Assessment of pension funding needs essential: EDHEC-Risk Institute

While public and private pension systems in the EU are under pressure, it is fundamental to evaluate the increasing funding needs, and decreasing funding basis of public pensions, a study by the EDHEC-Risk Institute warns.

On the basis of projections by the 2012 Ageing Report published by the European Commission to the year 2060, EDHEC-Risk Institute has estimated the net present value of the corresponding liabilities for various discount rates.

The present value of pension liabilities is very sensitive to the discount rate chosen, but is not negligible in any event.

“For the highest discount rate of 5%, we obtain accrued-to-date liabilities around or above 100% of 2010 GDP in 18 countries out of 27; above 200% in 8 countries; and up to 483% for Belgium. With the central hypothesis of a 4% rate, 12 countries are above 200% and 7 countries above 400%. Finally, for the lowest hypothesis of 3%, 11 countries are above 400%, 6 countries are above 800% of GDP, and it is impossible to calculate a discount rate for three countries whose pension expenditure growth rates are above 3%,” EDHEC said.

Ultimately, the values for public pension liabilities that EDHEC-Risk Institute has calculated can lead to solvability analyses that are substantially different from those habitually taken into account by ratings agencies or investors.

As such, countries with virtuous public finances such as Sweden, Luxembourg or Denmark, are much less virtuous if their public pension commitments are taken into account, while the situation of countries such as Spain, Italy, or even Portugal, is relatively better.

According to the report, the risk factors that could erode these forecasts further are mainly demographic (increase in the old-age dependency ratio), economic (persistent unemployment, reduction in hours worked, stagnant potential GDP) and political (notably the difficulty in ensuring that previous commitments are applied).

Finally, in this perspective, EDHEC-Risk Institute made three major recommendations:

1. Investors must be more vigilant on pensions risk when evaluating the solvency of sovereign issuers.

2. European institutions should continue to work towards more transparency and information in the area of public finances, notably with regard to the data available and the modelling of public and private pensions liabilities.

3. Ultimately, one should envisage the inclusion of explicit criteria on pension liabilities, in addition to the goals of the stability and growth pact and the budgetary pact. This inclusion would allow all stakeholders to better evaluate pensions risk and would favour the implementation of indispensable reforms.

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