BRUSSELS - The European Commission has nudged open the door to liberalizing investment restrictions on European Union pension funds and life insurance companies.
While advocacy of freer investment rules for the EU's $1.56 trillion in pension assets was expected, the commission's long-awaited green paper on supplementary pensions also raised the prospect of easing investment rules for EU life insurers, who had some $2.45 trillion in insurance assets at year-end 1995.
The issue comes at a time when insurance industry officials and official bodies, such as the Paris-based Organization for Economic Co-Operation and Development, are debating whether greater freedom of investment is desirable. A more flexible regulatory environment could pave the way for greater investment in equities.
Such a shift could create the possibility of outsourcing assets, noted Stephen Oxley, a vice president at InterSec Research Corp., London. Insurers lacking internal equity investment capability might hire external managers.
Currently, EU-based insurers are regulated by the commission's Third Life Directive, which permits national regulators to require insurers to invest assets equivalent to 80% of their liabilities in instruments denominated in their home currency. Introduction of a single European currency would loosen those currency-matching requirements, but the commission asks whether it should go further.
The discussion paper, which seeks comments by year-end, lays out four options designed to level the playing field between insurers and pension funds:
Extend life insurance investment standards to pension funds - a proposal made two years ago by the Comite Europeen des Assurances, the Paris-based lobby for the European insurance industry.
Apply the insurance industry solvency requirement to pension funds, especially where insurers and pension funds are in direct competition. Life insurers must maintain a 4% solvency ratio, which tends to make their investment policies more conservative.
Adopt "new common EU standards" for both pension funds and group life insurers.
Do nothing, accepting "the differences that currently exist because de facto they do not lead to significant distortions of competition."
European pension funds oppose the first two options, leaving the third as an intriguing alternative. A common standard could provide significant new investment freedoms for both pension funds and insurers while eliminating any competitive disadvantages between the two.
At present, individual country rules for EU pension funds and life insurers are a hodgepodge. While nations such as Great Britain and the Netherlands provide very few constraints beyond a general prudent-man rule, others set out detailed limits.
Germany, for example, imposes a limit on insurers of 30% on domestic equities, 25% property, 6% foreign equity, 5% foreign bonds, 10% unlisted securities, and 50% combined limit for mortgages and loans. Its limits on German pension funds are similar.
Elsewhere, Denmark sets a 40% ceiling on total equities for Danish insurers, and a similar limit for "high-risk assets," such as equities and unlisted securities, for pension funds.
The effect on asset allocations is apparent. At year-end 1994, U.K. pension funds had 80% of assets invested in equities while British insurers had 61% in stocks.
In contrast, German pension funds and life insurers had 11% and 5%, respectively, invested in stocks. Danish pension funds were 22% invested in equities, while Danish life insurers had 25% in the asset class.
All of that difference, however, cannot be explained by regulations, the paper noted, as many pension funds and insurers do not come close to the regulatory ceilings.
That leads some observers, such as Mr. Oxley, to suggest that any pronounced shift toward equities will be "market driven" and not "regulatory driven." The real risk for insurers, he said, is that life insurers might lose private clients to competing financial products. Many insurers already have lost institutional clients to more equity-driven investment strategies, he said.
Alan Broxson, chairman of the European Federation for Retirement Provision, strongly favors a common standard governing both insured and non-insured pension assets.
"The point we have been making as EFRP is, if we agree there is a need for a common standard, it's because we believe a pension fund is a pension fund, regardless of who manages it," he said.
Mr. Broxson said the trade group favors a common prudent investment standard, and that pension funds and insurers need to agree on a standard. He rejects, however, other options of pension funds adopting insurance-industry regulation or solvency tests.
European life insurance industry officials said they had not yet formulated a position on the green paper.
The green paper trots out the familiar arguments in favor of developing private pension systems and easing investment rules on EU pension funds.
The burden of financing state pay-as-you-go pensions is huge -currently amounting to 10% of gross domestic product - and will increase by three to four percentage points in 11 EU states by 2030. In some states, such as Belgium, Finland, France, Germany and Italy, pension expenditures may reach 15% to 20% of GDP if current trends are unchanged.
Meanwhile, the ratio of active workers to retirees is projected to shrink to 2: 1 by 2040 from 4: 1 now. State pension systems provide 88% of EU pension payments.
Outside of Great Britain, the Netherlands and Ireland, European pension funds are subject to restrictive investment limits that often have the effect of steering pension assets into government bonds, the paper noted.
Liberalized investment rules also will provide long-term capital for European industry and infrastructure, through both equities and bonds. Higher real rates of return will lower pension contributions and thus labor costs. For example, an increase in the real rate of return to 6% from 4% could cause contribution rates to halve to just 5% of salary, the paper notes.
To implement the EU's goals of freedom of investment, services and mobility of workers, reforms need to be made in pension practices, commission staff believe. The paper also asks whether barriers to cross-border movements by workers could be alleviated or removed.
However, the European Commission has a poor track record in adopting directives to override local pension investment rules. The commission first issued an ambitious discussion paper in October 1990 covering freedom of money managers to provide services across Europe; liberalization of cross-border pension investments; and creation of pan-European funds. It quickly dropped the third issue because of complex tax issues.
Efforts to propose a directive were dropped in 1994 as some countries with strong insurance lobbies opposed a rule limiting currency-matching to 60%.
A subsequent staff communication, simply spelling out the commission's views but without the force of law, was challenged in the European Court of Justice by the French and Spanish governments; the court threw out the communication, saying the commission had overstepped its bounds in issuing it.