EDHEC: Impact of regulations on the ALM of European Pension Funds

16 June 2009

The study analyses the impact of prudential and accounting constraints on the asset-liability management (ALM) of pension funds in the Netherlands, UK, Germany, and Switzerland. 

Pension funds and their sponsors face two main bodies of regulation: accounting standards, which require charging the impact of surpluses and deficits to the P&L of the sponsor, and prudential regulations, which set minimum funding requirements and lay down the conditions for the correction of underfunding. 

One of the initial goals of the IORP directive was to facilitate the creation of cross-border pension plans. As domestic prudential regulations are very diverse, revisions to the IORP directive are being discussed. One of the main outside references is the coming prudential regulation for insurance companies, Solvency II.
 
The report also points out that specific attention should be paid to the long-term nature of pension funds. The replication of wage-indexed liabilities perfectly illustrates the coming challenges for both regulatory bodies and pension funds. These traditional pension liabilities have low short-term replicability, and risk-free long-term strategies involve short-term risk. As a consequence, and because of their role in providing very long-term benefits, the increasing focus on the short term is worrying for pension funds.
 
The report concludes that accounting standards and prudential regulations are tightening, requiring greater attention to the volatility of the surplus and less tolerance of underfunding. These changes call for an improvement in ALM strategies and the use of state-of-the-art models — such as dynamic liability driven investments — for the design of these strategies. An understanding of the constraints to which pension funds are subject is essential to building efficient ALM strategies.
 
Full report