REVIEW OF THE OCCUPATIONAL PENSION SCHEMES AND PRODUCTS
Jaroslav VOSTATEK
University of Finance and Administration, Estonská 500, 101 00 Praha 10, Czechia
ABSTRACT
We compare the concepts and role of occupational pension schemes and products in the pension
systems in the latest decades. Under the liberal social philosophy, dominating the Czech
pension policy in the nineties, occupational and social insurance schemes ought to be avoided.
In high income economies the occupational pension schemes differentiated to reflect various
welfare regimes and different pension gaps. The opt-out method of soft compulsion was used
by neo-liberal economists and politicians to change the pension pillars and products, some
countries were hit by misselling practices. Latest developments utilize the analyses of pension
products and markets and the efficiency of occupational schemes' administration to define the
future potential of these schemes. New workplace pensions with defined-ambition products are
supported by national pension institutions, trying to reduce the overhead costs and increase the
pension savings.
Keywords: occupational pensions, welfare regimes, soft compulsion, workplace pensions,
pension savings
JEL codes: H55, J32, O16
1 Introduction
The formation of universal pension schemes is preceded by pensions provided by the
employers. Under the 1896 Act on Civil Servant Pensions which remained in force, in principle,
until 1948, 10 years of service in our country gave rise to entitlement to a retirement pension
amounting to 40% of the final salary, increased by extra 2% for every 2 additional years.
Loyalty was a typical prerequisite for public service as well as for the right to benefit from of a
follow-up pension. The same still applies today in many western countries. A modern version
of a special public service pension scheme exists in Germany for instance; the pension is
calculated under the basic formula:
1.79375% * years of service * final salary (1)
The significant differences compared to the social insurance scheme used today in the private
sector include a higher coefficient (1.79375 compared to 1.5) and the application of the final
salary which is, as a rule, at the highest level achieved throughout the service career. In addition,
public servants do not pay contributions for their pensions. After WWII, there was a certain
conversion between these occupational pensions and other pension systems in the relevant
countries. However, the advantages consisting in the relatively high levels of public service
pensions remained – otherwise these separate schemes would lose their sense of existence for
that matter. At present, 13 (of the 25 listed) OECD countries have separate pension schemes for
public servants, while 12 countries have an integrated system [13].
A similar path led to the development of occupational pension schemes in the private sector.
Also here, the initial efforts aimed at applying the “loyalty” nature of these pensions. After
WWII, occupational pension schemes experienced a major boom in a great number of countries
and grew up to nearly nation-wide fully funded systems. Tax deductibility and similar
treatments were of major importance for the development of occupational pensions in the
different countries. Nowadays, emphasis worldwide is placed on the portability of the pension
rights arising in such a manner.
This paper aims at analysing, in particular, the contemporary development trends in the
occupational pension schemes in advanced countries, their interconnection with the basic
pension social models and, thus, the possibility of using occupational pension schemes in the
present Czech conditions.
2 Literature Review
A great number of various pension schemes have developed worldwide as a result of the
historical development of social policy in the relevant countries. Among those, we may
recognize several typical systems which can be considered to apply basic welfare regimes, as
defined by Esping-Andersen [3]. Consequently, we can distinguish liberal, conservative and
social-democratic social models. We also add the neoliberal model, which has developed since
the 1990’s, to the range of pension models. Choosing between these social models is a matter
of public choice in terms of modern public policy. The fundamental differences in the four
aforesaid basic social models and, thus, also pension models can be schematically illustrated
on the different emphasis on universality or selectivity, as the case may be, of the pension
security scheme, as well as on the individual choice or mandatory nature of this security scheme
– see Figure 1.
Figure 1 Typology of social models
Individual choice
Universality
Selectivity
Liberal model Neoliberal model
Conservative model Social-democratic model
Mandatory
Source: author.
