Back in 2012, the world's best-managed pension market was thrown a lifeline by the Danish government to help contain liabilities. That was when interest rates were still positive.
Seven years later, with rates now well below zero, even Denmark's $440 billion pension system says the environment has become so punishing that it may be time for a change in European rules.
Henrik Munck, a senior consultant at Insurance & Pension Denmark, an umbrella organization, said the way liabilities are currently calculated "could cause a negative spiral" that forces funds to keep buying low-risk assets, drive yields lower and the value of liabilities even higher.
The warning comes as pension firms across Europe struggle to generate the returns they need to cover growing obligations. Profitability remains under pressure despite steps to switch customers to products with lower or no guarantees, according to supervisors. In Denmark, some funds saddled with legacy policies guaranteeing returns as high as 4.5% have had to use equity to meet obligations.
To calculate liabilities, pension firms use a complex mathematical formula constructed by the European Insurance and Occupational Pensions Authority. The formula is intended to shield funds from erratic market swings that artificially inflate or hollow out balance sheets. But with negative rates more entrenched, there are signs the EIOPA curve, as it's called, may not be working as intended.
"When pension funds across Europe derisk simultaneously, it may actually become pro-cyclical: it increases the price movements, and it could result in yet more downward pressure on the EIOPA yield curve, exacerbating the problem," Mr. Munck said.
The curve is comprised of several elements. Its backbone — the euro interest-rate swap curve — has sunk since its implementation about four years ago, driving up the value of liabilities.