Norway anticipates wave of low cost plans
In the first half of 2006 the Norwegian insurance marked realised a modest growth in gross premiums of 2% hiding an increase of 113% in unit link/defined contribution (DC) products and a decline of 5% in traditional defined benefits (DB) products. The later figure can mainly be explained by a withdrawal of marketing of a popular insurance account product offered on too favourable terms according to the regulator Kredittilsynet. The other traditional products showed healthy growths of 12%.
Corporate DC plans were introduced in 2001 and at the moment many firms are considering changing from defined benefits plan, but that has not shown up in the statistics as the following table for the first half of 2006 shows:
The above figures are covering the insured plans only. In addition the pension funds count for NOK 133bn (€ 15.7bn) in assets, all DB plans.
It is expected, however, that the DC plans will increasingly make up the majority of new plans. The Storting (the Norwegian parliament) passed a new pension law, which introduced mandatory occupational pension (OTP) for all employees. About 600,000 (about 25% of the work force) will benefit from this law, which the employers have to implement within the year 2006 running from the second half of 2006. Employers that are already offering occupational pension schemes are not affected.
The minimum contribution should be 2% of pay and by law the employer has to pay for the cost of managing the scheme. The employees can, however, decide the allocation. It is expected that large low cost products will take a lion share of this new market.
But since the change from DB to DC plans is mainly taking place in medium to small businesses and the OTP does not affect existing schemes the amounts involved are relative small.
The Norwegian share market has experienced a fantastic increase since the 2003 and in the first half of 2006 the market rose by 23%. The corresponding return in the bond market was 2%. One can spot a trend that the live insurance companies have a tendency to be more conservative in taking investment risks than the pension funds as the above allocations as of June 30 2006 show:The pension funds invested about two thirds of the equities in foreign issues. The same figure for the life insurance companies was three quarters. Since 2000 the life insurance companies on average have returned 5.1% per annum (38.1% for the total period) compared with the average for pension funds of 6.0% per annum (46.5%) as the graph below shows: The reserve requirements and investment rules are the same for both institutions.
In addition to the introduction of the mandatory occupational pension, the Storting passed a new institutional pension law valid from the first of July this year, but the major change in regulations will not take effect until the January 1 2008. The new law introduces a new area in pension regulation - away from detailed product regulations to more agreement between the insurance parties based products. A new set of investment rules is expected to be introduced by year-end replacing the old one from 1998. The new capital investment regulation introduces prudent person principle in pension investing. Most of the detailed quantum based rules are proposed to give away to more quality-based rules. The new rules specify stress testing to qualify for the prudent test. The industry has used stress testing as a risk-measuring tool for some years, but as the pension liabilities are calculated based on a fixed discount rate this element has not been included in the stress test so far. Introduction of the coming Solvency II rules (2010/11) will change this and cause fundamental changes to how the Norwegian pension funds manage their risks. Norwegian pension funds have traditionally been fixed income investors, but they have always invested in short durations (ignoring the liabilities as regulation allowed them to) - on average a duration of about two years. Most of them have concentrated their portfolio in Norwegian krone dominated bonds.
The Norwegian bond market is typical of short duration - on average four years and the longest duration issues of some quantity are government bonds of 11 years duration. One will expect that the industry gradually will increase their duration in their fixed income portfolios and to do so they will look abroad to find longer maturities.
Finally, the new investment regulations specify that investments in non-SICAV qualified funds, included here are hedge funds and private equity funds, cannot count for more than 10% of total investments. Each fund cannot count for more than 1% of total investments. So far Norwegian pension funds have been slow to use such funds, but it is expected that within two years most of the funds will have some exposure to these funds for a small portion of their investment portfolio.
Caspar Holter is senior partner of Pensjon & Finans in Oslo