Brans Brief number 3, year 8, march 2005

In this issue of the Brans Brief:
 

	Coverage position, reserve position, indexation scope & premium discount threshold
	Hot topic: outsourcing
	Implementation of Pension Funds Directive
	Brans Brief in English

Coverage position, reserve position, indexation scope & premium discount threshold

Four expressions are important when assessing the financial position of a pension fund.

Coverage position: are the nominal pensions covered?
Under the ‘Actuariële Principes’ (APP, in effect up to and including 2005) pensions can still be discounted by the traditional account interest of 4%. With the ‘Financieel Toetsingskader’ (FTK, expected to be in force from 2006) the instalment structure of market interest is used. At the end of 2004, this was equivalent in value to a fixed account interest rate of 4.3% on average. This means that when the FTK is applied, the obligations will in the first instance end up roughly 5% lower. Under the new method, however, account is also taken of future developments in mortality risks and associated uncertainties. This will quickly involve an increase of between 5% and 8% or even more with a small membership. On balance, the coverage position under the FTK may therefore be less favourable than under the APP. (*)

Reserve position: is de solvency buffer adequate?
The required buffer under the FTK may be higher or lower than under the APP. The main reason for this is that, when the FTK is applied, the buffer is lower depending on how well the investments are focused towards the nominal obligations.

Indexation scope: what’s happening with indexation?
There is no expression of a conditional but durable indexation policy in the required coverage and reserve positions in either the APP or the FTK. Watson Wyatt Brans & Co calculates the indexation scope as being the extent to which the future indexation is covered. On average this involves a figure of between 45% and 60% of the cash value of the nominal pensions. As long as the indexation is conditional, a flexible buffer can be factored into the calculation of the indexation scope that can be used in bad times, but would have to be supplemented in good times (according to the ‘Branstoets’ system).

Premium discount threshold: is premium discounting possible?
Premium discounting and suchlike is only allowed if not just the unconditional but also the conditional sections of the pension contract can be met, even in the longer term. When working towards a durable, capital-covered indexation policy, the indexation scope will then have to be assumed to be 100%.

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Hot topic: outsourcing

In January 2004, De Nederlandsche Bank (DNB) published its policy on outsourcing by pension funds. We gave you information on this in the Brans Brief of March 2004. Pension funds had until 1 February 2005 both to amend the outsourcing contracts to meet the new DNB requirements and to adopt an outsourcing policy. But there are still some pension funds that have not addressed the topic of outsourcing. These pension funds can expect the DNB’s supervision to intensify. Also, the accountant will check extensively this year, for the first time, whether the outsourcing of commercial procedures has gone according to the book. External supervision is not, however, the only reason why pension funds should be taking the subject of outsourcing seriously. Proper outsourcing of work reduces the vulnerability of the pension fund, promotes continuity in the running of the business and contributes to further professionalisation. In addition, an efficiently run business delivers cost savings, certainly in the longer term. All in all, these are good reasons to get to grips with outsourcing.

When does outsourcing occur?
Virtually all pension funds have some parts of the running of their business done by third parties and therefore have to deal with the DNB’s outsourcing rules. This covers the following situations, amongst others:

• arranging for (part of) the membership or financial books to be kept by a bookkeeping office or a reinsurer;

• arranging for the internal actuarial work of the pension fund to be done by an actuarial advisory bureau;

• handing over control of asset management (or its monitoring);

• appointing a custodian;

• pension fund work being done by staff employed by the employer;

• reinsurance, unless it relates to coverage of relatively small risks (e.g. stop loss coverage).

Quickscan for outsourcing
The assessment and, if necessary, interim adjustment of existing outsourcing contracts is a difficult and time-consuming job for many pension funds. The legal advisers at Watson Wyatt have wide experience in this field and, using Quickscan, quickly assess whether adjustment of a contract is necessary or not. If so desired, they can also make textual suggestions. Naturally we can send out an indication of the costs involved.

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Implementation of Pension Funds Directive

The European Pension Funds Directive was published on 23 September 2003. This Directive is designed to be the first step towards a European market for company pension provision. The Directive has to be implemented in national legislation in the Netherlands, as in the other EU States, on 23 September 2005. We wrote about this in the Brans Brief in February 2004. On 11 March last, the Cabinet gave a green light for sending the legislative proposal to the ‘Raad van State’ for an accelerated opinion. The choice was for a limited adjustment of the Pensions & Savings Funds Act at the moment, with a complete incorporation of the Directive in the Pensions Act. There is little chance, however, of the Directive being implemented in time.

The Pension Funds Directive offers Dutch businesses the opportunity to farm out their pension schemes to a pension implementation body in a different EU Member State (plus Iceland, Liechtenstein and Norway, i.e. the European Economic Area - EER). In addition, employees in other EU Member States now have the chance to have their pension schemes housed in the Netherlands.

An important condition is also that, if a pension institution is going to implement a pension scheme that was agreed in a different EU Member State, the social and employment legislation of that other Member State will be applicable. That social and employment legislation will relate to the pension scheme, but not the pension institution. According to the Cabinet, this involves, in any case, compulsory participation in the pension scheme and the content of the pension scheme as arranged in the Collective Employment Agreements. The Dutch pension system is often held up as an example. And even in the Pension Fund Directive we can see many elements of the Dutch legislation on pensions. This might raise the expectation that the Netherlands might be about to welcome a number of foreign-based pension institutions. But this is also a reason for caution. Supervision of pension schemes has been firming up in recent years. Partly, that’s quite right. But sometimes this supervision has been felt too strongly. Since the Directive prescribes that the law of the country where the pension implementation body is established will be applicable, this might also lead to an outward migration of pension institutions. We’ve already seen something similar in the IT sector. Countries such as Ireland and Luxembourg in particular are good at taking advantage of this sort of European legislation and creating a favourable climate for settling there. The Dutch legislature should think long and hard about this.

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Brans Brief in English

From January of this year, an English-language version of the relevant Brans Brief will appear in the archive on our website shortly after it has been issued.

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Questions or Remarks?

If you have any questions or remarks concerning this issue of the BransBrief, please let us know.

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