Moving into a new phase
The European directive of 2003 concerning the activities and the regulation of occupational pension funds was adopted following a very long and difficult process.
All things considered, the impact of this directive is very limited for a country like France1. Nonetheless it is a good starting point for us to consider the question of the management of pension assets in this country. Why?
The central aim of this directive is to create a European market in pensions to cater for the specific professional activity of each worker. This aim which places responsibility for retirement provision with the employer distinguishes clearly between company pensions and universal statutory pensions. But it is also based on a pensions landscape which incorporates three pillars – a model which is not adapted to the French system. For historical reasons the complementary schemes which were created by employers and professions (including independent professions) function on a PAYG basis. For the members they have become interprofessional.
As a result of this: 1) using the PAYG system they can have reserves but not reserves to guarantee the pension promises; 2) although the main ones are of conventional origin 2 they are all subject to EU ruling 1408/71 which applies to the statutory state pension system. Otherwise their status as a system that is compulsory by law could be challenged in accordance with European law.
Only ‘supplementary’ pensions which do not form part of the framework of statutory pension provision are what the European model terms second pillar and thus are within the scope of the pensions directive of 2003. Today this supplementary pension is still marginal in terms of volume even though the pension reform adopted as a result of the Fillon Law of 2003 promotes its extension in various forms3.
Do we thus mean that asset management for French Caisses de Retraites (CdRs) does not fall within the scope of the 2003 directive? No, and here’s why.
The scope of the directive includes the structure and governance of the funds as well as their investments. The time horizon is very specific: it is exceptionally long and it is fairly predictable. These are two characteristics which an investment policy can promote in the context of the globalisation of markets and their growing sophistication.
Now what is happening in France? Since the end of the 1990s there has been increasing use of funded PAYG. It has come into fashion. Why?
In France as elsewhere we have to look for solutions to counter the impact of the baby boom, whose impact on the market will soon be felt. In a few years’ time several retirement schemes, whose financial viability depends on the equilibrium of resources and ongoing charges will no longer be able to function in decent and fair conditions.
Pure PAYG works well when a scheme is in the growth phase, has thus not yet reached maturity and contributions exceed payments. If demographics and the economy were stable the PAYG system would be able to continue indefinitely.
But the world is not stable and pensions will have to respond to two phenomena: the lengthening of life expectancy and the spike of the baby boom. It would be best to prepare for this transition which is expected to continue into the 2050s. The idea is simple: generate surpluses and invest them, so as to cover those financial obligations which will not be covered by future contributions. To achieve this, reserves are being created by over-charging for the acquisition of pension rights.
However, this over-charging has another effect: the current value of future payments is lower than the current value of the future contributions (acquired pension rights) which created them. When the coverage ratio of a scheme is calculated, the difference appears on the asset side of the balance sheet with the reserves while the total liabilities as at the balance sheet date appear on the liabilities side. The accumulated reserves are used as soon as the inflows to the scheme become insufficient to cover the payments.
This process requires resources and payments and long-term management which involves major decisions to ensure the future viability of any given scheme. This needs to be directed by government and requires a very professional investment policy.
The state itself set an example by creating the Fonds de Réserve Pour les Retraites (FRR) which concerns the basic social security and which represents the application of PAYG with reserves on a national level. Centralised and state-owned, the FRR has as yet insufficient funding but it is exemplary in terms of its governance which distinguishes political responsibilities from technical responsibilities and in terms of its very professional investment process Currently it has E25bn invested in the capital markets.
The big complementary AGIRC-ARRCO schemes do not practice expressly the principle of PAYG with reserves but they are trying to increase their invested reserves which reached E34bn at the end of 2004.
In addition, France has numerous small professional complementary schemes, independent and PAYG, which were created during the 1950s and 1960s. Through a capacity to anticipate developments which is superior to that of the large interprofessional schemes, they demonstrate more professional management. For example, some of them have been pursuing a policy of PAYG with reserves for a long time and today they have reserves equivalent to several years of contributions. Their invested reserves can be estimated at around E20bn today4. This gives us a total of the order of E100bn invested long-term in the financial markets for the PAYG schemes. And this figure is increasing5
These investments experience the same problems as those of the pension funds that are targeted by the directive. Under the triple pressure of their accumulation, which creates a responsibility, of tightening national regulation and of the improvement in their governance we are witnessing a professionalisation of the management of these assets.
In the institutions this professionalisation is manifesting itself as follows: 1) the enlargement and the diversification of the investment universe; 2) the replacement of direct management with selective outsourcing; 3) the centralisation of the administrative management of the assets to facilitate reporting; 4) recourse to specialised consultants to assist the institution and the management of its investment process taking into account the liabilities of the scheme.
Jean-Claude Angoulvant is an independent consultant and former CEO of CAVAMAC (compulsory pension institution of the insurance intermediaries). He has an association with Amadeis, a Paris-based consultancy for institutional investors
1Should be implemented in French law by the end of the first trimester 2006;
2Resulting from a social collective agreement between employers and unions of one or all professions;
3New ‘epargne salariale’ retirement schemes; new insurance schemes; new point schemes;
4Of this amount E10bn are represented by professions such as the legal profession, doctors, dentists etc;
5By contrast funds of the second and third pillar represents around E80bn.