Financial Crisis & Pension Funds: An Analysis

No. 2|2009

International Pension Papers

How the financial crisis affects pension
funds: What analysts expect

Allianz Global Investors International Pension Papers No. 2|2009

Content
Critical issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Proposition 1: The financial crisis has demonstrated that retirement income security
can essentially only be reached by public pay-as-you-go systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Proposition 2: Pension funds stabilize the financial markets thanks to their long-term investment horizon . . . . . . . . . 5
Proposition 3: Pension funds will increasingly apply the criteria of socially responsible investing
in investment decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Proposition 4a: The trend that firms fund their pension liabilities will continue (only Germany) . . . . . . . . . . . . . . . . . . . 7
Proposition 4b: The financial crisis will accelerate the shift from defined benefit
to defined contribution plans (only Switzerland) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Proposition 5: Companies will reduce (voluntary) contributions for occupational pensions
as a consequence of the financial crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Proposition 6: Employees will reduce contributions to occupational / private pension schemes
as a consequence of the financial crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Recent publications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Imprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

2


How the financial crisis
affects pension funds:
What analysts expect

Critical issues

Financial market experts in Germany and Switzerland recently were asked to share
their views on the consequences of the financial crisis on pension funds and pension
provision. The survey was conducted by the Centre for European Economic Research
(ZEW) on behalf of Allianz Global Investors. Here are the key findings:

• Most analysts in both countries do not think that the financial crisis proves that public
pay-as-you-go systems are superior to funded pensions

• German analysts tend to believe that pension funds play a stabilizing role on the
financial markets; Swiss analysts tend to disagree

• A large majority of German analysts expects that the funding of unfunded pension
promises in Germany will continue

• Most Swiss analysts believe that the financial crisis will accelerate the shift from
defined benefit to defined contribution plans in Switzerland

• Analysts are split on whether pension funds will increasingly invest according to
socially responsible investment criteria

• Most German and Swiss analysts think that employers will reduce their pension
contributions due to the financial crisis; a slight majority believes that employees
will reduce their contributions

3


How the financial crisis affects pension
funds: What analysts expect

T he financial crisis is now in its second
year and it is unclear how severe its
future consequences will be. One of the
To get answers to these questions, the
Centre for European Economic Research
(ZEW), on behalf of Allianz Global Investors,
crucial questions is: How will the downturn asked financial market experts for their views
affect retirement income, specifically the and expectations on these issues. The ZEW’s
future development of funded pensions monthly Financial Market Test asks experts
and pension systems? The financial crisis from banks, insurance companies and indus-
could affect pension provision in many trial companies for their near- to medium-
ways on many levels. For the purpose of this term economic expectations. Participants
study we looked at a number of key areas. were asked to answer several supplementary
questions that measured how much they
On a systemic level, the downturn could agree or disagree with statements covering
spark political efforts to strengthen the pub- the impact of the financial crisis on pensions.
lic pay-as-you-go system, which might push The survey was conducted in Germany, where
people away from funded pensions. When it 230 analysts responded, and Switzerland,
comes to the future of financial markets, two where 41 analysts participated.
crucial questions are: Do pension funds play
a stabilizing role and will the trend toward When analyzing the results one should
socially responsible investing among pen- note that the German and Swiss pension
sion funds continue? markets differ substantially. The German
pension system is dominated by the pub-
Other pension market trends could be lic pay-as-you-go pillar, although recent
affected by the crisis as well. Will there be reforms have tried to foster funded pen-
a continued shift from defined benefit to sions to achieve a higher diversification of
defined contribution plans? Will there be retirement income in the future. The level
continued funding of unfunded pension of public pension provision in Switzerland
promises? Regarding the adequacy of future is much lower; occupational pensions are
pension provision, an open issue is whether mandatory and contribute a major share
the financial crisis makes employers and of a person’s income in retirement.
employees contribute less to pension plans.

4


Proposition 1: The financial crisis has demonstrated that retirement income
security can essentially only be reached by public pay-as-you-go systems
The first proposition aims to shed some Overall, the analysts disagree with the
light on the future development of pension view that the financial crisis has proved the
systems. It can be assumed that the financial superiority of public pay-as-you-go systems.
crisis has reduced the confidence many peo- This is very much in line with economic
ple have in the financial markets. If that is the reasoning on the benefits of a multi-pillar
case, people may demand a reorientation pension system that consists of unfunded
of pension policy toward public pensions be- and funded elements to diversify the expo-
cause they are not exposed to financial market sure to different of types of risk.
risks. Also, politicians might exploit the
uneasiness about financial markets to pro-
mote a greater reliance on public pensions. “The financial crisis has demonstrated that retirement income security
can essentially only be reached by public pay-as-you-go systems”
The polled financial market experts
deny that this would be a useful approach. 40%
37.5 D
37
In Germany, 20 percent would agree/agree 35%
35 CH
strongly with the thesis that the financial
30%
crisis has demonstrated that public pay-
25
as-you-go systems are superior. A majority 25%
21 22
of 59 percent disagree/disagree strongly. 20%
Among the Swiss participants, only 2.5
15%
percent are in favour of this thesis, while 12
60 percent reject it. The share of undecided 10% 8
participants is nevertheless quite high in 5%
2.5
Switzerland as 37.5 percent do not hold 0
0%
strong views. In Germany 21 percent are Agree Agree Undecided Disagree Disagree
undecided. strongly strongly

