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Facing the cost of doubling as rainy day funds

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Defined contribution systems are providing countries battling the COVID-19 crisis with ready-made conduits for extending relief to employees, but at the cost of their focus on retirement outcomes.

Chile, Malaysia, Peru and Australia have been at the forefront of providing workers with access to their own government-mandated retirement savings to help them fight through the pandemic’s economic fallout, with combined drawdowns of more than $100 billion so far.

Defined contribution systems are increasingly the “retirement savings program of choice” around the globe, but with political time horizons inevitably shorter than the multiple decades needed to save for retirement, the temptation to tap DC savings pools to ameliorate economic hardships could grow, said Tyler Cloherty, managing director and head of the knowledge center at Stamford, Conn.-based Casey Quirk, a practice of Deloitte Consulting LLP.

That, in turn, could spawn “a siz- able gap in retirement savings” for participants taking advantage of that access, an outcome that could prompt consideration of tighter rules around hardship flexibility and “more gating around the political ability to adjust these plans on the fly,” Mr. Cloherty said.

On Oct. 31, Malaysia’s 989.1 billion ringgit ($238.6 billion) Employees Provident Fund offered details regarding its trade-off between providing economic relief for members and ensuring their retirement security, announcing that roughly $25 billion in “exceptional” withdrawals since March 2020 had left almost three quarters of its 14 million members facing poverty in retirement.

The EPF estimated that by the end of 2021, only 27% of its members will remain on track to reach the 240,000 ringgit threshold at age 55 needed to provide 1,000 ringgit of income a month over 20 years of retirement, down from 36% at the close of 2020.

Meanwhile, a new measure of pension adequacy the EPF is set to announce early next year will cast an even harsher light on the state of participants’ account balances, said Nurhisham Hussein, the EPF’s Kuala Lumpur-based chief strategy officer, in an interview. With a higher minimum savings threshold of close to 600,000 ringgit, only 3% of members now could be confident of avoiding poverty in retirement, he said.

The threat to retirement security posed by tapping defined contribution pools as rainy day funds is something analysts warned about at the outset of the COVID-19 crisis.

The World Bank, the Organization for Economic Cooperation and Development and the International Organization of Pension Supervisors, a Paris-based international body representing institutions involved in the supervision of private pension arrangements, had all urged that early retirement drawdowns — something most plans leave room for individual members to pursue on an emergency basis — only be considered as a “last resort,” said Dariusz Stanko, senior private pensions expert and head IOPS secretariat, in an interview.

The current crisis, instead, saw some countries offering such access “to almost everybody, almost automatically,” he said.

Among Australia, Chile, Malaysia and Peru, Australia has the strongest claim to honoring that last resort standard. At the most uncertain moments of the crisis in March 2020, Canbarra offered superannuation plan participants hurt by the pandemic the option of drawing down an initial A$10,000 from their accounts for the quarter through June 30, 2020, and a follow-on A$10,000 over the rest of the year.

Data released by the Australian Prudential Regulation Authority showed 3.5 million participants withdrawing a total of A$36.4 billion ($27 billion) in 2020 — a sizable chunk of change but just over 1% of the system’s A$3.3 trillion in retirement assets as of June 2021.

By contrast, Chile, Malaysia and Peru have all come back for additional bites of the apple over the 20 months since the pandemic struck.

Most recently, Chile’s Senate failed by a single vote on Nov. 10 to approve a bill letting members of the country’s DC system withdraw a fourth 10% chunk of their retirement savings, following similar drawdowns in July 2020, December 2020 and April 2021. The legislation could yet pass should Senate deliberations with Chile’s lower house, which approved the bill six weeks ago, result in a compromise.

If the bill eventually passes, that could add another $15 billion of outflows from the contributory pillar of Chile’s retirement safety net, on top of the roughly $50 billion taken out over the first three go-rounds, noted Manuel Tabilo, research manager with the Santiago, Chile-based International Federation of Pension Funds Administrators.

That $50 billion — representing just under 30% of the system’s $172 billion total as of March 2020 — has left 2.2 million of the Chilean system’s 11 million members with nothing left in their accounts, while a fourth 10% drawdown would likely drain the accounts of another 2.8 million members, he warned. (The 10% withdrawals can empty an account because each withdrawal is subject to a minimum amount of roughly 1.05 million pesos, or $1,200.)

