New benchmark for the pensions industry
The new legal framework for pension funds (now called OFPs) in Belgium has fundamentally changed the way the market for supplementary pensions works. It involves more than just a few changes to existing regulations. Since 1 January this year, both the field of play and the rules of play have changed. When bringing the regulations in line with the European Directive, the Belgian legislator used the occasion not only to sell Belgium as the best European base for ‘European' pension funds, but also to harmonise the existing legislation and adapt it to modern standards of ‘Good Pension Fund Governance' (based on the OESO guidelines).
Until late 2006, the only way to make pension contributions was through either a pension fund or an insurance company. The regulations for each differed considerably. Actually, there were no special regulations for pension funds at all, and they had to make do with a sort of "second hand" legislation passed down from the life assurance industry. Also, they did not have an appropriate legal form (VZW/OVV) and, for several other reasons, there was never a level playing field to speak of.
Pension funds were thus more heavily taxed but, on the other hand, they were not subject to the same administrative constraints.
This period was brought to an end with the introduction of the legislation on supplementary pensions (the WAP), the control law (IBP law of December 2006), and its implementing orders. In due time a number of other texts will be published, of which the most important are:
❏ Minimum funding
❏ Annual accounts
❏ Implementation of ‘good pension fund governance'
❏ Adjustment of the "guarantee" and technical interest rate
❏ The ‘institutional' UCITS.
These changes will fundamentally alter the way market players operate. Below we explain in more detail what we think the most important trends will be:
❏ Pension funds will need to professionalise and broaden their scope to survive;
❏ Asset managers will have to communicate more transparently as margins narrow and new opportunities will arise for custodians;
❏ Insurance companies will need to be more creative with their ‘guarantee', unpackage their services, and improve their administrative performance.
We can break down the pension fund market according to:
❏ Type of fund: long-standing (multi) employer pension funds on the one hand and, on the other, the more recent sectoral pension funds, and a few separate schemes for the self-employed and the liberal professions (doctors, lawyers, etc).
❏ Assets under management: Belgium has 270 pension funds. The average sized ones have €50m in assets, and only 25 funds manage assets of more €125m.
The fastest growing funds are the sectoral pension funds.
All these pension funds have a board of trustees, but only some employ management and personnel.
All but a few outsource their asset management, and they entrust the fund's administration to an appointed actuary or the human resources department. Genuinely autonomous funds, ie autonomous in their day-to-day management and administration, are more the exception than the rule.
The board of trustees is composed with a view to representativeness rather than competence, with the most important criterion being equality of representation.
Competence was traditionally of secondary importance and it was thought that by outsourcing, with the help of consultants in some cases, the responsibility had been passed on and all obligations fulfilled. Yet nothing could be further from the truth.
These pension funds now have to adapt to the new rules, and trustees must be competent and in possession of the appropriate professional qualifications.
Under the new rules, the delegation of powers from the board of trustees to the executive committee must be clearly defined, a management and financing contract must be concluded with the sponsor, a statement of investment principles must be written, service level agreements must be concluded with service providers, and communications with members and the authorities must be more frequent, more accurate, and more transparent.
For a few thousand "pension fund managers", this ushers in a period of reflection. They are now forced to face up to their responsibilities, and it is no longer tenable to seek shelter in, "I only represent…"
The pension fund will have to be much more independent of the sponsor (company or sector), suppliers and consultants. Whatever might be outsourced to third parties, there can be no avoidance of responsibility as a board member.
For the larger pension funds, the only solution is to professionalise. Board members will have to be educated and trained. There is a fascinating future ahead for those who want invest in knowledge, but for the others...
For many small funds this will probably be a difficult task. The really small ones are faced with a difficult choice: professionalise, follow the insurance model, or pool resources with other pension funds.
The asset managers
Pension funds invest more than 80% of their assets in UCITS.
This is due to:
❏ their small size (see above).
❏ the possibility to avoid withholding tax.
Assets managers have not neglected to make the most of the advantage referred to above (and rightly so).
