The International Conference on Administration and Business

­ ICEA - FAA 2009 ­ 14 – 15 NOVEMBER 2009 ­ http://conference.faa.ro ­

The Faculty of Business and Administration
University of Bucharest

The International Conference on Economics and Administration, Faculty of Administration and

Business, University of Bucharest, Romania
ICEA – FAA Bucharest, 14-15th November 2009

THE IMPACT OF THE FINANCIAL CRISIS UPON PENSION FUNDS

GAFTONIUC Daniela;
Doctoral student Faculty of International Business and Economics
The Bucharest Academy of Economic Studies;
d.gaftoniuc@europolis.com

Abstract forced to sell assets at the bottom of the

The present paper aims to ascertain the
effects of the accrued financial crisis,
respectively of the recent unfolded events on
the financial markets, upon pension funds.
The pursued objectives relate to an
evaluation of the degree and form of exposure
of private pension funds to financial
crunches, as well to a definition of potential
adjustment measures referring to the present
and future sustainability of pension funds.
Although pension funds haven’t remained
invulnerable to the financial crisis, the long
term nature of their investments provides
some natural protection.
The implications of the financial crunch
upon pension funds vary subject to the
different type and mix of pension funds -
funded pensions could see more direct
impacts due to potential decreasing values of
their investments. Within the private pension
funds the impact is and could be felt
differently both by funds organized as
Defined Benefit (DB) occupational schemes
and as Defined Contribution (DC) scheme.
Overall pension funds are not affected by the
financial crisis in a similar way as banks
and other financial institutions have been.
This due to the long term nature of the
majority of their liabilities, meaning that
assets held at present relate to promises to
pay several decades away. Although, since
the beginning of the financial turmoil,
pension funds worldwide have registered
losses, these are limited by comparison to
other financial institutions. First of all,
pension funds are typically conservative
investors holding in their portfolios well
diversified established assets and secondly,
pension funds invest their own money, not
borrowing to invest and therefore not being
market in order to pay due debts.
Following the crunch, structural issues
regarding the sustainability of pension
schemes have come into focus. Adjustments
may therefore be necessary to ensure the long
term health of pension schemes.
Key words: financial crisis, Defined Benefit
schemes, Defined contribution schemes, long
term investment, diversified portfolios.
1. Introduction
The following content of the present paper
refers to the financial turmoil which erupted
in the US in 2007 and spread up to present
to a serious and well concerning extent
worldwide and which affected especially the
private pension funds.
Given the importance of pension systems for
all matters related to society, economy and
overall protection of the individuals, an
evaluation of the registered losses within the
investment strategies of the pension funds
as well as of the future implications for these
investors and of the potential adjustment
measures is highly recommendable, if not
mandatory.
The evaluation of the impact of the crisis
upon pension funds focuses on presenting
various situations of different funds existing
both in the US and Europe, supported by
data published by specialized international
institutions as OCDE, IMF and World Bank.
Based on a presentation of the various
characteristics of the pension funds –
Defined Benefit and Defined Contribution
schemes, of the different portfolio
investment strategies as well as on
supervisory and risk management

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University of Bucharest

procedures within pension schemes, the relevant information available. The

effects of the crisis shall be highlighted and
recommendations for an improved
sustainability of pension funds shall be
drawn to the public’s attention.
In view of the financial crisis, the impact
upon pension schemes varies depending on
the respective type of fund.
The Defined Benefit (DB) occupational
pension schemes undertake the investments
risk, so that contributors, in general, will get
the pension they expect. In case of deficits,
these schemes will strive to restore their
funding balance. Individuals may be affected
due to adjustments to indexation or
contributions. Likewise, the crisis may force
fiduciaries to take decisions regarding the
closing of the funds they administrate to new
members or to create provisions in order to
control costs.
Within the Defined Contributions (DC)
pension schemes, the contributors take on
the entire risk, so that the impact will be felt
directly. Nevertheless, the pension members
who are far away from the retirement rely
on the long term nature of the investment,
meaning that there is time for the financial
markets to recover. As for those contributors
close to retirement, they may benefit from
certain protection thanks to the so called
“lifecycle investment strategies”. If
subscribed to this type of schemes, pension
members enjoy protection due to the fact
that the investment risk is taken when the
member is young and the investments move
gradually to less risky strategies e.g. cash or
bonds as retirement approaches.
argumentation within the present article is
based on facts and statistic data provided by
the above mentioned sources. The analysis of
these data as well as the drafted conclusions
represent the author’s contribution to the
subject as well as the own approach in
presenting the situation.
3. Theoretical Background (if the case)
In order to illustrate an accurate situation in
view of the effects of the crisis in various
countries worldwide, statistic data from
international sources (OECD) and national
reports (APAPR) has been gathered.
The following chart shows statistic
information related to the performance of
mandatory private pension plans (the so
called II. Pillar) during their entire
functioning period respectively including
also negative results from 2008 related to
the consequences of the financial turmoil.
Chart No. 1: Real yearly return of
mandatory private pension funds (II.Pillar)
Real return since
Country launching and up to
present (%)
Chile 8,79%
Peru 7,98%
Columbia 4,58%
Uruguay 8,45%
Mexico 6,14%
Bolivia 6,91%
El Salvador 7,20%