Proposition 2: Pension funds stabilize the financial markets
thanks to their long-term investment horizon
With the next question we wanted to deter- crucial for financial market trends because
mine how much pension funds affect finan- the funds belong to the main actors on the
cial markets. The popular assumption is that financial markets. The OECD estimates that
pension funds have a long-term investment 60 percent of assets held by institutional
horizon and therefore stabilize the markets investors worldwide are retirement-related;
during a financial crisis because they do not pension funds in a narrow sense managed * OECD 2009. Private
have to sell securities in a downturn. The assets of USD 18.6 trillion in 2007*. Pensions Outlook 2008.
investment behaviour of pension funds is OECD, Paris.

5


There is some dissent among German
and Swiss analysts on this question. While 49 “Pension funds stabilize the financial markets”
percent of the polled German analysts agree/
strongly agree that pension funds stabilize 45% 42 D
financial markets and only 29 percent disa- 40% 37
CH
gree/strongly disagree, Swiss analysts are
35%
much more pessimistic. Only 22 percent
29
agree and 49 percent disagree. This differ- 30%

ence is a very interesting result as pension 25% 22
20 21
funds in Switzerland are more mature and
20%
play a bigger role than their counterparts in
15% 12
Germany. Thus, it could be assumed that
the Swiss analysts have a longer-standing 10% 8 7
experience with pension fund behaviour and 5% 2
that experience seems to suggest that there
0%
is no substantial stabilizing role.
Agree Agree Undecided Disagree Disagree
strongly strongly

Proposition 3: Pension funds will increasingly apply the criteria
of socially responsible investing in investment decisions
The trend toward socially responsible invest- will include SRI considerations in their
ing (SRI) among pension funds started before decisions, while roughly another third of the
the financial crisis. SRI seeks to maximize both respondents do not expect that. The rest
financial return and social good by requiring
that environmental, social and governance
“Pension funds will increasingly apply the criteria of socially responsible
criteria be considered in the investment
investments (in investment decisions)”
process. This trend has several drivers. They
include national and international initia- 40% 38 D
tives, such as the Global Reporting Initiative, CH
35% 32
changing societal and political expectations
29 29 29
toward pension funds, and the belief that 30%
24
this investment strategy can reduce risk or 25%
generate excess returns. The current crisis
20%
has the potential to “mainstream” SRI strate-
15%
gies and make investors aware of the poten-
tial benefits of considering extra-financial 10% 7
5 5
factors, particularly governance structures. 5% 2

0%
The survey results were mixed. Slightly
more than a third of analysts in both coun- strongly strongly
tries expect that pension funds increasingly

6


were undecided. This could be interpreted future of SRI among pension funds and
as a substantial degree of insecurity among could indicate that the financial crisis will
financial market participants about the not automatically favour SRI.

Proposition 4a: The trend that firms fund their pension liabilities
will continue (only Germany)
Unfunded book reserves were the tradition-
al way of occupational pension provision in “Trend to fund pension promises will continue”
Germany. This picture has been changing
over the last few years as many firms, es- 70% D
pecially larger ones, choose to fund their 59
60%
pension promises through, for example,
Contractual Trust Arrangements (CTAs). 50%

According to the survey respondents, this 40%
development is very likely to continue as a
30%
strong majority of 73 percent agrees/strongly 20
agrees with the proposition. Only 7 percent 20% 14
of the surveyed analysts thinks that the trend 10% 7
toward funding will not continue. These re- 0
0%
sults are a strong indication that the role of Agree Agree Undecided Disagree Disagree
funding in occupational pension provision strongly strongly
in Germany is set to rise further.

Proposition 4b: The financial crisis will accelerate the shift from defined
benefit to defined contribution plans (only Switzerland)
There is a worldwide shift from defined is reason to believe that the financial cri-
benefit to defined contribution plans. This sis might accelerate this shift. The main
change takes place at many speeds and driver for the change could be the better
in many forms. Pure defined contribution calculability of contributions for the plan
plans, which would imply free investment sponsor. This benefit is appealing to firms
choice for the member and individual ac- that have been hit by the recession. * Allianz Global Investors
counts, are not possible in Switzerland. 2009. Funded Pensions
There is no investment choice and pension The survey results show that the trend in Western Europe 2008.
funds have to achieve a certain minimum toward defined contribution continues. Munich. http://publica-
return. Nevertheless, over the last few More than half – 58 percent – of the polled tions.allianzgi.com/
years there has been a slow shift toward Swiss analysts think that the financial crisis en/PensionResearch/
defined contribution plans in Switzer- will hasten the shift from defined benefit Documents/AllianzGI_
land. Today, most members and assets to defined contribution plans, about a third Western_Europe_Study.
are in defined contribution plans*. There of the respondents is undecided while only pdf

