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Big investors on red alert

As a consequence of poor investment returns in the equity markets, Danish pension funds are reconsidering their approach to investment. The most recent example is the Danish labour market supplementary first-pillar pension scheme, ATP, which at the end of August announced an important shift from equities into bonds. The fund, with assets of Dkr212bn (€28.7bn), lost 12.3% on its equity portfolio in the second quarter of the year and decided to reduce its exposure to stocks from 45% of total assets to 35%. Although the proportion invested in Danish equities by the fund has remained unchanged, exposure to both European and US equities was dramatically reduced.
ATP’s case has not been an isolated one. Many Danish pension funds, which significantly increased their exposure to equity investments during the past few years, have been on red alert since the market started performing badly.
Big names in the pensions and insurance business have been so severely affected by poor investment returns that in some cases the Danish Financial Supervisory Agency has intervened to secure members’ savings. This was the case with PFA, the Danish insurance group that a year ago announced losses of €2.4bn affecting the group’s bonus reserves, forcing its pensions division into emergency talks with the supervisory body to draw up a rescue plan. At the time PFA, which has a 20% of the Danish pensions market, commented that the losses were so serious that it was no longer able to comply with the capital requirements under Danish law.
Aware of the need for closer monitoring of pension funds and insurance providers, the Danish Financial Supervisory Authority developed a ‘traffic light’ system. Institutions are placed in a green, yellow or red light zone according to their ability to meet the interest guarantees required by law to meet future obligations.
Institutions in the yellow zone will be those that do not have sufficient reserves to absorb a loss of 30% in their equity portfolio and 12% on their property holdings, together with an interest decline of 1%. For those moving into the red light zone, the figures will be 12% for equities, 8% for property and an interest rate drop of 0.75%. The system requires those institutions in the red zone to notify the regulators and inform them about the measures that they will implement to improve their situation.
Given that some pension funds have now moved into the yellow light zone, more shifts away from equities, like that of ATP, can be expected.
These legal requirements, together with market underperformance, will probably delay the shift by Danish pension funds to increased equity exposure. Danish pension funds were late to join the equity culture but planned to have about half their total assets invested in this way. Taxation on equity investments also recently went up from 5% to 15%, while that on fixed income was reduced from 26% to 16%, making it still more difficult for investors to increase their portfolio exposure to stocks.
The legal framework will continue to make it difficult for insurance companies to keep up with the current funding requirements, although they remain the major players in the Danish pensions market. According to data from the Danish Insurance Information Service, around 43% of the industry’s assets were managed by insurance companies at the end of 2000. Pension funds managed a total of 21% of assets, with 14% being managed by banks and around 16% held under the ATP structure.

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