The year in pensions
Written by Nick Martindale
Nick Martindale looks back on all that has happened in the European pensions space in the past 12 months
The year currently drawing to a close has certainly been eventful, whether at a pan-European level or in the various initiatives that have taken place in individual countries. The decision in May by the European Commission to at least temporarily scrap proposals for a Solvency II insurance-stye system around capital requirements for occupational pension schemes, in the review of the Institutions for Occupational Retirement Provision (IORP) Directive, was broadly welcomed by the industry.
“The proposals introduced the concept of the ‘holistic balance sheet’ which would seek to put a value on security mechanisms such as employer covenant,” says Mercer retirement consultant Anne Bennett. “However, countries such as the UK, the Netherlands and Germany were very strongly opposed to the proposals, arguing that the implications for defined benefit scheme funding would be disastrous.”
Yet although the so-called first pillar was excluded, the second and third pillars – which relate to governance and disclosure rules – have yet to be resolved. These could have significant implications for defined contribution (DC) schemes, suggests Towers Watson senior consultant Paul Kelly, by imposing additional governance on trust-based plans and a standardised format and content for key information documents. “One fear is that this will inhibit more creative approaches to employee communication,” he says.
The general feeling in the industry is that the existing IORP Directive works well from a cross-border pensions perspective, says Aon Hewitt’s UK international retirement practice leader and partner Paul Bonser. “Where it is less satisfactory – and where we would like some change – is in enabling the way past service benefits from previous pension arrangements are consolidated,” he says. “This is a key element for increasing the popularity and effectiveness of cross-border arrangements, with all the economies of scale and improved governance that they can bring.”
Alongside this, the European Insurance and Occupational Pensions Authority EIOPA) worked to focus more on DC pensions and the importance of improving member communications and developing methods to mitigate risk for individual scheme members. “Moreover, a co-ordinated effort with EFAMA – the EU trade body for asset managers – is in place to develop a European DC-plan for the third pillar, which would be compliant in 30 EU member states,” says Robeco director of European pensions Jacqueline Lommen.
In the UK, the biggest development has undoubtedly been the rollout of auto-enrolment among larger firms; something that has been mainly successful. “Some had anticipated widespread compliance failures combined with high opt-out rates,” says Pensions Management Institute technical manager Tim Middleton. “In the event, employers demonstrated that they were able to execute successful implementation projects and in some cases achieved great success through innovative communication programmes. The end of the year has seen The Pensions Regulator serve just one enforcement notice, and the industry has been greatly encouraged by low opt-out rates.”
As a result of the move, some 500,000 people now belong to the Nest scheme created specifically for those employers looking to enrol staff as a result of the plan, with a similar number of new members signing up to commercial schemes, says PTL managing director Richard Butcher. “The combined reported opt-out rate has been lower than 10 per cent with some employers reporting rates significantly less than that, although there have been whispers that the three-month opt-out rate is drifting quite a lot higher,” he says. “This has all been done with relatively few problems, at a macro level anyway.” The real challenge could come next year, however, he warns, when large numbers of smaller employers are due to enrol staff.
Auto-enrolment has also sparked off a growing awareness of the need for the UK to get on top of its looming pensions crisis. “It has focused the UK regulator to look at defined contribution arrangements generally through the latter part of 2013,” says Premier senior consultant John Reeve. “Regulation and consultation has been issued looking at the management of these arrangements, the options available to members at retirement and the expenses paid by members. High-profile press coverage means that all of these are now in the public eye.”
This has also led the government to consider the merits of a collective defined contribution (CDC) scheme, under which employers and members would pay a fixed contribution and members would receive a targeted – but not guaranteed – outcome. “The CDC plan pays out pensions to members rather than requiring an open market annuity purchase, with bonus increases if the experience has been good but with reduced increases or even a cut to the face value of pensions if it has been bad,” says Aon Hewitt partner Matthew Arends.
Such a plan could eventually lead to conflict, though, warns State Street Global Advisors managing director and head of UK defined contribution Nigel Aston, with greater certainty of outcome likely to attract higher charges, running counter to other initiatives seeking to minimise these. “Many plans are starting to believe that the answer, surprisingly, exists in some of the sophisticated tools more likely to have been found in defined benefit plans,” he says. “The use of institutional indexed rather than retail building blocks, volatility controls, diversification and dynamic asset rotation can achieve a more harmonious blend of risk, return and cost. Within the constraints of the proposed regulation may lie the seed of innovation.”
In the Netherlands, a national investment institute was set up as a national fund for institutional investors, designed to encourage more local investment from pension funds and other investors. “Local loans could make sense from a liability matching perspective and, as the Netherlands has a large collective mortgage debt and at the same time the highest pension savings ratio versus GDP, a link between the two could make sense,” suggests Vanguard Asset Management head of institutional Simon Vanstone. There are, though, potential risks, including a home-biased approach to investment at the expense of a more diversified portfolio, he adds.
