Speech by Philippe DESFOSSES, CEO of ERAFP, French Civil Service Pension Scheme, at the European Parliamentary Financial Services Forum lunch, Brussels 8 th December 2010 Ladies and Gentlemen, Thank you for your invitation to speak here today. I would like to use this opportunity to share some ideas on pension provision. These personal opinions have been forged since I joined the Treasury in 1985 and especially over the last two years spent as CEO of a French pension fund, RAFP, a fully funded, mandatory pension fund for France s 4.6 million civil servants. Created in 2005, this relatively new pension scheme will be a major long-term investor in the years to come as it is expected to reach AUM of 100 billion euros by 2050. 1
In a French pension landscape where mandatory funded schemes are almost unknown, the RAFP is unusual. Indeed, at the outset, the board of trustees composed notably of employee and employer representatives chose to invest 100% of assets according to socially responsible principles. The scheme has chosen to take seriously the duty of providing pensions in a sustainable, responsible manner, fully respecting the notion of inter-generational solidarity. I would like to present the key principles that underpin our action. Access to an old age pension for today s workers seems to be a fundamental right, particularly in the context of an ageing society, where tomorrow s active population will be less numerous to pay future pensions. Constituting a pension is a long process where any design flaws may only be detected years down the line, when it is too late to remedy the problem. So, to my mind, pension providers have a duty to deliver failure is simply not an option. 2
The financial and economic crisis has obviously added to the debate. Legislators will naturally seek answers in legislation. As a professional working in the sector, I am anxious that the lessons of the crisis should be learnt and that we can use this knowledge to move forward. Each of the issues I will discuss seems to have solutions that generate positive outcomes for stakeholders, including workers and pensioners, present and future. I will focus on three main areas where there are key issues which should be addressed in the design phase: 1. liabilities and 2. assets during the accumulation phase of the individual and 3. the decumulation phase, where the person has stopped working and is receiving a pension. Before going any further, I would like to point out that pension provision should try to make the most of the safety and economies of scale provided by a collective vehicle. Solutions 3
involving a large group of individuals are more efficient than individual actions. This is the basic principle of insurance, efficiency through risk-pooling and reduced costs. However, if insured individuals can leave the pool, regulation should take this into account when deciding on the solvency ratios to apply to these activities. On the contrary, members of a mandatory pension scheme do not usually have the right to ask for their contributions to be repaid before retirement age. This point is important concerning the application of solvency rules to pension funds and insurers. It is not a question of ensuring a level playing-field the activities are fundamentally different. Calculating liabilities and ensuring solvency in case of difficult times is a complex procedure in the hands of actuaries. This is the foundation stone of a pension scheme the discount rate applied to liabilities will influence the parameters of the scheme. If you take a look at the slide on the handout, you will see how important this is. 4
In the scheme I manage, the trustees have set the discount rate at 1.8, a prudent level in view of the very long-term nature of the liabilities. In particular using a relatively low discount rate allows us to keep realistic required returns from an economic and financial perspective and to maintain a steady allocation through the turmoil. We believe this is to the benefit both of our beneficiaries and the general financial markets. In a nutshell, a retirement scheme should be run bearing in mind that the benefits the current beneficiaries are provided with should not be paid at the price of the sacrifice of the next generations. To put it simply, the yield of the scheme should be sustainable. Regarding asset management, as I said earlier, the Board of Trustees decided to implement a Socially Responsible Investment policy which is consistent with our long investment horizon. Through this investment policy, which covers all asset classes and all assets, RAFP intends to promote values such as environmental protection, good governance and transparency, respect for human rights and social progress. It is 5
a way through a best in class approach to weed out from our portfolio companies that have not understood that it is urgent to do business in a more responsible way and on the contrary to identify the winners of tomorrow. If you are a long-term investor, it makes sense to invest where the long-term is taken seriously. Engagement with companies and institutions is a means of influencing decisions in a positive way and ensuring long-term value in the investment. To people who say that responsible investing is not worth it or is too costly, I would cite the saying If you think education is expensive, just try ignorance. Pension funds, with their long-term horizon can play a part in financing long-term needs for society which are currently overlooked by institutions and other investors preoccupied with the short and medium-term. For example, infrastructure projects, SME development and green real-estate which all present returns over the long-term which may match needs of tomorrow s pensioners. 6
My third point concerns the payout phase of the pension. Schemes may allow members to take their accumulated assets as a lump sum, but, in general, a pension product should deliver a stream of income for the period of retirement of the member and their survivors. The economic and financial crisis has highlighted the problem of workers approaching retirement and suffering a double punishment; assets going down and the price of annuities rising. Here again, a collective solution will help to protect the individual against the risk of annuities purchase. A pension fund manages the risk and pays the annuities from the fund. The individual benefits from the pooled assets which are available to pay the annuity and the economies of scale which reduce the transaction costs which would otherwise reduce the level of pension paid. From the point of view of behavioural economics, it is well known that humans tend to underestimate their own life expectancy and will not set aside an adequate sum to live on in old age. It is also well known that the human brain has great 7
difficulty to make complex decisions concerning pensions especially when the decision concerns events a long way off in the future. The tendency is to put off the decision. This is the truth behind the so-called three ages of pension savers Too young, too busy, too late. It is essential that scheme design should aim to generate positive outcomes for today s workers for example using automatic enrolment with an option not to join, or default funds for non-choosers in order to turn human inertia today into a positive force for future retirement. Automatic conversion into annuities is one example of such a positive outcome. I must conclude here. Many thanks for inviting me to share these ideas with you here today. 8