Where size matters
The EU pensions directive is focusing the minds of Belgian pension funds. But it is not the implementation of the directive that is causing the major concern but a series of proposed changes that accompany it.
The directive should have been introduced last September but legislation transposing its provisions into Belgian law is expected to be introduced later this year.
The delay is due to the government wanting to do several things at the same time rather than because of problems with the directive, says Hugo Clemeur, general secretary of the Belgian Association of Pension Funds (BVPI/ABIP).
“One was the implementation of the directive itself but simultaneously it wanted to review the current legal framework for the regulation of pension funds,” he adds. “And this has made the process a little longer than expected. It was very difficult just to transpose the EU directive as it is into Belgian law, and I think that the government took a wise decision to take an overview of the whole area at the same time.”
But others are less sanguine about the regulatory changes. Earlier this year Thierry Verkest, a consultant at Hewitt Associates, noted that increasing regulatory requirements could destroy the smaller end of the market.
And others have echoed his views including the BVPI, which at the time went on the record as saying that the pension fund reporting requirements were “excessive” and “costly”.
The changes required reporting every three months not once a year and to both to the National Bank of Belgium (BNB) and the regulator, the Banking, Finance and Insurance Commission (CBFA). In addition, the CBFA decided to give a risk grading to all Belgian pension funds and, depending on the rating, undertake a control once a year or every three years depending on the risk profile. The changes also required more detailed information about funds including details of any changes to schemes, the number of members, the type of scheme and organiser, benefits and financial methods.
But the information was to be transmitted through a new common reporting channel that merged the securities data demanded by the BNB and the CBFA’s regulatory requirements.
The CBFA responded that the changes meant a decrease of costs because schemes would no longer have to pay annual updates for software providers and that the new reporting system made it easier for the pension funds to do the reporting themselves.
“There are two sides to the issue,” concedes Greet Geeroms, managing director of Aon Consulting in Belgium. “On the one hand as Verkest said, it is overdoing it a little because it is administratively strict and heavy and locally we feel that it is going too far, but on the other hand it is time that we got into line with the directive and it’s good that finally we are getting this law.”
But Verkest’s warning had been focused on the threat that new regulations posed to small pension schemes, and he had noted that Belgium is a country of small to mid-sized pension funds.
“The average size of Belgian pension funds is relatively small compared with Dutch pension funds, for example,” says Geeroms.
This structural issue is the result of historical policy choices, according to Koen de Ryck, chairman and managing director at Pragma Consulting.
“The main reason that we have far fewer second pillar participants than in the Netherlands is that right after World War II the Dutch set up industry- wide pension funds to which people are affiliated regardless of which company they work for, but we didn’t. So in Belgium traditionally only 30- 35% of those who could be eligible for the second pillar had joined. Now it’s about 45-50% as a result of the Vandenbroucke Law that enables the establishment of sector-wide plans. But in the Netherlands participation in the second pillar is well over 90%. In addition, we don’t have so many large companies, the largest in Belgium, Suez-Tractebel, would not be among the 20 largest in the Netherlands.”
And this question of size poses problems for the schemes. “The assets are insufficient because the participation is lower, the benefit promises on average are also lower and so the combination of lower coverage, participation and assets means we are not going to get very far with the second pillar in Belgium,” says De Ryck.
“But you have to compare comparable things,” says Clemeur. “The Netherlands has a Beveridge model for social security where everybody gets a basic minimum-life-income pension whereby there is no link with the person’s professional situation. But Belgium has a Bismarkian situation whereby there is a social security organised on a professional basis where legal pensions are linked to career and salary, and with caps.”
And Johan Vanbuylen, director of FBZ Elektriciens, the electrical sector pension plan, is optimistic. “We are a minority, but a growing minority in that we now have some major sectors planning to enter the system – the metal industry has already done so and the construction industry will probably join us,” he says. They will join sector plans that already exist for garages, auto repairers, metal trades and metal recovery, fuel dealers, the food industry and stage arts as well as his electricians, he adds.
