Political interference in pensions raises concerns in Europe

The most blatant smash-and-grab raid occurred in Hungary, where government policy appears to herald the destruction of the country's 2.7 trillion forint ($12.8bn) private pensions system. Last month private pension fund participants were given until the end of January 2011 to transfer their pension assets to the state treasury or lose certain rights to their state pension.

The French government has already transferred €36bn assets of the pension reserve fund, the FRR, to the state's social debt-sinking fund, Cades, and the Irish government has promised to deploy the €24bn National Pensions Reserve Fund's resources "to support the exchequer's funding programme".

Such moves are not cost-free. Polish capital market players have expressed concerns that planned pension contribution cuts will have a negative impact on the local stock market, which may in turn endanger the government's privatisation campaign, undertaken to assist with the debt problem.

New measures will halt around one third of the annual 25bn zlotys ($8.3bn) inflow to the pension funds that goes to domestic equities. To put it in context, the largest Polish initial public offering, that of insurer PZU, raised 8bn zlotys.

The Polish government's move was triggered by deteriorating public finances and an election next autumn. The state deficit is approaching a politically sensitive threshold of 55% of gross domestic product.

If it hits that figure, a public finance law will require the government to increase taxes and further cut spending. It is already raising VAT. Deterioration to 60% of GDP would see the government dragged before the constitutional court. There will be longer-term costs to these pensions grabs.

They endanger two strategies designed to counter the problems caused by longevity. Under threat are the creation of pensions reserve funds in western Europe and the private pension systems established in eastern and central Europe.

The reserve funds are financed by government surpluses and designed to underpin a pay-as-you-go state pension system when it falls into deficit.

In eastern and central Europe pension reform accompanied the economic restructuring following the collapse of communism, with governments adopting a World Bank-promoted model under which a proportion of the contributions to the state pay-as-you-go pension is diverted to a participant's individual account, which is managed by a specially licensed private management company.

The system had many advantages. In addition to creating a funded pensions system it helped lay the foundations of a financial infrastructure in countries where the market had previously been officially illegal, created new globally linked and financially literate professions, and began the financial education of the population.

Hungary was the pioneer of the experiment, establishing its private pensions in 1997. Now it is the prime example of a threat to the system. Contributions to the private pension systems come from payments into the state pension systems.

But the new funds are in an accumulation phase, being too young to be paying out pensions. Consequently, although contributions are often a small proportion of relatively low salaries, the assets have grown to be substantial relative to individual countries' economies.

Just as in Hungary, governments throughout the region are tempted to claw back the contributions to the state system allocated to private pensions.

Dariusz Stanko, of the Warsaw School of Economics, said: "If governments lower the pension contribution they can use the money to finance current pension years, so reducing the deficit in the social security system, and not have to issue so many treasury bonds, which in turn means their public debt is lower.

But it is not lower in economic terms because they have assumed higher liabilities for future pension years."

This month the Polish government will unveil a cut in contributions to the private pensions sector from 7.5% of a gross salary to 5.0% and announce that for the next two years the payments will be solely in bonds dedicated to the pension funds.

Stanko said: "The idea is that the bonds will not be tradable, will be held to maturity and not have a coupon, but their face value will be indexed annually to nominal or real GDP growth. And the hope is they will not be counted as a public debt."

He said the contribution cuts were not a silver bullet: "Claims that pension funds create debt are not true, they just show the future pension debt."

There are suspicions that governments are motivated by political as well as economic factors. France's FRR was seen as vulnerable because it had been created by a left-of-centre administration but evolved under governments of the right that never warmed to it and restricted its funding.

And Hungary's death sentence on its private pensions industry was issued after a poll found only 30% of pension fund participants would voluntarily repatriate their funds to the state.

The new government reportedly felt that such a low level of support would have represented a substantial blow to its prestige.

• Summit to review controversy

The European Union will look at how it calculates the pension deficits of eastern and central European countries at the European Council summit on December 16 and 17.

