OVERVIEW OF THE EUROPEAN PENSION FUND INDUSTRY

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Overview of pension schemes and products

In return for their productivity and contribution toward the achievement of corporate goals, employees earn benefits that are classified in four categories for accounting purposes (which are discussed in further details in a later section). We focus our attention on the second of these categories, post-employment benefits, which include retirement benefits (such as pensions and lump sum payments on retirement), post-employment life insurance and post-employment medical care (IFRS Foundation, 2011). As previously indicated in reference to the work of Bodie (The New Palgrave Dictionary of Economics, 2008): Pensions are benefit contracts that replace a person’s earnings after she reaches old age and retires from the labour force. Pension systems vary widely across countries, but everywhere the government’s role is to provide a minimum through a mix of cash and medical benefits. Governments often provide tax incentives for employers and unions to sponsor occupational pension plans that complement the government-run system. The nature of the pension benefits promised and the assets that back them have profound effects on social welfare, on the development of a country’s domestic asset markets, and on the global financial system. Similarly, Glaum (2009) indicates that “based on co ntracts, and often encouraged by tax incentives, employees agree to temporarily forego part of the remuneration owed to them for services rendered in a given period, in exchange for a promise to receive pension payments in later periods, usually after retirement” (2009, p. 275). As such, pensions repre sent an important element of deferred compensation and therefore are central to corporate reward policy. It appears therefore that pensions-related questions (such as how much to contribute or which type of schemes to select) represent critical issues for individuals. In practice, pension beneficiaries are mainly concerned about the amount of the monthly cash flow they will receive upon retirement. It is not uncommon for the monthly cash flow to be calculated based on the number of years of service, the employee’s salary at the end of his/her career (sometimes the average of the best years), and a fixed multiplier, of 2.6% for example. In this case, if an employee works for 28 years and earns a final average salary of €48,000, the annual pension benefit will amount to €34,944 ( = 48,000 x 28 x 0.026), which is equivalent to a monthly cash flow of €2,912. In contrast to this si mplified example, pension schemes’ features are much more complex than it appears. We discuss these characteristics in the next paragraphs.
According to material provided by the OECD, pension regimes vary widely across member states which renders the classification of pension regimes and schemes difficult. For the sake of simplicity, we rely on the classification described by the OECD in its Private Pensions, Classification and Glossary published in April 2005. The nomenclature commonly used refers to Pillars or Tiers. Pillar I or first-tier includes “redistributive components” designed to ensure that pensioners achieve some absolute, minimum standard of living (Pillar I is commonly referred to as “social security” in vernacular language), whereas Pillar II or second-tier comprises “insurance components” which are conceived to achieve some target standard of living in retirement compared with that when working (OECD, 2007). In practice, Pillar I pension schemes correspond to public plans, typically structured around defined benefit schemes incorporating some safety net and redistributive features, whereas Pillar II pension schemes represent employment-related schemes (in fact such schemes are referred to as occupational plans when there is a professional relationship between beneficiaries or plan members and the sponsor or employer or group of employers). Lastly, “voluntary provision, be it individual or employer-provided, makes up a third-tier” or Pillar III (OECD, 2007). Within these tiers, schemes are classified further by their provider (public or private) and the way benefits are determined (defined benefit or contribution, for instance).
As a result, public pension plans represent social security or programs sharing similar goals and are commonly managed by the government or some governmental bodies. Such pension schemes are typically funded through PAYG schemes (i.e. pay-as-you-go plans are in fact unfunded plans in which current contributions paid by workers serve to pay current benefits). As this unfunded pension system is not sustainable in the long run, increasingly OECD countries tend to partially fund public pension liabilities or to discontinue PAYG funds and replace those by private pension schemes. Funding of such publicly managed programs is commonly achieved through payroll taxes. Contrary to public pension plans, private pension plans are run by private organizations, either a firm acting as a plan sponsor, a pension fund or an entity representing a sector or a trade association. Private pension schemes are in general funded by employer and employees and typically provide a pension complement or surrogate for public pension schemes. Lastly, unfunded private pension schemes are banned across OECD countries. According to the OECD taxonomy, first-tier pension schemes seek to provide a minimum level of pension benefit and are further divided into three categories including resource-tested (pension benefit based on a beneficiary’s financial status), basic (a flat rate of pension is paid and depends on years of work), and minimum schemes (similar as resource-tested but differ in the way financial status is determined). Similarly, the OECD material classifies second-tier pension schemes into four categories, namely defined benefit plans (DB), defined contribution (DC), point schemes (PS), and notional-accounts (NA). DB plans are provided by both public and private sponsors and pension benefit is commonly function of the number of years of contribution and individual earnings. Furthermore, DB plans are sub-classified into traditional (in which pension benefit is calculated using a formula encompassing salaries, work period, or other parameters), mixed (which consist of two separate DB and DC plans), and hybrid plans (in which a rate of return is guaranteed in relation or regardless of pension asset performance). In contrast to DB plans, a sponsor does not retain any legal or constructive obligation to pay additional contributions to a DC plan in the case pension asset performance would be short of expectations. Typically, under DC plans, contributions accumulate into individual accounts which in general convert into annuities at retirement. The PS system is relatively rare across the OECD area (used only in four countries) and is commonly administered by public entities. Under such a system, employees accumulate over their work life points calculated based on annual earnings. Upon retirement, the accumulated number of pension points is multiplied by a pension-point score in order to determine the amount of pension paid. Finally, NA plans, also relatively rare across OECD countries, are in general managed by public entities. Similarly to PS plans, NA plans take into account the amount of a notional capital accumulated over a worker’s period of service and which is converted into regular pension payments upon retirement. Pension payment is often function of life expectancy. Because NA plans are aimed at mirroring DC plans, they are frequently referred to as notional defined-contribution plans (NDC).

