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In this issue of the Brans Brief:
We have made a rough estimate of the financial position of an average pension fund as of 1 October 2006 using detailed information as of the end of 2005 regarding a large number of pension funds and the changes in general indices and interest rates. A few leading pension funds have achieved higher returns on shares and property to date in 2006 than we assume here based on the MSCI global index. As a result our estimates are probably somewhat on the conservative side.
General picture
Watson Wyatt Brans & Co is confident about the future of Dutch pension funds. Our confidence is not so much instilled by the estimates presented here – which are only a snapshot of a given moment in time – as by the proven readiness to be bold when necessary and implement appropriate recovery measures. The fact that pension premiums are increased and conditional indexation is reduced in less prosperous times is now almost an integral part of the usual pension system in the Netherlands. Furthermore, premium discounts are only allowed if not only the unconditional, but also the conditional pensions are guaranteed. Together with the solvency buffers required by law, this produces a resilient, shock-resistant form of funding. As a result, pension agreements remain tenable and credible.
In the difficult years between 2000 and 2005 the Dutch pension funds seemed to end up in a vicious circle: falling share prices, interest rates and levels of funding; as a result a greater need for nominal security, and therefore more demand for bonds, leading to a further drop in interest rates and levels of funding. There has been a significant recovery since then, partly due to the measures taken to finance the shortfalls. However, the financial room for future indexation is still well below 100%. The extent to which indexation actually takes place will depend on the indexation policy of the fund concerned and in particular on any indexation step rates. The fact that the indexation is only partly funded does not therefore mean that it should be immediately reduced. However, it does mean that the extent to which the already existing pension entitlements can be index-linked in future will depend more on future premiums and future excess returns. Incidentally, there are major differences between pension funds as regards funding levels and room for indexation. Those differences are not expressed below.
Nominal funding level
We estimate the average funding level to be 125 to 130% as of 1 October 2006 (end of 2005: 120 to 125%). This does not take into account future indexation.
Index-linked funding levels
Based on the hypothesis that all accumulated, non-contributory and commenced pensions must be linked annually to the European price index, the average level of funding as of 1 October 2006 is 85 to 90% (end of 2005: 80 to 85%).
Room for indexation
According to our estimates, the room for indexation is on average 55 to 60% as of 1 October 2006 (end of 2005: 45 to 50%). This means that more than half of the future indexation increases is funded. A funding level of 100% in the index-linked variant corresponds on average to 145 to 150% in the nominal variant. Incidentally, this is not a rule of thumb, given the great differences between pension funds as regards the sensitivity to interest rate fluctuations, that is the duration, of the commitments.
Bad times, good times
For practical reasons, nearly all pension funds have a significant mismatch between their assets and their liabilities, especially if the indexation ambitions are included in the calculation. Based on that given, it is necessary to accept that levels of funding can rise or fall significantly as a result of developments in the financial markets. That itself – apart from the legal requirement for a solvency buffer – is a good reason to systematically maintain buffers that can be drawn upon in bad times but that must be restored in good times. This puts the observed recovery into perspective.
Accounting method |
For more information contact: Roland van Gaalen.
The Equal Treatment Commission (Commissie Gelijke Behandeling (CGB)) ruled on 28 August 2006 regarding the question as to whether there was prohibited differentiation based on age as a result of the implementation of a pre-pension scheme for people aged 55 and above and the application of an age requirement to join a compensation scheme for people aged under 55. The employer would also like to know whether the compensation scheme can also be declared applicable to future personnel without any prohibited differentiation based on age (ruling 2006-187).
The scheme as presented to the CGB is as follows. Based on the transitional regime under the Abolition of Voluntary Early Retirement and Pre-pension (Introduction of the Life Cycle Scheme) Act (Wet afschaffing VUT, prepensioen en introductie levensloopregeling (VPL Act)) the pre-pension scheme continues to exist for employees who were 55 or older on 31 December 2004. To compensate for the loss of pre-pension rights for employees who were younger than 55 on the aforementioned date a scheme was established in which employees aged 40 and above received an annual employer’s contribution of 6% of their fixed salary including holiday allowance. This contribution is deposited in a life cycle scheme (levensloopregeling).
Pursuant to the Equal Treatment in Employment (Age Discrimination) Act (Wet gelijke behandeling van leeftijd bij de arbeid), it is not permitted to differentiate based on age in pension schemes, unless that differentiation can be justified on objective grounds. The CGB previously ruled (2006-62) that the VPL Act does not automatically mean that differentiation based on age is permitted. In order to objectively justify differentiation based on age a legitimate purpose must be demonstrated for which this differentiation is suitable and necessary. As regards the implementation of the pre-pension scheme for employees aged 55 and above, the CGB wonders whether there really is differentiation based on age. Both the pre-pension scheme and the compensation scheme provide employees with the possibility to stop working when they reach 62 years of age. There is indeed a difference of 2% between the employer’s contribution in the pre-pension scheme and the compensation scheme. This difference is due to the fact that the people aged under 55 who take advantage of the life cycle scheme notionally continue to work for longer than the people aged 55 and above. The people aged 55 and above retire at 62 whereas those aged under 55 continue to work and accumulate old age pension entitlement until they are 65. Therefore, in the opinion of the CGB, there is no actual differentiation based on age in this case. Because the compensation scheme is not a pension provision, it is necessary to consider whether the age requirement of 40 for joining the scheme can be justified on objective grounds. According to the CGB, the purpose is legitimate because it is sufficiently compelling and non-discriminatory. This conclusion is based on the fact that not implementing an age requirement for joining the scheme goes beyond the purpose of the compensation scheme, given that it allocates more rights to employees under 40 than they could have claimed under the pre-pension scheme. The CGB also considers the differentiation to be suitable given that the Works Council has subscribed to the scheme. The CGB also does not put forward an alternative. The purpose can therefore also be considered necessary. On this basis, the CGB rules that the differentiation based on age is objectively justified. According to the CGB, the compensation scheme can also be declared applicable to future employees because, given the nature of the work, it is a sufficiently compelling purpose to have employees stop working at 62 years of age. Because there is no differentiation between the different groups the scheme is objectively justified and therefore legitimate.
In conclusion, it can be stated that this ruling by the CGB is very casuistic and is only applicable in a small number of cases.
For more information contact: Ingeborg Agema.
On 11 October 2006 the Ministry of Finance issued a decision in relation to the accumulation of pension rights with a disability premium waiver. In principle it is possible to continue accumulation on a non-contributory basis in the same way as before for people with an occupational disability who were granted a premium waiver before the introduction of the VPL Act. We will provide more information on this subject in the next Brans Brief.
For more information contact: Marlies Kastelein.
If you have any questions or remarks concerning this issue of the BransBrief, please let us know.
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