A rapidly changing environment for investments, overhaul of regulations, and the wider transition to defined contribution (DC) systems are lead pension schemes across Europe to rethink risk management and governance.
The changing landscape of risks in occupational pensions in Europe is intrinsically linked to the process of reforms aiming to make retirement systems financially sustainable.
In Germany, the government is planning to soon set up an equity fund managed by the nuclear waste management fund KENFO within the first pillar pension system to invest in equities – the Generationenkapital reform – while the first pure DC schemes, so-called social partner models, are taking shape in the chemical and energy sectors, moving away from guarantees for employees, cutting liabilities for employers, and putting in place buffer mechanisms for beneficiaries.
“For the very first time in Germany [the social partner model schemes] are true pay and forget schemes [with] benefits relying on contributions […] expanding investment opportunities,” Nikolaus Schmidt-Narischkin, managing director and head of sales and client management DACH at WTW, said last week at the PensionsEurope Annual Conference that took place in Berlin.
The social partner models aim to spread occupational pensions through collective bargaining agreements particularly for medium-sized companies. The German government has also set up a focus group with stakeholders to potentially redesign private pensions, as the number of Riester-Rente contracts is shrinking.
For Schmidt-Narischkin, governance is key to running the social partner models looking more at investment opportunities and risks, rather than guarantees, he said, adding: “IORPs have learned a lot about governance and implemented good governance in the last few years.”
Corporate funding of occupational pension schemes has made progress during the years, despite a lack of rules, he added, with almost all DAX companies now having some degree of funding, the largest over 100%, encouraged to fund pension promises from an accounting perspective, he said.
The interest rate environment is forcing corporate pension schemes to diversify investments, which means relying on “strict governance” with a budget, he noted.
The Dutch DC ‘big bang’
Dutch pension asset manager PGGM put in place a system of diversification in alliterative, equities, and very strict interest rage hedging with promised guarantees to beneficiaries.
But with an aging population, liabilities increased more than the amount of assets, putting pressure on the system, chief financial and risk officer Willem Jan Brinkman said.
“We are going to have a ‘big bang’ change to a more DC like system [in the Netherlands] – a collective DC with buffers – probably lower than in the current system, still with interest rate hedging, not so much very long duration”, he said, adding that risk management for liquid risks remains very important.
In-house expertise for interest rate hedging in a market that might consolidate further is an essential ingredient in the transition to thew new system, he added.
With the transition to the new system in the Netherlands, 90% of the pension assets in Europe are allocated to DC schemes, said Fausto Parente, executive director of the European Insurance and Occupational Pensions Authority (EIOPA).
“Providers need to completely change their minds, and make projections in the view of what will happen to beneficiaries” to improve transparency particularly in terms of returns on contributions, and adjust investment policies, he said.
ESG’s impact on risk
ESG is also having an impact on risks, with the board of directors of pension funds under pressure from stakeholders and beneficiaries to invest in fewer companies but with a positive impact, reducing the number of firms in their portfolios leading to less diversification.
“I think that is an interesting transition we will see, for now there has been an acceleration in exclusions [of companies from portfolios in terms of ESG impact], but there will be a transformation towards more inclusion. Good governance will mean you will make a transformation once you figure it how to do it in a responsible way,” Jan Brinkman said.
Corporate pension shames in Germany have started with exclusions, the next step being reporting and transparency, but strict regulations, and the risk of being accused of greenwashing, might represent a burden for pension funds, according to Schmidt-Narischkin.
EIOPA is also looking at sustainability in its consultation on technical advice to the IORP II Directive, going beyond traditional climate related factors to also include for example diversity and inclusion.
“I want to say honestly that I feel for the difficulties of the industry in coping with rapid and not so coordinated legislative production, but the ambition and the need is so important that you need to forgive lack of coordination in delivering the different pieces of advice,” Parente said.
Traditional corporate pension schemes have been baffled by EIOPA and the German financial supervisory authority, BaFin, conducting a survey of Institutions for Occupational Retirement Provision (IORPs) to gauge the costs of running the schemes, Schmidt-Narischkin said.
“We don’t have a cost issue, we have a return issue, having to do with guarantees and the reluctance of corporates and members to invest more energetically,” he added.