Public vs. private pension funds

In this section, we contrast public vs. private pension funds since we believe such a comparison adds value to our presentation of the pension fund industry. Although the line separating public and private entities may be blurred, public pension funds are typically managed under public law, administered by some governmental authority, and provide predominantly Pillar I pension schemes (thus implying PAYG schemes). Private pension funds are therefore administered by a private party other than a representative of the government. When comparing public and private pension funds, we consider in particular three differentiating factors: size, asset allocation, and accounting rules. In contrast to individual investors, pension funds can enjoy certain advantages at a larger scale. In fact, funds can pool assets, engage in diversification, gather and process large quantity of information, implement levered strategies, and create and enjoy economies of scale (e.g. reduced transaction costs for example). In the asset management industry, size is commonly measured in terms of assets under management (or AUM). It appears that size does matter as shown in the below graphs. We present summary statistics prepared by Pensions and Investments and Towers Watson (2013). The latter entity is a leading global financial adviser specialized in research and retirement issues and a public company whose shares (ticker TW) trade on the NYSE and NASDAQ.

Pan-European regulatory pressures and prospects for the pension fund industry

According to Towers Watson, the European pension fund industry had nearly $4.0 trillion worth of assets under management at the end of 2012 (or 28.5% of the global pension assets). Over the 2007-2012 period, the region experienced annualized growth rate of 5.5% which compares with 5.6% for the global pension industry. These figures, however, do not reveal the extent at which the industry has been impacted by the global financial crisis which erupted at the end of 2007. In response to the crisis, industry players and regulators have sought to change their strategy, improve transparency and strengthen the industry’s operations, solvency and reporting procedures. In this section, we describe the regulatory environment at the European level and discuss prospects for the industry as a whole.
In this section, we overview the characteristics and roles of the main regulatory bodies (such as the European Commission and EIOPA) that oversee pension funds across Europe. Because we have described retirement systems (e.g. Pillar system) and pension funds in previous sections, we focus here on European regulation (such as IORP) encompassing solvency and disclosure in particular. Pension schemes, by their nature, encompass long-term promises. The assets supporting such promises should be invested with this long-term horizon in mind, with due consideration to the risk profile and liquidity requirements of beneficiaries. Management of liabilities and assets cannot, however, be made solely based on economic factors, but is subject to regulatory, tax and accounting constraints. As discussed previously, the financial stakes are significant for national governments, corporations, and individuals. To ensure that the interest of stakeholders are protected, several institutions and mechanisms have been established while keeping in mind that regulation at the European level did not seek to supersede national authorities but such regulation corresponds to the efforts made to construct an integrated European Union.
At the pinnacle of the European Union resides the European Commission. Composed of a college of 28 commissioners (elected for a 5-year term and representing each EU member state, including recently joined Latvia), under the presidency of Portugal’s José Manuel Barroso since 2004 (as his tenure was prolonged in 2009), the European Commission acts primarily as a legislative organ by proposing new texts to the European Parliament and the Council of the European Union. After having reviewed existing legislation and performed “an imp act assessment” in order to measure the potential economic, social and environmental effects of any new text, the Commission runs wide consultations with stakeholders (Source: http://ec.europa.eu). Once new legislation