39 cross border IORPs

Already in early March, CEIOPS reported the status of cross-border IORPs that were active by the end of January 2007. For some reason, this has escaped our attention to date, which is quite unforgiveable since it is an interesting statistic.

Of the 39 institutions reported, 77% have been in operation prior to the Pensions Directive's entry into legal force. Only 9 are "new" IORPs, located in Finland (1), Germany (1), Ireland (4), Luxemburg (1) and the UK (2). Notably absent from that list are Belgium and Liechtenstein, but we would wager that the "many new cross-border IORPs" anticipated by CEIOPS should change that ranking fairly soon, especially since Belgium is a relatively late arrival in terms of directive transposition. We hope that this statistic is updated periodically, for instance quarterly.

CEIOPS also notes that the Budapest Protocol of supervisory cooperation works well, but that "some features of the IORP Directive might benefit from further clarification".

640% of GDP

That would be the steady state equilibrium size of a Finnish model pension fund, assuming an elderly dependency ratio of 44% by 2050, up from currently about 23%. This is one of the interesting numbers that yet another central banker, Mr Erkki Liikanen of the Bank of Finland, has quoted in his recent address to the Conference of Social Security Actuaries and Statisticians.

There is a lot of interesting food for thought in that speech. I have just one question mark concerning the conclusions, where Mr Liikanen claims that "the volumes needed for financing pensions mean [that] the system will always have to be based on a public PAYG scheme". We think that always is an awfully long time. Mr Liikanen does not specify why funded systems should be unable to reach the required level of funding in the course of a generation or so.

Incentives for DB plans

The Governor of the Bank of Canada, Mr David Dodge, has been singing defined benefit pension plans' praises in a recent speech. He recognised that "an effective defined-benefit pension system is a tremendous asset for individuals, for employers, and for our society as a whole", but is currently hampered by a number of disincentives, which favour DC over DB for sponsors. Specifically, he lists

uncertainties over the legal status of actuarial surplus

overly restrictive solvency requirements,

transition from smoothed accounting numbers to fair value accounting

group longevity risk

insufficient transparency about cost / financing of newly introduced benefits

lack of large multi-employer DB plans.

We agree with both parts of the analysis, namely that DB plans are preferable to DC, and that there is currently a lack of incentives for DB plans. We strongly disagree however with Mr Dodge's opposition to fair value accounting. He claims, essentially, that we are not interested in today's values, but in expected values far into the future. We think that analysts of pensions are very much interested in today's values. For one, every expected future value can be discounted to a current present value (assuming that the term structure holds). Thus, Mr Dodge's distinction would essentially become moot.

More importantly however, it is not at all clear at which specific point "far into the future" the expected value would need to be formed - surely that cannot be discretionary? How about changes to those expected future values, based on variations of underlying assumptions? Finally, the volatility introduced to sponsors' balance sheets is not artificial, it's an economic fact. Cognition of that fact is a prerequisite of sponsors' ability to manage the inherent economic risk of their DB plans and, therefore, an enabler of an effective defined-benefit pension system.

Corporate Finance meets pension management

"Pensions are being transformed from off-balance sheet operations with results smoothed over many years, to large consolidated business units with high potential short-term volatility, bringing them to center-stage for executive managers."

Earlier in the year, JP Morgan has come up with a white paper that is very much in line with our thinking: Corporate Finance meets Pension Management: A new era for pension leaders. The paper is obviously targeted to the US market struggling with implementing the Pension Protection Act of 2006 and US GAAP SFAS 158, but as accounting (and regulation) follows economics in Europe, too, Europeans are well advised to consider this a sneak peek preview of their own not too distant future.

JP Morgan established a set of three strategic pension metrics, namely shareholder equity at risk, corporate cash flow at risk and earnings at risk. These metrics measure the impact of pensions on the respective variable of the sponsoring corporation. Putting the metrics into action will lead to important changes in the pension plans' risk exposure: JPM expects a shift from the currently too high equity exposure into an allocation of 25%-35% in non-traditional assets. As the paper originates from JPM's asset management arm, I have a feeling that the wish may have been father to the thought ...

ILMA news

While the recently founded Institutional Life Markets Association (ILMA) still seems to have no proper website, a document containing its guiding principles has surfaced on the web. It's interesting to glean from it that the Association is explicitly positioned in opposition to Defined Benefit pension funds.