Brans Brief number 9, year 8, September 2005

In this issue of the Brans Brief:
 

	Actuarial interest rate of 4% no longer prudent, despite the postponement of the Financial Assessment Framework
	Consequences of the Care Insurance Act for pension providers
	Adjustment of accrual percentages for retirement age below 65
	Pension funds and VAT

Actuarial interest rate of 4% no longer prudent, despite the postponement of the Financial Assessment Framework

On 12 September 2005, DNB, the Dutch Central Bank announced that the Financial Assessment Framework (Financiële Toetsingskader) for pension funds will not take effect until 1 January 2007. The main reason for this is that the new Pension Act will not have completed its passage through Parliament in time for it to be introduced with effect from 1 January 2006.
Does this mean therefore that the traditional actuarial rate of 4% can still be used for the adequacy tests for the 2005 and 2006 financial years, with regard to nominal pension commitments, excluding future indexation? Watson Wyatt Brans & Co is of the opinion that an actuarial interest rate of 4% is not prudent, as long as the current market rate (see note 1) is lower than 4%. Unless the government stipulates otherwise, we assume that the pension commitments in the adequacy test do not need to be valued according to an actuarial interest rate of 4%. The reasons for this are as follows:
According to the current rules, the certifying actuary carrying out the adequacy test must form his or her own opinion with regard to the adequacy of the pension scheme. This is subject to the regulation that the provision for pension commitments that is required from a technical perspective must be calculated on the basis of prudent principles, including a maximum actuarial interest rate of 4%. The European Pensions Directive 2003/41/EC also stipulates that a prudent interest rate base be used. In addition, the Directive states that the provision must be sufficient “for benefits already in payment to beneficiaries to continue to be paid and reflect the commitments that arise out of members’ accrued pension rights” . According to the directive, not only must the provision be covered by assets, but the fund must maintain a permanent buffer consisting of equity capital. This represents a solvency margin that must be “free of all predictable obligations”. In our opinion, the consequence of this is that the provision must, at the very least, be equivalent to the current market value of a fictitious representative portfolio containing risk-free bonds that precisely cover the expected pension commitments. By definition, that market value corresponds exactly to a discount based on the market interest rate. Now imagine that the current system of maturity dates for market interest is equal to an interest rate of 3.7% for all maturities. A sum equivalent to the provision, subject to 4% interest, is then not sufficient to be able to acquire the fictitious portfolio, since the higher the discount rate, the lower the provision. For an average pension fund, the shortfall then forms approximately 4 to 6% of the required amount.
The fact that discounting with an interest rate higher than the market interest rate is not prudent can also be demonstrated in a different way. Assuming a higher yield implies taking an advance upon favourable investment results, whilst according to the European Directive it is necessary to observe a reasonable margin in order to cushion negative movements. Obviously, it is by no means certain that those favourable investment results will be achieved, either in the short or in the long term. The provision that is calculated in this manner is not therefore a full reflection of all commitments. This immediately implies that the associated solvency buffer is not free of all predictable obligations.

Current market interest rate and actuarial rate (in %) for the valuation of nominal pension commitments, excluding future indexation

1. Current market interest rate is understood to mean the interest rate equivalent to the current maturity structure, taking in account the maturities and amounts of the nominal pension commitments of the relevant pension fund.
2. Up to 1990: capital market rate of Statistics Netherlands; from 1990: estimated current market interest rate for an average pension fund.
3. Sources: Watson Wyatt Brans & Co en Rekenen op rente, Actuarieel Genootschap, 1998.
4. Estimates based upon provisional information (30 September 2005).