The current method penalises countries that enacted fundamental pension reforms. The European Commission had made this a precondition of the countries' accession to the EU but has since undermined the reforms by adding to deficits the funds transferred from the social security budgets to the private pension companies.

Mihai Bobocea, general secretary of the Romanian pension fund association, said: "This anomaly arises because the contributions to the state are counted as revenues while the proportion transferred to private pension companies is considered expenditure.

This is not the case with implicit pension liabilities kept on the books while the resources set aside to meet future liabilities are penalised. It's utter nonsense. My hopes are high for the summit," he said.

Last month the region's pension fund associations attacked the commission in response to a green paper. The countries allege that the EC was either deliberately or accidentally failing to understand the structure and nature of their retirement schemes.

www.efinancialnews.com

READ MORE - Political interference in pensions raises concerns in Europe

UK Pension Deficits Widen 50%?

Via Pension Pulse.

The UKPA reports, Pension fund deficit 'widens 50%':

The funding shortfall faced by the UK's biggest pension schemes has widened by 50% during the past four years, research has suggested.

The deficit of the UK's 200 largest defined benefit schemes, including final salary pensions, remained broadly stable during November, rising by only £2 billion to £71 billion, according to consultancy firm Aon Hewitt.

The group said if the recent pattern continued into December, 2010 would have been one of the most stable years for pension scheme funding since 2006.

But despite the recent stability, the group said the funding shortfall faced by the 200 largest schemes had still soared by 50% during the past four years, rising from an average of £55 billion during 2006 to one of £87 billion this year.

Sarah Abraham, consultant and actuary at Aon Hewitt, said: "In the aftermath of the financial crisis, pension deficits crept up to record highs. In mid-June 2010, the deficit reached its highest level of £112 billion.

"In recent months, deficits have started to reduce, although this trend appears to have stalled. Stability is a good thing for any company trying to get a handle on the size of its pension scheme obligations, however, many employers will have been relying on further market recovery to recoup some of the losses incurred in recent years."

But the group said the Government's proposals to change the measure of inflation that pensions must be increased in line with each year from the Retail Prices Index to the Consumer Prices Index, which tends to be lower, would have a big impact on the deficits. It estimates that the move could reduce the shortfall the 200 biggest defined benefit schemes face by around £35 billion - effectively halving the current deficit.

Ms Abraham said: "Depending on regulation and how it is approached by companies and trustees, and as a result of the shift from RPI to CPI, we predict a decrease of up to £35 billion to the Aon Hewitt 200 deficit.

"This is large enough to make a dent in the deficit of the Aon Hewitt 200, but is nowhere near enough to wipe out the aggregate deficit and send it into surplus."

Defined-benefit pensions have become increasingly expensive to offer in recent years in the face of investment volatility and increased life expectancy.

Commenting on the shift from RPI to CPI, Louisa Peacock of the Telegraph reports, Pensions RPI link could be revoked to save £100bn:

A Government consultation is today expected to unveil how companies that have the Retail Prices Index (RPI) measure of inflation "hard wired" into their schemes can benefit from linking payments to the Consumer Prices Index (CPI), which excludes housing costs.

The Government first announced the switch from RPI to CPI in the June Budget, which pensions experts said could reduce the estimated £239bn pensions black hole by about £100bn.

However, industry figures warned in July that companies with schemes that had RPI expressly listed as the statutory payment could not take advantage of the new rules unless the law changed. This is because it would be a worsening of benefits.

Speaking at the National Association of Pension Funds (NAPF) conference yesterday, employment minister Steve Webb said today's consultation would look at how to "make it easier" for all companies to take advantage of the switch.

Communications giant BT revealed last month that linking pension increases to CPI reduced its mammoth pension fund deficit from £7.9bn to £5.2bn.

But NAPF research, published today, found 61pc of companies have RPI stated in their pension schemes, meaning the majority of companies would be unable to switch to CPI unless the Government overruled the current legislation.

Almost half (48pc) would make use of a new legal power to switch to CPI, while just 21pc would not – preferring to maintain generous benefits for current and future staff, the study of 162 employers found.