7


8 percent disagree and 0 percent disagree
strongly. Based on these results, there “The financial crisis will accelerate the shift from DB to DC”
is strong evidence that the development
toward defined contribution plans will
40% 35 34 CH
accelerate.
30%
23
20%

8
10%
0
0%
strongly strongly

Proposition 5: Companies will reduce (voluntary) contributions
for occupational pensions as a consequence of the financial crisis
Occupational pensions are a major compo-
nent of retirement income in Switzerland, “Companies will reduce voluntary contributions for occupational pensions”
where they are mandatory. In Germany,
occupational pensions are set to deliver a
70% D
higher share of future retirement income 62
60% CH
due to political reforms and decreasing
benefits from public programs. The finan- 50% 46
cial crisis and the current recession may 40%
force companies to reduce their voluntary
30%
employer contributions to occupational 20
pensions as way of cutting costs. 20% 15 16 17
9 11
10%
2 2
Concern that employers will lower their
0%
contributions to pension plans seems to be Agree Agree Undecided Disagree Disagree
justified. The survey shows that 71 percent strongly strongly
of German analysts and 66 percent of Swiss
analysts agree/agree strongly that this will
happen. Less than 20 percent of the polled
analysts in both countries disagrees. If that
assessment materializes, and if it is more
than a temporary trend, the consequences
for future pensioners could be severe. The
pension gap would widen and the retirement
income from occupational plans would fall.

8


Proposition 6: Employees will reduce contributions to occupational/private
pension schemes as a consequence of the financial crisis
Firms are not the only ones under pressure reduce their contributions (Proposition 5)
when it comes to funding pension plans. The than employees. There are a number of
financial crisis could also affect employees’ possible reasons for this result: 1) Workers
willingness and/or ability to contribute to might be more reluctant to make changes
funded pensions. In times of economic crisis, because those changes could affect their
people who are worried about losing their retirement security; 2) Companies could
jobs might choose to invest in short-term, be quicker to react because they face bigger
more liquid and easily accessible financial financial challenges from the recession
assets rather than long-term pension plans. than individual employees; 3) Individual be-
Also, rising unemployment reduces income havioural factors could play a role.
and absolute overall savings, which in turn
cuts retirement savings. On the other hand,
given the declining public pension benefits “Employees will reduce contributions to pension schemes”
in Germany and the relatively modest level
of public pension benefits in Switzerland, 50% 45 46 D
voluntary retirement savings are crucial to CH
securing one’s standard of living after leav- 40%
32
ing the work force. 28
30%

More than half the analysts in both Germa- 18
20%
ny (51 percent) and Switzerland (53 percent) 13
10% 6 7
expect that employees will reduce their con- 3 2
tributions to pension plans. Roughly a third
0%
of the respondents in the two countries disa- Agree Agree Undecided Disagree Disagree
gree/disagree strongly with this view. Inter- strongly strongly
estingly, more analysts expect companies to

9


Conclusions

T he survey results point to several impor-
tant developments. The polled analysts
expect some trends to continue, such as the
The survey provided worrying results
regarding the impact of the financial crisis
on employers’ and employees’ contribu-
move toward funding occupational pensions tions to retirement plans. Analysts expect
in Germany and the shift from defined ben- both to contribute less than before. If that
efit to defined contribution in Switzerland. happens and this leads to a permanent
There is also a high degree of consensus that reduction, retirement income could be
it would be unsuitable to rescind pension re- affected substantially. Given that funded
forms and primarily rely on public pensions. pensions are a crucial component of re-
Meanwhile, the analysts provided an unclear tirement income in Switzerland and that
view on the future of socially responsible they are supposed to play a more impor-
investments and were split on whether pen- tant role in Germany, reducing pension
sion funds help stabilize financial markets. contributions should be considered very
carefully and only be done as a last resort.

10


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Imprint
Publisher: Allianz Global Investors AG, International Pensions, Seidlstr. 24-24a, 80335 Munich, Germany | International.Pensions@allianzgi.com
http://www.allianzglobalinvestors.com | Author: Dr. Alexander Börsch, Senior Pensions Analyst, Allianz Global Investors AG, alexander.boersch@allianzgi.com
Layout: volk:art51 GmbH, Munich | Printing: Christian Döring GmbH, Munich | Closing Date: August 20, 2009

The entire content of this publication is protected by copyright with all rights reserved to Allianz Global Investors AG. Any copying, modifying, distributing
or other use of the content for any purpose without the prior written consent of Allianz Global Investors AG is prohibited. The information contained in this
publication has been carefully verified by the time of release, however Allianz Global Investors AG does not warrant the accuracy, reliability or completeness
of any information contained in this publication. Neither Allianz Global Investors AG nor its employees and deputies will take legal responsibility for any
errors or omissions therein.
This publication is intended for general information purposes only. None of the information should be interpreted as a solicitation, offer or recommendation
of any kind. Certain of the statements contained herein may be statements of future expectations and involve known and unknown risks and uncertainties,
which may cause actual results, performance or events to differ materially from those expressed or implied in such statements.

11

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Seidlstr. 24 -24a
80335 Munich, Germany

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