Norway’s financial sector has been buffeted but pension funds look to stay afloat, finds George Coats

Last month an MP for Norway’s ruling Labour Party announced that she would not seek re-election after the media revealed that she had run up a NOK48,000 (€5,650) telephone bill ringing fortune tellers at parliament’s expense. It was not reported what kind of advice she sought but there are those in the financial sector who know exactly how she felt.

Earlier Folketrygdfondet, which manages the Government Pension Fund - Norway, posted a first-half return of -3.6%, representing losses of NOK4.3bn, as a result of the market turbulence. The fund, which invests in Norway and other Nordic countries, is 60% invested in equities and 40% in interest-bearing securities.

Over the same period its bigger brother, the Government Pension Fund - Global, the former National Oil Fund which is required to invest solely abroad, reported its return was -7.4%, representing a loss of NOK205.9bn.

“The state petroleum fund is being hurt by the developments in the stockmarket,” notes Axel West Pedersen, (pictured right) a senior researcher at Oslo-based social affairs think-tank the Nova Research Institute. “But as a huge long-term investor it can ride out any such losses.”

One of the first calamities of this crisis occurred in Norway - Export-finans, a Norwegian banking institution owned by the two biggest banks, Nordea and DnB, and the government. It had been used as a counterparty to issue more debt and invest its credit risk in diverse bond markets. Having invested heavily in institutions linked with global markets, especially in the US, it lost a fortune when the credit spreads moved and feared losing its triple-A rating. However, the bill was picked up by its owners.

“This was probably one of the first bailouts, around about the same time as Northern Rock,” says Christian Fotland at consultancy Gabler Partners. “But nobody talks about it because it was not retail. It was purely institutional.”

Confidence was also knocked by a mis-selling episode involving Icelandic bank Glitnir. “Going back a couple of years, the big hype here beside real estate was structured products distributed through banks and independent pushers on high commissions engaged in churning,” recalls Fotland. “And earlier this year Glitnir was one of the first casualties; it had bought a structured product pusher which lost its licence because of bad advice. Other big names were hit too. A Storebrand subsidiary also lost its licence and was closed while a large intermediary, Acta, was criticised for limited mis-selling but kept its licence.”

In addition, confidence was dented when four Danish savings banks collapsed in recent months.

“The Norwegian financial sector, particularly the banks, has been affected by the credit crisis,” says Pedersen. “In mid-October the government announced a plan to provide liquidity to the Norwegian banks in an effort to stimulate inter-bank lending, offering to take over mortgage loans and replacing them with long-term state bonds. A few days later the central bank lowered its interest rate - a move that had not even been considered necessary only a few weeks earlier.”

Earlier there had been what Fotland calls ‘Lehman Monday’. “That day there was no trading in Norwegian short-term liquidity,” he recalls. “The basic problem was that the short-term money market in Norway, the Norwegian LIBOR, is actually a function of the US LIBOR market and currency options, it is not traded as a separate currency it is an offset between a currency future and the US LIBOR market. So when the liquidity in the US currency stopped the Norwegian central bank had to go in and issue US dollar swaps just to get liquidity. I don’t think that it has ever had to auction dollar swaps before.”

And what impact has the turmoil had on pension funds? “Taking the long view pension funds will get through this,” says Rolf Skomsvold, secretary-general of the pension fund association. “But in Norway it is mandatory to have 8% capital at any time, so when equities started falling they had to sell before they reached that point. Forced to sell shares into a falling market, many lost a lot of money. Just how much depends on how much they had invested in equities but most had between 20% and 30% of their total balance in stocks and the value of that has halved since June, so they have seen 10-15% losses. As a result, although few have experienced serious problems, some have had to call in extra capital from their sponsors.” 

Among those affected was the NOK5.1bn municipal pension fund of Norway’s third-largest city Trondheim, which last month reported a NOK300m shortfall and asked the city to put in more money.

“The weeks since September have been very nasty indeed,” says Caspar Holter, senior partner at consultancy Pensjon & Finans in Oslo. “Normally pension funds see that what they have lost on equities will have been made up by fixed income. But this time they have lost on both fixed income and equities, September was a very bad month for fixed income, so there are huge losses in pension schemes and also in the life insurance industry.”

“The insurance commissioners are walking around on their toes looking for the latest financials,” says Fotland.

Last month the insurance supervisor asked pension funds to submit financial statements. This has exposed a problem of how to value their real estate holdings. “They are full up with real estate,” says Fotland. “But the accounting standards for real estate are rather vague, there is supposed to be a market value but when is a market value a market value? There is very little liquidity around because the life insurers are not selling and are holding at some kind of fake market value.”

Nevertheless, investors can buy fresh real estate at a completely different price. “So any corporates that really want real estate can leave their life insurance company, set up a pension fund and buy real estate. They can, in effect, short the life insurer, but you have to exit the life insurer, get the real estate at a different price or just go out and sit in the cash market. And some are doing this.”