Joanne Segars, NAPF chief executive, said: “The question of whether a pension can move to CPI is making it very difficult for pension funds to plan ahead. The Government has significantly underestimated the complexity of letting schemes switch their inflation measure. A seemingly simple change has become much trickier."

However, Ms Segars said allowing companies to switch to CPI does not necessarily mean they would. "There are implications for current and future pensioners," she said. "Trustees and employers know that any switch must be handled carefully."

Nick Griggs, an employment partner at Barnett Waddingham, said: "[The consultation] is welcome news for a significant number of employers. Whilst it is going to be hard to implement it will hopefully remove the drafting lottery that could have existed depending on whether RPI was hard coded into the rules or not.

"Whilst members will rightly find it difficult to accept a reduction in their benefits this must be considered in the context of the ever increasing cost of final salary benefits that employers have had to bear in recent years.”

The CBI urged the Government in July to bring in a piece of "overriding legislation" so that all companies could benefit from the switch, expected in April 2011.

Switching to CPI will significantly reduce UK pension deficits, but it won't eliminate them. And the switch won't be easy to implement. There will be opposition as many feel the CPI grossly underestimates the true inflation rate. Indeed, industry experts believe companies could be sued by their pension schemes if government plans to cut costs using lower inflation assumptions for public sector pensions are copied by the private sector.

But with the pension black hole getting larger, there is pressure to reign in pension deficits using any means possible, including switching the inflation measure that is used for cost of living adjustment. Policymakers around the world will be watching these developments closely as they struggle to cope with ever widening pension deficits in their countries.

Below, UK pensions minister Steve Webb, who has vowed to 'make it easier' for companies to benefit from the RPI switch, discusses some changes his government has proposed to bolster the pension system. It remains to be seen how smoothly the switch to CPI will go.

READ MORE - UK Pension Deficits Widen 50%?

Political interference in pensions raises concerns in Europe

The most blatant smash-and-grab raid occurred in Hungary, where government policy appears to herald the destruction of the country's 2.7 trillion forint ($12.8bn) private pensions system. Last month private pension fund participants were given until the end of January 2011 to transfer their pension assets to the state treasury or lose certain rights to their state pension.

The French government has already transferred €36bn assets of the pension reserve fund, the FRR, to the state's social debt-sinking fund, Cades, and the Irish government has promised to deploy the €24bn National Pensions Reserve Fund's resources "to support the exchequer's funding programme".

Such moves are not cost-free. Polish capital market players have expressed concerns that planned pension contribution cuts will have a negative impact on the local stock market, which may in turn endanger the government's privatisation campaign, undertaken to assist with the debt problem.

.

New measures will halt around one third of the annual 25bn zlotys ($8.3bn) inflow to the pension funds that goes to domestic equities. To put it in context, the largest Polish initial public offering, that of insurer PZU, raised 8bn zlotys.

The Polish government's move was triggered by deteriorating public finances and an election next autumn. The state deficit is approaching a politically sensitive threshold of 55% of gross domestic product.

If it hits that figure, a public finance law will require the government to increase taxes and further cut spending. It is already raising VAT. Deterioration to 60% of GDP would see the government dragged before the constitutional court. There will be longer-term costs to these pensions grabs.

They endanger two strategies designed to counter the problems caused by longevity. Under threat are the creation of pensions reserve funds in western Europe and the private pension systems established in eastern and central Europe.

The reserve funds are financed by government surpluses and designed to underpin a pay-as-you-go state pension system when it falls into deficit.

In eastern and central Europe pension reform accompanied the economic restructuring following the collapse of communism, with governments adopting a World Bank-promoted model under which a proportion of the contributions to the state pay-as-you-go pension is diverted to a participant's individual account, which is managed by a specially licensed private management company.

The system had many advantages. In addition to creating a funded pensions system it helped lay the foundations of a financial infrastructure in countries where the market had previously been officially illegal, created new globally linked and financially literate professions, and began the financial education of the population.

