The growth of an equity culture has been one of the success stories of continental European investment over the past 10 years, and pension funds have been an important part of this. Funds in Scandinavia, Switzerland and the Netherlands in particular have steadily increased their exposure to equities to take advantage of a bull market. As a result they have been able to increase their yields and build up their reserves
However, the events of 11 September have threatened to reverse much of this. Equity values, which were declining anyway this year, have gone into free fall. A recent analysis from pension consultant William M Mercer shows that between 1 April last year and 20 September Euro-zone equities fell 38%, US equities fell 32%, UK equities fell 29% and Japanese equities fell 43%.
Falling equity prices are eroding pension funds capital bases. In the UK the National Association of Pension Funds, which represents occupational pension fund trustees, is considering asking for a temporary suspension of the Minimum Funding Requirement (MFR).
Companies that have hitherto basked in the sunshine of a contributions holiday have suddenly been forced to pump cash into their employee retirement schemes. This could affect their creditworthiness. Credit rating agency Standard & Poor’s says that it is currently looking at the impact of pension fund liabilities on companies’ creditworthiness. The increased cashflow from companies into their pension funds could be one factor in a decision to lower their credit ratings
Ultimately, this could persuade some employers to abandon final salary schemes in favour of defined contribution (DC) schemes – effectively shifting the risk of stock market falls from employers to employees
In some countries, the US crisis has pushed some pension funds to the brink of insolvency. Danish pension funds have progressively increased their holding of equities over a number of years. It was therefore inevitable that they would experience large losses after the fall in equity prices that followed the events of 11 September.
Over the year to the end of September, Danish equity values have fallen by 24% and overseas equity values have fallen 28%. However, half of this fall has occurred since 11 September. Since that date, domestic stocks have fallen 12% and overseas equities have fallen 14%.
The effect of this on pension fund assets and returns has been dramatic. At the end of June, DIP, the pension fund for engineers, with some 13,500 members, had 47% of its portfolio invested in equities – 17% in listed Danish equities, 28% in overseas equities and 2% in unlisted equities. As a result, the value of its assets fell from DKr20.7bn (e2.8bn) at the end of June to DKr18.9bn by the end of September.
The return on equities in the year up to the beginning of August was a modest 0.3% on Danish equities, and –1.5% on overseas equities. The total return on investments was 0.4%.
However, six days after the events of 11 September, returns on listed Danish investments slid to –15.5% and –22.4% on overseas equities. A week later, returns fell to –21.47% on Danish equities and –27.8% on overseas equities. The total return on investments at the end of September was -9.6%.
DIP’s response to the crisis has been to reduce its equity allocation from 47% to 43% of its portfolio and reassure its members that it has sufficient reserves to meet the situation
Some Danish pension funds have fared far worse. PFA Pension, Denmark’s largest pension fund insurer, lost so much capital after 11 September that it was unable to meet capital requirements. It has now suspended the provision of new pension schemes.
Henrik Heideby, managing director of PFA Pension, says the fund faced “unheard-of” capital losses in less than two weeks. “We have to realise that the capital losses of the PFA Group imply that the bonus reserves are exhausted.” At the end of 2000, the reserves totalled DKr18.2bn.
Heideby says PFA Pensions was unable to sell off stock, for a number of reasons: “We wanted to have a considerable holding in Danish stocks in order to contribute towards the growth of Danish society. These stocks are not liquid considering the present market conditions. It is not possible to divest a large holding of Danish shares without experiencing further considerable capital losses, which could jeopardise the national economy as well.”
PFA Pension has now drawn up a recovery plan for approval by the Danish Financial Supervisory Authority. As part of the plan, PFA has reduced the deposit interest rate from 8.5% – a year after pension yield tax – to 4.5% a year from 1 October. As a result pension members can expect lower bonuses.
PFA has also attempted to prevent people withdrawing funds by imposing a 5% price indemnification charge on any transfer or surrender of pension savings after 24 September. The rate will be adjusted according to PFA’s future capital position.
A recovery in the market has enabled the fund to comply with capital adequacy requirement. However, it still needs capital, and has hired Alfred Berg Corporate Finance to devise ways of raising new capital investment, either new net capital or subordinated loan capital.
Other large funds have fared better. PKA, Denmark’s largest administrator of occupational pension funds, has assured the 165,000 members of its eight funds that its reserves are sufficient and their pensions are safe.
Claus Skadhauge, head of information at PKA, says: “We have had no problem whatsoever and that has been obvious for the whole crisis. It is a very serious problem for some funds and people are right to be concerned but we have been tucked up nice and tight through the whole crisis. We have sufficient reserves to match our exposure to risk. The market can drop 30% before we get into trouble.”
However, like others, the fund has reduced its exposure to equities. At the end of 2000 the eight pension funds that PKA manages had equity exposures ranging from 37% to 44%. This has now been progressively reduced to an average of 33%.

