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Impact Investing

IPE special report May 2018

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Non-stop changes driving system

At the beginning of this year Sweden
began applying the EU
pensions directive and introduced
a so-called traffic light system.
One of the most notable effect of the
EU directive is to free pension funds
from investment restrictions and
allow them to allocate assets according
to the prudent person principle
while the traffic lights enable the regulator,
the Finansinspektoren (FI), to
identify pension funds that are in danger
of not meeting their liabilities
because of their funding level and/or
asset allocation.
So, is this a case of giving away something
with one hand only to take it back
with the other or responding to greater
freedom by ensuring that there is a
safety net to rein in the freedom to do
damage? Well, in fact it is a bit of both.
“The EU directive and the local traffic
light system are obviously connected,”
says Peter Hansson, executive
vice-president and CFO of SPK.
Both have the effect of encouraging
pension funds to match liabilities based
on the mark-to-market principle.
“Then we have the low interest rate
environment in which they are implemented,
where you actually lock in at
the low level if you were totally
matched,” Hansson adds.
“The traffic light probably would
have happened anyway, but as soon as
the directive emerged the FI decided to
mobilise its checks and balances,” says
Cecilia Skingsley, financial commentator
at business newspaper Dagens
Industri.
As a result, for much of last year the
focus of pension funds was on the traffic
light system which,
as its name suggests,
initially consisted of
green, amber and red
elements, with those
judged to merit a red
light being required to
move into government
bonds.
“The bond markets
reacted after hedge
funds started buying
long bonds realising
asset managers would
need them, then the
asset managers complained
that they were
being forced to buy
expensive bonds and this created a
vicious circle that drove down yields
and in turn increased liabilities forcing
them to buy more bonds,” recalls
Skingsley.
Intense lobbying first delayed the system’s
introduction then resulted in its
simplification and the softening of the
FI’s demands, the removal of the
amber category and a concession that
corporate credit could be allowed as
well as sovereigns. And while this eased
some of the rigidities to which the pension
funds had objected to and
widened the pool of instruments from
which they could choose, questions
remain about whether the universe is
wide enough.
First, the National Debt Office,
which decides on official bond
issuance, stressed that it would not
meet demand by issuing additional
long-dated instruments. Second, Sweden’s
rejection of the euro in a 2003
referendum means that in practice
Euro-zone sovereign bonds could not
be used to fill the gap.
“Asset managers have been preparing
themselves for the first evaluation,” says
Skingsley. “The FI asked for the necessary
data by April and it would run the
traffic light system in practice on a full
scale. If it finds that funds are running
into a red light it will continue the investigation
into them, but it will not make
it public and identify them.”
And while the switch from a quantitative
restrictions to the prudent person
principle contained in the EU directive
might be seen as a liberating factor, not
all pension fund trustees have seen it as
such because it shifts responsibility for
the performance of a pension fund to its
board more explicitly than before. This
in turn raises the issue of the board’s
competence. “The change in regulation
to a more prudent asset management
from one where funds stayed in
their lane adds to the complications and
some funds will have problems with
that,” says Skingsley.
But one man’s challenge
is another’s opportunity.
“There is a whole
industry of consultants
and banks that has picked
up on this increased
demand for knowledge
about how to deal with
the new environment
and it is more than happy
to give pension funds
whatever advice they
need,” she adds. “They
were here before but
their services have
increased their liability
management and portfolio
design activity.”
But for Hansson the key challenges lie
elsewhere. “One can argue whether or
not the traffic light system will do any
good or harm, but if life expectancy data
don’t reflect the real situation there is a
real danger.”
The problem is that the actuaries who
put the numbers together use a generally
accepted standard that does not
necessarily correspond to a pension
fund’s specific membership characteristics,
he says.
“Normally it is thought that there is
50:50 mix between male and females
and if that is not the case, as with SPK
where we have a lot of female members,
you have to do something. We
adjusted for this and have increased
the premiums for our sponsors as of 1
January.
