PAYG pensions costs ‘could kill us’
The touch paper to the debate on the European Commission directive to be finalised next year has been lit at the launch in Brussels on November 19 of a keynote report by Koen De Ryck, managing director of Brussels-based Pragma Consulting.
Rebuilding Pensions – Recommendations for a European Code of Best Practice for Second Pillar Pension Funds is a EU-wide report supported by 125 detailed responses from pension professionals, asset managers, actuaries and university professors.
The report was sponsored by State Street Bank and supported Fortis Group.
Reiterating the case for funded pensions, De Ryck says financing the shortfall of the PAYG system through higher contributions and taxes was no longer possible due to the euro and the fiscal stability pact.
Any attempt to rectify the problem here could “destabilise” the system, he adds. De Ryck writes: “PAYG pensions under the circumstances of the past 15 years would have required three times’ higher contributions to pay for the same pension level as funded pensions.” The pensions shortfall is growing fast, he added.
Noting that PAYG as a percentage of GDP will rise to 15% in 2030, compared with a 9% level in 1995, based on EU approximations, he pointed out that the consequent shortfall will shoot up to 6% of GDP – twice the Maastrich budget deficit allowance.
“We need to make it clear to the politicians that this is going to kill us. The problem is not going away.”
While the PAYG pillar should not be dismantled, the report suggests funded reserves be built on top and, where possible, the first pillar should be partially funded.
The report argues that the approach will not hinder advanced countries but will provide an objective for other countries to reach at their own pace – giving a basis for mutual recognition and, over time, progress on mobility and taxation.
Fund security should include legal separation of the pension plan from the sponsor, while a Dynamic Minimum Funding Requirement (DMFR) should also be introduced. This would allow defined benefit funds a buffer zone of over or underfunding depending on the liability structure and age profile of members.
DMFR also sets a funding range that is scheme specific and can objectively be followed by supervisory and tax authorities, the report says.
ALM studies for funds are also strongly encouraged. Actuaries should have a duty to report anomalies to the supervisory body, notes the report, with methods and assumptions harmonised as much as possible on the EU level.
A call is again made for prudent person investment principles – with the only distinction between convertible and non-convertible currencies.
Restrictions which should be maintained include the obligation to diversify by asset class and to limit self-investment – avoiding “book reserves by the back door”, says De Ryck.
Plans should also be required produce a statement of investment principles, setting out long-term attitudes to risk, return objectives, strategic asset allocation and their application of prudential principles.
Members and supervisory bodies should also receive a clear annual report disclosing scheme and investment information, which should also be available on request. Similarly, defined contribution plans should provide employees with individual benefit statements and details on portfolio valuation, performance and risk.