2. Literature review Hungary 0,47%

Poland 6,00%
For a thorough documentation of the subject, Costa Rica 3,85%
as well as in order to have a relevant basis Croatia 0,82%
for argumentation, specialized and
Romania 6,18%
competent information has been collected
from sources as OECD, the World Bank, Source: OECD, APAPR
European Union as well as prestigious news
papers commenting and debating on the An analysis of the above data is emphasized
issue due to its importance and actuality. in the paper content.
The OECD reports are among the most
relevant and precise sources of information 4. Paper Content
for the subject, used and taken over by
national organizations and institutions as The financial turbulences that occurred in
well as governments. The competent the US towards the end of 2007, at the same
opinions of the OECD experts as well as time with the mortgage crisis, affected
accurate statistic data are largely publicized especially the private pension plans.
and spread in the media as one of the most According to the prestigious French journal

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“Le Figaro”, the total losses registered across
the entire OECD zone in October 2008
amounted 3300 billion dollars, respectively
20% of the total assets, by comparison with
December 2007.
If other types of assets were to be taken into
consideration, as for example, the ones
owned within the individual saving pension
accounts in the US and similar schemes in
other countries, the registered decrease
would come to 5000 billion dollars (Laboul,
OECD 2009).
Although the special feature of the pension
funds is based on long term investments,
which confers a certain degree of natural
protection, there can not be the talk of
absolute immunity either. The impact of the
crisis depended and depends first of all of
the type of the existing and functioning
pension schemes in various countries.
The registered losses are limited though, by
comparison with other financial institutions.
According to the calculations of the US
profile magazine “Pensions & Investments”,
the American pension funds have lost more
than 1700 billion dollars since the beginning
of the financial crunch. The value of the 200
most important funds, organized according
to the Defined Benefit (DB) criteria has
reduced by 16,5%, whereas the value of the
most relevant funds based on Defined
Contribution (DC) schemes presented losses
of about 13,7%, respectively 164 billion. The
hierarchy was not affected; all funds have
registered losses of about similar
proportions. The Calper’s pension fund
remains further in first place with assets
amounting 215 billion, even if the reduction
represented 16% throughout a single year
(30th of September 2007 – 30th of
September 2008). The second important
pension fund within this hierarchy – Federal
Retirement Thrift Investment Board –
registered a decrease of 5,7%, having an
actual value of 211 billion dollars.
According to the above mentioned US
magazine, a sole fund managed though to
perform a rise of the value of its assets, by
14 billion dollars, registered on the 30th of
September 2008, despite the unfavorable
economic situation which characterized the
financial markets. This is the Texas
municipality fund Texas Municipal
Retirement System.
The losses continued to rise, OECD cites
only for the US a loss of 3300 billion dollars
in 2008. Although important, the losses are
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inferior to the decline noticed for the stock
value and this mainly because pension funds
took advantage of diversification strategies
in view of their investment portfolios,
investing often in bonds with less but more
stable return. According to OECD data,
more than 50% of the assets were invested in
bonds, out of which 60% represented
investments in treasury bonds.
The consequences of the financial crisis upon
the returns of investments were notably
within funds investing more than one third
of their total assets in shares. This is the
case of Ireland, the Irish funds being the
most exposed on the stock market, 66% of
their portfolio being oriented towards
investments in stocks (Laboul, OECD 2009).
US, Great Britain and Australia follow. A
precise evaluation can be made only at the
time of presenting the annual reports of
2008 to the supervisory authorities. There is
a certain degree of incertitude referring to
the value of diverse illiquid assets – those
difficult to be transformed into short term
liquidities – as for example the real estate
investments or the “structured products”,
which imply a periodic remuneration
towards a predetermined rate or in case of
sell/purchase options to be performed at a
certain time. The direct exposure to the so
called “toxic” component of the structured
products or to those coming from
securitization (asset-backed securities) is
around 3% of the administered assets within
the pension funds (Laboul, OECD 2009). The
repartition of the assets varies depending on
the respective country or fund; some funds
took greater risks and have to handle now
the consequences related to losses.
Although the short term impact looks quite
gloomy, the performances of the funds can
not be evaluated now directly, without
taking into consideration the time factor.
From the past experience analysis, the 2001-
2002 crisis, there can be noticed a decrease
of the stock returns at comparable level.
Despite the crunch of the stock markets, the
pension funds obtained positive returns
during the last 15 years (Chart No. 2).
Chart No. 2: Average yearly nominal returns
of pension funds in the OECD countries
between 1993-2008
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5 years 10 yea rs 15 yea rs close to retirement is reduced. As the