“In addition, life expectancy is getting
longer than anybody has in their internal
guidelines and if you don’t adjust
you are going to be constantly underfunded.
We don’t have the statistical
data to allow us to take any big moves
but as a first step at SPK we have
adjusted for another
year of life expectancy.”
Tomas Nicolin, president
of Alecta, does not
consider the traffic light
and the EU directive as
real challenges either.
“The traffic light system
is a way of controlling
the risk in asset management
and we had
already developed our
own similar system
where we identify different
levels of risk at the
beginning of this
decade as a response to
the market crash,” he
says. “So the recent changes didn’t
really affect us.”
And neither is the National Debt
Office’s refusal to issue additional
long-dated bonds a problem for
Nicolin. “We have not increased our
bond exposure, rather the opposite,”
he says. “We have a higher exposure to
equities today than we had a year ago.
We have a good solvency ratio so we
have a very large cushion and we
haven’t been forced to do what a
weaker fund may have had to do.”
But Nicolin is preparing for a
broader challenge that will arise
when a switch in Sweden’s occupational
pension system from DB to
DC is completed. The process is considered
to be in its final stages, with the
STP pension arrangements for bluecollar
workers and the similar programmes
for the local government and
state sectors and having already
changed. But negotiations with whitecollar
workers over switching their ITP
plan are proving problematic.
“We began our third attempt since
the early 1990s to negotiate a change
with the white-collar trade union the
PTK in October last year,” says Ingvar
Backle, senior adviser at employers’
group the Confederation of Swedish
Enterprise, Svenskt Näringsliv. “We
include about 50 employer organisations
from various sectors, and
although they negotiate wages and
other issues at a lower level, pensions
agreements are arrived at through centralised
collective bargaining with the
trade union organisations – LO for
blue-collar workers and PPK for
salaried employees,” says Backle. “Such
agreements are mandatory and cover
everybody in a company except the
managing director and senior shareholders.”
The second attempt nearly succeeded
when 26 of the 28 PPK-affiliated
unions accepted the proposals. But one
of the two that rejected them was the
largest, with more than 50% of the PTK
membership, so it was back to the negotiating
table.
“Some companies are leaving our
organisation because of the pensions
issue and that sends an urgent message,”
says Backle. “Neither is it good
for the PTK as it means some of their
members are not working in companies
covered by collective agreements.”
The smoothness of the changeover to
DC for blue-collar workers was assisted
by the unsatisfactory nature of their previous
DB arrangement,
notes Mats Langensjö,
managing director of
Aon in Sweden. “The
old system had several
flaws,” he says. “It was
designed in the 1960s
and the trade unions
started to realise how
bad it was when people
began to retire. Workers
paid contributions all
their working life but
their pension was based
on what income they
had between the age of
55-59. So, for example,
a construction worker
may have made good money for many
years but may have been laid off at 55
because of the physically demanding
nature of the work and stayed out of
work until 60. In that case he would not
receive any pension.”
“In addition, because there are fewer
blue-collar workers our membership is
falling, and this meant that it would cost
much more to pay the defined benefit
contributions,” says Paul Carlsson of
the LO. “So we changed the whole system
from DB to DC, with 3.5% of a
wage being paid into a pension from the
age of 21 by the employer. Of course we
would like to have more but that is what
we have agreed and we have no complaints
about it from our members.”
When employees enter the system
they are given a list of pension providers
and can choose which organisation will
manage their pension contributions.
However, not all chose a low-cost
option. “There has been one negative
effect as a result of the change,” says
Langensjö. “In Sweden we think insurance
companies are a very good place to
save money, it’s a widespread perception.
I think it is just a cost-adding extra
layer that gives no benefits.”
Nevertheless, most wage earners have
opted for AMF Pension, a non-profit
making organisation that is jointly
owned by employers’ group Svenskt
Näringsliv and LO.
Like Nicolin, AMF Pension CEO
Christer Elmehagen has no problems
with the traffic light system. “Looking
at the second pillar pension industry
overall, we are the market leader with
32% of the market,” he says. “We have
a solvency ratio of 240% so traffic light
and solvency questions are not an issue
for us and we have great freedom in
deciding our asset allocation.”

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