From the historical point of view, occupational schemes were an option under the conservative
pension model in the private sector, existing next to the public servant schemes. The formation
and development of social insurance systems for mine workers and, in particular, for the bluecollars
and white-collars in the private sector gave an essential drive for the further development
of conservative systems. Social pension insurance systems concern the relevant social groups
in the territory of the entire state, and are significantly state-regulated, from financing and
pension structure up to, among other, pension indexation. After the development of social
insurance systems in the relevant countries, the occupational pensions were “shifted” to the role
of a “second” pillar or, where appropriate, a substitute system – if this system provided a higher
level of pensions. In this manner, the “substitute pension institutions” survived in the pre-war
Czechoslovakia; similarly, it was possible to avoid the newly established State EarningsRelated
Pension System in the United Kingdom at the end of 1970’s provided that the employer
had an adequate occupational system (“contracting-out”).
The occupational pensions in the role of the second pension pillar represent mostly a bonus in
addition to the social insurance scheme – both segmented (conservative model) and universal
(social-democratic model). Voluntary occupational pensions may also complement the liberal
system (currently in Ireland). The modern-age extreme theoreticians of liberalism fought hard
against the employers’ engagement in the social area, including occupational pensions; in their
opinion, the employers should dedicate themselves fully to generating profit in their businesses.
This policy won its way in the UK, for instance, where a “second” contracting-out – from
occupational schemes to personal pension schemes, i.e. to a third pension pillar – was promoted
under the Thatcher’s administration. It resulted in a great shame, as the sales representatives of
private financial corporations were often willing – because of their commission – to “advise”
their clients to shift to the pension scheme even if it was utterly disadvantageous for them. This
mis-selling could easily take place also due to the fact that the occupational pension schemes
were, and still are today, strongly differentiated even within the different countries. The Czech
liberal Klaus-led government prohibited the formation of occupational pensions in the early
1990’s and this prohibition applies until today in fact. In practice, neoliberal economists mostly
focus on transforming social insurance systems to mandatory personal pensions, and are not
bothered by occupational pensions. Mandatory occupational pensions are, in practice, also often
provided by private financial institutions, such as in Switzerland.
An analogical product to the initial fully-funded social pension insurance scheme can be
classified as a typical conservative occupational pension system, without the non-insurance
components such as the basic pension amount and with the pension being calculated from the
final wage, the years of employment with the relevant employer and a coefficient valuing each
year of employment. A person becomes entitled to pension after a prescribed minimum number
of years in employment. In the initial version, an employee who “prematurely” terminated
his/her employment contract lost all pension rights. In the innovated version, pension rights are
retained upon a change of jobs, but they cannot be transferred elsewhere and there is also no
indexation of the final wage that the employee was earning from the employer whom he left at
own initiative or due to own fault. The products of this type are called defined benefit (DB),
because here it is defined that the pension is calculated using the indicated pension formula
rather than based on the amount of contributions paid. In the DB occupational pension schemes,
the employer is liable for the entire scheme – and it is up to the employer to ensure that there
are enough funds in the system to pay the pensions. The employer may also agree with the trade
unions or the employees that employees will also pay contributions – and the level thereof. The
employer’s contribution may even be conditional upon a specific amount of contribution paid
by the employee.
An extreme example is the Netherlands where more than 90% of employees participate in the
occupational pension schemes based on nation-wide collective agreements – for that reason,
the system is sometimes referred to as quasi-mandatory. It is a fully-funded scheme, mostly
with a relatively high target replacement ratio at 70% of the wage.
A modern modification of occupational pensions consists in the possibility to transfer the funds
to another occupational fund or to a personal account held with a private financial institution,
such as an insurance company. This does not pose any problem from the actuarial point of view
– but also specific parameters are always essential. In this transfer, an employee does not
transfer his/her pension rights, but rather certain capital, the so-called “pension pot”. And from
this point, there is only a relatively short path to leave the DB system, to divide it into two timebased
stages – the first phase is a defined contribution (DC) savings system and the second
stage is the pay-out phase, the purchase of a life-long annuity for a lump-sum premium. A
transition from DB to DC systems is not only a mere change in the product, but also a significant
change in the governance and management system.
