also include a review of current
and pending retirement regulations in each country to ensure that any changes
considered will comply with local legislation.
The cost and risk perspective
In today’s benefits environment, companies wish to
demonstrate that, having weighed the alternatives, they have taken into account
where their retirement programs need to be on the cost-versus-risk
spectrum.
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Economic value, tax
positions and accounting disclosures all figure in the
equation
| As we discussed in Perspective, Issue 14, it is possible
to hedge most interest and inflation risks in DB plans. Mortality hedging may be
available soon in some countries. Individuals have also been shown to prefer
certainty over uncertainty, even if the outcome has a lower monetary value.
Hence, there is a notable value-add in providing employees with retirement
savings options that build in some form of guarantee, possibly at a lower
overall level than has traditionally been the case. The question is deciding how
far to go in providing employees with certainty and how the risk budget will
change with the incremental changes in design options. The answer will be more
than the cashflow or an expensing analysis. The impact on employee engagement
and output may be difficult to gauge, but it is likely to bring intrinsic, real
value. The management of risk may vary as the plan matures and will depend on
decisions reached on whether changes to benefits are contained within segregated
groups or in wider pools of experience within the whole plan.
A consideration of economic value, tax positions and accounting disclosures
all figure in the equation. A wide range of triggers exists that can help
employers develop their thinking and reach conclusions on the balance between cost and
risk that’s right for them, their employees and other stakeholders, bearing in
mind that many risks can now be hedged.
The employee perspective
Changing retirement programs to better manage risk or
cost or both doesn’t mean that employees are necessarily moving down in the
pecking order. Capturing employees’ attention and enhancing their engagement
could mean the difference between succeeding and simply surviving in the new
environment in the short term.
Although there are ways to measure
the potential impact of plan redesign on employees, employers need to determine
the kinds of outcomes they would like program redesigns to achieve with
employees before any redesigns take place.
Employee surveys consistently show that employees tend to
undervalue the retirement savings available to them. This combined with the observation
above, that individuals prefer certainty over uncertainty, indicates that current
conditions offer plan sponsors a great opportunity to rationalize arrangements
while potentially keeping employees on their side.
| Capturing employees' attention
and enhancing their engagement could mean the difference between
succeeding and simply surviving in the new environment in the short
term
| Employers reluctant
to take the step of redesigning the program itself still stand to gain by
making an effort to redesign the “packaging.” In some parts of the world
retirement benefits are becoming a more important part of the total rewards
package simply because working populations are aging. Surveys regularly show
that the older the worker, the more important retirement becomes. Considered
together, employers with good existing programs stand to gain by simply
communicating effectively about what employees currently have and then targeting
their message to different groups of plan members.
The employer perspective
Taken separately, from the cost and risk perspective,
this angle considers workforce planning and strategy as well as the implications
of retirement programs on internal management and administration. It takes a
holistic view and blends into a consideration of other reward strategies and
resource management.
Retirement planning is, by definition, for the
very long term, but business planning often looks at horizons of only up to five
years. Political, demographic, technological and social changes also happen
gradually over long periods. A challenge for today’s business is to respond to
these gradually shifting sands while operating an effective and competitive
business.
The arrival
In a changing world, reassessing and re-evaluating
retirement plan provision is a must. With multiple plans, across multiple
geographies with multiple legislative frameworks, the challenge of finding the
right opportunity for change can seem daunting. By reviewing your existing
arrangements through the four lenses described in this article, we are confident
you will find opportunities to reduce cost and risk as well as to enhance
employee engagement.
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