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Consequences of the Care Insurance Act for pension providers

With effect from 1 January 2006, pension providers will come into contact with the new Care Insurance Act (Zorgverzekeringswet). This new law will do away with the distinction between individuals insured for medical treatment under the state system and those who have private insurance. This means that pension managers will be required to deduct an income-dependent contribution of approximately 6.5% from all pensions to be paid out. This will apply up to a maximum income of approximately €30,000. This income includes benefits received by virtue of the General Old Age Pensions Act (Algemene Ouderdoms Wet, AOW), the Surviving Dependents Act (Algemene Nabestaandenwet, ANW), the Occupational Disability Insurance Act (Wet op de arbeidsongeschiktheidsverzekering, WAO) and/or additional provisions. The contribution must be deducted and forwarded to the Dutch & Customs Administration. In order to protect the purchasing power of those receiving payments via an AOW, early retirement or pre-pension benefit, the government may lower the income-dependent contribution payable by those parties. Amounts received under the AOW will also be taken into account. It is not yet known how this is to be implemented.
In principle, the person entitled to a pension must bear the cost of the income-related contribution him or herself. The pension provider is not required to contribute. In some cases, however, it is determined in the regulations of the pension scheme that the person entitled to a pension is entitled to compensation (either full or partial) for health insurance premiums. In that case, the pension provider is obliged, under the terms of the new law, to compensate for the premium. As the way in which the sickness insurance is financed is changing, it is advisable to check whether the wording relating to premium compensation that is included in the regulations of the pension scheme will give rise to additional costs as a result of the new law. If that is the case, the pension regulations will need to be amended in good time.
Alongside the income-related contribution, the person entitled to a pension will pay a nominal premium of approximately €1,100 per year directly to the sickness insurer for the sickness insurance package of his or her choice. In principle, the pension provider needs to take no action in this regard.

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Adjustment of accrual percentages for retirement age below 65

Following the introduction of the Act on Early Retirement, Pre-Pension and Life Course Planning (Wet VPL), pension schemes may incorporate a retirement age below the age of 65, as long as the size of the old age pension (hereinafter: OAP) to be accrued is no higher than the maximum OAP permitted under tax regulations at the age of 65 years, when recalculated according to generally accepted actuarial principles to take account of the lower retirement age. In its Decision – question and answer 05-046 dated 22/08/2005 – the Dutch Tax & Customs Administration set out the maximum accrual percentages, recalculated based upon a retirement age of 65 that will apply for an OAP commencing between the ages of 60 and 65 years. Details of these percentages can be found in the Decision. This does not mean, however, that the maximum accrual percentages for each pensionable year of service must be recalculated according to actuarial principles for the purposes of the surviving dependents’ pension (hereinafter: SDP) and the orphans’ pension. However, various aspects must be based upon the retirement date stipulated in the pension scheme. In addition, the Dutch Tax & Customs Administration has adopted the accrual percentages for in the event that the SDP is expressed in the form of a percentage of the OAP. In that case, a lower retirement age will give rise to a lower SDP, as well as a lower OAP. It is implicit that an SDP is transformed into an OAP at the ratio of 100:70. It is important to state at this point that the partner consents to this annual transformation. With regard to the available premium schemes, only the allocation tables based on a retirement age of 65 located in Annex 1 of the Decision of 28 April 2003, no. CPP2003/308M, may be used. When a pension commences early, the capital that has accrued at that point then forms the corresponding figure for the calculated entitlements at age 65.

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Pension funds and VAT

The principle rule is that business must charge VAT. VAT charged by other entities is deductible. A pension fund is exempt from VAT and may not deduct input tax. The Dutch Tax & Customs Administration seems to have granted a concession to various companies, with the effect that no VAT is owing for work carried out by the company that relates to the company’s own pension fund. It cannot be ruled out that such agreements contravene the law. In addition, it could constitute prohibited support from the state. The Dutch Tax & Customs Administration is obliged to notify the Ministry of Finance of all agreements with taxpayers that may contravene the law. Policy decisions that may be incompatible with the law also form part of the study. The study was recorded in writing in a report sent to the Lower House of Dutch Parliament on 3 June 2004 (no. DGB2004-3005). From answers to parliamentary questions in January 2005, it appears that no additional tax assessments will be imposed.

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