Pension Funds

From Max-EuP 2012

by Markus Roth

1. International development

Pension funds are a major force in corporate governance worldwide and are in many countries the principal investment vehicle for occupational pensions. Pension funds are found internationally in virtually all countries with developed occupational pension systems, primarily in the United States and United Kingdom. The significance of pension funds as the leading institutional investors in capital markets can be attributed both to the preferred tax treatment of private and especially occupational pensions and also to the great importance attached to occupational pension schemes in the aforementioned countries (occupational pensions). As of 2006, many of the largest international pension funds belonged to the public sector. This is true for the United States with the California Public Employee Retirement System (CalPERS), arguably the most well-known pension fund. Worldwide CalPERS ranks fifth behind the Japanese Government Pension Investment Fund, the Norwegian Government Pension Fund, the Dutch ADP and the Korean National Pension Fund.

2. The scope of the Pension Funds Directive (IORP Directive)

Pension funds are primarily regulated by the directive on the activities and supervision of institutions for occupational retirement provision (IORP or Pension Funds Directive, Dir 2003/41). The Pension Funds Directive does not apply to investment funds, which are subject to the UCITS Directive, or to insurance companies. Yet, a close relationship between pension funds and insurance companies has been signalled by the creation of the European Insurance and Occupational Pensions Committee (EIOPS) and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). Common oversight of insurance companies and pension funds is not required by the Pension Funds Directive. Rather, the specifics of the pension funds and, in particular, the liability of the employer for the pension obligations are taken into account.

The Pension Funds Directive does not apply to institutions managing social security schemes, insurance companies and collective investments in transferable securities under the UCITS Directive. It further does not apply to investment service providers, banks, life insurance companies, facilities which function according to the assessment procedures and companies which make pension allowances in relation to the payment of retirement benefits to their employees. Finally, it does not apply to institutions where employees of the sponsoring undertaking have no legal rights to benefits and where the sponsoring undertaking can redeem the assets at any time and not necessarily meet its obligations for payment of retirement benefits.

3. Legal status of pension funds and participation of workers

The Pension Funds Directive does not require legal personality for pension funds. Where the pension fund institution lacks legal personality under the relevant national law, the relevant Member State must apply the directive either to the institution itself or to the authorized entities responsible for managing it and acting on its behalf. In Germany, pension funds were allowed to manage their own funds until 1934; since their reintroduction in 2001 they function as external institutions for occupational retirement schemes with their own legal personality.

Employee participation in the form of co-determination is internationally widely used in pension funds. Parity co-determination is part of Swiss, Dutch and Danish occupational pension law. In the most prominent United States pension fund, the California Public Employees Retirement System (CalPERS), the employees even appoint the chairman of the board, while the deputy chairman is a representative of the retirees. In England, under the Pensions Act of 1995 scheme members could, in principle, appoint one-third of the trustees. The Pensions Act of 2004 has repealed the so-called ‘employer opt-out’ and has made the participation on boards of one-third of employees compulsory. Furthermore, the Pensions Act of 2004 authorizes the Secretary of State to standardize parity participation of scheme members in the appointment of trustees. The nominated trustees may also be involved in decisions concerning their own rights as scheme members.

Taking co-determination in enterprises into account, the international level of employee participation in the governance of pension funds is remarkable. Switzerland, like England and the United States, does not prescribe mandatory co-determination at board level for major enterprises. In Germany, with its quasi-parity co-determination in the supervisory board of major enterprises, the focus of employee participation in occupational pensions is on the works council. Works councils are mainly involved in the establishment of social institutions and in relation to the regulation of the remuneration of employees. In contrast to the widespread international practice, the German occupational pension law does not provide for mandatory participation of employees in the management or in the supervisory boards of external pension institutions. Such representation is prescribed neither for the pension funds nor for Pensionskassen. Due to the traditional German practice of figuring occupational pensions in the balance sheet rather than covering them with separate assets, employee protection in occupational pensions may very well be caught by the general rules on co-determination in terms of the Co-determination Act of 1976.

4. Supervision of pension funds

In Germany, pension funds and Pensionskassen are subject to the supervision of the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). They are regulated in the Insurance Supervision Act as insurance-like financial institutions. Similarly, Austrian pension funds are subject to the common oversight of the general financial market supervision agency. Extending the supervision of the insurance business to institutions for occupational pensions is unusual internationally. In particular, in countries in which occupational pensions constitute a major part of the overall retirement income, the institutions for occupational pensions fall under the supervision of a special supervision agency. In England, individual pensions (personal pensions) are regulated by the Financial Services and Markets Act 2000 and are subject to the supervision of the Financial Markets Authority (FSA), while occupational pensions are subject to the Pensions Act of 1995. The Pensions Regulator rather than the Financial Markets Authority (FSA) is responsible for the supervision of occupational pensions. The Pensions Regulator issues codes of practice regarding the assets underlying contributions. In the United States, federal oversight for occupational pensions is provided under the Employee Retirement Income Security Act (ERISA), or stated more precisely by a supervisor of the Department of Labor and the Employee Benefits Security Administration. In the United States, insurance companies have traditionally only been subject to supervision according to state law; federal oversight has been implemented as a result of the recent financial crisis. In Switzerland, the cantons are responsible for the supervision of occupational pension institutions. This remains unchanged even after the creation of the Federal Financial Market Supervisory Authority which also supervises insurance companies. The 2009 OECD recommendations for basic rules of regulation of occupational pensions expressly call for supervision of pension funds and pension plans (Core Principles 7). Private occupational pensions should be funded and the establishment of an insolvency guarantee scheme should in general be required for occupational defined benefit schemes that are financed through the book reserve system (Core Principle 3 and the Implementing Guidelines).