This reverses a long period in which PKA has increased its exposure to equities. Skadhauge says the retreat is only temporary. “For the time being we are not investing in stocks but it doesn’t mean we have turned against stocks. We have been building up stocks in our portfolio for many years and we will continue to do so when the markets become more settled.”
In some respects, the US crisis has served only to accentuate the trend of 2000 – falling equity prices and diminishing investment returns. This is the picture in Switzerland. On the same day that terrorists attacked the US, the Swiss Pension Fund Association (ASIP) released the results of a survey of pension fund returns in the first half of 2001 carried out by consultant Watson Wyatt.
The survey of 60 pension funds with assets of SFr80bn (e53.9bn) – a fifth of all pensions fund assets in Switzerland – showed that funds had managed a median return of –2.2%, with half of the funds reporting returns of worse than –2.2%. This compares with returns of more than 11% in 1999 and 1.5% last year.
The flight from equities had already begun. The ASIP/Watson Wyatt survey also showed that pension fund managers had already begun to reduce their exposure by an average of 2.6%.
Since then, global markets have fluctuated wildly. The Swiss Market Index (SMI), the prime benchmark for Swiss equities, fell 16% to below 5,000 points on 21 September, and its lowest level since 1997. Within a week it had bounced back 17.7% to over 6,000. However, Watson Wyatt warns that pension funds must expect worse yields for the second half of 2001.
This will mean that they will find it difficult to meet the legally prescribed interest rate of 4%. Unofficial estimates suggest that that only 20% of Swiss pension funds this year will achieve this rate. If they fail to achieve this, the federal law on occupational pensions requires them to draw on their reserves.
This requirement will particularly affect pension funds that have been set up in the past few years. Unlike older established funds, these funds have been unable to build their reserves on the back of the stockmarket boom. As a result, they do not have the cushion of reserves they need.
Swiss pension funds have been hit by the behaviour of the markets. In turn, their behaviour has affected the markets. The position of large institutional investors is crucial in the Swiss equity markets. In particular, the buying and selling habits of the Swiss pension funds, which administer SFr500bn of assets, provide stability to the market.
Pension funds’ strategic asset allocation will determine what proportion of their portfolio is held in shares. If the value of equities falls, so does the importance of the equity allocation as a proportion of the portfolio. Conversely, the share of time deposits, bonds or property will increase in importance
To maintain their strategic asset allocation, pension funds will normally buy shares at the end of each month. This guarantees a market for equities. However, in a crisis, pension funds behave differently.
What alters their strategy is the need for adequate cover – the ability of a fund to cover its liabilities. Pension funds whose cover has fallen below 100% will draw on reserves. If they do not have sufficient reserves they will be forced to sell some of their equity holdings.
Many pension funds are adequately covered. The City of Zurich pension fund, for example, currently has a cover of 128%. However, others are not so fortunate and will have to sell into a market where they are normally buyers.
Coverage is also an issue in the Netherlands, where regulators are expecting the currently healthy picture to alter at the end of this year.
The Pensioen-Verzekeringskamer (PVK), the pensions and insurance supervisory board that regulates almost 1,000 pension funds in the Netherlands, imposes a legal requirement on pension funds to maintain a 100% balance between liabilities and assets at the end of each year.
It also demands a buffer, the width of which will depend on how a pension fund invests. The riskier the investment, the wider the buffer
will be.
PVK figures show that at the end of 1999, the average cover was 150%. This had dropped to 140% by the end of 2000. “It could be a little or a lot lower at the end of this year, depending on how the markets behave,” says Loek van Daalen, PVK’s information consultant.

Dutch pension funds may have to adjust to different reserve requirements in future, irrespective of the crisis. In September, the PVK issued the first stage of a new assessment framework to improve transparency of pension fund reporting and to bring it in to line with international practice.
The initiative, laying down policy rules for financial testing, was launched in 1999 under the name New Actuarial Principles (NAP) and has since been renamed Financial Assessment Framework (Financial Toetsingskader FTK). Dirk Witteveen, chairman of the PVK board says that FTK will mean changes in the ways pension funds calculated their reserves “The PVK in no way intends the new framework to lead to the imposition of stricter average reserve requirements. However, at the level of the individual institution, depending on their risk profile or risk management practices, there may be a higher as well as a lower financial requirement than required at present.”
Other organisations in The Netherlands have seen the current crisis, as further evidence that pension funds, in particular the smaller ones, need a solvency safety net.
The NBP (Nederlandse Bond voor Pensioenbelangen) which represents interest of 30,000 pension members, has proposed the creation of pensioengarantiefonds (pension guarantee fund) along the lines of bank guarantee funds currently operated by De Nederlandsche Bank
In a plan promoted by NBP’s adviser Pieter de Wint, it suggests that guarantee fund could be funded by a levy on the pension funds themselves. The need for such a fund pre-dates the US crisis, and NBP cites the bankruptcy of Fokker in particular. However, the events of 11 September have given added impetus to the proposal.
NBP estimates that currently around 100 pension funds face financial
difficulties.
The response from pension funds has been mixed. The largest funds, like PGGM, say a guarantee fund is unnecessary. VB, the organisation that represents industrywide pension schemes, is also opposed to the idea. Smaller funds however support the proposal, while PVK says it is keeping an open mind.
So what has the impact of the US crisis been on European pension funds overall? The reaction of international pension consultants has been – understandably – “don’t panic”. In the long term, markets will recover, they say. Even in the medium term, markets have performed well.
Consider Ireland. Consultants William M Mercer points out that the aim of most Irish pension schemes is to achieve 4–5% above inflation. Irish pension funds have achieved annualised return of 11.1% per annum over a five-year period which included the blackest month of September. So with inflation running at 3.3% during this period, funds actually managed a return of almost 8%.
Pension funds themselves say they are not going to turn the clock back to pre-equity days and remain in the safe haven of cash or property. They will return to equities. The only question is when.

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