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In this Watson Wyatt Update:
The newsletter you are now reading has been given a facelift. We have published the Brans Brief every month since 1998. As of this number, the 3rd number of the 10th volume, we would like to continue to do exactly the same as we have been doing in the past 9 years and 2 numbers, but with a new name. The Watson Wyatt Update will keep you abreast of recent developments related to pensions, investment and human capital.
Since the introduction of the Dutch Pensions Act on 1 January 2007, pension funds are required to perform a continuity analysis in addition to the solvency test designed to map out short-term risks. The continuity analysis is intended to provide insight into a pension fund's financial situation and the effectiveness of its steering mechanisms over a long-term timeframe. The continuity analysis is further explained in the Decree on the Financial Assessment Framework for Pension Funds.
A continuity analysis has to provide a detailed image of the expectations and risks ensuing from the policy pursued by the pension fund. Following on from the recently introduced Policy Rule for the Pension Indexation Matrix (see below in this Update), the expectations are, among other things, related to the communication of forecast long-term benefits to participants. The risks are primarily related to economic developments, for example, a drop in share prices, a decrease in the market interest rate or a substantial rise in inflation.
As of 1 January 2008, when the obligations to provide information under the Pensions Act and the Industrywide Pension Funds (Obligatory Participation) Act take effect, pension funds must be able to rely on consistency among expectations, targets and communication in relation to the provision of future pension benefits. All pension funds must therefore perform at least one continuity analysis before 1 January 2008. After this, it will become mandatory for pension funds to carry out a continuity analysis once every three years, unless an earlier analysis is necessary due to unforeseen circumstances.
The Decree on the Financial Assessment Framework for Pension Funds imposes rules for how the analysis should be organised and the freedom of pension funds regarding the details that have to be included. This means that pension funds can largely decide what to include in the analysis, but have to work within the parameters specified in the respective ministerial regulation published on 22 December 2006 in the Netherlands Government Gazette (no. 250/ page 38).
The complete contents of the continuity analysis and an overview of the related requirements will be discussed during the seminar that we are organising on 23 May.
For more information contact: Sander Gerritsen.
The Policy Rule for the Pension Indexation Matrix was officially approved on 28 February 2007 and published in the Netherlands Government Gazette (no. 42/ page 43). This policy rule specifies how pension funds should apply the pension indexation matrix in 2007. From 1 January 2007 onwards, pension funds will have to ensure that there is consistency between the financing and realisation regarding benefits. The Policy Rule for the Pension Indexation Matrix consists of a further tightening of the regulations on the implementation of benefits policy, the financing of benefits and the registration thereof in the pension plan rules and the conditionality declaration.
Incidentally, this policy rule will only apply to 2007. It will be replaced at the start of 2008 by a ministerial regulation drawn up by the Minister of Social Affairs and Employment that shall apply to all pension fund administrators. This regulation will entail that pension benefits will only qualify as conditional if the pension agreement, the implementation agreement, the introductory explanatory letter and the information provided by the pension fund administrator include a conditionality statement.
In 2007, it will not be compulsory for pension funds to use the literal texts of the benefits indexation matrix. During this year, the Dutch central bank (DNB) will assess whether the way in which information is provided meets the set consistency requirements. If the information provided is not in line with the pension fund's benefits policy, i.e. consistency requirements are not met, either the information or the policy will have to be modified. If the pension fund does not do this, the way in which benefits are calculated and paid will be regarded as unconditional, which could have serious financial consequences. From 1 January 2008 onwards, the Netherlands Authority for the Financial Markets will supervise the consistency of pension fund information.
It is advisable to check the extent to which the information on the payment of benefits provided by your pension fund complies with the requirements. The texts in the pension indexation matrix can be used as a basis for doing this. If your pension fund consistently adheres to these texts in all the information on benefits policy that it publishes and expectations are in line with policy, the new requirements in this respect will in any case have been met.
We would be pleased to assist you both in assessing all the information provided by your pension fund, whether it is in line with its benefits policy and, if this is not the case, help you with making it conform to the policy and the pension indexation matrix policy rule.
For more information contact: Marijke Biewinga.
The financial assessment framework embedded in the Netherlands Pensions Act imposes specific minimum requirements in relation to the cover and reserve positions of pension funds. This obviously does not alter the fact that it is wise for pension funds to build up larger reserves than prescribed by the statutory minimum requirements. It is advisable to form additional reserves in times of prosperity when things are going well on the financial markets so that they can be used as a buffer in an economic downturn.
The table below illustrates how this idea would work for a representative pension fund with an average liability structure and an investment mix of 50% shares and 50% bonds with a 5-year term.
Year end |
Minimum required additional buffer |
1998 |
12 |
1999 |
51 |
2000 |
32 |
2001 |
20 |
2002 |
0 |
2003 |
0 |
2004 |
0 |
2005 |
0 |
2006 |
9 |
The model used in this example is based on Watson Wyatt's Brans Assessment. The formulas and exact results are secondary; the important factor here is the philosophy on which the Brans Assessment is based.
At the end of 1999, both share prices and interest rates were high by historic standards. With hindsight, there was at that time a good reason to be cautious with a financing surplus and to build up a substantial additional buffer. In the example, the additional buffer should be no less than 51% of the total pension liabilities.
After 1999, the hidden crash occurred and share prices remained low from 2000 to 2002. According to the logic of the granary buffer, during this period, it would have been reasonable to eat into the surplus that had been built up. The table shows that the market collapse was substantial enough that it would have been unreasonable to require that any additional buffer remained at the end of 2002.
From 2003 to 2005, there was virtually no recovery in general share prices and interest rates. This means that was not possible to form additional buffers in this period.
In the example, the required additional buffer at the end of 2006 is equal to 9% of pension liabilities. This is due to the favourable developments in share prices and interest rates during 2006.
The granary buffer has to be accumulated in times of economic prosperity so that it can be drawn on during a recession. Because share prices and interest rates are now improving, pension funds that pursue a granary buffer policy as part of their drive to attain long-term objectives must accept that the time has come to form additional reserves again.
For more information contact: Roland van Gaalen.
If you have any questions or remarks concerning this issue of the Watson Wyatt Update, please let us know.
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