14
12
10
8 the respective plans.
6 If in Switzerland and the US the losses
4 generated by investments in shares were
2 partially compensated by earnings from
0 bond investments, in The Netherlands the
A us tralia G reat B ritain United S tates
The return obtained in one single year
presents though a wrong image related to
the capacity of the funds to offer adequate
pensions at retirement. These institutions
were not forced to sell assets to very low
actual prices in order to cope with benefits or
costs, because they usually count on the
regulated flow of contributions and incomes
coming from investments, even if
diminished. The only exceptions are the
pension schemes organized as Defined
Benefits (DB) in case that a freezing of the
accumulation of the corresponding pension
rights has taken place. These pension plans
performed often cessions of their assets in
order to cope with the promised benefits and
were forced, in case of crisis to sell,
registering losses. The majority of this type
of schemes is found in Great Britain and the
US.
Even like this, the estimation of the
performance in time depends on the market
evolutions and at present, only optimistic or
pessimistic scenarios can be drawn. If the
negative evolutions will be lasting and
overstretched for several years, then the real
return in time of the fund’s investments
could suffer significant modifications.
In case of funds structured on Defined
Contribution (DC) schemes, the impact of
the crisis depends on the market value of the
assets held in individual accounts and of the
contributor’s age. The younger contributors
are not affected because they can hope for a
global readjustment and revitalization of the
markets on the long term. For those close to
retirement age, the depreciation of the
assets can generate losses, since the saved
money is designated to the purchase of
pensions at the time of the retirement. This
is the case of many countries in Latin
America or Eastern Europe where the DB
schemes are mandatory. Yet the effect is not
even here too large, as these systems are
recently dated and the number of people
benefits are linked to salaries, relevant
reductions can happen especially in case of
bankruptcies of the enterprises promoting
S weden
pension funds confronted themselves with a
strong decrease of the assets as the share
portfolios have been oriented towards the US
markets.
These difficulties forced the authorities to
adapt rescue plans. In The Netherlands the
conditioned indexation of the benefits is
being practiced with the aim of blocking the
indexation of the salaries to inflation until
the situation improves. Thus the income of
the retirees will be reduced in real terms. If
the financing level will be sufficient, the
pension funds will renounce to the freezing
of the indexation, increasing therefore the
benefits again.
Other loss risks are tied to unemployment
before retirement age or insolvency of the
employer. The public reserve funds existent
in some countries (Germany, US, UK,
Sweden) protect the benefits against this
type of risk until a certain age.
Why are pension funds not affected by
the financial crisis in a similar way as
banks and other financial institutions?
By contrast with the other institutions, the
DB schemes have some characteristics which
make them more resistant to the current
events on the financial markets. The
majority of the liabilities of these funds are
long term oriented - such liabilities are due
for payment usually after 40 years and will
continue to generate periodic payments, with
regularity for other approx. 30 years (EU
Memo, Brussels 2009). Therefore, the assets
held by pension funds at present will become
effective payments only after a few decades.
The long term approach of the portfolio
administration allows in time the overcome
of the turbulences present now on the
financial markets, as the liabilities are not
due immediately, in such an unfavorable
economic situation. The pension funds,
especially the European ones, haven’t
performed significant investments in the so
called “toxic assets” which provoked severe
problems in the banking sector. Generally

