Muted and constrained economic growth, continued low yields and quantitative easing, combined with a poor investment return outlook, loom over Europe’s pension sector.
Each of these factors represents a strong headwind to the successful attainment of pension outcomes in terms of funding and solvency ratios, and eventual retirement income.
In combination with inflexible regulatory approaches the outcome can be bizarre or very problematic. Swiss pension schemes, for instance, face the prospect of discounting liabilities at a negative rate under international accounting standards, which are based on the yields of high-quality corporate bonds.
Nestlé in August became the first company to have negative yielding 10-year debt and the stock of negative yielding corporate debt is growing – a scenario regarded as outlandish by mainstream opinion as little as a few years ago.
In Denmark and the Netherlands, pension funds are coming under severe public scrutiny for perceived failings. The Dutch regulator has come under pressure for its inflexible approach to pension funding as pension funds face the catastrophe of having to reduce pensions.
It will be hard to explain this to members when the Netherlands has one of the largest stocks of retirement savings in the world in relation to GDP and its pension system scores highly in the Melbourne-Mercer ranking.
In Denmark, another high-scoring pension system, ATP has also come under fire for its business model under which 80% of contributions are channelled into a low-yielding LDI-type portfolio.
Pension funding rules have generally tightened in Europe in the last decade, partially in response to the financial crisis.
Inflexible tightening of pension fund regulation has wide ranging consequences in countries with significant assets and where there is some measure of risk sharing or a defined benefit pension.
Constraining the risk-bearing capacity of large, long-term pools of capital unduly risks passing an unexpected future burden of funding pensions to employers and their shareholders, or to future generations through higher contributions or lower pensions.
Much thinking around long-term investment in policymaking and regulatory circles centres on reducing financial system risk or perceived benefits of channelling savings to favoured asset classes, such as venture capital or infrastructure.
If the economic reality is a structurally lower equity-risk premium, low or negative interest rates and geopolitical uncertainty, current regulatory and risk models may not be up to the job of generating adequate long-term savings pools and income.
Bold thinking must prevail.
Liam Kennedy, Editor