Occupational pension schemes of all types contribute to the segmentation of the pension
security system, particularly those on a voluntary basis; this path is also commonly followed
by the trade unions and their policy. All employers cannot afford to contribute to occupational
pensions. At the same time, however, these systems make it possible to adjust the pension
scheme to the specific work conditions in the particular sectors or branches. The specifics can
also be taken into account where a universal system exists, in the form of a supplement to the
system.
The occupational pensions in the different social systems play much differentiated roles. It is
no wonder: departmental liberals were refusing occupational pensions as an inefficient
paternalism. On contrary, conservatives were altogether satisfied with them, thanks to the
emphasis on “performance” or, in practice, rather on social stratification. The communists
abolished the occupational pensions because of being in contradiction with the central planning
as well as with the Leninist ideology of state social benefits at the full wage level, to then
introduce labour categories as a preference for manual and hazardous work within the otherwise
uniform state pension security system. Our liberal Prime Minister Klaus enforced the
abolishment of labour categories and, as certain compensation, allowed the employer’s
contributions to supplementary pension insurance provided by private companies. The social
democratic social model combines two universal pension pillars: uniform social insurance and
flat-rate or means-tested pension. In the logic of the matter, the social democratic policy is also
supported by the trade unions – and vice versa, which results in the promotion of occupational
pensions, in particular through collective agreements of higher and nation-wide type.
The application of various social models resulted in very strong variation of importance of
occupational pensions in different countries. In the US, for instance, pensions sponsored by the
employers are considered to constitute a third layer in a five-layer pyramid – after the public
pension pillar and property housing, followed by individual retirement accounts (including
transfers from occupational pensions) and other assets. Although the importance of each layer
differs depending on the income quintiles of the households, altogether they allowed the last
generations of pensioners to retain, on average, their existing living standard in retirement [6].
3 Administration and Costs
In their initial and basic form, occupational pensions are managed by foundations or trust funds
in the interest of the employees. Here the employers are in the position of sponsors responsible
for the financing of the scheme. This does not exclude contributions from the employees; such
contributions may even be a pre-condition for the contributions provided by the employer, with
auto-enrolment being used as well, etc. In addition, the specific terms and conditions for the
entitlement to a pension are nowadays also primarily a matter of mutual agreement between
social partners. There is no possibility of choice for a product or provider within a single
occupational pension system. It is in fact a collective pension insurance scheme managed by a
non-profit institution.
Occupational pension schemes can be of a various size and, just for that reason already,
outsourcing is often used for asset management as well as for ordinary administration. In this
manner, the non-profit institution can be restricted to the “mere” strategic management by the
administrative board, which entails not only economies of scale, but also potential conflicts of
interest with administrators and investors. The non-profit institutions operate in a more or less
perfect market environment and their overhead costs, which are reflected in the level of
pensions and other benefits, are very differentiated, in particular depending on the volume of
assets under their management.
The conventional model of occupational pension provision does not require any sales force
because the participants in the scheme include solely the employees of the relevant undertaking
or institution or even the relevant sector or branch. In some advanced countries, this model
survived in the competition with other occupational schemes (e.g. in Germany), in other
countries it was significantly unified into nation-wide social insurance-like systems (e.g. in
Finland), while in Switzerland and Australia, occupational pensions simply became mandatory.
When replacing DB systems with DC schemes, most countries experienced a fundamental
product change affecting the content and, thus, the administration of occupational pensions.
In DB schemes, the crucial part of the financial risk is borne by the employer, while in DC-type
schemes, the employer “only” pays a contribution – and the investment risk is primarily borne
by the client. It is then – in a certain way – systemically logical that the client has the possibility
to choose a pension fund in which “her/his” pension savings are to be invested: the collective
pension scheme is transferred to individual retirement accounts – which may or may not be
facilitated by the employers, thus turning into a personal pension savings or insurance scheme,
which is a fully different provision model. The basic differences in the bearing of the most risks
are shown in Table 1.
Table 1 Risk Bearing for Different Types of Scheme
Type of Scheme Working Retirement
Defined benefit Employer Employer
Defined contribution Member Insurer
Source: Sutcliffe, Ch. (2010). Back to the Future: A Long Term Solution to the Occupational Pensions Crisis.
Insurance Markets and Companies: Analyses and Actuarial Computations, vol. 1, p. 20.
