Double challenge for open funds
COVIP (Italy’s pension fund regulatory authority) gave the first green lights to open pension funds OPFs) in July 1998 following legislation originally enacted in 1993. So far they have not been particularly effective. Therefore, the past government decided to pass a new reform originally scheduled for 2006 but which has now been postponed until 2008.
The current system is therefore provisional and strongly limits OPFs’ room for manoeuvring. OPFs are free to woo self-employed workers (in direct competition with personal pension schemes and with some closed pension funds (CPFs)). However, they face strong restrictions when turning to employed workers – for instance, OPF cannot sell their products to those categories of wage earners which are covered by CPF schemes. Despite some remaining limitations, the new legislation will contribute to redress this asymmetry by giving OPFs a privileged position – they will be free to offer their products to both self-employed workers and wage earners, in competition with CPFs.
These legislative changes are part of a wider framework in which there is almost no demand for supplementary pension schemes; often clients are not familiar with pension issues and completely ignore the existence of a growing pension gap to be bridged by using ad-hoc products rather than substitute products. All this is compounded on by the fact that clients are not used to such long-term investments.
In such a market, with offer clearly outweighing demand, OPFs are paying dearly for the competition of both pension products and other products characterised by higher fees remitted to the distribution network.
The products: OPFs, which can be set up and managed only by banks, insurance companies, savings managing companies (SMC) and assets brokerage companies (ABC), are standardised products, transparent and easy to compare in terms of costs and contents. Normally, they offer four investment lines, but some propose five or even six lines. Upon joining, the member chooses one single line, as asset allocation is not allowed.
The offer: As early as 2000, all major Italian banking and insurance groups had created one or more OPFs. Later, attracted by the great potential of this market, smaller players and companies emanating from international groups started to offer this product as well.
After a peak in 2003, with 82 such products proposed by 59 players, in the course of the past two years the sector has witnessed both a partial reorganisation by players proposing various products and the entry of new products. Currently, the market encompasses 77 OPF offered by 58 players (39 insurance companies, 15 SMC, three banks and 1 ABC). Over time, many players have streamlined their offering in order not to waste energy on an excessive number of similar products and to create economies of scale bringing advantages both to the fund and to its members.
The market: Membership now stands at almost 415,000. Despite the constant widening of the contribution base, contribution flows have been stable for some years now, at around €450/475m a year. As a direct consequence, the average annual contribution by member has decreased (€1.1bn in 2005 against €1.2bn in 2004). In the first part of this year, average per capita contributions appear to have recovered and boosted collection as well (+15% compared with the same period a year earlier).
Thanks to a quarterly compound annual growth rate of nearly 6.5%, in the past 24 months AUM increased by over 60% to nearly €3.1bn.
OPFs’ assets have been growing substantially, in line with new pension products but much more than other managed savings products. The reasons are: first, inflows are much higher than outflows – OPFs are ‘young’ instruments, whose surrender and benefit payments are still limited compared with the constant flow of resources invested by members. Secondly, funds posted an average 22.9% return against an overall 19.2% recorded by newly set up pension funds.
The performance of this class of pension fund was boosted by the recovery of stock market prices. Asset allocation to the different line types is influenced by the strong propensity to buy the most aggressive lines when the product has just been launched: around 50% is invested in equity lines and balanced equity lines.
As regards asset management, at the end of 2005, 48% of assets were managed within the company operating the open fund; 48% of assets were delegated to a company belonging to the same group as the promoting company, while only 4% was delegated to external managers proper. The market appears particularly concentrated: the top five players represent 65% of members and 62% of assets.
Current trends: Between late 2005 and early 2006, many products have been restyled. This meant a reduction in costs and a trend to structuring funds in such a way as to target specific groups of members – individual investors or groups (at a lower price).
The distribution model which is emerging within financial groups envisages therefore one or more pension funds with different distribution channel and designed for individual investors, plus a fund designed for collective underwritings and mainly distributed by commercial departments,.
The wide press coverage of the pension reform at the end of 2004 has already had positive results: after reaching a negative peak in 2004, new business in 2005 and in the first part of 2006 has started growing again. This was due to big training initiatives the players launched among distributors and to a more responsive attitude on the demand side. In fact, prospective clients have demonstrated to be more attentive to the topic and ready to join in thanks to the better information they received.
The need to enhance the knowledge of financial and pension issues among workers is confirmed by the growing interest new members have been showing in the past 15 to 18 months for guaranteed lines and mainly bond lines to the detriment of equity lines. These investors need to be guided in their choices: besides being insensitive to the time frame of investments, they often make their choices on the basis of the moods or fears of the moment.
Development and challenges: In the
medium term, while waiting for pension reform, current growth trends are expected to go on. At the same time, players will start paying greater attention to the various opportunities offered by the current market: in fact, there are still around 5m self-employed workers with no supplementary pension schemes of any kind. At the level of collective underwritings, the potential target includes millions of wage earners not covered by any CPFs.
In the next 18 months, a double challenge awaits the various players: on the one hand they will have to increase their penetration in the existing market, while on the other hand preparing the product offer and the distribution networks necessary to face the full-range competition that will take the go in 2008, when the reform becomes effective. This has to be done bearing in mind that OPFs represent a unique instrument in the current pension product market, as they can offer their shares indistinctly and without restrictions to both collective members and single investors.
Luca Omarini is senior consultant with IAMA Consulting based in Milan