Nordic Pension Funds Embrace a New Reality

Nordic Pension Funds Embrace a New Reality

Asset Owners

New research from State Street explores the challenges facing

pension funds as they step up their focus on governance and

oversight, amid market volatility and changing member needs.

In many respects, the Nordic region’s pension funds appear to

represent a role model for success, despite facing their own

specific challenges.

The Nordic region boasts some of the highest levels of governance and scheme oversight in the global pension funds market. The Melbourne Mercer Global Pension Fund Index, which grades countries according to their sustainability, adequacy and integrity, consistently ranks Denmark as the best pension system in the world, achieving an A grade. Sweden and Finland, with B grades, are not far behind.1

Ongoing reform has helped Norway, Sweden, Finland and Denmark stay on top of critical challenges, including rising longevity.

But the Nordic region is not immune from the issues facing state and private pension systems the world over. These include stringent solvency requirements, an increasing exposure to global markets, the demand for deeper in-house risk and investment expertise, and the challenges posed by ageing populations.

1 2015 Melbourne Mercer Global Pension Index, October 2015.

ASSET OWNERS

2 NORDIC PENSION FUNDS EMBRACE A NEW REALITY

Sweden: The Swedish public pension system is facing upheaval as some of its five buffer funds — used to fund shortfalls in the state pension system — face merger. The AP fund system will see the second fund (AP2) merged with the sixth (AP6), while one of the three Stockholm-based AP funds will close.

The Swedish government is also mitigating rising retirement costs by increasing the pension age incrementally from age 61 to 63 by 2019. The occupational pension sector has also seen reform, with ITP — the plan for white-collar workers — moving to defined contribution (DC) in 2007.

The age limit for occupational and private pensions will also increase from age 55 to 62 by 2017. Meanwhile, employees will be allowed to remain in employment until 67, up from 65.

Sweden’s occupational pension plans also face additional solvency regulation, both from Europe via the Institutions for Occupational Retirement Provision (IORP) II Directive and domestically from its own additional capital requirements.

The Reform Agenda

Regulatory scrutiny and changes to the retirement age are redrawing the pension landscape across the Nordic region.

Finland: Reform is focused on managing the impact of demographic trends. The Finnish government has retained a flexible retirement age but the minimum pensionable age will increase gradually from 62 to 65. The upper limit at which they are required to take their pension will change from 68 to 70, allowing for more contributions.

As with Sweden, additional solvency requirements are anticipated ahead of the European Solvency II legislation. From 2017, investment in “riskier” asset classes such as alternatives will require pension plans to hold higher levels of capital.

Norway: Since 2009, Norway has been improving the sustainability of its system, and over the next few years will continue to introduce the flexible retirement act to manage its ageing population.

Occupational pension provision is compulsory in Norway. While plans used to be predominantly defined benefit (DB), DC is gaining popularity as individuals are expected to shoulder more of the risk and cost of funding their retirement.

“We see much more investment

in new assets, like infrastructure,

and a move from developed markets

to emerging markets. It will be

possible to have up to 30 percent of alternative assets in the portfolio —

and the governance structure

will change.”

OLA ERIKSSON

Head of Business Support, AP2

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“Asset classes such as global equities, emerging market equities and emerging market debt are being internalised, and the [asset management] budget is spent on investment you can’t easily do internally, like private equity, real estate, agriculture and forestry. It depends on what skillsets you have.”

MIMMI KHEDDACHE JENDEBY

Center for Applied Research, State Street

Denmark: The Danish pension system is also facing reform. Its government is considering changes to taxation of pensions to make them simpler and more affordable. However, the commission set up to review pension taxation was disbanded by the incoming government earlier this year.

Asset Allocation

Nordic pension schemes were early-adopters of alternative asset classes but have reduced their allocations to hedge funds and other alternative asset classes more recently. For example, the Mercer European Asset Allocation Survey 2015 shows that Swedish and Danish pension funds have decreased their allocation to alternatives recently by 2 percent and 3 percent respectively, while Finland made marginal increases of 1 percent.2 That is not to say the appetite for diversification has waned: the same survey shows forestry and renewable energy projects featuring in some pension portfolios.

Pension funds are increasingly looking for more cost-effective ways to manage their portfolios, and the Nordic plans have been pioneers in the use of smart beta — or enhanced indexation — strategies that seek to deliver returns above the index without some of the fees associated with active management. A survey of institutional investors by State Street Global Advisors (SSGA) in 2013 found almost one-quarter of European respondents have allocated 20 percent or more of equities in their portfolio to advanced beta.3

The increasing prevalence of DC plans in the region may further drive growth in low-cost investment strategies. Those that incur lower management fees — such as index/passive strategies — are usually favoured to keep the cost of DC pension provision at minimum.