“The schemes are growing because of the Vandenbroucke Law on supplementary pensions,” he says. “Every two years we have tripartite collective bargaining negotiations between the government and the social partners that set a national margin for wage increases within which the social partners can negotiate at a sectoral level. The Vandenbroucke Law specifically says that contributions to the second pillar can be added to the margin figure. This was an incentive to encourage sectors to create these funds.”
But the attitude of the trade unions, which share control of the schemes with employers, threatens to stunt the growth of the sector funds. “We don’t want the second pillar to become too big and replace the first pillar,” says Karel van Gutte, a member of the advisory board of the metal sector fund and president of his own union pension fund, the OVV/ACV Metaal. “Trade union thinking is that the second pillar should provide a ‘little wallet’ on retirement, something like pocket money. When we started the metal workers’ sector pension fund the amount was 1% of a gross salary and in the 2005-06 biannual branch level collective negotiations we managed to achieve a 0.1% increase to take it to 1.6%, and the challenge is to raise it to between 2% and 3%. After 40 years that would give a lump-sum payment of €50,000 or €60,000, which is a nice amount to have when you retire. But this is not something that the government can use to solve the financial problems of the retirement system.”
“The general view among the unions is that the second pillar can never replace the first pillar,” agrees Vanbuylen. “White-collar workers usually already have company pension schemes. But we are now in a period of transition and are seeing two debates on pensions. The first is on how the whole system will evolve and the second is between the unions and employers about the difference in status between blue and white-collar workers. There is still a legal difference between them and what the unions are doing now when working on pension
schemes for blue-collar workers is attempting to close the gap. Sooner or
late the gap must be closed.”
But Van Gutte identifies another challenge: “Sector pension funds are non-commercial schemes that are managed by the social partners. And the insurance companies are trying to crush us and drive us from the market.”
The size of contributions remains a problem, says Geeroms. “The Vandenbroucke Law was intended to socialise the second pillar, to ensure
that all the blue-collar workers got a second pillar,” she says. “Whereas workers previously got salary increases, now following labour negotiations it will sometimes go into the pension funds. But these are not huge amounts, there are lots of employees in them but the contributions are small.”
For Clemeur size, whether of sector or company plans, is not really an issue. “There is of course a sort of rationale to a claim that the smaller the pension fund the less effectively it’s managed,” he says. “But on the whole it’s not true. It’s not because a fund is small that it is not managed in a professional way, probably smaller pension funds would be more likely to outsource their asset management than a large one and be perhaps slightly more conservative. We look at this very closely and we compare returns and performances of small and larger pension funds. But over the long term there is not a significant difference. There are more important factors than size: the percentage in which they invest in equities, for example, is much more significant than size from a statistical point of view.”
But what about the impact of the EU directive itself?
“It is not seen as a problem but it does mean that a lot of adjustments must be made,” says Vanbuylen. “There must be an increase in professionalism, but this is already happening and it is increasing the pace of developments. But it is a challenge because, for example,
we have no criteria for membership of the pension fund board. Trade unions elect their board representatives. This has not been a problem
because they usually have experience in insurance or financial issues, but the representation was always chosen as a political affiliation
function rather than experience.”
And Edwin Meysmans, managing director and pension fund secretary of corporate DB pension fund of KBC, is untroubled. “It will not affect us. The new prudent person investment rules will have little impact because the Belgian system is very much in line with the EU directive. There are other small issues, like an obligation for all pension funds to have a statement of investment principles. This was not mandatory
under Belgian law but once the directive is transposed it will be. However, we have been doing this for a couple of years.”
