Aon Hewitt: De-Risking Tops Priorities Among European Pensions

(July 5, 2011) — European pension schemes are planning to de-risk, according to new research by Aon Hewitt.

Its findings — outlined in its Global Pension Risk Survey 2011 — revealed that pension funds around Europe have placed de-risking at the top of their list of priorities. The survey discovered that more than half of respondents are looking to fund their deficits solely through employer contributions. Meanwhile, the survey noted that risk is being taken in a more sophisticated way than in previous years; today, employers are seeking alternative asset classes to provide higher returns with lower risks.

Furthermore, a quarter of respondents have no policy regarding interest rate or inflation risk hedging.

Spurred by increasing life expectancy and regulations pressure, the urgency to de-risk is prevalent among pensions worldwide, reflected in a study last year by MetLife which showed that sponsors and trustees are struggling to develop strategies for managing longevity risk.

“While it’s apparent that scheme sponsors and trustees show a good understanding of the impact that longevity risk poses to their schemes and their organisations as a whole, they seem unable to manage this important risk on their own,” said MetLife Assurance chief executive Dan DeKeizer in the company’s UK Pension Risk Behaviour report.

DeKeizer said that part of the reason scheme sponsors and trustees have faced obstacles managing longevity risk on their own has been due to a lack of understanding regarding available options.

MetLife’s UK pension risk behavior index analyzed how 89 trustees and sponsors viewed 18 investment, liability and business risks that impacted their pensions. The research studied how well those schemes felt they were handling their risks. A majority of respondents acknowledged that “despite an estimated £1 trillion of assets being exposed,” they had failed to manage longevity risk successfully.

More recently, a study last month by Allianz Global Investors revealed a different order of priorities among European schemes, with interest rate risk topping concerns. Among pension funds and other institutional investors in Europe, government credit risk ranked as the second-biggest threat to investments. Of the 156 respondents surveyed, about 47% of respondents cite government credit risk as a considerable risk and about 15% as a huge risk.

Perception of risk varied by location, the study showed. Investors in Austria, France and Italy are most concerned about sovereign debt risk largely as a result of bailout packages granted to Greece, Ireland and Portugal. Meanwhile, British and Scandanavian investors view declines in market prices as well as interest rates as the main risks.

The perceived threat of inflation among European investors was also reflected in a Mercer survey in May that showed European pension funds are buying inflation-protected instruments to guard their portfolios from increasing inflation. The investment consultancy’s annual European Asset Allocation Survey of more than 1,000 European pension funds with assets of over $812 billion found that compared to last year, an overwhelming 80% of respondents are now more concerned about the threat of rising inflation.

“Protection, through acquiring inflation hedging assets (such as inflation bonds and swaps), looks to be expensive and there is a risk that such investments provide ‘insurance’ for events that never actually happen,” Tom Geraghty, Mercer’s head of investment consulting for Europe, Middle East and Africa, commented in a statement. “Pension funds also need to understand the extent to which their liabilities are affected by higher inflation. In some cases, inflation caps may mean that higher inflation is less negative for pension schemes than might be expected,” he said, noting that it is imperative that schemes understand how their liabilities are impacted by various inflation scenarios.