Financial Crisis & Pension Funds: An Analysis

How the financial crisis affects pension funds: What analysts expect

International Pension Papers

No. 2|2009

Allianz Global Investors International Pension Papers No. 2|2009

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ContentCritical issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Proposition 1: The financial crisis has demonstrated that retirement income security

can essentially only be reached by public pay-as-you-go systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Proposition 2: Pension funds stabilize the financial markets thanks to their long-term investment horizon . . . . . . . . . 5

Proposition 3: Pension funds will increasingly apply the criteria of socially responsible investing

in investment decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Proposition 4a: The trend that firms fund their pension liabilities will continue (only Germany) . . . . . . . . . . . . . . . . . . . 7

Proposition 4b: The financial crisis will accelerate the shift from defined benefit

to defined contribution plans (only Switzerland) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

Proposition 5: Companies will reduce (voluntary) contributions for occupational pensions

as a consequence of the financial crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Proposition 6: Employees will reduce contributions to occupational / private pension schemes

as a consequence of the financial crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Recent publications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Imprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11


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Critical issues

Financial market experts in Germany and Switzerland recently were asked to share their views on the consequences of the financial crisis on pension funds and pension provision. The survey was conducted by the Centre for European Economic Research (ZEW) on behalf of Allianz Global Investors. Here are the key findings:

• Mostanalystsinbothcountriesdonotthinkthatthefinancialcrisisprovesthatpublicpay-as-you-go systems are superior to funded pensions

• Germananalyststendtobelievethatpensionfundsplayastabilizingroleonthe financial markets; Swiss analysts tend to disagree

• AlargemajorityofGermananalystsexpectsthatthefundingofunfundedpensionpromises in Germany will continue

• MostSwissanalystsbelievethatthefinancialcrisiswillacceleratetheshiftfrom defined benefit to defined contribution plans in Switzerland

• Analystsaresplitonwhetherpensionfundswillincreasinglyinvestaccordingto socially responsible investment criteria

• MostGermanandSwissanalyststhinkthatemployerswillreducetheirpension contributionsduetothefinancialcrisis;aslightmajoritybelievesthatemployees will reduce their contributions



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The financial crisis is now in its second year and it is unclear how severe its

future consequences will be. One of the crucial questions is: How will the downturn affect retirement income, specifically the future development of funded pensions and pension systems? The financial crisis could affect pension provision in many ways on many levels. For the purpose of this study we looked at a number of key areas.

On a systemic level, the downturn could spark political efforts to strengthen the pub-lic pay-as-you-go system, which might push people away from funded pensions. When it comes to the future of financial markets, two crucial questions are: Do pension funds play a stabilizing role and will the trend toward socially responsible investing among pen-sion funds continue?

Other pension market trends could be affected by the crisis as well. Will there be a continued shift from defined benefit to defined contribution plans? Will there be continued funding of unfunded pension promises? Regarding the adequacy of future pension provision, an open issue is whether the financial crisis makes employers and employees contribute less to pension plans.

To get answers to these questions, the Centre for European Economic Research (ZEW), on behalf of Allianz Global Investors, asked financial market experts for their views and expectations on these issues. The ZEW’s monthly Financial Market Test asks experts from banks, insurance companies and indus-trial companies for their near- to medium-term economic expectations. Participants were asked to answer several supplementary questions that measured how much they agree or disagree with statements covering the impact of the financial crisis on pensions. The survey was conducted in Germany, where 230 analysts responded, and Switzerland, where 41 analysts participated.

When analyzing the results one should note that the German and Swiss pension markets differ substantially. The German pension system is dominated by the pub-lic pay-as-you-go pillar, although recent reforms have tried to foster funded pen-sions to achieve a higher diversification of retirement income in the future. The level of public pension provision in Switzerland is much lower; occupational pensions are mandatory and contribute a major share of a person’s income in retirement.



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Proposition 1: The financial crisis has demonstrated that retirement income security can essentially only be reached by public pay-as-you-go systems

The first proposition aims to shed some light on the future development of pension systems. It can be assumed that the financial crisis has reduced the confidence many peo-ple have in the financial markets. If that is the case, people may demand a reorientation of pension policy toward public pensions be-cause they are not exposed to financial market risks. Also, politicians might exploit the uneasiness about financial markets to pro-mote a greater reliance on public pensions.

The polled financial market experts deny that this would be a useful approach. In Germany, 20 percent would agree/agree strongly with the thesis that the financial crisis has demonstrated that public pay- as-you-go systems are superior. A majority of 59 percent disagree/disagree strongly. Among the Swiss participants, only 2.5 percent are in favour of this thesis, while 60 percent reject it. The share of undecided participants is nevertheless quite high in Switzerland as 37.5 percent do not hold strong views. In Germany 21 percent are undecided.

Overall, the analysts disagree with the view that the financial crisis has proved the superiority of public pay-as-you-go systems. This is very much in line with economic reasoning on the benefits of a multi-pillar pension system that consists of unfunded and funded elements to diversify the expo-sure to different of types of risk.

