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Asset Pooling: CFOs drive change in Europe's pension market

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A few years ago, General Motors was making the headlines for all the wrong reasons. The carmaker’s pension funds in the United States had run up a financing gap of almost USD 18 billion. Generous retirement and health care payouts were, said one newspaper, “eating GM alive”.

Since then, GM has pulled itself back from the brink. But the process was painful. The company went through a restructuring that saw it lay off thousands of workers and sell off some of its businesses.

Of course, GM was not alone. Falling share prices and changes to international accounting rules in the early 2000s left many company pension funds in both the United States and Europe severely underfunded.

The gathering storm did much to raise the profile of pension issues in boardrooms across the world. Suddenly funding workers’ retirements was no longer just a matter for the human resources department. The problem landed on the desk of the company CFO.

In Europe, the question of how to fund company pensions is, if anything, more complex than in the United States. Late last year, a global survey of pension experts found that the maze of different national pension arrangements in Europe makes the continent much harder to navigate, both for multinationals and for local groups (see chart below). Moreover, the survey, carried out by LIMRA International and the AEGON Pension Network, showed that many CFOs are beginning to realise that this complex set-up is adding to company costs. In effect, the lack of a single, harmonised pension system is making labour overall more expensive, and ultimately harming the competitiveness of European companies.

Ninety-three per cent of panellists agree that most companies find the complexity of European pension plan provisions difficult to navigate. This complexity, in turn, affects the cost of providing retirement benefits to the population.

Seventy-six per cent of exerts aggress that the differences in the cost of providing pension plans between Europe and other parts of the world affect the competitiveness

Source: LIMRA International-AEGON Pension Network global pension survey, December 2006.

Not surprisingly, CFOs across Europe have started to look for a different approach – a more international one that would make management of their sometimes disparate pension plans more efficient, and their costs easier to control. As one solution, a handful of large multinationals has already turned to ‘asset pooling’ – effectively bringing all their pension assets under one roof.

At the end of 2005, Unilever, one of the world’s largest consumer products companies, took a first step in this direction. In what is widely regarded as a landmark move in the industry, Unilever launched Univest, a new pension asset pooling vehicle, which it said should “reduce risk and enhance net return potential”. In all, Unilever’s new fund was expected to control between EUR 3 billion and EUR 5 billion in retirement assets. Almost two years on, other groups are going down a similar route, among them energy group Shell and IBM, the computer company.

Clear advantages

For these companies, asset pooling – switching assets held under separate national funds into a series of large central funds – has some clear advantages. Not least is the question of governance. For some multinationals, with operations in a number of different countries, keeping track of pension assets and liabilities in different places has proved far from straightforward. Asset pooling partially solves that problem by giving the CFO greater visibility and greater control, not only over financial risk but also over some of his company’s broader decision-making processes.

Another advantage, of course, is clearer and more transparent management of administrative costs. By definition, overseeing a central pool is easier than overseeing twenty, thirty or forty different pools. Potentially, for the company CFO, fewer funds may mean fewer resources are needed to accomplish the same task. Last year’s LIMRA International-APN survey asked multinational companies from around the world where exactly they expected the greatest efficiencies from cross-border pension plans to emerge. More than half – 52 percent – replied: “asset pooling” (see chart below).

Panellists from multinational firms expect asset pooling to be the biggest benefit of plan convergence and are least likely to expect increased efficiencies from reporting systems.

Source: LIMRA International-AEGON Pension Network global pension survey, December 2006.

In black and white

For most company CFOs, the question of pensions has become gradually more pressing in recent years. After the funding crisis in the United States and Europe – and the widely reported problems at GM – a combination of new accounting standards, tax reform and changing demographics has brought the issue into sharp relief.

Crucially, International Financial Reporting Standards (IFRS), when first introduced in 2005, obliged companies to re-value their pension assets every year and include any variations on their balance sheets. Though the system has since been refined, this accounting change made a significant difference. Overnight, CFOs – and, just as importantly, their shareholders and investors – could see exactly how well, or how badly, their assets had been faring. Underfunding problems started to show up, in black and white, on the corporate balance sheet.

If all this wasn’t scary enough to prompt a rethink, then CFOs have plenty of other things to worry about. The fact is, pressure on corporate pension funds is increasing. It’s well known that, in many countries around the world, life expectancy rates are increasing. By 2050, more than a quarter of the European population will be over 65, up from about 16 percent now. At the same time, the workforce available to fund retirement plans is dwindling. As a result, many governments which were providing very generous state pensions have begun to shift more responsibility to the private sector – and that means individual companies.

Big news

Changing demographics and new accounting rules have been prodding CFOs in Europe into thinking again on pensions. But it is a change in tax regulations that is persuading many that a new approach like asset pooling may at last be feasible.

There is also a broad consensus among panellists that countries will relax rules and limits on investing, making it easier for pension plans to pool assets internationally.

Source: LIMRA International-AEGON Pension Network global pension survey, December 2006.

