Investors neglecting EU member states' pension liabilities – EDHEC

EUROPE – Investors must do more to measure the impact of pension liabilities on public finances when analysing the solvency of European countries, the EDHEC-Risk Institute has argued.

The institute said it was "fundamental" to evaluate the extent to which increasing funding needs and decreasing coverage at public pensions could weigh on public deficits, particularly at a time when structural deficits became a target in the euro-zone.

"Due to the variety of national systems, obtaining a clear view of pension liabilities is not straightforward," it added.

"The recent 2012 Ageing Report [released by the European Commission last year] goes a long way in providing comparable figures and projections of public pension expenditures."

EDHEC, which based its results on the Commission's ageing report, has estimated a net present value of the corresponding liabilities for various discount rates.

While for the highest discount rate of 5% the report shows accrued-to-date liabilities around or above 100% of 2010 GDP in 18 EU member states, for a discount rate of 4%, 12 states are above 200% of the same GDP, and in the lowest hypothesis of 3%, 11 countries are above 400%.

The institute warned that the results of its analysis – which take into account pension liabilities – could lead to solvency analyses that are "substantially different" from those habitually taken into account by ratings agencies or investors.

"As such, countries with virtuous public finances in the Maastricht sense – such as, for example, Sweden, Luxembourg or Denmark – are much less virtuous if their public pension commitments are taken into account, while the situation of countries such as Spain, Italy or even Portugal is relatively better," EDHEC added.

According to institute, the risk factors that could erode these forecasts further are mainly demographic (an increase in the old-age dependency ratio), economic (persistent unemployment, a reduction in hours worked, stagnant potential GDP) and political (ensuring previous commitments are covered).

EDHEC finally pointed to the White Paper on Pensions released in February last year by the European Commission, in which Brussels called for adequate, safe and sustainable pensions across Europe.

In its response to the White Paper, EDHEC warned that the implementation of a common framework could lead to profound changes in national systems and called on investors to be more "vigilant" on pensions risk when evaluating the solvency of sovereign issuers.