5%

20%

35%

40%

30%

25%

15%

10%

Agree strongly

8

0

CH

D

Agree

12

2.5

Undecided

21

37.5

Disagree

22

35

Disagreestrongly

37

25

0%

“The financial crisis has demonstrated that retirement income security can essentially only be reached by public pay-as-you-go systems”

Proposition 2: Pension funds stabilize the financial markets thanks to their long-term investment horizon

With the next question we wanted to deter-mine how much pension funds affect finan-cial markets. The popular assumption is that pension funds have a long-term investment horizon and therefore stabilize the markets during a financial crisis because they do not have to sell securities in a downturn. The investment behaviour of pension funds is

crucial for financial market trends because the funds belong to the main actors on the financial markets. The OECD estimates that 60 percent of assets held by institutional investors worldwide are retirement-related; pension funds in a narrow sense managed assets of USD 18.6 trillion in 2007*.

* OECD 2009. Private

Pensions Outlook 2008.

OECD, Paris.


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Proposition 3: Pension funds will increasingly apply the criteria of socially responsible investing in investment decisions

The trend toward socially responsible invest-ing (SRI) among pension funds started before the financial crisis. SRI seeks to maximize both financial return and social good by requiring that environmental, social and governance criteria be considered in the investment process. This trend has several drivers. They include national and international initia-tives, such as the Global Reporting Initiative, changing societal and political expectations toward pension funds, and the belief that this investment strategy can reduce risk or generate excess returns. The current crisis has the potential to “mainstream” SRI strate-gies and make investors aware of the poten-tial benefits of considering extra-financial factors, particularly governance structures.

The survey results were mixed. Slightly more than a third of analysts in both coun-tries expect that pension funds increasingly

will include SRI considerations in their decisions, while roughly another third of the respondents do not expect that. The rest

5%

20%

35%

40%

30%

25%

15%

10%

Agree strongly

57

CH

D

Agree

29 29

Undecided

32

38

Disagree

29

24

Disagreestrongly

52

0%

“Pension funds will increasingly apply the criteria of socially responsible investments (in investment decisions)”

There is some dissent among German and Swiss analysts on this question. While 49 percent of the polled German analysts agree/strongly agree that pension funds stabilize financial markets and only 29 percent disa-gree/strongly disagree, Swiss analysts are much more pessimistic. Only 22 percent agree and 49 percent disagree. This differ-ence is a very interesting result as pension funds in Switzerland are more mature and play a bigger role than their counterparts in Germany. Thus, it could be assumed that the Swiss analysts have a longer-standing experience with pension fund behaviour and that experience seems to suggest that there is no substantial stabilizing role.

5%

20%

35%

40%

30%

25%

15%

10%

Agree strongly

12

CH

D45%

Agree

37

20

2

Undecided

22

29

Disagree

21

42

Disagreestrongly

8 7

0%

“Pension funds stabilize the financial markets”


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were undecided. This could be interpreted as a substantial degree of insecurity among financial market participants about the

future of SRI among pension funds and could indicate that the financial crisis will not automatically favour SRI.

Proposition 4a: The trend that firms fund their pension liabilities will continue (only Germany)

Unfunded book reserves were the tradition- al way of occupational pension provision in Germany. This picture has been changing over the last few years as many firms, es- pecially larger ones, choose to fund their pension promises through, for example, Contractual Trust Arrangements (CTAs). According to the survey respondents, this development is very likely to continue as a strong majority of 73 percent agrees/strongly agrees with the proposition. Only 7 percent of the surveyed analysts thinks that the trend toward funding will not continue. These re-sults are a strong indication that the role of funding in occupational pension provision in Germany is set to rise further.

10%

40%

70%

60%

50%

30%

20%

Agree strongly

14

D

Agree

59

Undecided

20

Disagree

7

Disagreestrongly

00%

“Trend to fund pension promises will continue”

Proposition 4b: The financial crisis will accelerate the shift from defined benefit to defined contribution plans (only Switzerland)

There is a worldwide shift from defined benefit to defined contribution plans. This change takes place at many speeds and in many forms. Pure defined contribution plans, which would imply free investment choice for the member and individual ac-counts, are not possible in Switzerland. There is no investment choice and pension funds have to achieve a certain minimum return. Nevertheless, over the last few years there has been a slow shift toward defined contribution plans in Switzer-land. Today, most members and assets are in defined contribution plans*. There

is reason to believe that the financial cri-sis might accelerate this shift. The main driver for the change could be the better calculability of contributions for the plan sponsor. This benefit is appealing to firms that have been hit by the recession.

The survey results show that the trend toward defined contribution continues. More than half – 58 percent – of the polled Swiss analysts think that the financial crisis will hasten the shift from defined benefit to defined contribution plans, about a third of the respondents is undecided while only

* Allianz Global Investors

2009. Funded Pensions

in Western Europe 2008.

