Pension fund assets climb back to pre-crisis levels but full recovery still uncertain
Having weathered the financial crisis, pension fund asset levels in most countries continue to show strong growth and are on the way to returning to pre-crisis levels. During 2010, both economic and financial indicators showed signs of further recovery. However, the outlook for future economic growth in developed economies remains uncertain and sluggish.
A sustained period of low long-term interest rates is an important medium term risk for pension funds, which typically have long-term obligations to pension members. These future obligations become more expensive in today?s terms when low interest rates increase the value of their liabilities. Their financial position worsens, even though an increase in the value of invested assets may mitigate this effect.
Against this backdrop, pension funds face other challenges and risks, such as recent accounting and regulatory changes. While bringing further transparency, the adoption of the new rules within IAS19 over the coming years which eliminate the smoothing option will increase volatility in sponsoring companies? financial statements. As a result, there will be added pressure to reduce risk in pension funds? asset holding in order to mitigate volatility and to keep funding ratios more stable than in the past. Pension funds may also transfer risk to financial markets via insurance or by greater use of derivatives for hedging purposes. The trend away from “pure” defined-benefit plans, "pure" (final-salary) DB schemes, which guarantee a certain replacement rate and specify pension benefits according to the employee?s final pay, length of service and other factors, towards defined contribution arrangements is also likely to intensify.
Regulatory changes are most likely in the European Union, as a result of the review of the pension funds directive (known as Institutions for Occupational Retirement Provision). The review includes a new look at funding and solvency regulations. Some other OECD countries have already reformed their funding rules. Canada stands out by having introduced a mechanism to ensure a high degree of counter-cyclicality by raising funding requirements in good times and allowing relatively long recovery periods.