Netherlands focus: under pressure

A cutting edge Pension Act bringing with it a new supervisory framework for pension funds and a stronger focus on pension scheme governance has helped pile the pressure onto Dutch pension plans this year. Francesca Fabrizi finds out how the industry is coping

It's been a big year so far for the Dutch pensions industry. The new Pension Act came into effect on
1 January increasing the focus on scheme communication and scheme governance and, as part of this, the controversial new Financial Assessment Framework (FTK) for pension funds finally became compulsory after months of deliberation over the finer details. So how are schemes coping so far?

To begin with, the changes in the regulatory environment in the shape of the FTK rules have made life that little bit more difficult for the pension funds, says Bart Heenk, managing director of the Benelux region at SEI, and perhaps unnecessarily so.

SEI, among others, were rather critical of the regulatory changes last year as they felt the Regulator,
the Dutch Central Bank (DNB), had over-reacted, going from being rather relaxed about pension fund governance to being overly involved and rather too prescriptive.

And, says Heenk, while the basic premise of regulatory change is a sound one - that pension funds take more responsibility for proper risk management - the DNB has gone a few steps further than that and come up with a set of parameters, some of which are highly restrictive and some of which force pension funds to act in the
short-term.

"And we know where this is coming from Ð BASEL II, which was designed for the banking industry, and has also been applied to the insurance companies; and while you could argue that there is some validity in doing that, they have also applied it in a slightly different format to pension funds but there is a fundamental difference between banks and pensions funds."

But it's not all doom and gloom - in response to industry criticism some of the rules were relaxed just before the 1 January implementation, explains Heenk: "The most unworkable rule, for example, was the fact that if you dropped below the MFR of 105 per cent, the initial proposals said that pension funds had just one year to correct it. That was thankfully changed at the last minute and so, under the new proposals, pension funds have three years to correct it and that gives them a lot more leeway.

"Under the first proposal you would only have had one option really and that would have been to get the sponsor to make up the difference; now they have numerous options as three years gives you a chance to adjust your asset allocation, for example, or to consider ways of sharing risk differently among pensioners, actives and employers and so on.Ó But criticism aside, the FTK rules are now here to stay and as part of the changes, pension funds are being forced to improve their knowledge and understanding of investment assets and financial instruments.

Heenk explains: "Before 2001, a lot of pension funds had contribution holidays Ð when neither employees nor employers contributed anything as funding ratios were high Ð plus you had fairly high market returns and people had plenty of internal resources to deal with the very few issues you had as a pension fund.

"Today, however, there are a lot of Sarbanes-Oxley type spin-offs that have put more liability on the directors of pension funds and they can no longer claim ignorance but rather have to take personal responsibility for the soundness of their pension fund."

As a result, pension funds now need to be intimately aware of new products - equities and bonds
may have been the extent of their knowledge at one time, but now they need to consider things such as derivative overlay techniques and hedge fund like techniques, so life has become a lot more complicated.

"While it is great that there are so many new products out there to help manage pension fund risk, it is also putting a lot of pressure on the levels of knowledge needed and the internal resources of the pension funds. So they are all operating in a rather complex environment where there isn't much room for error and the sponsor is breathing down their necks as they now have much more interest in the pension fund", says Heenk.

In response to these increasing pressures, pension funds have been forced to re-think their strategies, one way being to outsource, which has led to a boost in fiduciary management offerings in the Netherlands.

Heenk says: "One option for pension funds struggling under this extra regulation is to outsource some of the implementation of the difficult bits to a manager of managers, and if you want to keep control this is a nice way to do it as there is always a way back Ð you can fire a fiduciary manager if you're not happy with what you are getting; but what you are buying is expertise and professionalism, whatever you want analysed we can do that for you and we have far more professionals able to do so."

Rene Wiegel, senior sales manager, Benelux at ABN AMRO Mellon agrees that the asset and liability management perspective has completely changed. "Over the last three or four years the Dutch pensions landscape has changed dramatically with the introduction of a 'matching' concept to help safeguard pensions.

"The Dutch Central Bank wants to ensure not only that a pension scheme can provide its members with a pension after 30 years, but also that the scheme maintains a prudent coverage ratio [assets vs liabilities] on a year-by-year basis."

So, he adds, while in the old days it was all about creating alpha and making sure the pension fund could meet its liabilities after 30 years, now risk management is a more of a priority and liabilities are measured on a yearly basis.

As a result, you see pension funds in the Netherlands making wider use of derivatives because, says Wiegel, they make it easier to change the risk profile and the duration of your portfolio and are much more liquid.

But, he warns, they then face a challenge when it comes to the administration of those off-balance instruments, as they are more complex. It's all very well that you buy liability-linked funds, but how do you handle them in the context of bookkeeping and maintaining your general ledger?

"Put yourself in the shoes of a controller of a pension fund Ð all of a sudden they don't need to deal just with equities, fixed income and cash and maybe some real estate, but also with a portfolio of derivatives. How do they make sure that they are valuing those derivatives independently, correctly and in a robust IT environment?

"You either need to buy in the knowledge yourself or partner with an asset service provider like ourselves. That is one of the biggest changes in the market: clients are not only looking for a custodian in the traditional sense of providing safekeeping and settlement, they want an administrator. They want a partner that cannot only deal with traditional instruments but also one that can independently value derivatives and provide collateral management solutions."

Going forward, then, he believes there is going to a big split within the custodial world Ð the parties that maintain the status quo and remain as traditional custodians, and those who transform themselves into an asset servicer and offer an administrator type of function.

