This article was first published by BRINK on October 19, 2020
The impact of COVID-19 is now much broader than just a health crisis. Whatever the system, COVID-19 will affect the provision of pensions for decades to come.
COVID-19 Likely to Dampen Pension Values
The immediate consequences from COVID-19 on pension systems around the world are already visible. And its effects will continue to have long-term impacts on pension provision, such as a decrease in the value of pension plan assets and an increase in unemployment — resulting in lower pension contributions and higher government debt that could lead to reduced government pensions in the future.
These, and other, effects are likely to have negative consequences on the provision of future retirement income, potentially leading to:
- A lower standard of living in retirement
- A decision by some individuals to defer retirement and thereby make up their pension shortfall through additional years in the workforce
- An attempt by some plan members to increase their investment return by increasing the level of risk within their portfolio
Given the widespread impact of the pandemic, it’s not surprising that governments, pension regulators, individual members and pension plan fiduciaries have had a wide range of responses to the unusual events of 2020.
How Governments are Responding
In responding to COVID-19, some governments deployed a range of approaches to support their retirement income systems, while others left their system unchanged.
As seen in Australia, India and New Zealand, the simplest response was to increase the level of government support received by the older population. The provision of these additional benefits to retirees was designed to increase their spending and stimulate the economy.
As the 2020 Mercer CFA Institute Global Pension Index shows, some governments took the unprecedented action to enable pension plan members to access their accrued benefit to a greater extent than is normally permitted. For example, Australia enabled individuals whose income had dropped by more than 20% to access up to AUD 20,000 from their pension assets, while India allowed partial withdrawals for COVID-19 treatment and a payment from the Pension Fund account not exceeding three months’ wages and allowances.
These examples raise the question of the purpose of a funded retirement income system and whether, in extreme circumstances, a limited portion of the assets accrued by an individual should be available before retirement. As highlighted by The Organization for Economic Co-operation and Development (OECD), “Access to retirement savings should remain an exceptional measure based on individual specific circumstances and based on regulations already in place for that purpose.”
Decisions and Actions Made by Regulators
Pension regulators have made many pragmatic decisions to ease the burden of the COVID-19 impacts on pension schemes. However, it should be noted that in many jurisdictions, the scope of the regulator to ease regulations or requirements is limited by legislation.
Even before COVID-19, many countries were grappling with the social, economic and financial effects of aging populations — and this is now more important than ever, given the uncertainties of the post-COVID-19 world.
A common action was to defer deadlines for various reporting and other requirements. For example, Canada extended the deadlines for certain actions and annual filing requirements, while Denmark relaxed the deadlines for the publication of reports and shareholder meetings.
The European Insurance and Occupational Pensions Authority went further and suggested regulators should monitor several issues, including the liquidity of pension funds, the impact of reduced dividends and the potential difficulty of selling assets under current market conditions. There is no doubt that COVID-19 has required regulators to increase their surveillance of the industry whilst also recognizing the difficulties faced by the pension industry.
How Pension Plan Members are Reacting
Not surprisingly, the common behavior by many pension plan members during a financial crisis is a flight to safety. However, these actions are primarily only available to individuals with personal accounts in defined contribution (DC) plans or mutual funds. Members in defined benefit (DB) funds, with the backing of an employer sponsor, are unable to respond in this manner.
With this in mind, in Australia, Indonesia, Ireland, New Zealand and the United States, there was evidence of members switching to cash and other conservative investment options. There was also a switch to gold-based investments in Turkey. Interestingly, as the share market recovered (at least to some extent), the evidence is that some of these members have switched back into equities, probably prompted by the very low-interest rates available on cash investments.
As greater responsibility is given to individuals to manage their pension plans in many retirement systems, it highlights the need for sound member education and good communication from pension funds.
Plan Trustees and Fiduciaries
Naturally, the significant responses from the financial markets to the pandemic have caused pension plan trustees and fiduciaries to review their asset allocation and investment strategy. In most cases, the reaction has not been dramatic. Rather they have adopted the longer-term view while keeping a close watch on economic developments. Nevertheless, two developments have been observed.
The first is some adjustments to asset selection with a greater emphasis on equities that have less volatility as well as increased diversification, including more liquid infrastructure investments. This is consistent with a more cautious and risk-averse approach which has been the general approach around the world.
The second is a greater focus on liquidity — particularly in markets where there has been a significant reduction in investment income, a greater level of member switching to conservatives assets or a higher level of benefit payments.
COVID-19 has brought to light the important role that risk management should play in the responsibilities of trustees and fiduciaries. In particular, they should ‘expect the unexpected’ — after all, being underprepared is no excuse.
Learning from Each Other
Even before COVID-19, many countries were grappling with the social, economic and financial effects of aging populations. These issues are now more important than ever, given the uncertainties in the post-COVID-19 world.
More than ever before, it is important to understand the strengths and weaknesses of different pension systems around the world. The challenges of the time present us with an opportunity to come together as a global community, to learn from each other, with the aim of providing current and future retirees with dignity and confidence in their final years.