Pension and insurance fund insights:

demographic pressures on fund returns top industry sector challenges

Thought leaders representing the investment management industry convened with renowned academics at the SimCorp StrategyLab Copenhagen Summit 2011 to discuss key investment management industry challenges in the post financial crisis environment. They articulated their findings in three thought-provoking white papers now published and which are summarised in the following article.

by Massimo Massa (Ph.D.)

Share|

The biggest challenge facing pension and insurance funds today is the rapidly ageing population. This will force funds to provide participants with pay-outs for a longer period of time. Pension and insurance companies will be required to provide high returns and at the same time stable cash flows for the retiring population.

In other words, the industry is under pressure to provide higher returns, presumably adopting an increasingly client-centric approach with more customised services, and, at the same time, lower risk and greater dependability. This will increase demands on the companies. In the next 10-20 years, the entire industry has to restructure itself in order to simultaneously better manage risk, provide stable cash flows and meet more and more the tailored needs of their corporate sponsors and participants.

One of the key factors that could lead the industry to a successful future is consolidation. The simultaneous requirement of higher performance, lower risk and more stable cash flows can be met in a better way mostly by bigger financial groups that can invest across many different asset classes and perform stable and reliable risk management by acquiring the right asset management system to enable and support this.

No doubt, the biggest opportunity facing the industry is the switch from a pay-as-you-go system to a new one based on three pillars. Pillar I is mainly pay-as-you-go, usually defined benefit and redistributive; Pillar II is the private funded, almost always defined contribution; and Pillar III is the private funded, voluntary, supplementary, preferably defined contribution.

Next to the government-provided funds, private funds will participate in the growing business of providing coverage to an increasingly aging population. Both the company-sponsored plans and the employee-funded funds will be mostly in the private domain. Private pension funds and insurance companies will be competing to exploit this new opportunity.

The four main conclusions in the Pension and insurance funds white paper are:

  • Changing demographics (i.e. ageing population) will alter pension funding patterns, creating new cost challenges but also growth opportunities for the pension and insurance funds industry as a whole.
  • Greater market volatility, increased financial instability and more regulatory change are creating challenges as well as opportunities that are not necessarily always in equal measure. The main drivers for success in the pension and insurance funds industry will be flexibility in implementation and adaptability in operation.
  • Scale, internationalisation and the right choice of investment management software system are key determinants in mitigating risk, controlling costs and promoting growth. It is not only the investment side of handling assets under management that is to be considered but also a software system for handling assets and liabilities; therefore an appropriate investment management system for the entire business should be considered.
  • The investment management software system is the common denominator running through all the themes discussed. It is beneficial in ways to reduce cost, promote flexibility and create a huge barrier to entry for others intent on entering the industry. If sufficient resources are forthcoming and the company big enough, the right operational platform (operational setup, procedures, staff as well as IT solutions) effectively helps create a special niche and to fend off competition.

 

Massimo Massa (Ph.D.) is the Roths­child Chair Professor of Banking and Finance at INSEAD, where he teaches international finance, corporate finance, information financial economics and behavioural finance in MBA, Ph.D. and Executive programmes. He has obtained an MBA from the Yale School of Management and an M.A. and Ph.D. in Financial Economics from Yale University. His research interests include portfolio theory, theory of information in financial markets, behavioural finance, market microstructure and investment funds. His articles have been published in academic journals such as the Review of Financial Studies, Journal of Finance, Journal of Financial Economics, Journal of Business, Journal of Financial and Quantitative Analysis, Journal of Financial Markets, Review of Finance, and European Journal of Financial Management. Massimo Massa has previously worked in the Bank of Italy in its Banking Division (1989–92) and in the Research Department of its Monetary and Financial Markets Division (1993–97).