has been adopted together by the European Parliament and the Council of the European Union, the European Commission makes sure that laws are applied by all member states or may otherwise take legal action to enforce regulation (if a member state persistently fails to enact European laws, the Commission may initiate “infringement proceedings,” request the European Co urt of Justice to deliberate, or impose financial penalties (Source: http://ec.europa.eu). Currently, the Commission primarily focuses on “ Europe 2020 Strategy” aimed at lifting the EU out of the e conomic crisis but also seeks to enhance the rights and security of European citizens, spearhead climate change and foster the role of the EU in the world (Source: http://ec.europa.eu). In the context of pension regulation, the European Insurance and Occupational Pensions Committee (or EIOPC) was established under EU Directive 2004/9/EC to assist the Commission in matters concerning insurance and occupational pensions. The EIOPC is comprised of representatives from member states’ supervisory authorities. Lastly, it is noteworthy to know that EU law is categorized into primary (such as treaties) and secondary legislation (encompassing regulations, directives and decisions which are derived from treaties). While regulations and decisions are more prescriptive by nature, directives define a desired outcome, granting member state some flexibility in terms of the way legislation is implemented (though by a specified deadline).
Speaking of directive, the European Commission promulgated on June 3rd, 2003 Directive 2003/41/EC to govern the activities of occupational pensions and to “ensure a high level of protection for members and beneficiaries of pension funds” ( Source: http://europa.eu/legislation_summaries). A prescriptive body of rules has been established for Institutions for Occupational Retirement Provision or IORP according to three requirements (Source: http://europa.eu/legislation_summaries):
· Strict prudential rules to protect the beneficiaries and members of IORPs, who must have sufficient information on the rules of the pension scheme, on the institution’s financial situation and on their rights.
· Investment rules adapted to the characteristics of IORPs and to an efficient management of savings since IORPs invest on a long-term basis and have to diversify their assets by taking full advantage of the benefits offered by the single market and the euro. If each institution is to establish the safest and most efficient investment policy, the investment rules, and in particular the rules for investing in shares, must not be too restrictive.
· Rules permitting cross-border management of occupational pension schemes.
In essence, the overarching ambition behind IORP is to protect members and beneficiaries by in particular fostering proper disclosure of financial information, stimulate cross-border activities (and thus facilitate members’ mobility across the EU), and allow pension institutions to implement sound and prudent investment strategies (which need theoretically to align with both national and EU rules, especially in regards to solvency and asset allocation). Obviously, Directive IORP prescribes the proper functioning of occupational pension plans while social security schemes (i.e. Pillar I) remain the prerogative of national governments. Issued in 2003, Directive IORP needed to be implemented by member states by September 2005. However, the implementation phase took more time than expected prompting the Commission to review progress in 2009: despite overall positive achievements across the EU, the Commission noted several issues that needed to be addressed. These included the relatively poor level of cross-border activities, the difficulty to reconcile EU and national rules in regards to investment rules (especially those relating to asset allocation), and the need to speed up the adaptation of national supervisory bodies to EU legislation and the cooperation between pension supervisory authorities. In order to address these issues among others, the European Commission enacted successive amendments in 2009 (2009/138/EC), 2010 (2010/78/EU) and 2011 (2011/61/EU). These amendments also reflected the fact that the Union was going through a challenging period due to the global financial crisis.