Munich. http://publica-

tions.allianzgi.com/

en/PensionResearch/

Documents/AllianzGI_

Western_Europe_Study.

pdf


8

Proposition 5: Companies will reduce (voluntary) contributions for occupational pensions as a consequence of the financial crisis

Occupational pensions are a major compo-nent of retirement income in Switzerland, where they are mandatory. In Germany, occupational pensions are set to deliver a higher share of future retirement income due to political reforms and decreasing benefits from public programs. The finan-cial crisis and the current recession may force companies to reduce their voluntary employer contributions to occupational pensions as way of cutting costs.

Concern that employers will lower their contributions to pension plans seems to be justified. The survey shows that 71 percent of German analysts and 66 percent of Swiss analysts agree/agree strongly that this will happen. Less than 20 percent of the polled analysts in both countries disagrees. If that assessment materializes, and if it is more than a temporary trend, the consequences for future pensioners could be severe. The pension gap would widen and the retirement income from occupational plans would fall.

10%

40%

70%

60%

50%

30%

20%

Agree strongly

9

20

CH

D

Agree

62

46

Undecided

1115

Disagree

16 17

Disagreestrongly

2 20%

“Companies will reduce voluntary contributions for occupational pensions”

8 percent disagree and 0 percent disagree strongly. Based on these results, there is strong evidence that the development toward defined contribution plans will accelerate.

10%

40%

30%

20%

Agree strongly

CH

Agree

35

Undecided

34

Disagree

8

Disagreestrongly

00%

23

“The financial crisis will accelerate the shift from DB to DC”


9

Proposition 6: Employees will reduce contributions to occupational/private pension schemes as a consequence of the financial crisis

Firms are not the only ones under pressure when it comes to funding pension plans. The financial crisis could also affect employees’ willingness and/or ability to contribute to funded pensions. In times of economic crisis, people who are worried about losing their jobs might choose to invest in short-term, more liquid and easily accessible financial assets rather than long-term pension plans. Also, rising unemployment reduces income and absolute overall savings, which in turn cuts retirement savings. On the other hand, given the declining public pension benefits in Germany and the relatively modest level of public pension benefits in Switzerland, voluntary retirement savings are crucial to securing one’s standard of living after leav-ing the work force.

More than half the analysts in both Germa-ny (51 percent) and Switzerland (53 percent) expect that employees will reduce their con-tributions to pension plans. Roughly a third of the respondents in the two countries disa-gree/disagree strongly with this view. Inter-estingly, more analysts expect companies to

reduce their contributions (Proposition 5) than employees. There are a number of possible reasons for this result: 1) Workers might be more reluctant to make changes because those changes could affect their retirement security; 2) Companies could be quicker to react because they face bigger financial challenges from the recession than individual employees; 3) Individual be-havioural factors could play a role.

10%

40%

50%

30%

20%

Agree strongly

6 7

CH

D

Agree

45 46

Undecided

1813

Disagree

2832

Disagreestrongly

3 2

0%

“Employees will reduce contributions to pension schemes”


10

The survey results point to several impor-tant developments. The polled analysts

expect some trends to continue, such as the move toward funding occupational pensions in Germany and the shift from defined ben-efit to defined contribution in Switzerland. There is also a high degree of consensus that it would be unsuitable to rescind pension re-forms and primarily rely on public pensions. Meanwhile, the analysts provided an unclear view on the future of socially responsible investments and were split on whether pen-sion funds help stabilize financial markets.

The survey provided worrying results regarding the impact of the financial crisis on employers’ and employees’ contribu-tions to retirement plans. Analysts expect both to contribute less than before. If that happens and this leads to a permanent reduction, retirement income could be affected substantially. Given that funded pensions are a crucial component of re-tirement income in Switzerland and that they are supposed to play a more impor-tant role in Germany, reducing pension contributions should be considered very carefully and only be done as a last resort.

Conclusions


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Imprint

Publisher: Allianz Global Investors AG, International Pensions, Seidlstr. 24-24a, 80335 Munich, Germany | [email protected]

http://www.allianzglobalinvestors.com | Author: Dr. Alexander Börsch, Senior Pensions Analyst, Allianz Global Investors AG, [email protected]

Layout: volk:art51 GmbH, Munich | Printing: Christian Döring GmbH, Munich | Closing Date: August 20, 2009

The entire content of this publication is protected by copyright with all rights reserved to Allianz Global Investors AG. Any copying, modifying, distributing

or other use of the content for any purpose without the prior written consent of Allianz Global Investors AG is prohibited. The information contained in this

publication has been carefully verified by the time of release, however Allianz Global Investors AG does not warrant the accuracy, reliability or completeness

of any information contained in this publication. Neither Allianz Global Investors AG nor its employees and deputies will take legal responsibility for any

errors or omissions therein.

This publication is intended for general information purposes only. None of the information should be interpreted as a solicitation, offer or recommendation

of any kind. Certain of the statements contained herein may be statements of future expectations and involve known and unknown risks and uncertainties,

which may cause actual results, performance or events to differ materially from those expressed or implied in such statements.

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Financial Crisis & Pension Funds: An Analysis

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