According to the Pension Funds Directive, a Member State may exempt an institution for a limited period of time from having sufficient assets to cover the technical liabilities towards beneficiaries and retirees. The competent authorities require the institution in this case to provide a concrete and feasible rescue plan. The pension fund concerned must present a concrete and viable plan to re-establish the required amount of assets to fully cover the technical provisions within a reasonable period of time. The plan must also be made available to scheme members or their representatives.

5. Investment rules

According to the Pension Funds Directive, the assets are to be invested for the maximum benefit of members and beneficiaries. In the case of a potential conflict of interest, the institution or the entity which manages its portfolio is to ensure that investments are made in the sole interest of members and beneficiaries. The sole focus on the interests of the beneficiaries (exclusive benefit rule) is criticized in the United States. If the pension institution guarantees a certain amount of money, the interest of this institution to avoid liability also needs to be taken into account. Thereby, more conservative investment strategies are justified. The rule to invest assets solely in the interest of the beneficiaries should therefore be limited to occupational and individual pension contracts which provide for the results of the investment in old age only, ie to defined contribution schemes.

According to the Pension Fund Directive, the assets are to be invested by the pension fund or other institution in a manner which ensures the security, quality, liquidity and profitability of the portfolio as a whole. The Pension Funds Directive further prescribes that the pension fund diversify investments in such a way as to avoid excessive reliance on a particular asset, issuer or group of undertakings and accumulations of risk in the portfolio as a whole. Investments in assets issued by the same issuer or by issuers belonging to the same group are not to expose the institution to excessive risk concentration. Assets of the pension funds are to be predominantly invested on regulated markets. Investment in assets not admitted to trading on regulated financial markets must in any event be kept at prudent levels. Investments in derivative financial instruments are possible as long as they contribute to a reduction of investment risks or facilitate efficient portfolio management. Their value must be determined on a prudent basis, taking into account the underlying asset, and that value must be included in the valuation of the institution’s assets. Furthermore, excessive risk exposure in relation to a single counterparty and to other derivative transactions is to be avoided.

According to the Pension Funds Directive, Member States shall not prevent pension funds from investing up to seventy percent of assets in guaranteed schemes in equity, or investing the entire portfolio in schemes in which the members bear the investment risks. Besides shares, negotiable securities treated as shares and corporate bonds comprised investments which shall predominantly be admitted to trading on regulated markets. Pension institutions have the discretion to decide on the relative weight of these securities in their investment portfolio. Provided it is prudently justified, Member States may, however, apply a lower limit to institutions which provide retirement pension products with long-term interest rate guarantees, bear the investment risk, and where the institutions themselves provide for the guarantee. According to the Pension Funds Directive, pension funds may invest up to thirty percent of assets covering technical provisions in assets denominated in currencies other than those in which the liabilities are expressed.

In terms of the Pension Funds Directive, Member States do not prevent pension funds from investing in risk capital markets. The recitals of the directive distinguish between investment in shares, and investment in risk capital markets within prudent limits. This indicates that the European directive, contrary to the traditional German understanding, does not classify investment of shares as risky assets.

6. Information

According to the Pension Funds Directive, members are to be sufficiently informed of the conditions of the pension scheme, in particular concerning (i) the rights and obligations of the parties involved in the pension system, (ii) the financial, technical and other risks associated with the pension scheme, and (iii) the nature and distribution of those risks. Members are to receive brief particulars of the institution’s situation every year as well as the current level of financing of their accrued individual entitlements. The Pension Funds Directive stipulates the provision of further information on request. The statement of investment policy principles is to be made available to the members and beneficiaries. Each member shall also receive on request the target level of the retirement benefits; if applicable, the level of benefits in the case of cessation of employment; where the member bears the investment risk, the range of investment options; if applicable, the actual investment portfolio as well as the information on risk exposure and costs related to the investments; and finally the arrangements relating to the transfer of pension rights to another institution for occupational retirement provision in the event of termination of the employment relationship.


René Maatman, Dutch Pension Funds—Fiduciary Duties and Investing (2004); Martin Jenkins and Martin Poore, Blackstone’s Guide to the Pensions Act 2004 (2005); Gordon L Clark, Alicia H Munnell and J Michael Orszag (eds), The Oxford Handbook of Pensions and Retirement Income (2006); Alec Ure and Gavin Moffatt, Tolley’s Guide to the Pensions Act 2004—A Complete Update of Law and Practice (2006); Watson Wyatt International Global Investment Matters 2008 (2008); OECD Private Pensions Outlook 2008 (2009); Markus Roth, Private Altersvorsorge: Betriebsrentenrecht und individuelle Vorsorge—Eine rechtsvergleichende Gesamtschau (2009); OECD Pensions at a Glance 2009: Retirement-Income Systems in OECD Countries (2009); Dan M McGill and others, Fundamentals of Private Pensions (9th edn, 2010); Markus Roth, ‘Employee Participation, Corporate Governance and the Firm, A Transatlantic View focused on Occupational Pensions and Co-Determination’ (2010) 11 EBOR 51; John H Langbein, David Pratt and Susan J Stabile, Pension and Employee Benefit Law (5th edn, 2010); Towers Watson 2011 Global Pensions Asset Study (2011).

Retrieved from Pension Funds – Max-EuP 2012 on 15 June 2024.

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