LONDON - Unfunded European retirement systems pose a barrier to eventual monetary integration of European Union states and to harmonization of pension practices internationally.
A new study of global retirement systems by UBS Asset Management London Ltd. finds they diverge enormously around the world. But nowhere do they vary as much as in Europe - and with as much potential impact.
Under the Maastricht treaty, EU states are required to reduce national debt levels to 60% of gross domestic product as one of several conditions in order to create a central European bank and a single currency. The soonest this could happen under law is the end of 1997, but meeting that date is considered unlikely, especially given the growing divergence of views on whether European ties should become closer.
As it is, national debt as a percentage of GDP rose across Europe in 1993, with the average proportion rising to 67.9% from 60.9% the year before, according to the European Commission, Brussels.
But the situation looks far worse if countries' pension obligations are added in. In calculating pension debts, UBS assumed countries should have pension assets equal to 50% of GDP - roughly the level in the United States and Japan; anything less than that was considered a shortfall.
Based on 1992 figures, Belgium's government debt jumps to 183% of GDP from 136% when pension liabilities are included; Italy's indebtedness soars to 158% from 108%; Denmark's, to 102% from 62%; and debt-conscious Germany's debt rises to 79% from 43%, according to UBS.
Nations that fund their retirement obligations in advance, however, look much better, with the United Kingdom's debt remaining at 41% of GDP and the Netherlands staying at 78%.
The problem is that if the unfunded pension obligations are ignored, then countries with funded systems end up subsidizing those without, said Jim McCaughan, president of UBS International Investment. "The highly indebted country would get the debt paid off by the whole," he said.
A study done last year by officials of the $96 billion Algemeen Burgerlijk Pensioenfonds, Heerlen, the Netherlands, and the Centre for European Policy Studies, Brussels, arrived at similar conclusions, albeit through a different methodology.
That study calculated the aggregate projected benefit obligation - which includes expected future service and salary growth - of the 12 EU member states totaled 7.5 trillion European Currency Units ($9.22 trillion), based on 1990 data. The accumulated benefit obligation was 4.74 trillion ECUs ($5.83 trillion).
Looking at the ABO as a percentage of gross domestic product, the study found unfunded pension obligations ranged from 42% of GDP in the United Kingdom to 138% in Luxembourg. Half of the countries had pension obligations exceeding 100% of GDP, including pre-unification West Germany, 122%; Greece, 118%; Italy, 107%; the Netherlands, 137%; and Spain, 109%.
The study employed a low discount rate of 4%, which tends to magnify pension liabilities. But benefits were not indexed for inflation - the norm in Europe - which offsets the low rate.
Alain Morisset, head of surveillance of budgetary situations in the European Commission's economic affairs division, acknowledged pension liabilities are not included in the EC's calculations of government debt. But he said quantifying retirement obligations are heavily dependent on the discount rate used.
Use of a different rate can change those figures dramatically, he noted.
In addition, under EC rules, each member state is given autonomy over its fiscal and budgetary policies, he noted. There is no policy to redistribute social security or pension obligations.
The problems of lack of compatibility of different pension systems also affects these systems' ability to deliver on promised benefits at a reasonable cost.
UBS, in its new Global Pension Fund Indicators survey, examined the experience of 18 different systems in beating price and wage inflation.
The results clearly weighed in favor of those systems that have greater average investments in real assets, defined as stocks and real estate. From 1983 through 1993, the seven countries with a real return of 8% or less had less than one-third of assets invested in real assets.
For the remaining 11 countries, whose real returns exceeded 8%, the average real asset weight was 49%, UBS found.
Surprisingly, France topped the list with 13% during the period, although real assets comprised only 32% of total assets during the 11-year period. That stemmed from the strong performance of domestic bonds, which accounted for 62% of assets in 1993.
But the other top countries in terms of real returns were Australia, Ireland, the United Kingdom, New Zealand and the United States, all with allocations of at least 50% in real assets.
Countries with relatively low equity exposure may be locking in lower returns, the study warned. Conversely, the study warned countries with higher exposure to equities, such as the Great Britain and Hong Kong, may be exposed to excessive volatility.
Hong Kong, with its young population, is in a better situation to tolerate risk than the aging Britain, Mr. McCaughan noted.
Comparing average pension fund returns with wages also showed most countries experienced favorable real returns of 6% to 10%.
But Hong Kong suffered a low real return of 2.3% because of its high economic growth while high bond weightings dragged down the real return in Switzerland to 2.4%. Singapore, with both high economic growth and high bond weightings, experienced a -4.7% real return when compared with salaries during the 11-year period.
For the long run, asset allocations slowly are starting to converge, especially as multinational corporations are beginning to coordinate their pension investments across borders. These corporate giants will set the pace for more localized companies.
On a national basis, the biggest shifts are happening in Dutch pension funds, which have been increasing their international equity exposure, said Robert Ross, director of consulting, Frank Russell International, London.
But the process is gradual, given the greater volatility of equities. Pension executives "don't want to be the hero and be caught if there's a downturn in the first 12 to 18 months," Mr. Ross said.