IMF team recommends adjustments to Dutch second pillar system

A new report from a staff team of the International Monetary Fund (IMF) has outlined the challenges facing the Dutch pension system in light of the recent international economic crisis and demographic changes, suggesting a series of measures to address the system’s issues.

The technical note, published as part of the Financial Sector Assessment Programme, states that the financial crisis and interest rate declines have placed “severe strain” on the Dutch occupational pension system.

Cover ratios of Dutch funds have dropped from 130 per cent to around 100 per cent, which is below regulatory solvency requirements.

“Unprecedented” technical and supervisory measures have been triggered as a result, such as most plans stopping the conditional indexation of the accrued benefits for the last two years. Furthermore, the report said 430 pension funds are under supervisory recovery plans, and seven are required to cut benefits in the next months.

Increased longevity has further stressed the system, after an increase in life expectancies in mortality tables published last year reduced cover ratios by seven to 10 percentage points, implying an additional capital need of around €50 billion.

These factors have combined to rock public confidence in the pension system, the report said.

“The benefit cutting measures, all in congruency with the law, have been received by the public as an unexpected and almost unknown option inherent in the pension contracts. While the first pension fund that was scheduled to cut benefits has avoided the situation by adding solvency capital into the fund, the general belief of the Dutch population in the safety of their pensions and the untouched image of the pension funds is undergoing a major crisis.”

A stress test exercise was carried out on the Dutch second pillar system, analysing its resilience to particular market shocks. It revealed that funds are particularly sensitive to low interest rate, equity and real estate risks.

“The stress test also calculated the cover ratios assuming indexation of the future benefits. The additional drop in cover ratio that resulted is over 30 per cent underscoring the urgency of the discussions currently being carried out on the needed changes towards a strong and explicit conditionality of the indexation of future benefits including the accrued benefits.”

The IMF staff team recommended separating the risk management strategy of the two major risks affecting pensions funds: market risk and longevity risk.

Careful communication was raised as necessary to address the image crisis identified in the Dutch system. A communication plan to “regain a realistic image of the quality of the pension funds” was recommended, along with taking care to ensure all parties understand the new risks assumed in a new pensions contract.

The team also recommended adjustments to the Financial Assessment Framework, to better assess the riskiness of pension fund portfolios, and drafting regulation to require the incorporation of professional board members for pension funds of a “given size and complexity”.

Access the technical note on pensions, and the other Financial Sector Assessment Programme documents here

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