2 Mercer European Asset Allocation Survey, 2015. 3 Advanced Beta Comes of Age, State Street Global Advisors, 2014.

ASSET OWNERS


“We’ve seen a number of pension

funds, including ourselves, moving

much more into different types of credit, especially in light of banks

being less willing to extend loan credit. This really opens up the market for pension funds to move in and give

long-term credit in different sectors of

the economy.”

JENS-CHRISTIAN STOUGAARD

Director (former CEO), PensionDanmark;

Chairman of Danish Social Investment Forum

Source: Mercer European Asset Allocation Survey 2015

0

20

40

60

80

100

AlternativesCashPropertyBondsNon-Domestic EquityDomestic Equity

Strategic Asset Allocation by Country

19

22

443

12

45

47422

15

23

4622

12

10

28

4723

10

23

10

56173

10

23

4831

15

20

11

42

73

17

11

20

38

144

14

7

22

574

10

3

23

45

6

23

7

18

60

744

5

20

53

94

9

8

17

52

104

10

15

9

594

121

5

10

52

11

22

Sweden

Germany

(CTA

)

Ireland

Belgium

Spain

United

Kingdom

France

Switzerland

Netherlands

Denmark

Norway

Finland

Italy

Portugal

Germany

Average

11

21

5134

11

Internal and External Oversight

While Nordic pension funds may be pulling back from some alternative asset classes, the persistent low-yield environment and market volatility means the funds must continue to diversify their portfolios in order to meet their liabilities. As such, there is a growing pressure on those responsible for asset managers to broaden in-house expertise or source external support.

While the larger pension plans have substantial internal teams and the resources to recruit specialist consultants, the picture is different for smaller occupational plans. These funds may need to turn to fiduciary arrangements — as seen in the UK and the Netherlands — where an asset manager or consultant takes control of tactical decision-making while the board of trustees retains strategic responsibility.

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“We see signs of more demand for technology-driven engagement. Not solely looking at how to comply [with regulation] but also looking at what to do with data flows — how to improve data quality to make more informed decisions.” RALF SJOE, Senior Manager, PwC

“In Finland, activity involving outside experts and consultants is quite limited compared to some European markets such as the UK. In terms of investment strategy, for example, it’s often the asset managers or operational management that do the analysis, and then the boards make decisions on that basis”

MATIAS KLEMELÄ

Director, Finance & Risk Control, Etera

As the funds the trustees oversee become more complex, there is an appreciation that more specialist investment expertise is required at the board level. However, the rules governing trustee board composition may hamper efforts to this end. In Finland, for example, two-thirds of trustee boards are comprised of trade union representatives while the use of external consultants remains limited.

Data-Driven Decisions

The move to increased digital processes and systems will play an important role in improved governance models.

Stringent regulatory requirements governing reporting of scheme investments, funding levels and solvency positions puts pressure on current administrative systems. Increasing the sophistication with which membership data is managed will also be increasingly important, as plans seek intelligence on how to manage longevity risk and improve communications.

Where pension plans manage both DB and DC schemes, data management helps them plan for longevity and manage liabilities and risk. The latest technology will help trustees stay on top of membership, improve communications, reduce risk and manage costs.

Conclusion: The Need to Take Control

The Nordic region continues to provide examples of strong public and occupational pension provision, but it is not without challenges.

While seeking to diversify investment strategies and drive returns in a low-yield environment, they need to meet new international and domestic funding requirements. There is also a growing need to strike the right balance of in-house and external expertise to manage more complex investments, while keeping costs down.

And, as funds manage new structures and seek closer control, they must equip themselves with the skills to master data — and provide a clear picture to their members of the opportunities and risks ahead.

ASSET OWNERS


State Street 2015 Asset

Owners Survey

The global pension industry has a clear but intensely challenging mission: how to improve outcomes for members over the long run, amid significant demographic shifts, increased market volatility and growing funding pressures.

New research from State Street investigates how pension funds around the world are adapting their governance and risk management strategies to meet the challenge.

Published in early 2016, the report explores key issues regionally and globally:

How do you maintain control in the context of dynamically shifting mandates and market conditions? Some Nordic pension plans feel that solvency regulation is at odds with their need to diversify investment strategies and take more risk.

How do pension funds get the right structures in place? There is a need to professionalise decision-making, but restrictions in some countries prevent change taking place.

Excellence in data management is imperative for the region’s pension plans. But do asset owners have the right skills, technology and strategy in place?

Sources: Mercer European Asset Allocation Survey 2015, Mercer Global Pensions Index 2015 and pensionfundsonline.co.uk

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© 2015 State Street Corporation - All Rights Reserved GS UK-0248

To receive the full results of our survey when available, please email us at:

[email protected]

Expiration date: 09/30/2016

For more information about our solutions for pension funds please contact:

Oliver Berger [email protected]

+49 69 6677 45277

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