Dutch courage pays off

Lynn Strongin Dodds looks at how Dutch pension schemes are coping with the recent financial turmoil

The financial maelstrom which has wreaked havoc in the past few months has impacted all pension funds across the European spectrum. Dutch schemes, which are known for their robust health, have also been hard hit by plunging share prices. However, market participants believe that the fairly recent introduction of the financial assessment framework, Financieel Toetsingskader (FTK), coupled with more rigorous risk management policies has enabled them to better weather the storm than their counterparts.

The FTK, which was implemented in 2007, introduced a mark to market reporting and 105 per cent solvency at all times, with buffers of up to 130 per cent depending on the risk profile of the portfolio. It also operates on the basis of conditional indexation in which pension increases, both in deferment and in payment, are only awarded when a scheme can afford to do so. Indexation is restored when the fund has recovered.

Of course the Netherlands, like the rest of Europe has had its fair share of problems. In recent weeks, the government has injected €10bn into ING, the banking and insurance giant, as well as participating along with Belgium and Luxembourg, in a €11.2bn bailout of Fortis, the Belgo financial group.

The country's pension funds have also been battered by turbulent markets although a review undertaken by Lehman Brothers in September (before the bank's collapse) revealed that UK pension funds suffered the steepest decline in solvency ratios in the first half of 2008 compared with their Dutch and German peers. The four largest Dutch pension players – ABP, the €212bn civil service scheme; PFZW, the €86bn healthcare scheme; PMT, the €33bn engineering fund; and PME, the €19bn electro-technical engineering sector fund posted losses of €16bn in the first half of the year. ABP was the hardest hit, with a -5.1 per cent drop in performance.

Industry reports also show that half of all Dutch pension funds have dipped below the 105 per cent level, while a study by Mercer tracking the solvency rates of its client pension funds noted that there had been significant falls in the average solvency rate to about 116 per cent as of early October 2008 from around 130 per cent earlier in the year.

Tim Burggraaf, Dutch based European partner at Mercer, believes that on a relative basis, Dutch pension funds are holding their own. "Generally speaking, the current financial crisis is the second test for Dutch pension funds. The first was September 11th and the bursting of the dot.com bubble. While it is still early days, it seems that the FTK is doing its job and the dikes are holding. Premiums have risen 25 per cent since 2002 and as a result the buffers are stronger than they were six years ago."

Some might argue that one downside to the FTK is its requirement on pension funds with a deficit to present a three year recovery plan to the pension fund regulator De Nederlandse Bank (DNB) showing how it intends to restore its financial health. Henk Van Embden, managing director and partner at Lane Clark Peacock in the Netherlands, doesn't believe these recovery plans are feasible. "I agree with Frans Prins, (director of the Dutch Association of Company Pension Funds) who said that we need to build provisions into the framework that deal with unforeseen rises in inflation and unexpected market conditions."

In the meantime, the DNB issued a statement, saying that "under no circumstance" would pension funds be forced to adjust their investment policy, even when the fund has reached an unfavourable financial position. It recommended that in the event of an actual shortfall, pension funds should not take any rash decisions regarding contribution rates and indexation and instead conduct a thorough analysis of the fund's situation and its management tools. The regulator also made it clear that the FTK does not automatically prescribe divestment when a scheme's cover ratio decreases significantly, nor does it expect schemes to raise contributions or lower indexation.

In addition, although the impact of the current financial turmoil is yet to be determined, the DNB reiterated that the Netherlands has a sound pension system based on capital funding. Total available pension capital is currently estimated at approximately €600bn versus annual pension payments of about €20bn.

Luigi Leo, senior investment consultant at Watson Wyatt, notes, "The regulator has been sensible in putting out a press release telling pension funds not to take any actions in haste. In case of shortages pension funds should take their time to do a proper analysis before coming up with a recovery plan. So far, the FTK has done a good job in that it has enabled pension funds to monitor and manage their risks in a more effective manner. Depending on the fund, cover ratios have fallen and buffers have come down. However, the degree to which this has happened differs from fund to fund."

At the moment, several pension funds are heeding the regulator's rallying call not to panic and are in the process of assessing the best course of action regarding indexation. For example, ABP has recently announced it may delay its decision on indexation due to turbulent market conditions while the Labour Foundation (The Star), which comprises representative organisations of employees and employers, has asked pension fund boards to follow suit.

Burggraaf comments: "FTK has a focus on conditional indexation and one of the big questions is whether pension funds will have sufficient funds to make the indexation payments for 2009. The general view is that for a very significant number of funds, indexation will be limited or not be imposed at all, although it is too early to tell."

Van Embden agrees adding: "I do not expect that pension funds will offer the full 100 per cent indexation. It is too tricky in these volatile markets. In general, though, when ABP says something, most funds tend to listen to their bigger brother."

Although most market participants agree that indexation will be delayed, views are mixed on whether the current situation will precipitate an even larger growth in the field of fiduciary management. The practice has flourished in the Netherlands, with third-party fiduciary assets under management estimated to be about €300bn, according to data from Avida International, an Amsterdam-based independent consultant specialising in fiduciary management.

Some believe the turbulence will highlight the need for greater corporate governance, while others think that the practice might be shunned due to the asset allocation advice that was given. Brian Strange, vice president & client adviser, European relationship management at JPMorgan Asset Management comments: "I am not sure whether recent events will accelerate the trend towards fiduciary management. Pension funds had already been moving in that direction. Although it makes sense for one person to be responsible for everything, it is important to note that there are differences between fiduciary managers and their roles. There are also some investment consultants who are offering a broad range of services including asset liability management studies to hiring, monitoring performance and reporting back to the board. I am not sure there is such a huge difference between them and fiduciary managers."

Overall, fiduciary management offerings tend to vary widely from one firm to another. There are those firms that provide a wholesale solution to pension funds, covering asset management, reporting, consulting and administration and others who focus more on investments and asset allocation.

Van Embden believes that against the current volatile background, pension funds might think twice before taking the plunge. "It is difficult to predict what will happen but I think that the whole pension fund industry will be careful in their future decisions regarding fiduciary management. The big question is whether they really add value. One could argue that these managers encouraged pension funds to move into riskier assets such as asset backed securities."

As for asset allocation, not surprisingly, Dutch pension funds are sitting on the sidelines waiting and watching. According to industry figures, the average pension fund has 10 per cent in foreign bonds, 33 per cent in Eurobonds, 12 per cent in European equities, 29 per cent in foreign equities, 10 per cent in real estate and the rest in alternative asset classes and cash.

Leo says: "Changes in asset allocation will depend on the fund and its cover ratio. However, investment decisions are part of long-term asset liability management studies. Many pension funds looking to de-risk their portfolio stopped re-balancing until markets stabilise and they have a clearer view of their financial position."

Written by Lynn Strongin Dodds, a freelance writer