The common hypotheses that have been put forth to explain the shift to DC plans include the
following [7]:
 the simplicity of DC plan designs
 the reduction in risk to employers when undertaking such a change in plan design
 the opportunity for plan sponsors to reduce their annual contributions
 the rising costs associated with the government's increased regulation of DB plans and
 the superior portability properties of DC plans, which fit today's more mobile and
independent workforce.
The neoliberal supporters of privatization are in favour of DC schemes, arguing that the
individuals may allocate their pension wealth into financial assets according to their preferences
[2]. From purely ideological point of view, this argument is understandable; nevertheless, the
vast majority of clients of these schemes is inert and has no interest or real possibility to make
use of this option, and even government programmes to raise financial literacy are of no help
here. The economic theory indicates that employees are not suitable economic entities (agents)
to bear investment and annuity risks [11].
The objective advantage of the transition of occupational pension schemes from DB to DC type
consists in the introduction of easy portability of savings from one fund (employer) to another;
the need for this portability arises even just from the modern labour market itself. It is not
possible to build major pension systems on the hypothesis that an employee will work for a
single employer throughout her/his life or, more specifically, that it is at least impractical to
acquire pension rights from several employers and have, in her/his old age, the “partial”
retirement pensions paid from all or most of the employers, and all this regardless of the fact
that every occupational pension scheme also has its “technical minimum requirements” for
becoming entitled to a pension which means that, in some cases, entitlement to a partial pension
may not always arise.
Historically, occupational pensions are “associated” with pension pay-out; the transition to a
DC system provides conditions for not using the annuities as a part of the pension scheme. This
is usually also the case in practice, unless provided otherwise – in exceptional cases – by state
regulations or by agreement between employers’ associations and trade unions. An exception
of this type is the Netherlands where the DB type occupational pensions continue to prevail
(used by ca. 90% of participants) and where a life-long annuity must be paid to DC type scheme
participants as well. Switzerland is another exception – there the annuitization is not mandatory
but, on the other hand, the conversion rate of the pension pots to annuities is regulated by the
state. Since 2014 the minimum conversion rate of 6.8% in the mandatory occupational
insurance scheme applies to clients at 65 years of age. In the optional occupational insurance
scheme, this regulation does not apply and the conversion rates are significantly lower!
4 Results and Discussion
The quasi-mandatory Dutch model of occupational pensions raises interest of theoreticians and
politicians in a number of other countries, also due to the fact that the local DB systems of these
pensions have been in a modification process since the beginning of this century; these
transformations were accelerated after the decrease of investment yields around the world,
which resulted and continue to result in a pressure to increase the occupational pension
contribution rates, while this pressure has already become unbearable for the business sphere.
The main modification of the DB system was the setting of ceilings for the existing contribution
rates (in 2012, the average contribution rate was approximately 17.5% of the wage, of which
11.3% was paid by the employer) and the subsequent partial shifting of the investment risk (and
the longevity risk) to the employees and pensioners. In 2013, in particular, there was even a
decrease in the nominal pensions paid. Many authors are of the opinion that – in this manner –
the country actually developed a combined DB + DC system or, in other words, established a
stand-alone collective pension scheme [1]. Generally speaking, there may be a range of such
combined scheme – depending on whether the product is closer to DB or DC or somewhere
“in the middle” between the two, as the case may be. Two options of these combined products
are illustrated in Figure 2: one product is referred to as CDC (collective DC), the other as DA
(defined ambition). The DB product is present in two versions here: the historically first product
derives the pension from the final salary, while the later DB product calculates the pension from
the average life-long (valorised) salaries.
In Great Britain, the occupational pension scheme was and is significantly different from the
Dutch system. Less than 50% of employees were participating in this pension pillar in Great
Britain in 2013. DB systems continue to prevail, as the DC-type occupational systems have not
developed much (8-9% of employees). The contribution rates in the DB and DC systems were
and still are diametrically different: in DB systems, the average contribution earlier was 14%
of the wage (of which 4% were paid by the employee), while in 2013 the average contribution
was as high as 20% (with 5% of the wage paid by the employee). On contrary, the average
contribution in DC systems earlier was 7% (of which less than 3% paid by the employee) and
less than 10% of the wage (of which 3% paid by the employee) in 2013 [12]. The new UK
Pension Schemes Act (2015) focuses on scheme classification, introduces the concepts of DB,
DC and shared risk pensions, which is the legislative term for the DB and DC combinations.