The Pension Act: communication and information
A large proportion of the new Pension Act relating to the provision of information and to improving clarity and communication also came into play on 1 January, having what most deem a positive impact on employer offerings.

Yvette Van Gemerden, employ-ment, pensions and benefits partner at DLA Piper Nederland N.V. explains: "All in all, these rules are welcome, especially because they give more clarity for employees and employers alike, and also because the previous Pension Act was old and outdated; so I think it is a good thing that this Act has come into force."

As with the previous Pension Act there is no "pension obligation" to provide a pension for an employee i.e. there are still employees without a pension commitment, and to whom no pension contract is offered.

There is, however, a legal presumption that if the employee is part of a group of employees to whom the employer has made a pension commitment, the employer is deemed to have made the same pension commitment to the employee.

Governance
In addition to adhering to the new FTK framework, pension schemes also have to visibly improve the governance of their schemes. Andre Van Hooren, managing consultant at Towers Perrin in the Netherlands, explains: "There is a new governance code for pension funds being implemented at the moment and pension funds have to organise an internal supervisory board, like you have in companies - previously governance was only overseen by external supervisory body, the Dutch National Bank (DNB) - and on 1 July the DNB will check momentum to see how pension funds are getting on."

But while the importance of improved governance cannot be underestimated, smaller funds are likely to struggle, warns Van Hooren: "The problem is that there is a huge difference in terms of the size of funds - some of them have only a hundred actives while others have up to a million, and when you have billions of euros in assets it helps to have an internal supervisory body to track your procedures and help your fund to be more organised, but when you are a very small fund it might be a bit heavy having both an internal supervisory body and also an assembly of stakeholders to answer to on a yearly basis, as well as the DNB.

"It means you essentially end up with three different bodies running a very small pension fund and I can imagine this being a bit too much for those smaller funds and is likely to push them towards abandoning the whole idea of running a pension fund and going to an insurer."

Scheme design: Collective DC
Another way of managing liabilities, and another big topic of discussion among Dutch pension funds today, is the potential move towards Collective DC, an approach which effectively changes the risk-sharing characteristics of the DB plan, transferring risk away from the employer to the plan participants.

It does not, however, go as far as pure DC. Roland van Gaalen, consultant at Watson Wyatt Netherlands, says: "Collective DC is type of hybrid plan, so somewhere between DB and DC, and the need for it stems from the new accounting requirements imposed on listed companies Ð IAS19 and the like.

"Basically companies don't like to have all this volatility on their balance sheets, as the risks are becoming too much to bear. On the other hand Dutch employees don't like pure DC, it is not popular at all in the Netherlands with employees or the representative organisations (compared to other countries such as the US or the UK), so there hasn't been much of a shift towards DC in the Netherlands and you could say that, to a certain extent, DB here is alive and well and that's what employees want."

Typically, a Collective DC plan is, for example, a career average plan with mechanisms to share some of the risks differently. The essential characteristic of the approach is the way in which overfunding or underfunding is corrected. Plan benefits are adjusted, taking into account the available assets.

But while this may sound like an effective compromise, fitting Collective DC into the Dutch regulatory framework is proving difficult. Van Gaalen explains: "One of the problems with the new Pension Act is that there is no separate category for this type of plan, it only outlines DB or DC, so Collective DC is regarded as a DB plan for statutory purposes because it is not individual DC."

What this means is that all the requirements that apply to traditional DB pension plans apply to these plans too, including minimum funding, minimum solvency, annual contributions and the like. Van Gaalen adds: "Accrued benefits also have to be guaranteed which in practice means that you can reduce accrued benefits only in emergency situations - it is not something that you should do systematically when there is a deficit, so that is quite
an obstacle for a Collective DC system which by its very nature allows you to increase or decrease benefits depending on the scheme's funding status."

In an effort to address this issue, proposals were made before the implementation of the Act to create a separate category for Collective DC but the government feared that this would jeopardise transparency, says Van Galen: "They want pension funds and pension players to be very clear as to what the employees are being promised, so to cut a long story short, this sort of very flexible hybrid plan is not easy to force into the DB/DC dichotomy of the law."

Another problem is that schemes have to be very careful that they are not creating any constructive obligation, says Van Gaalen: "For example, if you are telling your employees that you are offering them a Collective DC plan that it is almost as good as a DB plan, and it is very likely that they are going to get their DB benefits, chances are that your accountant will say that is a constructive obligation, i.e. that you are promising too much and you are creating expectations.

Looking ahead
Despite all these changes, the mood among pension funds is still positive in the Netherlands and the affected parties appear to be facing up to the challenging environment.

Paul Cutts, managing director for the Netherlands, Northern Trust, says: "I think we see the market
here responding in a positive way to these pressures. And I think while any pension fund would be feeling the pain, across the market we generally see a high level of expertise, a high level of consciousness and responsibility about making the necessary changes.

"So yes there is pressure, and there is an increasing need for Dutch pension funds to be more dependant on their suppliers, so we are working alongside them in a spirited partnership to do whatever we can to help and support them through this challenging time."

ABN AMRO Mellon's Wiegel agrees that there is plenty of realism within the pension fund community about today's situation. "Of course there is always some resistance to change, but among the pension funds that we are talking to, which range from the small to mid-sized through to the largest ones, they are realistic that they need to ensure they are really in control.

"That's the new realism, that's where the entire market is going."