This month’s Off the Record looks at the subject of pension fund regulation and asks whether the efforts of European governments to make occupational pension systems less risky are doing more harm than good.
A leading figure in the Dutch pensions industry has attacked the Dutch government’s policy for supplementary pensions as “approaching a disaster”. Kees van Rees, a former managing director of Shell Pensioenfonds and a past chairman of the European Federation for Retirement Provision, said that he believed that the Dutch government had over-reacted to the correction in financial markets between 2000 and 2002.
In particular, he said, the government did not acknowledge the ‘very reasonable’ returns of pension funds over the long term, both before 2000 and in the years between 2002 and 2005. The net effect, he argued, has been damaging to the Dutch occupational pension system. “New supervisory powers were brought in that have effectively led to a decline in member rights of active members and absence of inflation compensation of many schemes. Contributions have skyrocketed,” he said. The only winners in this situation are consultants and investment managers, who have gained additional work and fees as a result of new regulations and regulatory requirements, he suggested.
Other European governments have followed similar courses.
So are efforts to make occupational pensions more risk averse ultimately counter-productive? Or do they encourage pensions funds to manage risk more effectively?
We wanted your views. And the message from the pension fund managers, administrators and trustees who responded to our questionnaire is unequivocal. They are deeply concerned about the unintended consequences of changes in the regulation of occupational pension schemes in Europe.
Most of our respondents (83%) agree with Kees van Rees that European governments have over-reacted to the fall in equity markets between 2000 and 2002. A similar majority (86%) feel that, by encouraging occupational schemes to be more risk averse, European governments - through their regulators - have limited their ability to invest optimally.
Three in four managers (76%) agree that tougher regulations will mean reduced benefits for members of pension funds, and that active members are likely to have to contribute more and receive less, in terms of benefits, as a result of tighter solvency requirements.
Returns are another issue. As John Maynard Keynes might have said, in the long term we are all dead but equities will always deliver. Supervisors seem to have forgotten the long-term outperformance of equities over bonds in their efforts to persuade underfunded pension funds to sell equities and invest in fixed income.
A large majority of our respondents (79%) think that European governments and their financial supervisory authorities tend to overlook or under-rate the long-term returns pension funds have generated from equities in the past and are likely to generate in the future.
There is a view, however, that the level of pension funds’ exposure to equities, particularly in the UK, was rash and ill-advised, and that the impact of the collapse of equity markets in 2000 to 2002 on the value of European pension fund portfolios was the clearest demonstration of the need for tighter regulation.
There is considerable support for this view, and opinion divided, with fewer disagreeing (45%) than agreeing. Some feel that tighter regulation is necessary for some but not all pension schemes. They are necessary, says one pension fund manager, “as far as the difficulties with underfunded schemes are concerned”.
Others feel that some tightening up was needed but that the regulators have been over-zealous. One manager of a UK pension plan comments: “It required some re-thinking but not the amount of regulation we got.”
The response of the asset management business to the tighter regulations also comes in for some criticism. In particular, liability-driven investment (LDI) is seen as an over-engineered solution to a simple problem, and one likely to involve pension funds in unnecessary expense. Half our respondents agree that LDI is expensive and unnecessary.
One manager suggests that it depends on the financial strength and commitment of the plan sponsor. Another suggests that “it is only necessary when a scheme is very mature and cash flow management techniques such as this can reduce the risk of forced sales to meet cash flow”.
For some, it is a matter of applying LDI properly. LDI will only work, says one manager, “if liabilities are properly understood as real and long term, like equities, not nominal and short term, like bonds”.
Yet a significant number feel that, although LDI is expensive it is also necessary. A Dutch pension fund manager comments: “They are expensive but they are necessary” while the manager of a Swiss pension fund agrees that LDI is unnecessary but adds dryly “as long as one can disregard accounting standards”.
Could it be that tighter regulation has caused the pendulum of investment practice to swing too far, putting too much emphasis on liability matching and too little on traditional asset management? Here opinion is evenly divided with 52% agreeing that there is too much focus on liability matching. Others feel the pendulum has not swung too far “as yet, at least”. Yet perhaps the two options are not really poles apart. One manager wisely observes that liability matching and asset management “are not mutually exclusive or alternative approaches”.
The idea that the initiative of Danish and Swedish supervisory authorities, who have introduced systems to stress-test pension funds for solvency, should be replicated in the rest of Europe has few supporters. Not all our respondents were familiar with these so-called ‘traffic light’ systems. One in five (21%) says they do not know enough about their operation to be able to give an opinion. However a large majority of those who do comment (78%) are opposed to an adoption of the Scandinavian model. “They have some merits and are a useful addition to the regulatory toolbox, but they are not a panacea,” one manager observes.
A constant criticism of solvency requirements by pension funds and asset managers is that they are generally more suited to banks and insurance companies than pension funds, and a majority (68%) agree with this view. Yet a far larger majority (86%) think that tougher solvency requirements have encouraged occupational pension funds to become more aware of the importance of risk management.
There are some reservations, however. One manager suggests that solvency requirements have “encouraged tick box compliance rather than best practice”, while another says that “the way solvency requirements are formulated makes it inevitable that people’s behaviour will be modified excessively. It has made pension funds more aware of one kind of risk, but at the expense of another equally important risk management issues.”
There is also considerable scepticism about whether the tighter regulation of occupational pension funds will ensure a healthier pension fund system in Europe. More than half (55%) our respondents think it will not have this effect, while 38% think it will, and the rest are undecided.
One manager points out that “already there are many indications that employers are reducing pension commitments”, while another suggest that Europe may have a healthier pension fund system as a result of tighter regulation “but it will be more costly”.
Kees van Rees takes an apocalyptic view of the effects of the introduction of tougher regulatory regimes, suggesting that it will lead to the dismantling of the Netherlands present occupational pension system. Could this happen throughout Europe? Opinion is again divided, with 45% agreeing and 41% disagreeing, while 14% were undecided.
Most feel defined benefit (DB) schemes are doomed. “Regulation has it has sounded the death knell for most DB schemes,” a UK pension fund manager comments gloomily. Perhaps even pensions are doomed.
It looks like a case of apocalypse now, rather than later.