He adds: “The life insurers might face liquidity problems, but not in terms of assets - they have all the assets - but from an arbitrages point of view. Because of an accounting trick in the insurance sector, they can keep book values higher than market values. But an assured pension scheme has a two-month option to move all assets into the cash market and then avoid the below-market value because they get paid the higher of book value than the market value. This means there is a huge arbitrage now going against the life assurance companies. So I believe that either there will be some liquidity strains or we will see the introduction of new rules saying you can short sell your life insurance company as they have with the short selling of stocks.”

“Indeed quite a few are actually panicking now and fleeing for safety by buying government bonds,” says Holter. “So we have seen that government bonds are over-bought at the moment; there is a huge difference between the effective yield of government bonds and credit bonds.”

But are there government bonds available to buy, given that oil and gas revenues solved the Norwegian government’s fiscal problems years ago? “When I started in the consultancy business back in 1997 the government’s issuance was about NOK700bn,” Holter says. “Now it is down to half that and they are only issuing paper to make the market more liquid. The market needs more paper, so the government should issue more but it doesn’t need to.”

were any steps taken to fend off problems? “Last December the government passed a new investment law that, while lifting the cap on investing in equities, put a cap on how much could be invested in different funds,” says Holter.

“It partially introduced the prudent person principle but said stay away from alternative investments. Hedge funds were especially affected, they are capped at 1% per fund up to 7% of the total investment of each pension fund and life insurance company. A lot of sub-prime loans had surfaced at the end of last year and this will have had an influence on the limit. Some funds had an alternatives exposure, although they were not heavily involved, but many had planned to go into it. In practice the limit had made it very difficult for them to invest in alternatives because it is too much of a hassle to find good managers to then only buy an exposure of 1%.

“Some two years ago we introduced obligatory pension funds, and they are all DC with individual unit-linked investment choices,” says Pedersen. “And these investors are likely to have lost money over the last few months. But their pension contributions will have been quite modest, only a fraction of very small accumulated contributions, so it hasn’t caused any particular uproar and it hasn’t really attracted any media attention.”

“When members of the new DC schemes look at their fund statements they will see that they have less rather than more,” says Fotland. “But there is no way they can get out of it so it, so they will have to look at the long term. And we do not have any evidence that there has been a major shift in these schemes’ allocations towards either bonds or equities. Anyway, they tend to be lower risk-based, with a pretty serious bond content already.”

But the launch of the new system, known as the minimum mandatory occupational pension (OTP), is adding to the pressure on the life insurers that dominate the pension provision sector in Norway.

“On the one hand the OTP schemes were very good for financial institutions because they suddenly got the whole working population as clients,” says Fotland. “But it is also quite clear that anybody who wants to go in and provide services in the DC sector, and that’s nearly everybody who can creep and walk in the financial industry, is losing money because the pricing is ridiculous.”

Life insurance giants Storebrand and Vital dominate the OTP market but even they are running the business as a substantial loss leader so they can sell other products, says Fotland. “It’s interesting to see how much they are willing to loose just to get clients,” he adds. “It’s like the mobile telephone sector where the companies nearly give the handsets away to get some other flows. But I guess once it starts to turn profitable some other people will come into the market.”

With the introduction of the OTPs the pension reforms proposed by an all-party commission chaired by former finance minister Sigbjørn Johnsen in a report released in January 2004 were more of less completed. However, public sector occupational pensions have yet to be adapted to the new reform. They are DB and guarantee members with 30 years of contributions 66% of a final wage including the statutory old age pension.

“If this principle is upheld, then the pension reform would not have any consequences for public sector employees, even though longevity will continue to increase,” says Pedersen.

“And here we are talking about more than one-third of the workforce. The Johnsen report was not very specific about public sector employee schemes but it clearly said that the schemes must be adapted to the reform’s basic principles like longevity adjustment and flexible retirement. But, for example, the 30-year contribution requirement for a full pension is in conflict with the principles of lifelong contributions in the general scheme. So if nothing is done the whole pension reform would lose its creditability.”

The government and trade unions have established a joint committee to prepare for negotiations on the pensions issue in the next collective bargaining round. “The final settlement of this issue could come in the spring of the next year,” says Pedersen. 

“Of course the unions want to hold on to their members’ privileges while the signal from the government has not been particularly clear. On the one hand it has been saying it will preserve the occupational pensions for public sector employees and that they will still be generous but on the other they have to be adapted to the principles of the new systems. So it seems the principle of longevity adjustment, with future pensions being reduced if longevity rises, will also be applied to the public sector employee schemes as will the principle of having an actuarially flexible and fair retirement age where the employee will pay for early retirement or reap the benefits of postponing it.”

Another outstanding issue is that of the tax incentives offered by voluntary third-pillar plans. “The government has long wanted to reduce the advantages quite drastically,” says Pedersen. “The issue of how far voluntary savings should be subsidised has been a consistent left-right divide and a very clear element of pension politics, with the centrist parties siding with the right and wanting more subsidies while the Labour Party has been consistently sceptical, seeing them as a subsidy for the better off sections of society. The 1992 tax reform switch to taxing gross rather than net income meant that the tax break was already rather modest. In the event, resistance by the trade unions meant changes did not go as far as the government wanted and some tax advantages are still in place.”

“They government actually took the tax advantages away last year,” says Holter. “And there was a row about that so they had to restore them. But the amount on which tax can be deducted has been reduced to NOK15,000.”