Malaysia’s Employees Provident Fund, meanwhile, followed up the initial program it announced on March 23, 2020, allowing members to dip into their Account 2 totals reserved for needs other than retirement, with additional programs in November 2020 and June 2021 that provided access to their retirement-focused Account 1 savings as well. More recently, the government’s 2022 budget, unveiled on Oct. 29, extended a 9% contribution rate for EPF members, below the statutory rate of 11%, for the first six months of the coming year.

Peru’s government, meanwhile, has issued one emergency decree and passed three subsequent laws since March 2020, allowing workers to withdraw $15.9 billion of their savings in the country’s private pension system.

Mr. Stanko said he sees expediency, not bad intentions, driving those decisions. “It’s simply they search for the options and for the options that are least politically painful,” he said.

And DC systems offer a far more conducive backdrop for such decisions than the defined benefit plans they’re replacing now, he said. “The clarity of defined contribution is also the weakness, in the way that you see your money — it’s your money, it’s visible, it’s not entitlements,” Mr. Stanko said. And as members accumulate ever-bigger pools of retirement savings, “it’s very tempting to reach out for this money, especially if it’s organized by the state,” he said.

As defined contribution systems continue to grow as a percentage of their country’s gross domestic product, analysts warn it could become ever more tempting for governments to pull that particular economic support lever going forward.

“Once you’ve been to the well, you know where the well is and you’re likely to head in that direction” when the next economic or social crisis arrives, said Ashley Palmer, Hong Kong-based partner and actuary, regional head of retirement, Asia-Pacific, with Aon plc.

But forcing a country’s defined contribution system to take on the role of rainy day fund will have consequences, analysts say.

“The pension system is there for retirement” while supporting people who require help during their working careers — whether because of the pandemic or some other crisis — should be the role of some other government system, said David Knox, Melbourne-based senior partner with Mercer Investments and an author of the firm’s annual global pension ranking, which placed Australia at sixth out of 43 countries for the latest year; Chile was 16th, Malaysia 23rd and Peru 29th.

If retirement savings are pressed into that role, “inevitably there will be consequences,” said Mr. Knox.

That has left some analysts calling for more institutional hurdles to be put in place to maintain the sole focus of retirement systems on retirement, even as they concede it’s not possible to foolproof a system in an environment dominated by political considerations.

There’s room to put in place higher guardrails or better ring fencing to make long-term retirement policy less vulnerable to short-term political interventions, Aon’s Mr. Palmer said. Still, with what are essentially national cash cows subject to prevailing political whims, “it’s probably a little bit too optimistic to expect no tampering,” he said.

The EPF’s Mr. Nurhisham said there’s reason to believe the pandemic crisis and the policy responses it elicited will prove a one-off event. Still, with signs of recovery in Malaysia and progress in vaccinations now, the EPF — in an effort to “stave off some of the pressure for additional withdrawals” — has begun highlighting the urgent need to rebuild members’ retirement balances, he said.

The fund’s concession, when it launched its third early withdrawal program at the end of June, that it needed to “balance current demands against future needs and facilitate temporary relief for members amid the pandemic,” has given way recently to a more cautious tone. The EPF’s Oct. 31 news release concluded that “future exceptional withdrawals will need to be very carefully considered.”

With Malaysia’s government enjoying less room than some developed market countries to simply spend its way out of the pandemic crisis, the EPF had to do its part when “movement control orders” went into effect, leaving roughly 2 million workers on unpaid leave, the strategist said. But now is the time to focus on participants’ depleted accounts — the number of accounts with less than 1,000 ringgit has surged to 3.6 million from 1.4 million at the start of 2020 — to emphasize that “there’s a limit to how much you can call on the EPF to assist,” Mr. Nurhisham said.

Mr. Tabilo likewise said there’s reason to hope that relegating retirement savings to economic stimulus duties won’t become commonplace. Despite the unfortunate examples being set by Chile and Peru, in the rest of the region — Colombia, Costa Rica, El Salvador, the Dominican Republic and Mexico — attempts to tap into retirement savings have been resisted so far, he noted.

“In Colombia and Mexico, for example, the use of unemployment funds to alleviate the negative effects of the COVID-19 crisis on income and jobs (has) slowed down initiatives to use pension funds,” he said.