Moving to 'second age'
The downturn in the markets has highlighted the fact that Spain’s corporate DC plans, introduced as employer-sponsored qualified pension plans (EPPs), are unsophisticated in terms of the investment strategy their funds pursue and the investment choice they offer.
For a start, there is no individual investment choice within an EPP. José Luis Masferrer, head of the investment division at Buck Heissmann in Barcelona, explains: “There is no such thing at the moment as investment choice. A corporate or individual pensions plan in Spain must be integrated into just one pension fund which is managed by a single asset manager or ‘entidad gestora’. Under the rules of the fund the investment policy has to be established by a fund supervisory commission which is made up of representatives of each plan, and must be the same for all plans integrated and for all participants of each plan.”
Masferrer says that Law 24/2001, published at the end of 2001, could relax this rule. The law establishes that under a future legal development pension plans could have several pension funds. “This seems to open the possibility of some choice, but we need to know its scope and when it will be approved to get a better opinion.”
A corporate pension plan can switch from a pension fund to another managed by another asset manager. However, the chances that it will do so are small, says Jesús Lana, technical director at Novaster. “What has happened over the past year is that the control commissions have asked the managers to explain what is happening. The managers in almost all cases have managed to convince them that the situation is the same across the market, and that there is little they can do but wait for the markets to recover.”
One of the problems of both the DC and DB options within EPPs is that the rules governing EPPs were drafted to be non-discriminatory. Under the current law a pension plan must credit the same return to everyone, regardless of how near or far from retirement they are. As a result, the older members of a plan are exposed to the same investment risk as new members.
This situation could be remedied with the introduction of a ‘life-cycle’ concept, whereby the investment risk is progressively reduced as people near retirement, says Christian Lux, senior consultant in the Madrid office of Watson Wyatt. Legislation allowing this investment approach is in the pipeline. “It is possible that legislation could be passed that would authorise the use of a life-cycle approach within a pension fund. This would provide higher returns for younger people and lessen the risk of losing all their money for older people,” he says.
The idea could win the support of the labour unions, which have until now supported the idea of uniform returns “The unions consider that if you do not credit the same returns to everyone you somehow discriminate. However, they may accept the life-cycle concept because the employees themselves will not choose. The choice will be determined by their stage in the life cycle.”
The idea of a guarantee underpinning a DC plan is also gaining support from pension fund providers. José Maria Concejois, head of sales of the Madrid team of JP Morgan Fleming Asset Management says Spanish financial institutions are showing greater interest in designing guaranteed products for people who have burnt their fingers badly in the equity markets. JP Morgan Fleming is currently involved in the design of a structured product that will carry a guarantee. Concejois says he expects it to be launched before the summer.
“Some financial institutions were coming up last year with innovative products such as funds linked to the performance of real estate rather than equities or fixed income. This year they are looking at offering something that is also linked to the performance of different assets classes but with a guarantee in the long term.” There is hunger for products with guarantees, he says. “People are really hurt considering what they have lost in the equity market and they see this as an opportunity to have some exposure to the equality markets without risking the principal.”
The opportunity for a minimum return guarantee contributory pension already exists in group insurance policies. A typical with-profits contract will currently provide a minimum guarantee of 2% or 3%. However, contributions are not tax-deductible, and one of the main drivers of DC plans has been their tax advantages.
A change to the rules regulating both DB and DC options within EPPs seems likely in the next year or two. Jesús Lana, technical director at pensions consultants Novaster in Madrid, says: “Whatever happens to the market we will move to a change in the existing system. The existing plans will change mainly because most of the plans themselves were not very well designed. Contribution level were set without a proper study of expectations of benefit. The new plans coming into being will little by little abandon the pure DC schemes and will want something more sophisticated.
Lana points out that the DC pensions market is a young one and that the learning curve has been steep. “It’s a problem of social provision culture. We are still in the first age of our culture of social provision and benefits. That was demonstrated when funds were buoyed up by the markets and everyone wanted to be in DC schemes. We should not let the pendulum swing back too far to DB. We need something in between a DC and a DB plan.”
One solution often canvassed is a cash balance plan. However, the problem with a cash balance scheme is that it is essentially a DB scheme in disguise. And few wish to return to this. It is time, instead, that Spanish pensions moved into their ‘second age’.