Europe is now witnessing a fundamental shift in its pension industry. Prompted by efforts at political and regulatory reform at the European level, a number of countries – most notably Luxembourg, Ireland and the Netherlands – are setting up new, tax-transparent asset vehicles, actively promoting themselves as locations for asset pooling. These vehicles allow pension funds to make indirect cross-border investments, but still maintain the kind of advantageous tax rates that, in the past, they could claim only in their own countries.

This may seem like a technical change, but for Europe’s pension industry, it has been big news. For many years, the uneven withholding tax landscape in Europe was arguably the most daunting obstacle to managing workable cross-border pension plans. Lowering that barrier has suddenly made it possible for CFOs, really for the first time, to consider measures such as asset pooling.

AEGON Pension Network believes this trend is likely to continue in the years ahead. Pressure for change from multinational companies will see the market for asset pooling blossom, whether that is based on the current set-up or, in fact, on other European countries following the lead set by Luxembourg, Ireland and the Netherlands.

For Europe’s pension business, asset pooling may be only the start of something far more significant. Different tax and retirement regimes mean that the pension industry in Europe has grown up, over the years, along mostly national lines. That could be about to change. While it should be remembered that mechanisms such as asset pooling are just a first step, they do hint at the beginnings in Europe of a more coordinated cross-border pension industry.

But what would that mean for the future of Europe’s pension business? It is clear that the asset management industry as a whole is far more fragmented on this side of the Atlantic than on the other. In terms of value, the United States has more assets under management than Europe, yet Europe numbers considerably more pension and investment funds. That fragmented structure – a reflection of different national retirement systems – means that, in effect, pensions have become part of the problem of Europe’s relatively uncompetitive labour costs.

Any shift towards a more cross-border industry within Europe would inevitably bring a period of possibly painful adjustment. It seems likely that, in the coming years, the search for efficiency and economies of scale will reduce the number of funds in Europe. The upside of this adjustment, of course, is that it will also shrink the cost to its leading companies of running Europe’s pension systems – something that will, in the end, have a beneficial, flowthrough effect on the continent’s economies.

Clear trend

The trend towards more cross-border solutions for company pension plans is clear enough. But that doesn’t mean all obstacles have simply vanished. Cross-border solutions can be complex. To work and achieve its objectives, asset pooling, for example, requires a clear and effective management structure. For many multinational companies, operating in a number of different countries, one of the toughest challenges will be a managerial one: striking a balance between the obvious advantages of greater centralisation in pension management and the need to preserve local responsibility and local decision-making.

There may be a clear trend towards reform. But what is also apparent is that, for the moment, it is large multinationals that are driving the process, rather than Europe’s politicians. Unsurprisingly, for such a complex area, political efforts to harmonise Europe’s pension systems in recent years have proved far from straightforward.

At a political level, Europe has been actively pushing for further pension reform. The European Union Commission called for a shake-up of the industry more than a decade ago. And, in September 2005, a new pension directive was introduced. But, understandably, reform has proved difficult and translating such measures into real change tricky. For many CFOs, pension reform has been advancing too slowly. There’s no doubt that a growing number of particularly large, multinational companies are beginning to say that they cannot wait for regulatory or legislative change; they have to come up with solutions of their own now.

Most panellists feel global organisations will lead this initiative to consolidate as many pension plans as possible into one efficient arrangement. These firms, and their associated trade groups, will seek a convergence of pension plan regulations, such as tax treatment of contributions, vestment rules, and funding levels.

Source: LIMRA International-AEGON Pension Network global pension survey, December 2006.

Those within the insurance and pension business who have been most interested in reform and most active in promoting solutions such as asset pooling tend to be found not among pension providers, but from the custodial side of the industry – those firms that administer often billions in assets on behalf of investors such as banks and insurance companies. Custodians are in an ideal position to see and understand the technical benefits of bringing pension assets together in a central fund.

Off the peg

Very soon, though, pension providers will have to make moves of their own, pushing both the issue of asset pooling and the wider cause of cross-border pension reform, into new territory. A handful of companies, especially the large multinationals, may have the size and expertise needed to introduce asset pooling on their own. But for others the task will prove too onerous. Increasingly, they will turn to pension providers to come up with cross-border asset management solutions for them.

All this is part of a natural progression. These new solutions will inevitably be more generic, more ‘off the peg’ in nature than those the industry has seen up till now. That should boost demand for asset pooling and eventually prove a significant step on the road to building a genuine market in Europe. A key test for pension providers in the next several years will undoubtedly be developing such solutions, while at the same time ensuring they still meet the specific needs of individual companies.

Of course, asset pooling is just one possible solution for CFOs searching for cross-border solutions to cross-border issues. Others, still for the time being in a developmental phase, include designing retirement plans for expatriate employees, or products aimed at helping CFOs track pension risks and liabilities.

Some internationally-minded pension providers have already realised which way the wind is blowing and are moving in that direction, putting in place new structures and new products to meet the changing requirements of their clients. For CFOs grappling with increasingly complex pension issues, that will be welcome news.