But while the EU directive is not a problem, the IFRS accounting standards are. ”We are in the course of implementing a new strategic asset
allocation for the next three years, 2006-08,” says Meysmans. “The major factor that drove this was the accounting issue, the fact that our
sponsor, KBC Bank, which is a quoted company, will have to carry the results of the pension fund on its balance sheet. So it requested less volatility in the portfolio. That brings up the issue of LDI and trying to get the portfolio right. We have a strategic asset allocation with 57% of our portfolio in equities and only 36% in bonds, which for a Belgian fund was quite aggressive. Now we are reducing our equity holding
to 50% and upgrading the fixed income to 40% and real estate to 10% from 7%. So it is getting less aggressive and more in line with other Belgian pension funds.”
Geeroms flags another potential problem: “Previously most pension plans only paid lump sums to employees but since the Vandenbroucke
Law plans have to give members the option of taking an annuity. Not a lot of people will do that because there are tax advantages to taking a lump sum but it could become a longterm risk. Therefore, we will possibly have to deal with a significant longevity risk in the future.”
However, government initiatives to keep people working longer – including a ‘generation pact’ making it harder to retire early, a need to work 40 years before getting a pension and fiscal incentives to keep older workers in employment – appear to leave pension plans unmoved.
“Pension funds are a neutral player in this field,” says Clemeur. “All the plans are based on actuarial principles of equivalence between contributions and benefits. If they make more contributions they get more benefits, if they take their pension at a later age they will get higher benefits for their contributions and vice-versa. Whether the members and employers will like it or not and how it is perceived is a different story but the pensions institutions will just do what they are told.”
“I don’t think it will have much of an impact on the sort of pensions that we are paying,” says Meysmans. “We pay pensions at the age of 65 in theory but the vast majority, 97-98%, will retire at 60. The generation pact includes incentives for people to work longer but no penalties. So, for example, as far as it affects the second pillar and where it is the employer that is paying the contributions, which is the vast majority of cases, a pension payout is taxed at 16.5%. Under the generation pact the tax is reduced to 10% if people work until 65. So if you work longer you will get a higher pension and a lower tax rate. But I doubt that this is a real incentive. If you work until 60 and make come sound investments you will receive the tax difference very easily.”
Vanbuylen agrees: “The generation pact won’t have much of an impact on us because most sectoral pension funds set the retirement age at 65.”
But De Ryck identifies another issue where government policy is having a negative effect. “Generally, when Belgian pension funds invest directly in shares, bonds and asset classes they pay a withholding tax on their dividends and interest which they cannot recuperate even if they don’t receive the money because it is already invested,” he says. “So they invest heavily in SICAVs, in UCITS, in mutual funds
because if they are not receiving the dividend they are not paying the tax. As a result at the end of 2005 pension funds had invested 75.8% of their total assets by means of UCITS. So tax avoidance to a large extent is defining the asset allocation structure of pension funds. And while for tax reasons this is good, for other reasons it is not so good because you are in a fund or several funds and have no influence on the allocation within these funds. And there are the fees.”
And Verkest was prescient when he added to his warning that: “Regulations and requirements are increasing every year. I do not expect a change in this trend.”
“Every pension fund is required to have an external auditor and an appointed actuary,” says Meysmans. “But we have been concerned by a
draft circular that our regulator has put on its website and consider it completely unrealistic. The CBFA has taken the existing rules for banks and insurance companies, added them to OECD guidelines for pension fund governance and announced that this will be the new rule. This would mean, for example, that not only would we be required to have an external auditor and an appointed actuary but also an internal auditor and a compliance officer.”
The move is an overreaction by the CBFA to IMF criticism of its supervision of pension funds, says Meysmans. But within the context of the Belgian pensions arena the consequences could be problematic.
“We have a lot of very small pension funds and only a limited number of larger pension funds, which in the Belgian case means ranging between €200-300m and €800-900m,” he says. “So that proposal is something that would probably kill any future development of pension funds because no employer would ever consider setting one up if it had to have an internal auditor, a compliance officer, business continuity planning, charters, codes and so on.”