Nina Röhrbein spoke to Edwin Meysmans, managing director of Pensioenfonds KBC, about running a two-tier pension scheme and the different investment strategies necessary

‘A second-pillar pension is a shared responsibility of both employer and employee.’ This is one of the basic rules that sums up the pensions philosophy and strategy of Belgian Pensioenfonds KBC. It is also reflected in the design of the plan, which comprises of 18,000 employees from the 20 different employers that belong to the KBC banking and insurance group in Belgium.

The pension has consisted of two components since 1992 - a defined benefit (DB) fund, financed only by the employer and an employee-financed defined contribution (DC) fund.

“That is where the philosophy of sharing comes into play,” says Edwin Meysmans, managing director of Pensioenfonds KBC. “Apart from sharing the financing, the risk is also shared, albeit not on an equal footing, as the employer is in a much better position to take the risk.” In the DB plan, Meysmans points out, it is solely the employer who takes the risk whereas in a Belgian DC plan a minimum guarantee of return - currently 3.75% - is imposed on the employer. Investment risk on top of that is taken by the employee.

For each section the board of directors comprises 50% employer and 50% trade union or employee representation.

KBC Group set up its DB plan back in 1942. Some 50 years later it added the DC plan. Every new KBC employee is automatically included in the DB and since 1992 also in the mandatory DC plan. And according to Meysmans only a very limited number of employees - some the ones that started prior to 1992 - do not belong to the DC plan.

The two-tier system is also the reason for two different investment strategies.

“Due to the minimum guarantee borne by the employer, the DC fund requires a different, more defensive strategy than the one of the DB fund,” says Meysmans. “Therefore the DC plan is heavily invested in bonds, which make up 60% of its total invested assets. Only 35% is invested in equities and 5% in real estate.”

The basic strategic asset allocation for the DB fund assigns 40% to bonds, 50% to equities and 10% to real assets. However, after Pensioenfonds KBC adopted a liability-driven investment (LDI) strategy in the summer of 2007 with an expected return of 6%, the DB plan underwent some major changes.

“While the 50% equity exposure remained the same - equally split between European and rest-of-the-world equities including a 5% allocation to private equity - the main change occurred in the fixed income space,” says Meysmans. “Before we implemented the LDI strategy we had a 40% exposure to government bonds. That was then switched to a derivative strategy based on a UCITS III Luxembourg vehicle with a range of constant duration sub-funds covering different durations. The vehicle works with interest rate swaps with a 200% leverage on top. In other words, it allows the fixed income component to hedge twice as many liabilities with less money than before.”

The drivers behind the pension fund’s LDI strategy were changing accounting standards that force companies to reveal the value of their pension scheme liabilities on their balance sheets from year to year, as well as the Belgian regulator’s requirements for pension funds to calculate their technical provisions with a discount rate linked to the expected return of the assets of the fund from 2007, and not with a fixed discount rate as in the past.

“The volatility of the results, of the pension liabilities versus the assets, was reflected in the accounts of our sponsor KBC, a quoted company, following the introduction of international accounting standards IAS19 in 2008.”

And for 2009, the pension scheme is set to continue this strategy. “Our funding level is still OK at around 130% so there is no need for recovery or similar plans,” says Meysmans. “Although we have been hit by the market downturn like everybody else, we have seen that the LDI strategy we adopted in 2007 has worked pretty well, given the circumstances, and so we will continue this strategy for the next year.”

“What is now on the menu for the board of directors is to watch the markets, in particularly equities. Because of the market downturn in 2008 we are underweight in equities in the DB as well as the DC plan. But we still need to debate when we are going to start the rebalancing, in other words when to buy equities. We are still hesitant about whether the timing is right at the moment. However, there are two alternatives to equities. First, this may be a great opportunity to buy corporate bonds, in which we are also underweight. And secondly, if we are too hesitant to increase our equity allocation we may consider convertible bonds, whose risk lies between that of bonds and equities. If we were to rebalance we would use some of our current cash exposure to buy into equities, as well as reduce the total bond exposure.”

At the end of 2008, KBC’s DB plan had an allocation of 54% in bonds, 33% in equities, 10% in real estate and 3% in cash. Its DC scheme had a 62% exposure to bonds, 28% invested in equities, 3% in real estate and 7% in cash.

While the minimum guarantee places some restrictions on the DC plan’s exposure to equities, Belgian funds in general - aside from a 5% investment limit in shares of the sponsor - have no quantitative minima or maxima and follow the European investment directive. 

In general, the pension market and the number of large pension funds, is small in Belgium. Nevertheless, Meysmans feels that Pensioenfonds KBC distinguishes itself from the others through one feature: its sponsor.

“Our sponsor is a bank, which means there is a correlation between what the sponsor is doing and what the pension fund is doing,” says Meysmans. “In years such as 2008 when things are not going well for the pension fund, the sponsor is having a rough ride too, meaning that the fund would need to ask the employer for money at the worst possible time. And we would also need to consider this in our investment approach.”