Dear Actuary: What are demographic and longevity risks?
A primer for plan sponsors on demographic and longevity risks and how they affect public pensions.
Worldwide, as the economic impact of COVID-19 continues to deepen, countries have moved to stem economic losses from rising permanent and temporary unemployment and furloughed workers. It is a varied patchwork of attempted solutions, but one common theme is emerging: Governments, private employers and employees will face shortfalls in the provisions for retirement savings, and will need to consider key questions, such as:
While a number of countries have managed to contain the virus to some extent, it could only be temporary, and we are likely to see continuing shutdowns, especially with the onset of winter in the Northern Hemisphere, meaning more temporary unemployment measures and reduced salaries for employees. This could have a long-term negative effect on retirement fund contributions and the funding status of some public and private funds.
While global companies may have resources to shape their own strategies in their home country, figuring out how far they should go to make up for missed contributions to pension funding elsewhere within their business will be a challenge. Governments forge policies, such that in some cases commercial entities have to take on the burden themselves, while in other countries mandates call for a mix of public and private sector financial responses.
Defined benefit (DB) plan sponsors face a squeeze on funding status from two directions. Ongoing and renewed COVID-19 lockdowns worldwide will potentially reduce the value of investments of pension fund assets as stock markets could decline as a result of closed businesses. Meanwhile, pension funds are falling behind in terms of keeping pace with contributions as workers are furloughed and contributions are reduced or delayed. Correspondingly, members of defined contribution (DC) plans face similar shortfalls in the funding of their own pension pots.
Milliman has surveyed its consultants in various markets. While multinational companies face the key question of how far they should go towards helping employees financially, governments worldwide have instituted various programs or measures to provide short-term relief.
Please note that the situation in each of these countries continues to evolve. We will publish updates as new information becomes available.
In the United States, the CARES Act established two noteworthy provisions. The first was the ability for individuals to take COVID withdrawals from DC plans and to not take Minimum Required Distributions from DC plans and IRAs, and second was the ability for DB plan sponsors to defer 2020 minimum required contributions until 2021 (at which time they must be paid with interest). For the latter, it will be interesting to see what happens in Washington as the due date for paying those deferred contributions comes closer at the same time the coronavirus situation is significantly worsening. There is also the Paycheck Protection Program (PPP), providing small businesses—including non-profit organisations with DB plans—with loans to cover payroll costs for eight or 24 weeks. General loan forgiveness provisions should apply in most cases. Employer contributions for retirement plan benefits are considered part of payroll costs for this purpose subject to certain limitations established by the PPP. Sponsors that use PPP funds for retirement contributions are consulting frequently with their attorneys on the acceptable allocation toward salary and benefits in the context of their company.
Canada took several steps to support businesses, including covering a portion of an employee’s wages for eligible employers. Some jurisdictions provided relief of special contributions, aimed at reducing pension deficits. In addition, the federal government removed the requirement for employers to contribute a minimum of 1% of pay for DC plans. It also extended the deadline for plan members to elect to have periods of reduced pay. Relief of special payment contributions for federally regulated plans is applicable for contributions due from April to November 2020.
Europe’s situation mirrors that of other regions, with pensions facing widening gaps in funding positions, particularly for DB funds. “The current situation in the financial markets will create new funding pressures”, noted an April 2020 statement by PensionsEurope, which represents national associations of pension funds across the continent. There may be “impacts on the funding position of pension funds - in particular DB funds, as the value of assets decreases drastically and lower interest rates increase the value of liabilities further”. At the time of writing, markets have rebounded from the abrupt falls in the first quarter of 2020. Volatility of markets alongside subsequent waves in infection rates is perhaps to be expected. These will translate into corresponding swings in funding status. Below we touch upon some of the developments since the spring in selected countries.
In the United Kingdom, National Insurance contributions are the main payroll tax used to pay benefits such as unemployment, retirement and healthcare. Employers can claim funding from government for National Insurance contributions on 80% of salary, up to a maximum of £2,500 (US$3,200) monthly wages in respect of employees on furlough through March 31, 2021. Employers can also claim for their mandatory minimum pension contributions equal to 3% of qualifying earnings.
The Dutch government introduced the ‘Noodmaatregel Overbrugging voor Werkbehoud’, or NOW. Employers that meet the criteria of NOW receive compensation for salaries and pension contributions. The goal of NOW is to help employees of employers with liquidity issues. The payments are grants—not repayable loans—subject to conditions. Already facing large-scale pension cuts, the government had reduced the minimum required funding ratio for pension funds to 90%, down from 100%, for 2019 and 2020. That has now been extended to 2021. The government announced that pension funds with low funding ratios do not have to lower the pension payments as they would have had to according to the regulations in a normal year. The government said it made this exception because of the sustained low interest rates. Only pension funds with funding ratios below 90% will have to lower the pension payments.
