Financial crisis whets appetite for LDI by German pension funds

German corporate pension plans turn their attention to interest rate and inflation hedging

An increasing awareness of risk management by multinationals as a result of the recent financial crisis has prompted a wholesale switch to liability-driven investment (LDI) approaches among German corporate pension plans, a trend that regulation is set to increase.

According to actuarial consultancy Towers Watson, the use of inflation hedging by German multinationals has risen by 23% since 2009, with the number of corporates using interest rate hedging also shooting up from 25% to 38% in the past year.

"What we found is that the risk awareness of German companies has increased following the financial crisis. Inflation and interest risks are better understood as key risks and, therefore, hedging strategies implemented against them are now more prevalent," says Nigel Cresswell. Cresswell is head of investment consulting at Towers Watson Germany (TWG) and co-author of a recent TWG study entitled Pension risk management and investment strategies of multinational corporations.

German multinationals' increased focus on risk management has been echoed by smaller and medium-sized enterprises due to the imposition of mark-to-market valuation as part of the Bilanzrechtsmodernisierungsgesetz
(BilMoG) accountancy standard implemented on January 1 this year.

Previously, SMEs could use German generally accepted accounting principles at a fixed discount rate of 6% to value their pension liabilities, however, since the start of the year they have had to use a seven-year average of market rates, currently standing at about 4.5%.

This increased volatility has created some impetus for derisking practices, despite the lack of hedging instruments that match the new discount rate, says Cresswell. And according to Olaf John, head of Europe - distribution at London-based Insight Investment, the increased focus on derisking by German pension plan sponsors is only set to increase.

"Every sponsor using BilMoG or IFRS [international financial reporting standards] will eventually look into de-risking. Given that two years ago almost no-one would look into it, for the past six months or so we have noticed a huge appetite for derisking - and now the discussion has moved from strategies on to implementation issues," he says.

Additionally, both the Pensionsfond and Pensionkasse vehicles are insurance-based, and there is presently confusion in the market over whether the Solvency II directive will apply to them. If so, this is likely to drive a further round of derisking in the German pension market.

An in-depth look at derisking German corporate pensions will appear in the December issue of Life & Pension Risk.