The long haul to pan-Euro pensions
Despite the European Commission’s research paper Rebuilding pensions – recommendations for a European-wide code of best practice, written by Koen de Ryck (see below), pension fund managers are not expecting any sudden movement on the proposed pan-European pension fund directive. Many conference delegates at last month’s Multi Pensions ’99 conference in Amsterdam believed it would be 10 to 15 years before EU countries came close to resolving their pension differences.
The principal hurdle to a pan-European pension directive was seen to be the diversity of social security arrangements across Europe. “The development of the second pillar has varied according to the national social security arrangements, so any integration at a pan-European level will be painful,” said Domenica Sereina Huber, life and pensions manager at Winterthur International in Zurich.
Local taxation practices also present a significant barrier to further developments, as Ruth Goldman, head of pensions at Linklaters & Alliance, outlined in her presentation. She covered the methods of taxation used across Europe, where taxes can be levied on either contributions, investment income or final payments, or even a combination of the three.
While de Ryck, managing director of Pragma Consulting in Brussels, was optimistic about a “convergence process” towards pan-European pensions legislation, other speakers drew a parallel with the storm surrounding recent negotiations for a pan-European witholding tax.
The theory is that this pan-European pension fund structure would assist multinational companies to manage assets and liabilities across Europe, smoothing the way for centralised administration, asset and risk pooling and the associated economies of scale. From a human resources perspective, the structure would cross national borders, with benefits for internationally mobile employees. In practice, however, none of the conference speakers expected an early resolution, and focused instead on offering immediate solutions to the pan-European pension problem.
Simon Gilliat, senior principal consultant at Watson Wyatt in London, argued that the benefits that would be achieved under a pan-European regime can be implemented using existing methods and structures, based on Watson Wyatt’s Global Asset Study. “The biggest cost savings come from the investment process. Do you have the right benchmark and asset allocation, because this can give you additional returns of 1% a year? Do you have the right balance between passive and active; core tracking and satellite managers? The right structures and the right choice of manager could give you additional returns of 1%. By pooling assets and entering global negotiations, you can also reduce investment management fees by 0.5%. These three benefits can be achieved without a pan-European pension fund,” Gilliat said.
Desmond Mac Intyre, chief financial officer of General Motors Investment Management Corporation (GMIMCo) and General Motors Trust Company, illustrated the importance of asset consolidation. In the US, General Motors has consolidated the retirement schemes of its 800,000 domestic members, resulting in a 25% reduction of fees for 401K members. GMIMCo manages $40bn in defined benefit, defined contribution and 401K schemes for US members. Outside the US, General Motors has some 160,000 participants, principally in Canada and the UK. Here GMIMCo has not consolidated assets, but provides advisory services aimed at boosting investment returns and ensuring consistent performance.
MacIntyre said GMIMCo has been considering pooling assets in Europe for the past year. However, the benefits will only be significant if the UK joins the Euro-zone. “It is our largest pension fund in Europe, so the potential benefits of scale are large. Even so, we have $3.3bn in book reserves in Germany and if that goes into the investible realm, it could spur consolidation,” he said.
Like GMIMCo, Philips Pension Fund is developing a worldwide pension policy for the group’s E19.6bn fund. The aim is to achieve consistency in the level of pensions and the type of pension scheme at the corporate level. Policies include a defined contributions (DC) approach for new plans and the increasing use of hybrid plans, as well as eliminating links to social security. “Creating a pan-European structure has to be done from a pan-European packaged approach,” said John Ruben, director of the pensions and actuarial department in Eindhoven. “We want to set out global rules and rights and control costs and cash flow.”
However, country-specific social security and asset allocation requirements make it impractical to consolidate assets, he said. Instead, Philips supports a country orientation and responsibility rests with the management of local subsidiaries.
ABN Amro Bank is also tackling the problem of escalating future liabilities with a hybrid scheme. The bank pension programme has 75,000 participants, with current liabilities of E4bn on assets of E6bn. But the liability figure is set to rise to E8bn in 10 years and E14bn in 20 years. Employees can choose between a “standard” defined benefits (DB) plan, calculated at 75% of averaged indexed income (as opposed to 60% of final salary, under the old system) or a DC “options” scheme. The DB plan has also shifted the retirement date to 62, from 65, but there will be no benefit for early retirees. The DC scheme offers greater flexibility for early retirement and switching between the widowers’ and OAP plan, employees can also invest 25% or 100% of the contribution into investment funds, based on a salary threshold of E75,000.
The main benefit to the bank is the reduction in early retirees cutting costs to the pension fund by 10%. There will also be a reduction in the administration of schemes relating only to the DC side, says Lex Heijnis, managing director of ABN Amro Bank pension fund. The plan was rolled out to its Dutch participants at the start of the year, with a view to going global soon.
However, Steve Mingle, group pensions and benefit director of Diageo, argued against the DC trend, saying long-term investment returns drive pension scheme costs, not contribution levels. “The problem with DC is what happens when you hit retirement. In most cases the annuity from the insurance company is 100% bonds or gilts. With the very low interest rates in Europe, this is expensive.” Instead, Diageo has opted for a DB scheme that is fully invested, with 90% in equity and 10% in real estate. “We have a bit of surplus that allows us to invest aggressively for the long term. You will face fluctuations, but with the buffer of the surplus, you will ride it out,” he said.
Gerard Roelofs, director for the Benelux region for Deutsche Asset Management, talked about the importance of investment returns, with research showing that 80% of pension fund capital is generated from investment returns and only 20% from contributions. “Asset allocation has the greatest impact on returns and so this is the primary investment decision. Professional asset managers can help with this decision,” he said. However they would be involved only in providing advice on investment policy and risk management.
Roelofs highlighted investment approaches such as guidance on investing in alternative instruments, such as private equity, hedge funds and emerging debt. He concluded that in future, the European market will place less emphasis on local asset classes and managers and there will be a stronger trend towards asset pooling. “Multinational funds need to be investment driven and if investment managers can’t act more as advisers, they will not be able to provide the right solutions.”