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the funds are prudent investors, making
conservative and diversified investments,
choosing a large range of assets, although
equities and bonds are also here
predominant.
Another trend is the fact that the pension
funds invest only their own accumulations
without lending money in order to invest for
exponential rises of the profits, as hedge
funds have been doing. In the actual crisis,
hedge funds which do not work in general
with their own capital, implicating
important resources borrowed from banks,
have registered important losses (Stewart,
OECD 2007). The same happened also in
case of the so called “private equity
companies” but also of the investment
banks, their business behavior being
identical to the one practiced by hedge
funds.
Therefore the pension funds do not have to
repay credits or refinance themselves as
banks or other actors on the financial
markets usually do. These last ones have
faced difficulties because of contracting or
blocking of lending operations. This means
also that pension funds were not forced to
sell assets in order to pay debts.
In their case, the raised problem refers to
the necessity of taking actions on short term
for the protection and maintenance of the
long term interests. The national regulatory
systems have a special role. The political
responsible parties and the surveillance
institutions receive the mission of
permanently supervising the prudent
administration of the pension savings.
Although the regulation of the private
pensions evolved, there are still
uncertainties connected to the
implementation of the regulations referring
to risky financing.
The consequences of the financial crunch
upon the pension savings can be
summarized as follows:
-in case of contributors to pension schemes of
the DC type, the impact of the crisis depends
firstly of the way the assets are being
allocated and of the contributor’s age. In
case of older contributors, if the portfolio has
been oriented in a larger scale towards
shares, the effect is negative. By contrast,
the younger contributors will be able to
benefit in time from the change of the
investment trend;
-in case of DB pension plans, the benefits are
related to the individual salaries. The
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contributors to these schemes risk seeing
reductions of their benefits in case of
bankruptcy of the company promoting the
respective pension plans.
In order to cope with the assumed
obligations referring to pension payments,
companies can be constrained to raise
contributions in case of DB schemes. Such a
raise was performed through the rescue
plans adapted after the stock market
downfall in 2000-2002.
Attention is also directed to the orientation
or preparation of funds whose composition
shall automatically evaluate, towards a
portfolio orientation related to less risky
investments, as the retirement age
approaches, without forcing the contributor
to intervene. It is the case of the so called
“profiled funds” or “horizon funds”.
In the context of the financial turmoil, as a
consequence of the extension and fast
development of the DC pension plans in
many countries, it is necessary to transmit
information and financial education
programs for sustaining the functioning of
the private pension systems.
Effects of the crisis in countries
worldwide
In 2008, following the financial crisis, the
asset depreciation of the pension funds
amounted to 18% at global level (APAPR -
sources) and 23% in the OECD countries (5,4
trillion USD according to OECD data).
The major part of this loss is based on the
huge proportion and size of the US pension
system, which registered massive
depreciations. Though, the effects of the
crisis upon OECD member states are various
in relative terms and present significant
differences based on different portfolio
compositions and regulatory framework.
Thus, as previously stated in the present
article, while Ireland faced serious problems
due to the investments of its pension funds
in stocks on the US market (loss of 35%),
Mexico and the Czech Republic suffered
minor losses, not exceeding -5% (OECD
sources).
Considering the uneven effects worldwide,
the situation among the developed and the
emerging countries depends on the causes of
the depreciations. According to APAPR data,
very strong effects leading to losses higher
than 25% have been registered on markets
in the US, Ireland and Island, due to the
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high exposure to toxic assets and to losses on
the global stock markets. The majority of the
western European countries as well as
Australia and countries in Asia faced serious
problems caused by the same type of
exposure (depreciations between 15% and
25%). According to statistical data of the
APAPR, in Central and Eastern Europe and
Latin America, the effects were considered
moderate (lower than 15%).
The almost zero exposure to toxic assets, the
reduced investments on the global stock
markets, as well as the prudential strategy
of the fiduciaries and the restrictive
legislation saved countries like Romania,
Czech Republic and Turkey from serious
effects. In such countries, the assets faced
even appreciations.
Following the crisis, a trend towards more
secure strategies and a more conservative
approach such as domestic investments can
be observed in a range of countries such as
Norway, Slovakia, Spain, Turkey, Bulgaria
etc. In other Eastern European countries as
well as the Baltic States, the mandatory
private pension systems (II. Pillar) recovered
in 2009, after hitting the crisis effects in
2008. Besides the previously mentioned
