From surpluses to deficits
What has changed for your fund over the last 15 years?
LPFA pension fund
• Invested assets: £2.4bn (€2.9bn) (active fund) and £1.5bn (pensioners' fund)
• Members: 80,000
• Solvency level: 80% overall
• Established: 1920s (in its current form)
The 1995-96 London Pensions Fund Authority annual report stated that cost-efficiency and improving member services were the twin objectives for the past four years - and this is not very different from today.
However, a number of significant changes have taken place over the last 15 years. Back then the active part of the fund was managed on a balanced basis with 64% invested in equities, 19% in bonds, 9% in property and 8% in cash. Equities were split into 70% UK and 30% overseas.
Rather than being led by a consultant, today it is a specialist active fund with specialist managers - with a CIO acting as a manager of managers. It has a £260m (€315m) exposure to diversified growth funds and a £730m exposure to alternatives such as private equity, property, infrastructure, hedge funds, commodities and opportunity funds. The £1.4bn exposure to equities is predominantly invested overseas - UK equities only make up 10%.
In 1995-96, 82% of the pensioners' fund was allocated to bonds, primarily index-linked gilts. Although the bond proportion is similar today, it is dominated by LDI bonds with a target of achieving the cash flow liabilities of the fund and more.
Fifteen years ago, the solvency level was 100%, compared with an average 80% today. The contribution rate of employers stood at around 8.7% compared with contributors of just under 6% - today the contributor rate stands at about 6.9% and the employers' rates are just under 13% before deficit contributions of a further 5%.
Passing the point where active membership had been declining, in 1995-96 the fund was seeking new members. However, as a result of the public-sector austerity measures, active membership has declined by 9.5% over the last 21 months.
One of the most important developments over the last 15 years has been the growth in mark-to market accounting. We have responded to that through our LDI approach in the pensioner fund. The other main development has been the increase in longevity forecasts by the actuaries, which made us readdress our investment risk.
The most important issues for the pension fund today are its valuation level and the potential for further declines in active membership. This has influenced our risk profile, which is why we are reviewing the asset allocation strategy in the context of different cash flows from those we were predicting at our last valuation in March 2010.
• Invested assets: CHF16.9bn (€13.8bn)
• Members: 81,000
• Funding level: 100%
• Established: 1934
One of the most important developments for the Swiss occupational pension fund industry was the introduction of the Freizügigkeitsgesetz in 1995. This law introduced full portability and changed the design of pension plans. At the same time, members were given the opportunity to use up to 50% of their pensions capital to buy residential property. In divorce cases 50% of the accrued pension claims during marriage could be transferred to the spouse.
The second big milestone was the BVG review, implemented between 2004 and 2006. It improved the transparency of pension funds, adjusted the threshold for admittance into a pension scheme in co-ordination with the first pillar, reduced the conversion rate (Umwandlungssatz) and outlawed tax optimisation under the pretext of occupational pensions. We adapted to those changes although the pension fund had implemented full portability five years previously. We introduced transparency of our annual report prior to the BVG review.
The economic developments in the 2000s meant we had to raise the retirement age for our members from initially 62 to 63 years, and to 64 years in 2012. Our target pension rate of the insured salary was also downgraded, from 74.1% to 70.2% as of January.
The asset allocation of the average Swiss pension fund has changed as well. In the 1990s, loans to the employer or investments in shares of the sponsor were more common than they are today - they made up on average 10% of investments, when today they practically no longer exist. Investments in mortgages have also subsided. The home bias in equities has also changed since the 1990s. In 1998, 15% of overall investments were invested in domestic and 10% in foreign equity, whereas today on average 16% is invested in international and 10% in Swiss equity.
Alternatives such as private equity, hedge funds, commodities and insurance-linked securities have also become more popular over the last 15 years, making up around 5% of investments.
The challenge for us 15 years ago was how to fairly distribute the surplus among the active members, the employer and the retirees. Today the main challenge is the historically low interest rate environment and the low yields it generates, which has led to cuts in benefits or hikes in contributions. Because of low interest rates, the effects of demographic changes are also more strongly felt, not only by occupational pension funds but also by the first pillar.
• Invested assets: €6bn
• Members: 15,000
• Solvency level: 105%
• Established: 1973
One of the most important pension developments over the last 15 years was the introduction of the financial solvency framework (FTK) and its concept of market valuation. This changed the shape of our industry and altered our policy on the hedging of interest rates. At present we have a hedge level of around 70% but 15 years ago we only had a natural hedge through bonds we owned. As a result, our risk budget has been reduced. But even with this high interest hedge ratio, we still have to deal with more volatility.
Fifteen years ago, the government wanted to abolish mandatory pension schemes for self-employed professionals, such as our scheme for medical specialists. In 2007, we were forced to set up a pension-only association for medical specialists. To continue the mandatory scheme, at least 60% of the medical specialists have to join this association. Currently 80% are members. This strategic development forced the fund to improve its transparency, governance and communication with members.
Another big change was the switch in our indexation policy to 3% guaranteed indexation almost five years ago. From 1 January 2012, the yearly actuarial accrual increases by one third for new members, while old members can choose to opt out if they do not want to increase their yearly accrual.
Over the last 15 years we have increased alternatives such as real estate, commodities and hedge funds, the latter of which make up almost 10% - in the pursuit of greater diversification.
Within the equity portfolio, there has been a switch towards emerging markets. In the bond portfolio, we have significantly reduced our exposure to government bonds and focused on credits, high yields and emerging market debt. Due to the euro crisis, we have altered our government bonds portfolio to concentrate on Germany and the Netherlands.
The pension fund environment was completely different 15 years ago. Back then we had a very long period of high investment returns, which is why one of our discussions was about what we were going to do with the fund's high surplus. Unlike many other pension funds that chose to reduce their premium, we stuck to our relatively high premium and increased benefit levels with profiteering.
Today, the investment environment is the exact opposite. Funding levels are low and we run the risk of having to reduce benefits.