The precise details have yet to be formulated, in particular around the government incentives that will be used to encourage such investment. “Investors will demand a yield to justify the investments over alternatives and as compensation for the risk,” says ING Investment Management International strategic advisor for institutional investors Tjitsger Hulshoff. “The government will end up paying for this yield. With government now able to borrow in the market at all-time lows, this appears a complex way of changing the low government rates into high yield like rates.”
Elsewhere in the Netherlands, the Dutch regulatory framework forced underfunded pension funds to reduce pension rights for all their members, including retirees, while after several years of discussion agreement was reached on modifications of the current pension deal. “The new regulatory framework is best described as a middle ground between the two main standpoints; the real and the nominal contract,” says Cardano head of innovation Stefan Lundberg. “This closed the Dutch pension contract; a debate that spanned several years.”
Finally, new fiscal changes are currently being debated which could see the partial reduction of the Dutch national budget financed by cuts in the fiscal treatment of pension contributions. “These propose to lower the build-up rate to a maximum of 2.15 per cent instead of the current maximum of 2.25 per cent for career average wage pensions,” says Lundberg. “They also propose to remove fiscal incentives for pension contributions on the part of the income that exceeds €100,000.” The outcome of the debate is uncertain, he adds.
In Ireland, the decision not to end the controversial levy imposed in 2011 on pension assets in occupational and personal pension schemes in 2014 as planned, but instead to increase this by 0.15 per cent to 0.75 per cent in 2014 and to apply a further levy of 0.15 per cent in 2015, dominated the agenda.
“We have had confirmation from the social protection minister Joan Burton that shortfalls in certain defined benefit schemes will be funded from this levy,” says Source Pensions sales director Barry Ennis. “The question being asked now is whether we can believe the government promise that 2015 will see the end of this levy. At a time when the government is highlighting the fact that pension coverage in Ireland is so poor and increasing the state retirement age, they are penalising those who are trying to provide for themselves.”
Alongside this, the Irish Pensions Board published its consultation into the future of DC pensions in August, highlighting the large number of very small or single-person pension arrangements in Ireland, and the subsequent large number of individuals acting as trustees. “Ireland has more small and single-member schemes than any other country in Europe,” points out Ennis. “As of 31 July 2013, there were 145,331 registered pension schemes, with a total of 866,405 active members.”
“The Pension Board’s consultation on the future of DC schemes is a sensible step that focuses on the correct issues,” adds Principal Global Investors head of institutional business, UK & Ireland Stephen Holt. “Hopefully the board’s ultimate actions will also be sensible, avoiding over-regulation and unnecessary complexity and encouraging DC provision in Ireland.”
France also found itself making the headlines in 2013, when President Hollande’s state pension reform package was narrowly voted through the lower house in November. The proposed changes maintain the statutory pension age at 62 – rather than 60 as it had been until 2010 – and focus on increasing the actual retirement age by requiring longer contribution periods for a full pension entitlement, says Bennett, as well as raising employee and employer contributions.
“France has been under strong pressure from the European Commission to make changes to its first-pillar pension system, to avoid projected deficits of around €20 billion by 2020,” she says. “However, the EC has professed disappointment in the scope of the measures put forward, which fall short of their recommendations which had called for more fundamental structural reform, including a review of the separate provisions covering public sector employees.”
From a funding perspective, a typical scheme’s level improved by around 5 per cent in 2013, says Aon Hewitt partner Lynda Whitney. “This may not sound a lot but may represent the deficit decreasing by a third,” she says. “In the first quarter this did not look a likely outcome as gilt yields continued to fall but they recovered in the summer, leaving liabilities broadly flat over the year to date.”
Schemes that have improved their funding level have increasingly looked to de-risk, she says, from the third quarter onwards. “We found schemes moved fairly quickly from being some distance away from their de-risking triggers to them being enacted,” she adds.
A number of areas emerged in 2013 as attractive investments, including infrastructure. “This year has seen various initiatives across Europe aimed at increasing investors’ appetite in infrastructure investments,” says Standard & Poor’s managing director, infrastructure finance Michael Wilkins.
“The main impetus behind capital market project finance issuance is the European Investment Bank’s project bond credit enhancement programme.”
Sustainable investments in areas such as resource efficiency and environmental markets were also popular, says Impax Asset Management head of global distribution Ominder Dhillon.
“This is a trend we expect to continue for many years as investors recognise the evidence of new risks and opportunities arising from climate change and issues linked to the scarcity of our finite natural and environmental resources. We have started to see a number of institutions divesting their fossil fuel holdings and re-allocating this capital as they become concerned of the potential stranded asset risk.”
Looking to 2014, investors will increasingly have to contend with maximising returns in an environment where interest rates finally start to rise.
“It is important that asset values continue to outpace salary and price inflation,” says Holt. “Equity valuations are now close to long-term averages, so the easy money has been made. Further progress needs economic growth and improvements in corporate earnings and, while the picture seems to be improving, there is a long way still to go.”
Nick Martindale is a freelance journalist