Reaching a compromise

David Adams admires Belgium's approach to pensions reform

Belgium owes its existence to the art of compromise: the nation’s two regions, Flemish-speaking Flanders and French-speaking Wallonia, have stuck together through thick and thin since the country won its independence from the Netherlands in 1830, despite tensions between them sometimes running dangerously high. The experience of that sometimes rocky, but enduring partnership has also helped Belgium play a key role in the development of a far more ambitious political project built on cultural compromise: the European Union.

So perhaps the Belgian pension industry can draw some comfort from the fact that the challenges it now faces, products of both the country’s own conventions on retirement provision and of external forces, will surely be solved through the use of further intelligent compromise.

In some ways this is a country where old habits die hard and conservative influences remain strong. The majority of pension funds are still relatively small in comparison to those seen in other rich European countries; most are based on defined benefit (DB) schemes. Many Belgians still follow the convention of obtaining pension benefits as a lump sum at retirement, rather than buying annuities or other pension products.

But the political and economic events of the last decade, within Belgium and the EU as a whole, stimulated regulatory and legislative reform, designed to formalise processes that protect the financial integrity and formalise governance of pension funds. A series of regulatory and legislative changes began in 2003 and continued until 2007. Most pension funds are still working through the implications of those changes.

The country’s 2006 Law on the supervision of Institutions for Occupational Retirement Provision (IORPs) and the Executive Decree which followed in January 2007, defined the principles of funding and investing pension assets, stipulating that contribution policy and technical provisions must be described in a financing plan.

Pension funds are no longer permitted to use technical provisions equal only to vested reserves (the present value of vested benefits), in other words, the minimum provision. In addition, continuity tests are now required every three years for DB schemes, to help funds project future liabilities and cashflow, to determine the probability of underfunding and thus calculate the optimum financial buffer required.

Funds are also now required to appoint a compliance officer and an internal auditor. To some countries these measures will hardly seem revolutionary, but they are new to many Belgian pension funds.

“Many funds are still in the process of reviewing liabilities,” says Thierry Verkest, consulting actuary and head of Hewitt’s pensions practice in Belgium. “The authorities are saying you need to use more prudent assumptions about [factors] like mortality tables and early retirement. You need to look at the reality of people leaving the pension plan. It all means the landscape is really changing for pension funds in Belgium, including pension fund governance. You could ask yourself, are we not going too far? We are only a small country with small pension funds.”

Indeed, that question was put to the regulator, the CBFA, by actuaries and pension funds, and was asked quite forcefully by some of the smaller and medium-sized funds on whom the changes were having a particularly onerous impact.

Luckily, the CBFA appears far less intransigent than some other national regulators. “The authorities are very accessible, open-minded and prepared to help,” says Verkest. “You can see the authorities accept you must be more pragmatic than just [following] the formal rules. That’s good news for smaller pension funds – otherwise I’m afraid a lot of them would disappear.”

The result is that pension funds have been left with some helpful room for manoeuvre. “You need to be prudent on the question of technical provisions, but there is nothing that is defined quantitatively,” says Thierry Verkest. “There is nothing saying ‘you a ten per cent buffer’, or a 20 per cent buffer. It is the responsibility of the trustee, with the sponsoring company, to define the buffer that you need.”

The exact method to be used for continuity testing has also been left undefined. “The authorities didn’t want to come back with one single method of how the continuity test in the long run should be performed,” says Paul Logghe, managing consultant at Watson Wyatt’s Brussels office. “They will look at what the pension funds are actually doing and may say that what they are doing is insufficient, but they won’t say ‘you must apply this method and nothing else’.”

The pressures imposed on pension funds by regulatory change have been exacerbated by the global economic crisis. A number of pension funds, adversely affected by plunging financial markets, have been forced to provide the Regulator with detailed recovery plans.

“A lot of funds have developed recovery plans, have submitted them to the authorities and are seeking extra cash injections,” says Gret’hl Van Hoyweghen, retirement practice leader, Towers Perrin Belgium. She notes that this has resulted in an increase in the numbers of funds reviewing the asset allocation by carrying out asset liability modelling studies and are envisaging to introduce changes in investment strategies.

