4. The European pension fund sector 35

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1 4. The European pension fund sector 35 The current macroeconomic environment and ongoing low interest rates pose challenges to the European occupational pension fund sector. Low interest rates keep the pressure on pension funds. Especially, Traditional Defined Benefit plans (DB), which account for approximately 75% of the sector in terms of assets, are affected as these types of pension plans provide employees with a defined level of pension, sometimes conditional on market developments and a degree of risk-sharing between employers, current and future plan members. DB funds are often long-term investors, whose liabilities have a longer duration than the assets, potentially leading to long-term asset-liability mismatches that sometimes can be greater than those experienced in the insurance sector. Defined contribution funds (DC) are also affected by the low interest rate environment. However, by not having a strict liability structure they adjust instantly to the macroeconomic developments Latest market development Total assets held by occupational pension funds slightly decreased during 2016 (-0.2%) in the EEA. In the Euro area (EA) total assets showed a substantial growth (+8%) in 2016 (Figure 4.1). The decline of total assets can also be attributed to the substantial exchange rate depreciation of the GBP over the EUR in 2016, negatively affecting the EUR value of total assets in the country with the largest IORP sector in Europe, the UK. The EA growth rate of total assets has been significantly higher during the course of In the NL, the second largest IORP market, the value of total assets increased by. Finally, when looking at all other countries in the sample (excluding UK and NL) total assets also increased by 5% in value over the course of The UK and the Netherlands account for about 83% of the European occupational pensions sector (Table 4.1). Cross-country differences of the importance of the sector are mainly driven by the relative share of private and public pension provision with both UK and NL providing its citizens with relatively modest flat-rate state pensions. Pension funds under Pillar I are not covered in this chapter. 35 All data employed in this section refers to IORPs (Institutions for Occupational Retirement Provision pension funds). 41

2 Table 4.1: Total assets per country as a share of total assets reported for 2016 UK NL DE IT IE ES NO IS AT SE PT DK RO 46.3% 36.5% 5.6% 3.4% % 0.75% 0.56% 0.53% 0.49% 0.22% 0.21% LI FI LU SK GR SI PL LV HR BG HU MT Total 0.18% 0.12% 0.05% 0.05% 0.034% 0.019% 0.012% 0.011% 0.003% % % % Note: Data is preliminary and subject to revisions. For the UK data refer only to DB and HY schemes only. Data for BE is not yet available. The penetration rate of the occupational pension fund sector remained at the same level in 2016 compared to the previous year (29% for EEA and 22% for the EA) (Figure 4.2). This ratio is calculated as the total size of assets over GDP and gives an indication of the relative wealth accumulated by the sector. In most of the countries penetration rates did not change significantly. The highest increase was observed in the NL (+11%) and in IS (+9%). Figure 4.1: Total Assets (in EUR trn) Figure 4.2: Penetration rates (total assets as % of GDP) Note: 2016 data is preliminary and subject to revisions. For the UK data refer only to DB and HY schemes. For Belgium, only the estimate of total assets was available at the level of EUR 29bn corresponding to a penetration rate of 7% at the end of Figure 4.1 is based on data received by 25 countries (EEA) and 14 countries (EA) which provided total assets for The category Other includes all countries except UK and NL. Figure 4.2 Penetration rates for GR, HR, PL, MT, BG, and HU is lower than 1% Investment allocation and performance of the sector The investment allocation of pension funds has overall remained broadly unchanged in 2016 for the EEA compared to the previous year (Figures 4.3 and 42

3 4.4). However, when looking at the country breakdown in more detail some changes can be identified. In the euro area, a 2% increase in investments in equity can be observed, partly driven by the higher equity exposures in the NL. This change can be also observed in the other category of the sample which includes all countries except the UK and NL. In aggregate terms, equity represents a higher share of investments in the pension fund sector than in the insurance sector (over 30 per cent for the EEA, EA, UK and the NL in 2016). 36 The increased investments in equity might be driven by the ongoing low interest rate environment as well as by the positive market development in equity. As a consequence, the exposure of the pension funds to market risk has also increased. It is only the case of the UK, where IORPs continue to increase their investments in fixed income securities (mainly sovereigns) in an effort to de-risk balance sheets in view of the their maturing membership. Figure 4.3: Investment Allocation in 2015 (in %) Figure 4.4: Investment Allocation in 2016 (in %) Sovereign bonds Financial bonds Other bonds Equity Other Sovereign bonds Financial bonds Other bonds Equity Other % 18% 19% 8% % 17% 18% 8% % 33% 33% 39% 39% % 35% 3 38% % 9% 15% 13% 18% 13% 29% 28% 3 29% 19% 7% 11% 24% % 9% 15% 12% 3 27% 17% 34% 13% 28% 21% 7% 23% EEA EA UK NL Other EEA EA UK NL Other Note: Both charts are based on 22 countries for the EEA and 12 countries for the EA that provided the investment breakdown for Data for NO, FI, LU and BE is not yet available. Data for 2016 is preliminary and subject to revisions. Data for the UK figure DB and hybrid (HY) schemes only. The category Other includes all the countries except UK and NL. Red circles represent major changes and trends commented in the text. The average rate of rate of return on assets (ROA) has increased in 2016 (Figure 4.5). The average ROA in 2016 (un-weighted 4.4%, weighted 8.9%) has significantly increased since 2015 (un-weighted 2.9%, weighted 2.1%). This can be 36 Not evenly distributed across the countries of the sample. Equity exposures may vary from 6% in DK and ES of total assets to in the NL and 91% in MT. 43

4 partly attributed to the strong stock market performance during the final months of Figure 4.5: Rate of Return on Assets (in %) Note: Data for 2016 is preliminary and subject to major revisions. Both the weighted and un-weighted averages for the EEA are calculated on the basis of the 20 countries that provided data and are depicted in the chart. The weighting is based on total assets. For ES the rate corresponds to the rate of return of all pension funds (including all costs). Please note that data on: UK, DE, FI, HU, MT and BE for 2016 are not yet available. Coverage ratios for DB schemes slightly increased in 2016 (Figure 4.6). 37 For 2016, preliminary data indicates that the funding situation improved. Overall, the weighted average coverage ratio increased from 94% in 2015 to 95% in 2016 whereas the un-weighted average coverage ratio increased from 106.7% to 107.5% for the same period. Coverage ratios below 10 are a cause for concern as they signal that IORPs have insufficient assets to pay future pensions. Low coverage ratios are dealt with in different ways in different countries across the EU. In a number of countries there is full sponsor support available and in some countries guarantees on DB plans exist. In other countries recovery of pension protection schemes is in place. In some cases changes to the value of the future benefits is possible and may become necessary in order to mitigate the consequences of the low cover ratios on future generations, if they persist. As such, these measures comprise transfers of risks across time as well as different actors, like pension funds, sponsors, members and beneficiaries and pension protection schemes (where relevant). 37 Cover ratios are defined as net assets covering technical provisions divided by technical provisions. 44

5 Figure 4.6: National cover ratios (in %) Notes: Data for 2016 is preliminary and subject to major revisions. Both the weighted and un-weighted averages for the cover ratio are calculated on the basis of the 13 countries that provided data and are depicted in the chart. The weighting is based on total assets. Cover ratios refer only to DB schemes. Due to different calculation methods and legislation, the reported cover ratios are not fully comparable across jurisdictions. 45