Rigid regulation could lead to a situation where pension funding is no longer affordable, warns Philip Neyt
The environment for pension funds is a very challenging one, due not only to the overall economic situation but also the actions of central banks, policymakers and regulators. Safe-haven or risk-free assets no longer exist, and EU-government bond volatility is reaching levels not seen since World War II, with expected nominal returns close to 0%. Although quantitative easing (QE) policies have boosted asset returns, the considerable reductions in bond yields have pushed liability values to heights never before seen.
Pension funds are forced to invest in higher-risk asset classes, yet trustees and regulators are calling for de-risking, given the results of stress tests hitting funding levels that are already low. This increases the downward pressure on long-term bond yields. Pension deficits may increase further, while pension funding has never been so expensive. Moreover, when interest rates are raised, pension funds will suffer huge losses, which could compound their deficit problems even further.
Central banks and regulators should know that low bond yields are not “matching” assets but rather increase the risk of pension portfolios considerably, since pension liabilities move in line with longevity, earnings and prices and not just interest rates. I am concerned pension funds are pulling out of stock markets and buying bonds at evermore expensive levels, rather than investing in assets that can boost growth. But policymakers are ignoring the implications of falling bond yields on long-term economic performance, even though the risk of dangerous asset bubbles is clear. QE has distorted investment markets in ways we do not yet understand, and pension funds, in an effort to be prudent, may be adding much more risk than they realise.
Regulation tends to be procyclical. In considering government bonds as the optimum investment class, bonds are bought at very expensive levels, risking asset bubbles and rising pension deficits when interest rates are increased. Regulators should do more to acknowledge we are going through extraordinary, unprecedented market conditions. Their rigid, rule-based regulation could lead to new risks and a situation where pension funding is no longer affordable from an economic point of view.
Supervision should focus on the sustainability and affordability of IORPs in terms of pension benefits for participants, as well as their potential to recover in bad times – that is, on the current and future financial position, as well as the communication of that to participants. Adequate supervision on these issues will no doubt lead to better pensions for participants.
Philip Neyt is chairman at PensioPlus (Belgian Association of Pension Institutions), a member of EIOPA’s occupational pensions stakeholder group and a senior adviser to APG