Still in good heart
This is the time of year when Off The Record can invite its readers to take a broad look at what has happened, and what is happening in the world of pensions management and to hazard some guesses about what is likely to happen in 2006 and beyond.
Of course, no one can be certain what will happen, but in some areas we can be fairly sure. The decline of the defined benefit type of pension appears irreversible. The reform of European pension systems seems inevitable.
Yet other areas of pensions management and pensions investment are less predictable. Will the current interest in fixed interest securities continue in 2006, for example?
Is the fascination with liability-driven investment merely a passing fancy? Will the cult of the equity make a comeback?
We wanted your views on these and other ponderables and imponderables. We set out a number of predictions for the year 2006 and beyond and asked your opinion on whether or not you felt they were likely to happen.
The pension fund managers, administrators and trustees who responded to our survey take a sober view of 2006. Their broad conclusion is that nothing likely to change very much, either for the better or for the worse in the way pensions are managed in Europe.
Pensions will continue to hog the headlines, however.There is almost unanimous agreement that pensions and pensions issues will gain even more public attention in 2006 than they did in 2005
Bearing in mind the bad press pensions matters have received in the past years, one Swiss pension fund manager who adds, “I hope not in a negative way”.
UK pension fund managers point out that the report of Lord Turner and the introduction of new pensions regulations are likely to raise the profile of pensions even further in the UK.
There has been some evidence that fears of a pensions crisis may have been overstated. In the UK, a report by Tomorrow's Company, a business led think tank, said that we should ignore the ratio of over 60s to under 60s and concentrate on the capacity of all age groups to produce wealth. From such a perspective, the dependency gap narrows considerably.
Will further evidence in 2006 show that fears about a demographic time bomb are unnecessarily alarmist?Most of our managers are doubtful. A clear majority - two in three - say that such fears are fully justified.
Some point out that the evidence- one way or the other – is unlikely to emerge in the next 12 months. “It will take much longer to show if true,” one UK manager observes.
It would of course suit the book of many European governments, currently in the process of introducing pension reforms, if the demographic time bomb could be shown to be a damp squib. One Swiss pension fund manager warns,“politicians will try to present it this way, but in fact we know that longer life expectancy and lower birth rates will be a challenge”.
And they will be a challenge across Europe, managers believe. Three in four of our respondents agree that that Europe as a whole, and not just individual countries, will face a pensions crisis in 2006 and beyond because of lower fertility and longer life expectancy.
The sense of doom and gloom about pensions could be counter-productive and exacerbate rather than resolve the problem. There is a school of thought that the constant talk of a pensions crisis will lead to a loss of confidence in pensions as a form of saving for retirement.
A majority of our managers do not buy this however. One UK pension fund manager suggests this is to mistake the symptoms for the cause of the malaise. “Loss of confidence comes from hearing about people losing all their lifetime benefits when a company goes under, and from uncertainty about the government’s intentions.”
Another UK pension fund manager suggests that the talk of a pensions crisis will encourage people to take a greater interest in the operation of their pensions. “People will look more critically at the value they can expect tomorrow from the contributions made today,” he says.
Worries about the whether pensions represent good value for money could encourage people to look to other forms of retirement savings such as building up their own business or buying their home. The managers in our survey see this as highly likely. Three out of four think that more people will look to forms of retirement saving other than pensions in 2006.
These options will not be available to the low paid, however. As one pension fund manager points out “only people who can afford it will be able to do this”.
The death of the defined benefit (DB) pension scheme will also be a matter for speculation in 2006. Some predictions are decidedly gloomy. Recently, Werner Nussbaum, one of the architects of the Swiss second pillar pension system, predicted that the DB schemes offered by corporate sponsors would disappear within the next three to five years.
Opinion on this is evenly divided.Predictably, the response from managers based in the UK, where the DB pension is in terminal decline, are the most pessimistic. The new Pensions Regulations have not improved the situation, either.One UK manager warns that DB schemes are doomed if the regulations remain as currently drafted. “This would provoke a rigorous debate on the differences between public and private sector pensions provision.”
Yet DB schemes may take longer than five years to die. One UK pension fund manager suggests that some may even survive:“Also legacy schemes do not go away, only accrual for the future, so they will continue to feature for many years in the future.”
The introduction of so-called hybrid DB schemes could also prolong the active life of DB schemes in 2006 and beyond. Two out of three managers in our survey agree that hybrids could ensure the survival of DB type pension plans.
The manager of a multinational pension fund suggests that such hybrid schemes are likely to be cash balance/investment return and annuity guarantee, rather than the career average DB schemes favoured in the Netherlands.
The reverse side of this coin is that defined contribution (DC) schemes are likely to become the dominant type of pension.Here there is broad agreement, with four out of five respondents predicting the dominance of DC type plans within the next six years. One Swiss manager adds, “if they are not already”.
In some countries, notably the Netherlands, DC schemes will make less progress than in others.However, in the UK, a major switch to DC is likely in 2006 following a relaxation of the rules governing pension scheme membership. As one UK pension fund manager points out “more DC schemes will, be taken out by people already in DB schemes, when this becomes permitted in April”.
Which investment strategies will fall in and out of favour in 2006? Will the current interest in liability matching diminish as equity markets improve? Our managers think this unlikely, with only one in three agreeing that interest in liability matching will fade.
“Mature DB schemes will maintain the interest, and continued closure of DB schemes may increase it,’ one manager observes.
However, some feel that pension fund managers might consider adding a little more equity risk to the portfolio. Although there will a continuing interest in matching a significant proportion of liabilities, one manager comments, “taking greater risk with the remainder could be considered.
Similarly there are few supporters for the return of the cult of the equity, and most respondents feel that equities are unlikely to become the favourite asset class in 2006. “After three years strong returns this would be regrettable,” one manager comments. “Accounting standards linking liability values to bonds will ensure that bonds retain their position,” another suggests.
However, old habits die hard. “It will be interesting to see if the usual ‘herd in arrears’ pattern repeat itself,” a UK pension fund manager remarks. “The equity market has enjoyed a good run, so people think it will continue for ever and often join in just as things head south.”
Pension fund managers have no doubt that pension reform will become one of the most politically sensitive areas of European social policy in 2006.
Whether this will raise the standing of people in the pension industry is doubtful, however.The suggestion that pension fund managers, administrators and trustees will begin to get the recognition they deserve in 2006 drew scorn from many respondents.
“Ha! More likely to get abuse than recognition from Joe Public, the way things are looking,” says one. “Many may well be scared off too.”
One manager perhaps speaks for all:“It is high time they did, but it is a rather weary process.”
And so it is.Happy New Year.