Low interest rates could pose a threat to the futures of pension funds as they struggle to generate returns to match performance promises made to investors, claims a new report.
Retirement savers with private pensions could find their funds at risk because the new global normal for interest rates are much lower than when the investments were started.
The Organisation of Economic Cooperation and Development (OECD) Business and Finance Outlook warns that investment managers need to hunt for yield to match investment pledges made to investors – and the yield they need is beyond the current returns offered by financial markets.
This could see pension firms going bust, says the OECD report.
“The financial landscape has changed significantly for many financial providers who forecast returns on their products that are just not feasible today,” said an OECD spokesman.
Poor money management
“Meanwhile, populations are aging and the companies will have to pay out pensions for longer while returns are more conservative.
“These companies will have to look at how they can do this without taking too many risks. Regulators still need to guard against the effects of the boom and bust cycles we have seen in recent decades.”
The study also cautions against a global trend for pension and financial firms to keep investors sweet by offering dividends or share buy backs.
“The capital that these companies should be investing to shore up their pledges to customers is going to shareholders when the money should go towards more productive activities,” said the spokesman.
“In the long term, pleasing shareholders will be at the expense of providing returns for consumers and we can see that risky higher yield investments and more complex products have poor liquidity.”
Stark choice for financial firms
The OECD study explains how lower yields will affect returns for consumers and could affect the viability of financial institutions.
The report gives examples like lower yielding bonds replacing those with higher returns, lower interest rates giving lower returns for pension funds as many invest up to 40% of their cash in fixed income securities.
“Pension funds face a stark choice. If interest rates remain low, funds will not support their promises to consumers so they will have to adjust those promises or find some other financial solution,” said the spokesman.
The OECD suggest this could mean lower guaranteed returns on future pensions, the renegotiation of contracts or even cancel plans.