countries Slovakia and Bulgaria – this is
also the case of Poland, Hungary, Croatia
and the Baltic States as well.
In Romania, the value of the real
performance of the mandatory private
pension plans (II. Pillar), publicized by
APAPR, amounted 3,92% in 2008. The
yearly average real performance since the
launching of these funds in Romania and up
to present shows also a positive value of
6,18% (considering though the young age of
the II. Pillar respectively 1 year).
According to various OECD studies, the
mandatory private pension plans (II pillar),
similar to the Romanian system, have
registered, since their launching and until
now, performances above the inflation rate.
5. Conclusions and implications
In view of the reactions to turbulences on the
financial markets, a few main ideas can be
highlighted, towards the debate is being
oriented:
-renewed discussion of the private pension
systems;
-reorientation of the assets allocation;
-modification of the risk management;
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-revision of the actual regulatory framework.
Governments in some countries use the
occasion to reduce the private components
within their pension systems. For example,
in October 2008, the Argentinean
government nationalized the pension funds
through their reintegration in the public
system. The same problem is being discussed
and considered in several European
countries, mainly in Slovakia.
The opinion of the OECD experts is that
such sudden and rash decisions are only
meant to enforce the panic feeling, degrading
the opinion of the private pension
participants. Other governments could profit
from the present conjuncture postponing a
range of reforms within the public pension
system.
Since both the public system and the private
one involve major risks, a combination of the
pension income sources is being
recommended – state and private systems,
as well as a mix of the two biggest financing
forms – repartition and capitalization.
The public pension systems are being
pressured due to demographic aging,
decrease of the active population and debt
rising, which makes deficit covering
especially difficult in periods of financial
turmoil. According to the OECD expert
Edward Whitehouse, on a worldwide
perspective, the state plans (I. Pillar –
PAYG) were most affected by the economic
crisis. Due to the reduction of global
production and to the rise of unemployment,
the contributions to the public system PAYG
were considerably lower, governments
implementing measures such as increasing
the retirement age.
Regarding the modification of the assets
allocation behavior, the pension funds could
become “market stabilizing actors” through
attenuation of market fluctuations, selling in
times of market ascensions and purchasing
in times of market downfalls. Instead of
sustaining the real economy, in the context
of the actual financial crush, many funds
performed total dissolutions of their assets
in shares, placing the contributions in bank
depots and other financial instruments
benefiting from government safety. Such an
orientation will maintain on the long term
the pension level very low, so that it is not
very indicated. The crisis could determine
funds to reconsider investments in
alternative products, firstly in hedge funds,
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equities, row materials etc. A change of the
management vision and strategy is also
necessary as well as an enforcement of the
risk management and risk control. Many
funds have influenced each other when
investing in alternative products aiming for
high returns without estimating enough the
risks involved. Therefore, some funds
oriented themselves towards purchasing
companies with the objective of reselling.
The diversification strategy in this direction
is reflected by the case of the Dutch fund
ABP which suffered big losses due to the
investment in Lehman Brothers, performed
just shortly before the bankruptcy started.
Concerning the risk management
instruments, the pension funds have been
utilizing more and more derivatives, mainly
the ones based on interest, as “swaps”, the
operations being realized directly between
parties, on an unregulated market. The
operations are complicated and the credit
deadlock determined for now a slowness of
the innovation process, although interesting
products have been already developed, as for
example “swap-longevity” instruments– a
formula preconized for this “risk”: the
pension funds pay the other party an agreed
flow of resources and receive in return an
income which will rise if the longevity is
superior to the estimations.
The future contracts on debt securities are
no longer enjoying a large succes; the
regulatory bodies as well as the funds
foresee the reduction or the renunciation of
such tranzactions.
The revision of the reglementations and the
private pension reform have been in the
focus of OECD since 2001, when the
“directive principles” related to this subject
have been published. The “directive
principles” insist on the rigorous following of
risks and performances and of the relation
assets/liabilities. They also recommend that
independent experts shall be nominated
within the management bodies of pension
funds. Since small funds are more risk
exposed, the recommendations foresee also
consolidations by fusions, creation of hybrid
schemes, given the trend to close DB plans,
conceiving of funds whose contributions
evolve automatically orienting the portfolio
towards less risky instruments as the
retirement age approaches, without
intervention of the beneficiary (profiled
funds or horizon funds).
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