Pension funds should make sure their investment policy matches the risk-bearing capacity arising from a fund’s specific features, like the financial position of a fund and the ratio between the number of active members and the number of pensioners, according to Dutch regulator De Nederlandsche Bank.

A pension fund has several means to absorb risks without lowering nominal pension entitlements. The first is the capital buffer, which is essential for being largely certain of meeting nominal pension promises and has proven its usefulness during the financial crisis. At the end of June 2011, the average funding ratio of the Dutch pension sector was 111%, which means that ratios for the sector are not yet back at the desired level of 115%.

The second relevant factor is the effectiveness of the contribution rate as a steering instrument, which indicates the degree to which a pension fund can correct its course by adjusting pension contributions. De Nederlandsche Banks said this can work well for young funds, and by levying a temporary recovery contribution, it can absorb more severe shocks.

However, for the pension sector as a whole, the effectiveness of this instrument is limited, as an average shock of 5% would require a recovery contribution of 9% of pensionable earnings for three years.

The regulator said that there are large differences between the resilience of various pension funds, with some funds having a funding shortfall while the effectiveness of the contribution instrument is relatively weak. As they can neither use capital buffers nor increase contributions to absorb new shocks, those funds are in a difficult position. DNB therefore believes that this may prompt another close look at the financial structure or consultations with social partners on the pension scheme that is to be carried out.

The resilience of a pension fund also depends on the maturity of its pension liabilities. By reducing indexation, a young fund with relatively long maturities has more time to recover from weak returns. The average maturity of liabilities for the entire sector is around 17 years, but will shorten over time due to the changing age profile of pension funds.

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