An essential reform consists in the transition to a workplace pension system, which is to be
completed in 2016.
Figure 2 Risk profile of pension systems
Source: Schouten, E. – Robinson, T. (2012). Defined ambition pensions – Have the Dutch found the golden
mean for retirement savings? Pensions, vol. 17, p. 337.
In Great Britain, the administration decided to implement a number of major reforming changes
in order to increase transparency, reduce administrative and other costs, etc.; the occupational
pensions are under transformation to workplace pensions – with auto-enrolment of employees.
The reason behind this is the high expenses of private pension savings providers. The basic
services should newly be provided by the employer, including the use of a default fund and the
possibility to use NEST, a low-cost national pension company (competing with both the private
companies and the employer funds). The products should be simple; the system is restricted to
“pension” savings (NEST will not provide annuities). Workplace pensions are a solution for
the problems in the occupational pension provision on the basis of soft compulsion, in reality it
is in fact a different model of these pensions.
The developments of occupational pensions in the Netherlands and in Great Britain, for
example, imply that the choice of product/system in this pension pillar is of a major importance.
The transition from DB to DC entails not only “unburdening” the employers from full financial
liability for “their” systems, but also an essential trend to reduce the pension system to a savings
system only. In addition, a large number of comparisons showed that DC systems provided by
the private sector are significantly more costly and less profitable for the clients – under
otherwise the same, comparable circumstances. Bovenberg and Nijman [1], also referring to
many other authors, indicate that the costs of the individual defined contribution systems are
50-100 p.p. higher than the costs of occupational pension funds. Pitt-Watson [9] documents
that, in the past 57 years, collective pensions in Great Britain would have generated 33% better
results than the individual pensions and would have also been more predictable. This conclusion
is also reproduced in a research paper of the British House of Commons [12].
As from the new fiscal year of 2015, Great Britain abolished the mandatory annuitization of a
substantial part of pension pots in DC pension schemes under the slogan “Freedom and choice
in pensions”. The official explanation of the competent Secretary was that “as nature of
retirement changes, annuities are no longer the right product for everyone”. Another essential
reason was that “the annuities market is currently not working in the best interests of all
consumers. It is neither competitive nor innovative and some consumers are getting a poor deal”
[4]. Following public consultations, the explanation was modified as follows: “Annuities will
remain the right product for some, but I believe that people should be free to make their own
choice about how to use their savings. I have been encouraged by the way in which the pensions
and investment industry is creating innovative new products designed around the needs and
preferences of consumers, and that will better suit the changing nature of retirement” [5].
In the US, there was a strong trend of transforming occupational pensions to DC plans, with a
one-off disbursement of pension savings (upon reaching the “retirement age”, here usually 59.5
years). In the middle of 2011, DC-type occupational funds and DB-type occupational funds
held USD 7.9 trillion and USD 2.5 trillion of assets, respectively; the assets of citizens held at
the individual retirement accounts were estimated at USD 4.9 trillion at the same period. The
level of annuitization in DC-type funds (incl. IRA) is negligible. Employers are not interested
in annuitization; for them, it is only a complication resulting in higher costs [8].
Following the major change in the concept of voluntary occupational pensions in some
countries where the employers were degraded to payers of contributions in favour of pension
accounts of their employees, the main purpose and the reason for existence of the occupational
pensions should be redefined. Personal pensions can fully assume their role, at least from the
technical and legal perspectives. There is only a single possible reason left for the existence of
occupational schemes, namely the economic reason: the potential advantage of occupational
pensions compared to personal pensions consists in their costs – under otherwise identical
conditions, occupational pensions entail significantly lower overhead costs because there are
no sales and similar costs and no profit margin. In addition to the adequate governance, the
relevant pension funds must be aggregated at a sectoral or nation-wide level in order to be able
to realize these potential advantages of the occupational schemes, such as based on the Dutch
or Swedish models. If this is implemented, the resulting system will already be closer to or
essentially equal to a segmented social pension insurance scheme.
