The Pension Fund and the financial market crisis: situation and prospects

The Pension Fund

For the past several weeks, stock markets have undergone a crisis marked by a sharp decline in equities and high volatility in stock prices. This situation raises many questions and concerns on the part of participants and beneficiaries with regard to the repercussions of these developments for the Pension Fund, whose assets are invested in financial markets. This article is intended to assess the situation by first presenting the facts and then discussing possible prospects.

Let us begin with the facts. Stock prices in most markets have plummeted as they have not done since the crash of 1987, nearly 15 years ago. The Dow Jones industrial average fell by15.8 per cent in the third quarter of 2001; the Standard and Poor’s 500 index fell by 15 per cent, and the Nasdaq, by 30.6 per cent. Since the beginning of 2001, these three United States financial market indexes have fallen by 18, 21 and 40 per cent, respectively. In European markets, the trend has been of the same order of magnitude in France (CAC 40 index: -31 per cent), Germany (DAX index: -33 per cent) and the United Kingdom (FTSE index: -21 per cent). Stock prices returned to their levels of early 1998, thereby eliminating virtually all the wealth created over the past three years. Much of this loss followed the attacks on the United States on 11 September. Nonetheless, these tragic events and their strong impact on many economic sectors took place in a period when growth had already slowed considerably in most countries and when concerns had already arisen about the possibility of recession. After peaking in the spring of 2000, stock markets took a downward turn, which accelerated in the second half of September.

The total value of the Pension Fund’s assets followed the same pattern, moving in a favourable direction until March 2000, when these assets reached record values, and then gradually falling. The assets’ market value declined by 6.1 per cent in the third quarter of 2001 and by 14 per cent in the first three quarters of 2001. These figures show that, while the Fund has not been immune to the unfavourable experience of the stock markets, it has been affected to a much lesser degree.

The explanation for the Fund’s resistance to the decline lies in the fact that only some of its investments are in equities (about 54 per cent), while the rest are in bonds (about 28 per cent), real estate (5 per cent) and money market securities (13 per cent). Based on analyses by the Fund’s financial managers and advice from the members of the Investments Committee, the allocation of assets was adapted to take into account the unpromising outlook in certain markets and, more generally, the growing uncertainty as to the direction of future movements. The cash holdings were therefore significantly increased to reach a level not seen in the Fund since
1991.Though yielding a low rate of return, this type of monetary investment was nevertheless considered a temporary, risk-free “parking space”, well suited in view of the circumstances, to the management of some of the Fund’s reserves pending the emergence of better prospects.

The question now is whether the negative performance over the past year and a half could affect the Fund’s capacity to pay benefits. The answer at this time is unambiguous: the Fund has the means to meet its obligations. This is so for a number of reasons, all of which concern the manner in which the Fund is managed. In the short term — that is, for each month of this year and for the next few years — the amount of the contributions collected is, and will remain, sufficient to cover most of the benefits payable, while the difference can be made up, if necessary, with the liquid assets held by the Fund. In other words, cash flow is normally ensured by the regular inflow of contributions.

But the Fund is not content merely to balance its income and expenditure for the current year; it builds up reserves for the future. Its aim is to cover at all times, including the present time, the full amount of its obligations corresponding to the pension entitlements and other benefits of current participants and to the pensions of retirees and other beneficiaries. The amount of reserves which the Fund requires for this purpose is calculated periodically by its actuary and verified by an independent Committee of Actuaries. Today, the Fund holds considerable reserves which are sufficient in terms of its objective and its rules of management.

These reserves are invested in financial markets. Owing to the strong upturn in the markets in recent years, the value of the Fund’s reserves has exceeded the amount deemed necessary to cover all its short, mediumand long-term obligations and has created a surplus. This surplus, valued at
0.36 per cent of pensionable remuneration in December 1997, greatly increased to reach 4.25 per cent in December 1999. It is important to understand that this surplus is not used by the Fund to cover expenditures, since the amount of the latter in the short and long terms is taken into account before the surplus is calculated.

The surplus merely serves as a cushion; for example, it enables the Fund to cover the cost of favourable changes in life expectancy beyond the assumptions already established by the actuaries (since, for the Fund, this is an additional expense); to finance, without raising contribution rates, the improvements which the Pension Board decided to introduce in certain benefits; and to cover wide variations in the value of financial assets, which can occur in a situation of major, lasting financial crisis. In this last case, full use would be made of reserves as a cushion before the Fund’s long-term viability could begin to come into question.

It is precisely because its management is so strongly oriented towards financing the benefits which it will have to pay over many years that the Fund, with its short-term cash position assured, has a long-term vision of its financial performance. The amount of its obligations is calculated every two years (whereas, in other pension funds, this is often done at longer intervals of about four years) and is then compared to the value of its financial assets (valued according to a conservative method and after various adjustments have been made). The last such calculation took place in December 1999; the next one will take place in December 2001. At that time, adjustments will be made to the valuation of obligations, and the new amount of the surplus will be calculated on the basis of the then-current value of the Fund’s assets.

By way of illustration, an analysis carried out by the actuary last year concluded that the Fund could bear a temporary loss of 40 per cent of the market value of its financial assets without detriment to its shortand long-term viability. Of course, no one can predict what the value of the Fund’s assets will be at the end of 2001, but, on the basis of the current valuation and in comparison to the one carried out in 1999, which served as a basis for the actuaries’ calculations, it may be concluded that the surplus has decreased but has not disappeared. To date, it has fulfilled its role as a cushion in a satisfactory manner.

In a changing world, it is logical that the parameters of the Fund should also change. This should not be perceived as worrisome. Rather, it highlights and serves as a reminder of the importance of the supervisory and control functions performed by our Fund’s decision-making organs.

The author is Chief Executive Officer of the United Nations Joint Staff Pension Fund. Completed on 2 October 2001, translated from French.