As a consequence of unfavourable demographic trends, pension schemes based on pay-as-you-go financin...
As a consequence of unfavourable demographic trends, pension schemes based on pay-as-you-go financing are increasingly endangered. Therefore many national legislators have taken measures to strengthen funded pension provision. The establishment of new, and the fortification of existing, pension funds is under consideration all over Europe.
Nevertheless there are large differences in the legal basis, especially in terms of regulation, and the extent of provision of funded pensions in different European countries.
Within the regulatory framework of pension funds one of the most prevailing questions is whether to apply the prudent man principle or to establish quantitative investment restrictions. Different national rules already point out that this issue is seemingly quite controversial.
While pension funds in the UK and in the US are subject to the prudent man rule, pension funds in Sweden, Denmark, Switzerland and France are regulated by legal portfolio guidelines.
Prudent man concept
The concept of prudent man gives the trustee who is in charge of the management of a fund the right to decide the investment strategy of the fund without being liable to any legal requirements regarding a certain proportion of specific asset classes. The only restriction the trustee has to consider is their decisions are made prudently. The opposite of the prudent man principle is legal quantitative investment restrictions.
Such rules prescribe a certain minimum or maximum proportion of the fund that can be allocated to a specific asset class. Usually the maximum percentage of assets that can be subject to currency risk is also ruled.
According to the Anglo-American comprehension, a pension fund is a separate pool of assets put aside to provide collateral for the promised benefits. Pension funds are constituted for occupational pension schemes. Within defined benefit pension plans, the sponsor promises a certain amount of later pension. Thus the sponsor of the plan or an insurance company absorbs the investment risk. In a defined contribution plan, by definition the value of the benefits corresponds to that of the assets. Consequently those plans are always fully funded.
With respect to the features of a pension fund, the German law of occupational pension provision (Betriebsrentengesetz) comprises four main types of scheme:
The largest are direct commitments (Direktzusagen) on the balance sheet of the company. In 1996, the amount of raised capital totalled DM292 billion (57% of total assets). Within this scheme the assets remain in the company. Therefore Direktzusagen are incompatible with the above understanding of a pension fund.
The second company scheme is direct insurance (Direktversicherung), whereby a company takes out a life policy on behalf of the beneficiary. By the end of 1996, Direktversicherungen had amounted to DM67 billion (13% of total assets). Like Direktzusagen this form may also not be considered to be a pension fund.
Thirdly, the company may assign a legally independent institution, a so-called Pensionskasse. With DM114 billion raised in 1996, nearly one out of four pension plans (23% of total assets) was financed using Pensionskassen.
Fourthly, there exists the possibility of commissioning a provident fund, also called a support fund (Unterstiitzungskasse). In 1996, Unterstuzungskassen contained DM42 billion (9% of total assets).
In contrast to a Pensionskasse, an Unterstfitzungskasse grants no legal claim concerning later pension provision. Therefore most international comparisons of pension funds only cover Pensionskassen.
Besides the company pension system, the German legislator has recently permitted Altersvorsorge-Sondervermogen, investment funds with the special purpose of pension provision.
Even though advocates often draw a parallel to Anglo-American pension funds, Altersvorsorge-Sondervermogen do not match the requirements of a typical pension fund. Altersvorsorge-Sondervermogen are not company pension schemes. These investment products address the individual who wants to obtain supplementary pension provision.
Principal-agent problems arise when there is imperfect information, either concerning what action the agent has undertaken or what they should undertake. In terms of agency theory the asset manager has to be hindered to exploit his/her discretion at the expense of the investor.
On the one hand this can be achieved by monitoring the agent's actions. Monitoring requires that the principal is able to exercise efficient control at adequate cost.
On the other hand the discretion itself can be narrowed by setting quantitative portfolio regulations either by the principal or by law. This alternative is reasonable, if the principal is not able to efficiently monitor the agent. This could be the case if the principal is lacking expertise or if monitoring costs are disproportionately high.
The control problem is serious when the ownership of the fund is very fragmented and therefore a free rider problem occurs. With regards to Altersvorsorge-Sondervermogen, the legislator has set many quantitative portfolio restrictions.
For instance the proportion of funds invested in tangible assets such as equities or real estate may not fall below 51% and may not exceed 75%, whereas property is limited to a maximum of 30%. The remaining funds are invested in loans. Moreover only 30% of the total portfolio value may be subject to currency risk.
Indeed quantitative portfolio regulations may have a detrimental effect as far as incentives of funding are concerned. The humble acceptance of Pensionskassen may be attributed to strong quantitative regulation. Since they are subject to the state su
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