In three years, the pension scheme for Belgian doctors and dentists has been transformed, writes Fennell Betson. No one said it was going to be easy

When the pension scheme for doctors and related professions in Belgium switched from a pay-as-you-go to a funded basis, it broke moulds. Brussels-based Caisse de Prevoyance des Medecins, Dentistes et Pharmaciens (CPM), with Bfr11bn ($310m) of assets, is now managed on state-of-the-art lines that other schemes are begining to grope towards.

Early in the 1990s, CPM calculated its scheme covering 12,500 members would not last beyond 2010, when the assets to pay retirees would run out, even though it had assets to match 78% of its liabilities, an exceptional situation for a PAYG scheme. Repeated attempts to make CPM membership compulsory for the profession, a prerequisite of financial stability, had failed. In a daring do-or-die exercise, CPM in 1994 renegotiated its contractual benefits package with pensioners and amazingly 87% of its 2,000 or so pensioners voluntarily surrendered that part of their pension entitlement that was unfunded in exchange for a lump sum.

Contributing members had the balance of the reserves assigned to new individual accounts, which should they earn 7.75% throughout retirement age, would provide the original level of benefits.

Much of the credit for getting this drastic medicine across to members goes to the fund’s energetic director-general Rose-Marie Hermosa and her equally energetic deputy Karel Stroobants, who handles the investments. The restructuring of the fund largely took place during 1994 and early in 1995, Stroobants despatched the Bfr2.2bn cash payment to the pensioners. I was almost sick doing this,” he admits.

This left some Bfr8bn in the fund to rebuild the scheme on the basis of individually capitalised accounts - which, however, are invested in a common fund. He reflects: “We had a bit of luck in that we could do all this from scratch. It’s an unbelievable advantage to have.” Not everyone in their position, having come through what they had, would be so positive.

But the 7.75% annual return, of which 4.75% is guaranteed by CPM, was not the only constraint. The Office de Controle des Assurances in Brussels insisted that the fund have 100% solvency from day one. “We thought that was an unfair demand, having gone from PAYG to funded. They could have given us a transition period,” says Hermosa. But because of the history of state involvemen t in medical pensions, the government underpinned the solvency with a five-year guarantee of Bfr600m, operational up to 1999.

The beginning was not auspicious. “1994 was a bad year to start, as it was a year when we had a return of minus 2%,” says Stroobants. At that stage the fund was up to 70% invested in bonds and was hit by interest rate rises. But an asset/liability study pointed to the strengths of the fund once the Bfr2.2bn was paid out. “We found the fund had a positive cash flow in almost every possible scenario,” says Stroobants. With members’ ages averaging around 42 and the rules not allow sums to be withdrawn before the age of 60, the liabilities have a very long duration.

So the asset allocation was changed completely. Up to then management was done by three Belgian banks, with portfolios mainly in bonds and some stocks. “We knew they were following their policies and not ours,” says Hermosa acidly.

CPM set up an asset allocation committee on which Hermosa and Stroobants sit with the fund’s president and two outside consultants, Pragma Consulting and MeesPierson, now Fortis. “We said we wanted to go equity, but if we did, we would have the problem of volatility,” says Stroobants. The decision was taken to go international as well and diversify to use the non-correlation of markets. “A complete asset allocation method was set up.” Fortis advises on the asset side. Equity is now around 60% of the portfolio, 30% is in bonds, 8% in real estate and the balance in cash.

During 1994 an internal document was drafted, which Stroobants says is similar to a statement of investment principles. “This runs to 30 pages of policy statement, about what to do and not to do and how the system works.”

The decision was to move to specialist managers, with Pragma advising on the selection. Now nine are in place. “We started putting this in place in 1995, going from the three Belgian managers.” All the managers are subject to the same 45-page detailed standard contract. “The main clause is that they can be dismissed on 24 hours’ notice,” he says. “Imagine the normal Belgian contract for dismissing money managers requires six months’ notice!”

The other step CPM took was to surround these managers with a global custodian and it chose State Street in Brussels. “This was a completely new concept when we introduced it in 1994.” In fact pension funds were not allowed to have a custodian outside Belgium. “This meant you could not professionalise!” Eventually permission was forthcoming but only after CPM had made the appointment. As Stroobants says, the authorities could not be against it fundamentally.

Besides settlement, State Street looks after all reporting and manager monitoring. The custodian was essential in going international and using nine different managers, with only one and a half people looking after the assets at CPM, says Hermosa.

At the end of 1996, on the equity side, Belgian equities comprised 23% of the portfolio and these were managed by Puilaetco; European large caps (11% by Gartmore); European mid-small caps (5%, Framlington); US mid-caps (3%, Denver in Colorado); US large caps (3%, Sanford C Bernstein in New York); Pacific (including Japan, 10%, Invesco); Japan (3%, Bernstein, 2%, Gartmore). Bonds amounting to 28% were handled by Dewaay and real estate (6%) by Richard Ellis. CPM manages the cash in-house.

“We have started to look for someone to manage an eastern Europe and Latin American portfolio eventually. It is not decided finally we will do this, but we are to come up with a proposal for the board,” Stroobants says. When selecting money managers, he believes it is very important that they are pension fund and not mutual fund managers. “Their market reactions can be different.”

Keeping 100% solvent is a tough challenge with such a high equity content. “You have to build up your solvency margin. You are in a vicious circle, which do you do first, distribute returns or build up your margin?” Luckily, with two good years for total returns - 16.3% in 1995 and 19.6% 1996 - the fund was able to distribute 7.75% and add to its margin.

“Now we are trying to constitute a mathematical and consistent way to calculate a solvency margin for the equity portfolio. We are using value-at-risk technology to help. What will be enough, nobody knows, but we will be prudent.” He reckons something of the order of 15% or 20% of the equity portfolio is what is needed.

But already, members are looking at the reserves building up. “We are now coming to a position after two years that our equity reserves are too high for those beneficiaries who want their money.” And CPM is facing another threat. It is awaiting a court decision on a challenge to its rule forbidding withdrawals before the age of 60. If this went against the fund, it could have serious implications for their approach, acknowledge Hermosa and Stroobants.

Both have a very clear view of their role as an institutional investor, acting on behalf of their members. “We think we are the prototype of an institutional investor, who takes the decision on asset allocation and does not put it with the member. Nor do you delegate it to the money managers. Asset allocation should be in the fund and not taken by the individual, but by the collectivity,” says Stroobants. “