The French government introduced a program that helps companies offer assistance to employees who have lost wages. The initiative is dubbed ‘chomage partiel’, which translates to ‘partial unemployment’. It covers 84% of salary net of social taxes (up to a maximum salary of €5,500, or roughly US$6,500, per month) from March 2020 to May 2020 for furloughed employees. This arrangement has been extended to December 2020 for the most impacted sectors, such as hotels, restaurants, tourism and culture. Companies are allowed to postpone the payment of social taxes by three months. Partial activity compensation is exempt from social taxes and from contributions to mandatory retirement plans. Employees continue to accrue pension rights under the mandatory retirement plans, and the employer is allowed to postpone by six months the payment of employee profit-sharing and incentive plans, until December 31, 2020.
The Greek government announced measures to soften the impact from COVID-19, amounting to about €10 billion. The measures are aimed to offer aid to businesses and employees until the end of the year. This includes Synergasia, a government program that helps businesses cover up to 60% of lost income, and allows for hours of full-time employees to be cut as much as half. The government also extended the deadline for the payment of social security contributions for both the employer and employee. For example, payments that were due on March 31 and April 30 could be deferred by up to six months.
In March, the country’s House of Representatives approved for 60% of the salary for an employee to be covered for the time not working due to furloughs. The estimated cost was €159 million. The measures include granting leave to workers in the private sector who have to stay home to take care of their children, and unemployment pay for workers of companies that suspend operations. It applies to businesses that suffer a 25% reduction in staff due to coronavirus by providing protection measures and sickness benefits. It also provides remuneration for those who teach in the afternoon school of the Ministry of Education. In the private sector, employers will pay social security contributions on 40% of salaries. Companies can suspend payment of contributions for employees who received a special benefit from the government due to COVID-19.
Asia on the whole faces a looming pension crisis. Before the pandemic, the combination of low retirement ages, an ageing population and inadequate contribution rates in the private sector had made adequate retirement funding a struggle for both plan sponsors and the retirees themselves. The issues have only been exacerbated by COVID-19 and growing geopolitical uncertainty. Many governments have allowed for plan sponsors to allow members to defer contributions, but this means that these constituents are choosing between subsidising the present versus the future.
In Singapore, retirement savings are mandated and managed in the public sector via the Central Provident Fund (CPF). There has been no relaxation on payment of CPF contributions or flexibility for members to withdraw funds early. However, the ‘Job Support Scheme’ was introduced to provide support to employers to retain staff. The government co-funded between 25% and 75% of the first S$4,600 (about US$3,800) of gross monthly wages for Singaporeans and Singapore Permanent Residents (PRs) for 10 months, up to August 2020. For the following seven months up to March 2021, the co-funding ranges from 10% to 50% depending on sector. Still, retirement funding problems are likely to persist. According to DBS Bank, the share of customers who experienced a greater than 10% decline in income had risen sharply as a result of COVID-19, to 26% in May. Among them, around one-third suffered even sharper income decline in excess of 50%.
Under the 2020 Economic Stimulus Package, the statutory employee contribution rate to the Employee Provident Fund (EPF) for those below age 60 was reduced from 11% to 7% from April to December 2020. This may result in a total reduction in EPF contributions over the period of up to MYR9.4 billion (about US$2.3 billion). The employee contribution rate remains unchanged for those age 60 years and above. Employees, however, have the option to maintain their contribution at 11%. For small and medium enterprises, in April the EPF launched the Employer COVID-19 Assistance Program (e-CAP) to allow for the deferment and restructuring of employers’ contributions for April, May and June 2020. The deferred contribution can be settled over a maximum of three months. The government has also allowed for EPF members below age 55 to apply for monthly withdrawals of from MYR50 (about US$12) to MYR500 per month from their retirement funds from one of their two government-mandated retirement accounts in the EPF that allows for pre-retirement withdrawals, for a 12-month period ending in March 2021.
The Australian government introduced a scheme known as ‘Jobkeeper’ to subsidize wages for employers that met certain eligibility criteria, with the aim of encouraging employers to retain staff during the pandemic. As part of the program, the government provided A$1,500 (about US$1,050) per two-week period per employee from March through September, and then A$1,200 for each period up through January 3, 2021, for employees working 20 or more hours per week, and A$750 for those working less than that. The payments were means tested based on company size and revenue lost relative to 12 months prior. For eligible employers with annual turnover of more than A$1 billion, Jobkeeper was available if revenue reduced by 50% compared with the same period a year earlier. For companies with annual turnover less than A$1 billion, the program was available if revenue fell by 30%.
The above list of countries is just a sample of the countries that Milliman surveyed. The initiatives mentioned are summaries of the key decisions. Many DB plans were already in poor health before the COVID-19 crisis. Plan sponsors will ultimately need to decide how to address the funding ratios of DB plans that have now possibly fallen further. Moreover, members of DC plans will have also been badly affected if their contributions have been disrupted while on temporary unemployment. Will employers consider a corresponding sense of obligation to make up for the shortfall in DC contributions?
For employers with global operations, it is a good time to consider the value proposition of an investment now to make up for the lost contributions earlier this year, in the interest of long-term retention of a workforce, which could offer big dividends after the crisis subsides and the economy rebounds. In the event of the expected recovery, will employers be ready? While tough choices lie ahead, the situation presents an opportunity.