As Watson Wyatt’s Paul Logghe explains, there are two main types of plan: “The first is there in case technical provisions don’t meet short-term provisions. In that case, the deficit has to be paid off within a year. Most plans meet short-term obligations. But a number don’t meet the long term obligations and don’t pass the continuity test.

“There are other measures that can be taken beyond just paying off the deficit,” he continues. “You can pay advances or loans to the pension funds that can be reimbursed to the employer. Another possible measure is to change asset allocation to be more conservative. In the past there were quite a lot of pension funds for whom assets just met minimum funding obligations, so from the moment something negative happened in the financial markets they were in trouble.”

Again, there is a willingness on the part of the regulator to make allowances for funds in difficulties. “[The regulator has] indicated clearly that concerning governance procedures it is more important a fund takes more time to do something properly, rather than to do something on paper that doesn’t work in reality,” says Van Hoyweghen. She notes approvingly that the regulator doesn’t impose blanket conditions on funds.

One feared possible consequence of the current economic crisis – companies taking negative action towards pension funds to reduce their benefit plans is not happening on any significant scale. “We don’t see a clear trend that companies are reducing their benefits plans,” says Van Hoyweghen. “Some are thinking about it, but our impression is that there are other elements of the remuneration package which they are tackling first.”

As her colleague, Marcel Rottiers, managing principal at Towers Perrin Belgium, points out, practical issues may be playing a role in safeguarding the pension fund, for the time being. “You don’t change a plan overnight and although any change you might impose would not be irreversible, it is much harder to undo than it would be to undo temporary measures to do with bonuses or base salaries,” he explains. Nonetheless: “if the economic crisis has a longer term impact then we will see those things happen.”

In the meantime, the economic crisis is accelerating a shift from DB to DC, a growing trend visible in Belgium for some years. “As a result of the underfunding problem there will be an extra push towards DC, enforced by a desire to reduce the P&L volatility and balance sheet impact,” says Van Hoyweghen.

But, as Watson Wyatt’s Paul Logghe points out, moving to DC is not always the answer. “If you move to DC maybe your problems are solved in the short run, but you may face other problems in the future. As the retirement benefit from a DC-plan is in general lower than from a DB plan, people could refuse to retire because everyone knows that also the state pensions will not increase but rather decrease ,” he notes. “If there is not sufficient supplementary retirement income then the trade unions will oppose any restructuring programmes and will ask for other, probably more expensive compensation . This is a problem not many employers realise, I think.

“Employers should not just think that by shifting to a DC plan, which is in general less expensive, that their problems are solved. They are solved in the short term but they may face problems in the future.”

The crisis is also affecting the ways multinational companies use pension funds. “It’s too early to call it a trend, [but] a number of companies belonging to multinational groups are more interested in solutions [that entail] pooling assets and pension plans,” says Christian Bayart, partner in the employee and benefits department at Allen & Overy. “Or solutions where, by centralising pension plan assets, they seek better control on what happens with pension plans. The crisis has made those companies more aware of the risks, so, to some extent, pensions are a stage higher on the corporate agenda.”

It’s interesting also to reflect on the potential of another factor that may yet have an indirect influence on the Belgian pensions industry: a growth in the numbers of companies wanting to develop pan-European pensions arrangements.

“I see an increased awareness on how pension plans and solutions are operated in respect to workers who are internationally mobile,” says Christian Bayart. “There is an increased awareness on how to deal with sometimes very complex tax or regulatory issues. It’s related to the changes we made in our legislation with respect to pension funds, where it has become more explicitly regulated on how you should deal with persons working in an international context.” Hewitt is already working towards formal regulatory approval, both within Belgium and in the other countries where such arrangements would be in operation of a framework that would enable the implementation of cross-border pension arrangements for its clients.

But in the near term, there’s no doubt that the industry will be preoccupied by the impact of regulatory and legislative change, at national and EU level, and by global economic turbulence. The hope has to be that the net effect of these forces will be positive.

Gret’hl Van Hoyweghen believes the pensions industry in Belgium is learning to be more comfortable with this kind of change. “I think we are making an enormous improvement with governance and risk control,” she says. “If you compare the situation with a couple of years ago, Belgium has improved enormously. We still have a way to go, but so do other countries.” The industry may one day stand as another useful Belgian example of the way that intelligent compromise can lead to radical reform.

WRITTEN BY DAVID ADAMS,
A FREELANCE JOURNALIST