When it comes to retirement provision, the Netherlands are always seen as the country with the best pension system. But although some might see it as an example of a good retirement model, the Dutch are also facing problems of longevity, low interest rates and the aftermath of the financial crisis.

Although the pension system in the Netherlands proved to be sufficient for many years, the financial crisis of 2008 has made it clear that reforms are necessary. The Dutch pension regulator, De Nederlandsche Bank (DNB), obliged all pension funds with a coverage ratio of less than 105% to submit a recovery plan before 1 April 2009. Back then, many pension funds were not even able to keep their coverage ratio above 90%.

The main reason for the continued under funding is said to be the low discount rate. But Henk van Embden, partner at LCP Netherlands, says this might be something that will not improve in the near future: “Since 1900, discounts rates have changed a lot and haven’t always been above 4%. It might just be that it has now finally returned to its normal level of 3-4% or maybe even somewhere above 2%.”

But according to Ulrika Bergman, head of institutional sales, Benelux & Scandinavia, at Principal Global Investors, most of the funds have recovered relatively well from the financial crisis. “Because they were more cautious during the crisis, they now have more cash to spend and they are now actively seeking ways to invest this money.”

Nonetheless, many are still not meeting DNB’s requirements and are now looking for ways to increase their investment returns while at the same time decreasing their liabilities. Their last and least preferred option is cutting benefits, but if they can’t meet their recovery plans, they might be forced to do so. Due to negative developments in financial markets, many are currently not on schedule with their recovery plan.

Patrick Dunnewolt, senior vice president and head of business development in the Benelux region at PIMCO, explains: “The likelihood of cutting benefits is increasing by the day. They have already stopped the compensation for inflation, pension premiums are at a maximum already, and there is limited freedom to take on board more risk by changing the investment policy. Therefore it is extremely challenging to turn the tide on short term. One of the consequences of the low coverage ratio of pension funds is that they are only allowed to take relatively low risk which means it is very difficult for them to get out of the under funding position. They are caught in a solvency trap.”

Feike Goudsmit, executive director Benelux at Threadneedle, sees this focus on low risk investments while in under funding as one of the reasons why pension funds have not recovered as well as they could have. “The regulatory rules forced them to take less risk, so they invested for a large part in ''safe'' fixed income such as Dutch and German government bonds. The returns on these have been minimal. In addition this massive buying by pension funds put further downward pressure on the swap rate which the pension funds have to use to discount their liabilities. So, ironically, they have taken more risk by taking less risk.”

Although the coverage ratio of most funds has gone up since the depth of the crisis, at the moment many funds are still in between 95% and 100%. If this doesn’t improve, they will most likely have to take certain measurements from 1 April 2012 onwards. These will differ from pension fund to pension fund, but in the long run DNB requires a higher coverage ratio than the bare minimum of 105%. To be able to have a robust policy, also in the long run, the coverage ratio is typically around 130%.

Mark den Hollander, head of investment solutions at ING Investment Management, says: “There are many changes that pension funds and the supervisor can make in order to create a financially healthier pension sector. All these potential adjustments (like pension right cuts, changing the discount rate, fair distribution of risk between generations) shouldn’t be approached separately, but need to be examined together in order to find the best solution, including clarity on the new pension contracts next year.”

Compared to other countries’ regulators, DNB has a tight lease on the Dutch pension funds, and as the benefits of thousands now need to be cut, the question arises if maybe DNB’s policy is too strict.

Dunnewolt thinks this depends on the starting point. “Back in 2007 Dutch pension funds had average coverage ratio of around 140%, and if this drops to a average of around 100%, then that is quite a steep fall. We need to bear in mind that a large part of this drop can be allocated to the low interest swap rates and to the increased longevity, as the pension funds never had more assets on their balance sheet than today.''

Van Embden is not surprised by DNB’s ‘wait and see’ regarding the discount rate: “It is a logical attitude. DNB might be in an uncomfortable position since it has been criticized in the media for the financial problems caused by the Icesave Bank, for which they gave admission to the Dutch savings market in spite of warnings from insiders, so they want to make sure this doesn’t happen again.”

Because of DNB’s many rules, of which more are announced each month, smaller pension funds find it hard to cope. They often don’t have the knowledge and manpower to be able to meet all of the regulator’s requirements, which means that increasingly more small funds choose to merge with other funds, to hire a fiduciary management firm, or to hand over their liabilities to an insurance company.

Wouter Pelser, chief investment officer at fiduciary management company Mn Services, believes their services offer a solution to under funded pension funds without forcing the board to give away all the decisions. “The fiduciary management model has found its place in the Netherlands. We have passed the stage of a growing market and are now firmly established.”

According to Pelser, fiduciary management is not comparable to the other two options. “If you opt for an insurance company, you leave the strong Dutch pension system. Some funds also go back to an industry fund. They used to do it on their own, but now decide to go back to the bigger industry fund.”

Many also look at the Dutch government to come up with new legislation to solve the pension problems. After agreeing to put up the retirement age for the state pension to 66 by 2020, minister of Social Affairs, Henk Kamp, was asked to put up the discount rate, but after some consideration, he decided not to.

The government has also expressed their opinion that they feel employers should have less influence when it comes to pensions, something which Den Hollander disagrees with. “Employers have always been involved in the development of pension funds and have taken their responsibility. Cutting employer’s involvement on pension funds would be a bad decision. Employees are with employers jointly at the base of pension funds.”

Although he believes the private pension age will go up with the retirement age for the State Pension, Van Embden believes the government should stick to their tasks. “They should only focus on the State Pension. The private pension is something between employers and employees and the government has nothing to do with that. On the other hand the Social Partners also have nothing to do with the State Pension.”

Bergman however, thinks that the outlook for the Dutch pension industry entirely depends on politics, as the pension funds all seem to hope that Kamp will change the discount rate. “Nothing will happen until the government discusses the discount rate, which won’t happen until early next year.”

Like most pension systems around the world, the Dutch pension funds are entering a time of many changes. Most of them are drifting towards a different scheme, as the current system is unsustainable. At the moment 85% of the funds have a defined benefit (DB) scheme, which is called collective defined contribution (CDC) because everyone pays in a collective pot out of which all the pensions are being paid.

The three pillars in the pension system will be filled in differently. Pensioners are now living of the State Pension (first pillar), complemented by the compulsory CDC contributions (second pillar). Voluntarily contributions (third pillar) are quite uncommon and often also unnecessary.

But soon some schemes will move completely to DC, while others will move further towards DC while also keeping some DB elements. Goudsmit says: “Almost every employee in the Netherlands builds up a pension, so the second pillar is in principle fully funded. But with upcoming changes, the third pillar will definitely become more important and more risk will go to the individual.”

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