Highlights of the study include: The valuation and risk characteristics of DB liabilities under national regulation varies significantly across OECD countries. This has a direct impact on the asset portfolio – for example, even for identical pension plans there is no uniform optimal "liability-driven investment strategy" in different countries. Furthermore, the difference in the way accounting rules measure the liabilities on the balance sheet creates a potential dilemma for schemes, as they cannot "serve two masters at once".
Where regulation forces schemes into sub-optimal asset portfolios the employer’s funding contributions will rise in order to meet future DB obligations.
There are marked differences in the type of regulation requirements ranging from general recommendations such as the "Prudent Person Principle" to mandatory and strictly enforced solvency requirements. These requirements trigger different contribution and liquidity demands and influence the choice of the funds investment policy.
There is a direct correlation between the DB benefit structure and the cost to the employer, in terms of the level and flexibility of the corporate funding strategy. Final salary schemes with guaranteed indexation are approximately double the cost of career average schemes with conditional (discretionary) indexation.
AllianzGI examines impact of pension scheme regulations
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New rules in many jurisdictions
Over the past four decades DB schemes have enabled employers in many OECD countries to create and sustain a competitive edge in their respective national and global labor markets. DB schemes have provided a genuine return on corporate capital through the employer's investment in its employees' welfare. Importantly, through their DB schemes, employers have also created a vital supplementary layer of pension provision to support state retirement benefits and private savings.
In recent years regulators in many jurisdictions have introduced new rules to protect members' benefits, but at the same time they have imposed additional costs and complexity for schemes and employers. Until now it has not been clear how variations in the way investment-focused regulation and accounting rules have affected the schemes' ability to construct optimal asset portfolios, which help reduce the employers' immediate and longer-term funding costs.
Study shows impact of regulation
A major new study shows for the first time the effects of national variations in investment-focussed regulations for DB schemes in OECD countries. It demonstrates the crucial impact of regulation and quantitative asset class restrictions on the scheme’s ability to adopt a rational investment strategy and it models the resulting asset allocations over a 30-year period.
The study was commissioned by Allianz Global Investors (AllianzGI) and formed the basis for a new policy report, "Pension Fund Regulation and Risk Management: Results from an ALM Optimisation Exercise", published today by the Organisation for Economic Cooperation and Development (OECD) in collaboration with risklab germany GmbH a company of AllianzGI.
Facts to make informed choices
The report will alert employers, regulators and accounting boards to the impact of the complex interrelationship between regulation and funding costs for a "typical" (synthetic) scheme, based on a study of a simplified version of rules in Germany, Japan, the Netherlands, the United Kingdom, and the United States. All of these countries have introduced new regulation in recent years focused on improving risk management and, hence, benefit security. For comparative analysis the modeling assumes a similar starting position for each scheme and a similar rational approach to investment and risk.
Brigitte Miksa, Head of Pensions International, AllianzGI, says: "We were becoming increasingly concerned about the difficulties our multinational clients face as they strive to deal with very different pension scheme regulations and the associated impact these have on the funding strategy. This study set out to discover the facts and framework conditions our clients need to make informed choices, so that their pension arrangements are affordable and meet their corporate goals."
Need for a more harmonized regulation
Gerhard Scheuenstuhl, Managing Director of risklab germany GmbH, explains: "What we found was that regulation and accounting rules impose different rules on how liabilities are measured, which significantly influences the investment behavior of pension funds, leading to quite different asset allocations even for identical pension plans. Regulation and accounting rules directly affect the portfolio returns and, therefore, the funding demands on employers."
"Importantly, regulatory restrictions can deny employers access to the optimal active liability driven investment strategies they need to help manage their pension liabilities efficiently. In a global corporate world, such discrepancies between national regulatory systems could trigger regulatory arbitrage strategies. The study highlights not only the need for a more harmonized regulation but also the need for a stronger emphasis on risk-based regulation in combination with more flexibility, providing the right incentives for an effective investment policy.
"Juan Yermo, Coordinator Private Pensions Unit, Financial Affairs Division, OECD, says: "With this report our objective was to deepen our understanding of the impact of different funding regulations and accounting standards on DB plans in OECD countries. This new study has important implications for policy. It will further our discussions with regulators to enable them to achieve their twin goals: benefit security for scheme members and flexibility and affordability for employers."
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