It can be quantified and sounds like music to the ears of the board of trustees. Too often, this argument overruled the more basic reasoning for investing in UCITS, ie spread of assets, administrative efficiency, etc. The investment process tended to be bottom-up rather than top-down, and asset allocation was, as it were, the consequence of the investment, not the starting point.
Giving the pension funds the same tax regime as the UCITS means that withholding tax is no longer a sales argument for UCITS. On top of this, board members are professionalising (see above), quantitative rules about investment diversification are being replaced by the "prudent expert" principle, and it is now compulsory to pen an investment policy covering risks and expected returns. And as if that is not enough, it will be possible in a few months for the pension funds themselves to set up an institutional UCITS.
The asset managers in smaller pension funds will have to pay a lot more attention to the real added value potential in the UCIT structure.
Though the benefits of wide diversification and administrative simplification are still there to be had, the costs involved will have to be scrutinised. Do the costs outweigh the benefits? Smaller pension funds will probably still have enough incentives left to invest in UCITS, provided they are correctly and transparently priced, and a viable instrument for the ALM.
In a sense, the issue is different for the bigger pension funds: they can consider switching over to direct lines. By using the services of a (global) custodian, they can outsource the administrative workload and avail themselves of extra services such as performance and risk monitoring. They will then be able to compare the prices of these services with the total expenses associated with a UCIT.
In both cases, this will require much work on the part of the assets manager and will have the effect of narrowing margins.
More than 70% of the sponsors of a supplementary pension scheme have chosen to outsource to an insurance company via group insurance. These schemes can be classified as:
❏ Company schemes: all these schemes have to be brought in line with the new legislation and will compete with DC plans (with guarantees).
❏ New sectoral pension funds (DC plans with guarantees) which have opted to start on the basis of an ‘insured' model.
These last contracts have a life of five
years on average and the first are now in need of renewal. They were concluded because they enabled the scheme's founder to hedge its compulsory long-term return guarantee (not unimportant four years ago given the negative returns on the stock market) and to outsource the administration.
The legislator restricted the administration costs to a maximum of 5% of the premiums. In the case of the fixed premium schemes, the insurance companies converted the long-term guarantee provided by the sponsor into an (expensive?) annual guarantee (due to the lack of legislation in this area). There are no details on pricing for the majority of services.
As soon as the details are known on how the CBFA (supervisory authority for pensions) will organise the minimum funding for these DC schemes, we may see a change in the need to hedge the ‘guarantee'.
The question is whether the long-term guarantee will be translated into a
dynamic minimum funding concept whereby, according to the prevailing risk model, it will be possible to apply an ‘equalisation fund' which can be either positive or negative. This would render unnecessary the need to buy in an annual guarantee. The new legislation also allows insurance companies to choose to apply the rules on pension funds to all their activities in this area. The recent high returns from share investments are causing many pension fund managers to think long and hard. It throws light on the cost of the annual guarantee (lost returns). The challenge facing the insurance companies is that of being creative with this aspect. Will they be able to unpackage their services and charge separate rates for assets management on the one hand, and the guarantee (annual or long-term) on the other?
Where outsourcing the administrative tasks is concerned, the development has been that the insurance company will limit itself to the actuarial processing of accounts and the setting up the annual individual account. Communication with the members of the pension fund and data collection appears to be shifting more and more to the sponsor. Here too, to maintain its position the insurance company will either have to improve its performance or charge transparent and modulated fees.
All this takes place in a society where individualism reigns supreme, where everyone wants (or has) immediate access to all information, and where the only concern is that of crossing over to the greener grass on the other side.
This serves only to increase the pressure on pension institutions, be they pension funds or life insurance companies, to do better in the areas of administration and investment, to communicate more transparently, and to spend less in reaching these objectives.
If you ask me, this is more a revolution than an evolution, and it will undoubtedly lead to a few sleepless nights. However, such nights can sometimes be very inspiring.
Karel Stroobants is chief executive officer of Akkermans Stroobants & Partners based in Antwerp