FRANCE - Officials at the ERAFP pension scheme have raised concerns that pension funds may be pricing their schemes' asset allocation strategy at too high a discount rate to be achievable and argue this may have contributed to the recent market crisis because the high returns needed placed too much pressure on the companies they invested in.

Philippe Desfossés, chief executive of France's €6.5bn defined contribution supplementary pension fund for civil servants, told IPE the key issue pension funds need to get to grips with after the recent crisis is the discount rate at which they price assets over the long-term, as a high target means the real return may not be achievable.

More specifically, he argued that whereas the focus in recent months has been on the cover ratio of a pension fund and the value of the assets held, what should instead be the priority is to look at the liabilities and whether a high discount rate will assist those liabilities as any increase in the discount rate could substantially increase the liabilities over time.

"I think the most important issue is pension funds have maybe, for 40 years, been underpriced," said Desfossés.

"When the pension fund discounts its liabilities at 7% a year, it means it will have to invest in assets delivering at least 7% a year. But is it sound? The time frames that [a pension fund] takes is not applied on the asset side, but on the liabilities. So the impact of lowering the discount rate over a 30-year period by 10bp is 3% that you need to generate in that time. You need to be very prudential in the way you discount the future rates. If the assets deliver more it will provide the fund with a figure which will allow to be more aggressive. But you don't begin by discounting the over-optimistic discount rate," he argued.

He suggested the discount rate at which liabilities have to be reached has increased to such an extent that pension funds may have inadvertently placed undue pressure on the listed companies they invest in because in order to continue to meet shareholder growth demands on equity returns companies felt they needed to borrow more.

"Pension funds with high discount rate are partly responsible for the crisis because they put the pressure on the companies to deliver. If you leverage as much as you can from the companies, you are forgetting that the leverage works both ways," added Desfossés.

In order to ensure future liabilities are achieveable pension funds should turn away from looking at the cover ratio of a pension fund, suggested Desfossés and instead concentrate on lowering the long-term discount rate.

The ERAFP pension scheme is currently 80% invested in fixed income, with 12% in equities and the remainder in alternatives and other assets, including real estate and forestry.

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