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Current state of the European pension system

To conclude this section devoted to the European pension fund industry, we use a SWOT analysis as a means of highlighting strengths, weaknesses, opportunities, and threats. We therefore briefly rephrase the main facts previously analyzed and illustrate our examination with the below diagram that represents our SWOT Matrix. Before discussing the rationale of our SWOT analysis, we do acknowledge that it is a daunting task to try to produce a single and unifying description of the European pension system since the European context is fundamentally diverse in terms of legislation, economics, politics, culture or demographics. As a result, we attempt with this SWOT analysis to highlight what we believe are common features or issues across Europe. In addition, we have taken the liberty here to relax the definition of a SWOT analysis because internal and external factors are not evident characteristics that can be conceptualized in the context of the European pension system. First of all, the European pension landscape is characterized by several elements that constitute strengths. Most importantly, the pension system structured around the pillar system aims at addressing a social issue of general interest (i.e. the provision of adequate pension income). Moreover, the public pension system across EU countries seeks to guarantee some minimum standard of living. Governments essentially rely on payroll taxes and other forms of levy to fund public pension schemes. Policy-makers have also taken steps to regulate the pension fund industry and safeguard the interests of the public at large. Nonetheless, the current system suffers several weaknesses including the challenges that pose the management and reform of pension systems across Europe, PAYG schemes, or the chronic deficit of social insurance funds. In addition to these factors, the European pension system faces both opportunities and threats. We believe that the rising level in financial literacy of workers and retirees, improving pension fund governance, professionalized pension fund management, or a better-integrated pan-European pension system to help improve funding and mobility of workers and retirees represent significant opportunities. In contrast, we posit that the sustainability of the European pension system is jeopardized by adverse demographics (especially a rapidly ageing population), poor financial markets performance, the reliance on PAYG (i.e. unfunded) pension schemes, and the relatively high degree of instability in legislative and political realms across Europe.

Table of contents :

ABSTRACT
ACKNOWLEDGEMENTS
LIST OF ABBREVIATIONS
PART I – THEORETICAL FRAMEWORK: PENSION ACCOUNTING CONCEPTS, RULES AND PRACTICES
CHAPTER I: SCOPE AND RESEARCH QUESTION
1: SCOPE OF THESIS
2: RESEARCH QUESTION
3: THEORETICAL FRAMEWORK
4: HYPOTHESES DEVELOPMENT
5: CONCEPTS AND DEFINITIONS
6: EPISTEMOLOGICAL AND EMPIRICAL FRAMEWORKS
7: DISSERTATION STRUCTURE
CHAPTER II: A REVIEW OF PENSION ACCOUNTING RULES
1: OVERVIEW OF THE EUROPEAN PENSION FUND INDUSTRY
2: PENSION ACCOUNTING: REGULATORY ENVIRONMENT
3: PENSION ACCOUNTING: RULES AND PRACTICES
4: REVIEW OF ACADEMIC LITERATURE
5: CHAPTER CONCLUSION
CHAPTER III: THEORETICAL FRAMEWORK
1: POSITIVE ACCOUNTING THEORY
2: NEO-INSTITUTIONALISM THEORY
3: OTHER THEORETICAL CONSIDERATIONS
4: CHAPTER CONCLUSION
PART II – EPISTEMOLOGICAL AND EMPIRICAL FRAMEWORKS: STUDY OF THE DETERMINANTS OF THE RATES ASSUMPTIONS
CHAPTER IV: STUDY OF THE DETERMINANTS OF THE RATES ASSUMPTIONS 
1: RESEARCH DESIGN
2: EPISTEMOLOGICAL PERSPECTIVES
3: JUSTIFYING THE DISSERTATION’S RESEARCH HYPOTHESES
4: RESEARCH METHODOLOGY
5: CHAPTER CONCLUSION
CHAPTER V: ANALYSIS OF RESULTS
1: OVERVIEW OF RESULTS
2: DETAILED ANALYSIS
3: DISCUSSION OF FINDINGS
4: CHAPTER CONCLUSION
CHAPTER VI: CONCLUSION AND ELEMENTS FOR FURTHER RESEARCH
1: OVERALL CONCLUSION
2: PRACTICAL USEFULNESS AND APPLICABILITY
3: RESEARCH LIMITATIONS
4: ELEMENTS FOR FURTHER RESEARCH
REFERENCES 

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