Hungary was the pioneer of the experiment, establishing its private pensions in 1997. Now it is the prime example of a threat to the system. Contributions to the private pension systems come from payments into the state pension systems.

But the new funds are in an accumulation phase, being too young to be paying out pensions. Consequently, although contributions are often a small proportion of relatively low salaries, the assets have grown to be substantial relative to individual countries' economies.

Just as in Hungary, governments throughout the region are tempted to claw back the contributions to the state system allocated to private pensions.

Dariusz Stanko, of the Warsaw School of Economics, said: "If governments lower the pension contribution they can use the money to finance current pension years, so reducing the deficit in the social security system, and not have to issue so many treasury bonds, which in turn means their public debt is lower.

But it is not lower in economic terms because they have assumed higher liabilities for future pension years."

This month the Polish government will unveil a cut in contributions to the private pensions sector from 7.5% of a gross salary to 5.0% and announce that for the next two years the payments will be solely in bonds dedicated to the pension funds.

Stanko said: "The idea is that the bonds will not be tradable, will be held to maturity and not have a coupon, but their face value will be indexed annually to nominal or real GDP growth. And the hope is they will not be counted as a public debt."

He said the contribution cuts were not a silver bullet: "Claims that pension funds create debt are not true, they just show the future pension debt."

There are suspicions that governments are motivated by political as well as economic factors. France's FRR was seen as vulnerable because it had been created by a left-of-centre administration but evolved under governments of the right that never warmed to it and restricted its funding.

And Hungary's death sentence on its private pensions industry was issued after a poll found only 30% of pension fund participants would voluntarily repatriate their funds to the state.

The new government reportedly felt that such a low level of support would have represented a substantial blow to its prestige.

• Summit to review controversy

The European Union will look at how it calculates the pension deficits of eastern and central European countries at the European Council summit on December 16 and 17.

The current method penalises countries that enacted fundamental pension reforms. The European Commission had made this a precondition of the countries' accession to the EU but has since undermined the reforms by adding to deficits the funds transferred from the social security budgets to the private pension companies.

Mihai Bobocea, general secretary of the Romanian pension fund association, said: "This anomaly arises because the contributions to the state are counted as revenues while the proportion transferred to private pension companies is considered expenditure.

This is not the case with implicit pension liabilities kept on the books while the resources set aside to meet future liabilities are penalised. It's utter nonsense. My hopes are high for the summit," he said.

Last month the region's pension fund associations attacked the commission in response to a green paper. The countries allege that the EC was either deliberately or accidentally failing to understand the structure and nature of their retirement schemes.

www.efinancialnews.com

READ MORE - Political interference in pensions raises concerns in Europe

Pension Accounting Change to Hit Profits?

