Ghost of pensions past
Written by Ilonka Oudenampsen
Ilonka Oudenampsen explores how the Dutch are haunted by their pension legacy issues
Many changes are taking place in the Dutch pension market, but before the industry can focus on a brighter future, it first has to deal with its demons of the past.
After several years of negotiations, the government and social partners finally agreed upon a long-awaited Pension Accord in June 2011. But after the government fell in April this year, the government let go of the agreements made in the Accord and left pension funds once again in the dark on which direction to take.
While the move towards a new form of pension provision, the so-called smart DC, is already underway, the problem of the huge deficits remains. So far no solution has been found to facilitate the transfer of old DB rights to smart DC, ‘invaren’ in Dutch, which is seen as essential to overcome the deficits.
A smart DC scheme is a collective second pillar pension scheme, agreed upon by employer and provider, but unlike a traditional DB scheme it offers employers cost control as more risks are being transferred to the employee. It differs from a normal DC plan in that these risks that are being transferred to individuals are being mitigated, so that not all the risks are fully borne by the employees.
“The real problem in the Dutch pension market is not so much for the future what kind of pension schemes and pension institutions will be used. That transition is already underway. The real problem is what happens to the past rights; the large volume of under-funded closed DB schemes,” Robeco director European pensions Jacqueline Lommen explains.
“You can compare it with the government debt crisis in Greece. You can have more discipline for Greece in the future, but their deficits and their problems from the past are so huge you have to solve them. That’s the same with pensions in the Netherlands. For the future the transition towards smart DC is underway, but with regards to the deficits in the built-up DB rights, we have to bite the bullet, the sooner the better.”
To deal with this legacy, pension funds could move from an inflation-linked pension contract to a nominal pension contract.
In July, Social Affairs Minister Henk Kamp told the Financieele Dagblad that he is going to tempt pension funds to move to a nominal pension contract. However, Bergamin & Gielink Pensions Law partner Eric Bergamin notes that it is not possible to tempt funds into doing this, as there is no legislative framework in place yet.
He adds: “The problem is that we have many concept rules and ideas about what we need, but the most important question, what exactly do we need, is not being asked. Do we really need a lifelong indexed pension in the Netherlands?”
While the Minister has said it would be good to transfer the old DB rights, worth €800-900 billion, into the new conditional contract, he has also stated he is not going to make it compulsory, as “the pension funds belong to the social partners”. It is their responsibility, according to the Minister, and he explains he does not want to bear the legal risks for such a transfer.
“It’s either one or the other. Or it is important, we should do it and we arrange it by law, or it is not important, the risks are too big and we don’t arrange it. The Minister is actually saying the former combined with the latter, which is a bit of a staggering policy,” Bergamin comments.
The Minister is also keen on bringing forward the introduction of the Ultimate Forward Rate (UFR), one of the most criticised points in the now abandoned Pension Accord. The UFR curve will only take into account market information until a certain point in time, called the Last Liquid Point, which is currently set at 20 years, and the curve trends towards a theoretical level of 4.2 per cent after that.
Cardano senior risk manager Joeri Potters explains: “The obvious effect is that the long end of the new discounting curve will be much higher than the market curve currently is, and funding ratios will improve. This may lead to pension funds postponing their decision to cut pension rights.” An additional concern is that an average return of 4.2 per cent is unlikely to be met by any investment manager.
But Potters adds that that is not the only issue concerning the introduction of the UFR. “Adoption of the UFR will also result in a strong concentration of interest rate risk at the Last Liquid Point, leading to distortions in the swap market. The 20 year swap rate – and the whole yield curve thereafter - will very likely be pushed down once European insurance companies and pension funds start adjusting their hedging programs.
“By government decree, the Last Liquid Point will in fact become the ´Most Illiquid Point´, especially when all regulators choose the same UFR parameters. There will be a big gap between the regulatory and the economic hedge. Another unintended side effect of the new regulatory proposal is that annual hedging costs will increase dramatically to keep this artificial ‘regulatory’ hedge at the right 20 year point every year again.”
Apart from regulatory changes in the Netherlands, the Dutch pension industry has also been focusing on legislation coming from Europe. While Bergamin believes the Netherlands should be careful, as it would be “extremely appealing for the European Union to fill the gap in the budget with pension money from the Netherlands”, Lommen says that local pension markets can no longer ignore EU pension developments.
“[The discussing about IORP2] makes member states, especially also the Netherlands, aware that a lot of regulatory decisions will be made at European level in future and not at local level anymore. It will also make the Netherlands aware that it’s better to co-think this through with Europe instead of trying to neglect, or trying to stop it. This new, pro-active policy stance towards the EU is a promising development in the Dutch pension market. The Dutch have ample and unique practical experience regarding risk-based solvency rules for pension institutions,” she says.
Separate from all the regulatory changes which might or might not happen in the future, another trend that has clearly been developing is the tendency of trustees to work more professional, to be in control and to meet all the requirements of the increased regulation.
With pension funds being more on the public agenda, trustees are under more scrutiny and therefore get a better sense of responsibility. “They are really looking for some certainty, in terms of data, reliability and also in terms of how best to organise it. There is more attention for that now than before, mainly due to outside pressures, the regulatory oversight, the society. That is a playing field that is really shifting,” KAS BANK managing board member Sikko van Katwijk notes.
One of the changes trustees have to deal with is the communication to members, especially with the new smart DC, ‘invaren’ and many funds needing to cut benefits next year. “From the 70s, we have inherited this informal benchmark of that you get 70 per cent of your last salary as your pension. The question is A) who has officially invented this, and B) is this really a promise. That is the informal benchmark hanging over the market and everything that detracts from that, and that is also how the media report on it, is negative perception,” Van Katwijk explains.
“That 70 per cent for the entire market should be replaced by what your pension fund promises you. If you can link that to the communication to the member, and if you can do this in such a way that the member understands it and sees the long-term aspect of it all, which is the major problem, then you are almost there, but that is an enormous challenge.”