In our country, the occupational pension system was rejected by the Klaus government in the
beginning of 1990’s for ideological reasons as well as because of the concerns at that time
related to the siphoning-off of funds in the situation of insufficient infrastructure for state
regulation of financial institutions. The later right-wing governments consistently continued in
the rigorous rejection of occupational pensions – to such an extent that they went into a conflict
with the European Union which promoted a single EU market in the segment of (fully funded)
occupational pensions in order to decrease the costs of these systems, through the so-called EU
Pensions Directive (Directive 2003/41/EC on the activities and supervision of institutions for
occupational retirement provision /IORPs/). Essentially, the Czech government won this
conflict although, finally, the Directive was transposed by the Act (amendment in 2011) on
activities of “institutions for occupational retirement provision from EU Member States … in
the territory of the Czech Republic” providing, however, that these institutions may not be
established in the territory of the Czech Republic (Section 10h of the amendment) and are not
entitled to be granted a licence even if they meet the requirements. The VF Corporation UK
Pension Plan was granted registration by the state supervision authorities (the Czech National
Bank); however, the activities of this institution are not clear.
The EU Pensions Directive aimed at developing a single market in the segment of those pension
funds that are run under the standard rules of comparable financial institutions – thus
contributing to reduced overhead costs. The purpose of this Directive was to establish panEuropean
pension funds, such as at the level of large multinational corporations. The resulting
effects of the Pensions Directive are negligible, as there were 75 active pan-European funds last
year. A revision of this Directive has been ongoing and pending for several years. However,
the problem might be of a more fundamental nature than the EU officials have been willing to
admit so far.
The occupational pension provision model has been differentiated to a large extent: in some
countries, the original system was essentially retained (Germany) while, in other countries, the
occupational pensions have become quasi-mandatory on a collective basis (the Netherlands,
Sweden, Finland) or mandatory, in one way or another, based on workplace pensions (Australia,
Great Britain) and, last but not least, there has been a mix between the occupational and personal
pensions with a robust tax support (US).
The differentiation of the occupational pension provision is, in principle, determined by the
choice of the social pension model. Collective systems tend to incline to the segmented social
insurance and generate significantly higher pensions under otherwise identical circumstances.
The more or less neoliberal policy is associated with high margins for the private savings and
annuities providers and with the efforts to regulate the products and use the entire occupational
pension system to reduce the overhead costs, largely by using the behavioural economics;
national pension institutions as providers of low-cost pension savings are also being joined to
this system; a successful concept of low-cost private annuities is lacking and the pay-out phase
of these pension systems is left out of the sphere of interest of the politicians with liberal
orientation, e.g. under the slogan of freedom and choice for the participants in the modified
occupational pension systems.
5 Conclusions
In the past decades, the world has witnessed major transformations of occupational schemes
and products arising from the changes in the labour markets as well as in the financial markets,
with a significant link to the development of pension welfare regimes. In several countries, the
occupational pensions came very close to the segmented social insurance system. Other
countries implemented neoliberal reforms aiming at transforming occupational pensions into
mandatory personal pensions; in reality, however, personal pensions entail higher overhead
costs that forced the governments to significantly extend the state regulation, including the
establishment of a low-cost national pension institution, exit from annuitization of pension
savings and the application of auto-enrolment of employees into the system. The EU Pensions
Directive, which was expected to enhance competition in the segment of occupational pensions
and to reduce the overhead costs of IORPs, continues to be of low importance overall.
Occupational pensions have their irreplaceable role in the pension security system of employees
in specific sectors and may also play an important role in the pressure to reduce the costs of
private pension savings providers. That holds for the Czech Republic as well; the neoliberal
pension model is to be abandoned.
Acknowledgments
This paper was elaborated within the project „Current trends in the development of financial
markets”, supported by the Institutional grant for long-term strategic development of research
organization in 2015.
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