Via Pension Pulse. Bob Tita of the Dow Jones Newswire reports in the WSJ, Pension Accounting Change Could Make Company Profits Less Predictable: Efforts to make pension accounting more transparent could cause corporate profits to become more volatile if gains and losses from pension assets are mingled with results from companies' business operations. The agency for international accounting standards is expected to take up a proposal next year that would require companies with defined-benefit pensions to report annual changes in the value of their pension assets as part in their income statements. Under current procedures, returns on pension investments and gains and losses in pension-plan assets are accounted for in small increments over several years to keep them from skewing companies' earnings.    The change would provide a more immediate snapshot of companies' pension-plan performance. But U.S. companies, aside from Honeywell International Inc. (HON), have so far been reluctant to voluntarily change their pension accounting. Observers warn that investors could be subjected to bouncier stock prices if earnings become significantly less reliable with the addition of unpredictable gains and losses from pensions.  "If we've learned nothing else over the last three years, it's that the market isn't always rational," said Alan Glickstein, senior consultant for Towers Watson, an employee benefits consultancy. "It's not necessarily a good thing if [the accounting change] just increases earnings volatility." If the International Accounting Standards Board--the nongovernmental agency for accounting rules used by companies outside the U.S.--adopts the change for pension accounting, observers predict the Financial Accounting Standards Board will follow suit for the sake of consistency and amend the Generally Accepted Accounting Principles used by U.S. companies.  "To the degree that a company wants to make sure that their financials are reflective of their operations, it would make sense to go through a change like this. It would add transparency to the numbers," said Daniel Holland, an analyst for research firm Morningstar Inc. More than 340 companies in the Standard & Poor's 500 Index have defined-benefit pensions that guarantee employees pension incomes when they retire. To meet these obligations, the companies have set aside a combined $1.22 trillion that is invested in stocks, bonds and other types of investments. Smoothing out annual gains and losses from defined-benefit pensions has come under increasing scrutiny as regulators dismantle other accounting practices used for decades to wall off pension costs and liabilities from companies' balance sheets and their profit statements. "The pension volatility has always been there. It's just not measured today. The accounting doesn't require that it be highlighted," said David Larsen, managing director for corporate finance consulting at Duff & Phelps Corp., a financial services and investment banking advisory firm. Honeywell is the largest U.S. company to begin using market-to-market accounting for its pension. The move is intended to put the brakes on escalating costs for Honeywell's pension. Falling interest rates on bonds used to determine companies' future pension obligations have driven up annual pension costs for all companies with defined-benefit plans. But Honeywell's expenses have been exacerbated by a decision it made in the late 1990s to use a six-year schedule for amortizing pension gains and losses on pension assets and a three-year schedule for smoothing out returns from pension investments. Most companies amortize gains and losses over 10 years or 12 years and account for investment returns over five years. Honeywell's shorter time frame helped the company lower its pension expenses when asset values soared. But when pension-fund performance tanked in 2008, Honeywell's pension headwinds were magnified in its earnings. Without the option of switching back to a longer amortization schedule, Honeywell will stop deferring gains and losses. The aerospace and building-systems manufacturer will recognize $5.5 billion in prior asset losses in its 2010 income statement. Going forward, Honeywell will report gains and losses in their entirety during the year they occur. The change will increase the company's pension costs for this year to $1.61 billion, compared with $791 million under the six-year schedule. But its pension expenses are expected to plunge to $200 million in 2011. "It takes all that old stuff and puts it behind them," said Howard Silverblatt, an analyst with Standard & Poor's investment services unit. Once the slate is wiped clean, Honeywell aims to limit its pension expenses to about $200 million a year. Moreover, the company will attempt hold down pension-related volatility in its earnings by making pension asset values and returns more predictable than in the past. "I can see investors having this fear that every fourth quarter there's going to be this wild swing," Chairman and Chief Executive David Cote said during a Nov. 16 conference call with analysts. "More likely than not, that is not going to happen." In the coming years, Honeywell plans to shift more of its pension funds from equities to fixed-income investments. That will lower annual returns to 6.5% from 9%, but will lessen Honeywell's exposure to sudden swings in stock values and returns that would contribute to earnings volatility. If mark-to-market pension accounting becomes the standard, other companies will likely change their investment mix as well, creating a profound shift in the allocation of pension funds the next decade.    "I would expect it to take a while, but pension assets would shift to less volatile securities," Morningstar's Holland said. Is there a "profound" shift in asset allocation going on? I'm not convinced. If corporate plans adopt mark-to-market pension accounting rules, they will reduce pension costs and likely shift assets into less volatile securities, winding up their existing defined-benefit plans while scrapping them for new employees (moving them into defined-contribution plans). But I've already discussed that while private pension plans are reducing risk, most public plans are increasing risk, continuing to invest the bulk of their assets in equities and alternatives. Public plans are much larger and shifts in their asset mix carry a lot more weight. In other words, we can speculate all we want, but it remains to be seen whether a "profound" shift in asset mix will take place over the next decade, even among corporate plans. Of course, if Charles Nenner is right (see Yahoo Tech Ticker interview below), and a Japan-style slump hits the US economy, then corporate plans adopting Honeywell's approach might come out ahead. I don't agree with Mr. Nenner (correlation does not imply causation!!!), but if he's right, bonds will continue to outperform over the next decade.www.zerohedge.com

READ MORE - Pension Accounting Change to Hit Profits?