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In this Watson Wyatt Update:
During the first six months of 2007, Watson Wyatt assessed the financial positions of around 200 Dutch pension funds (25-30% of the pension market in the Netherlands). The average cover ratio according to the Financial Assessment Framework at the end of 2006 was 133%, while the average cover ratio required by the DNB was 120%. By the end of 2006, all our clients had recovered from their lack of cover, while the reserves of 18% of those pension funds fell short in relation to the cover ratio required by the DNB. Average indexing capability was 65%.
Indexing capability represents the portion of price indexation that a pension fund can cover without incurring any risks. That means that a pension fund with capital equal to the fair value of its obligations (i.e. its indexed obligations) has an indexing capability of 100%, while a pension fund whose capital equals its nominal obligations has an indexing capability of 0%. The average indexing capability of Watson Wyatt’s clients at year-end 2006 was 65%. This means that the capital held by pension funds is sufficient to cover 65% of the price inflation without any risks.
However, an indexing capability of 65% does not mean that 65% of the indexation is awarded. It merely serves as a snapshot, based on the fund’s financial position in relation to market interest rates. This figure does not take into account any future developments, such as contribution and investment policies. Those factors are taken into consideration in the continuity analyses that became obligatory with the introduction of the Financial Assessment Framework.
Compared with the pension funds’ financial positions at the end of 2005, the results show a considerable improvement:
These improvements stem from a variety of causes. Market interest rates rose substantially during 2006, causing many funds’ provisions for pension obligations to drop considerably. In addition, 2006 was a good year in terms of investments in shares. Finally, during 2006 many pension funds were still in the process of implementing their recovery plans, resulting in relatively higher contribution receipts and/or lower indexation.
The indexing capability of all pension funds as at year-end 2006 can be broken down as follows:
For more information contact: Josje Wijckmans.
‘Placing long-term financial targets for the investments in a context of sustainability and social responsibility.’ Many pension funds have defined similar principles in their ‘Statements on Investment Policy’. Those funds are in the process of designing their investment portfolios based on an ethically responsible approach. Watson Wyatt Investment Consulting has defined three considerations that come into play in preparing SRI strategy:
For more information contact: Jeroen Verheijden.
As from 2007, provisions for pension obligations have to be stated at market value. One of the implications of this new requirement is that market interest rates have to be taken into account. Furthermore, all projected improvements in mortality rates must now also be factored into the provisions.
The same principles also apply to flexibility factors, such as acceleration, deferral and exchange factors. The implications of foreseeable improvements in mortality rates on the level of the flexibility factors should not be underestimated. There are two issues at play here. Firstly, switching to a mortality table that assumes an expected improvement in mortality rates will result in a one-off increase. Secondly, the mortality rates per age will increase from year to year. The expected lifespan of a 65 year-old in 2008 slightly exceeds that of a 65-year-old in 2007, for example. This means that provisions for old age pensions will increase slightly every year, while those for survivors’ pensions will drop slightly every year.
In an average fund calculating its reserves using the GBMV tables for the entire male and female population (adjusted for age), a participant exchanging €100 in survivors’ pension will receive €22 in old-age pension in return. Based on the new tables (the Dutch Actuarial Association’s projection table and the Brans historical mortality table), the same participant will receive just over €21 in old-age pension for €100 in survivors’ pension in 2007, and only a bit more than €19 in 2017. This effect is much less pronounced for acceleration factors. Previously, a participant who brought forward €100 in old age pension from the age of 65 to a pension from the age of 62 would receive €79 annually. Based on the new tables, that same participant will receive almost €80 in old age pension in 2007 and just over €80 in 2017.
As such, the new mortality rates will not only require a one-off adjustment of the exchange factors, but also annual adjustments. This effect is particularly visible in exchanges of survivors’ pensions for old-age pensions (and vice versa).
For more information contact: Josje Wijckmans.
Section 126 of the Dutch Pensions Act (Pensioenwet) states that all pension funds must calculate their technical provisions based on market valuation. Pension funds that have reinsured all their obligations under guarantee contracts must therefore also comply with this statutory requirement.
The Dutch Financial Assessment Framework (Pension Funds) Decree (Besluit financieel toetsingskader pensioenfondsen) provides further details for the concept of market valuation, stipulating that the DNB’s future interest rate structure is to be used and that foreseeable trends in mortality rates must be taken into account.
In most instances, the interest and mortality principles as set out in the Financial Assessment Framework (Pension Funds) Decree will not be the same as the principles defined in the pension funds’ agreements with their insurers. Consequently, the level of the technical provisions presented in these funds’ annual accounts will not correspond to those presented by the insurers.
For more information contact: Ronald van Dam.
Last spring, the Dutch pension sector was rattled by the news about the Organisation for Financing Pensions (Organisme voor de Financiering van Pensioenen, or OFP), a new Belgian pension vehicle that tied in with the possibilities offered under the European Pension Funds Directive. OFPs were thought to constitute a threat to Dutch pension funds and might result in a mass exodus to Belgium.
While the initial Dutch response to the Pension Funds Directive was effectively a call to construct a wall around the dependable Dutch pension system, it was now the political circles in the Netherlands that panicked. However, the Ministry of Social Affairs and Employment was already working on the Dutch variant: General Pension Institution (Algemene Pensioen Instelling, or API). The API concept is based directly on the Pension Funds Directive, and as such is only subject to the requirements stemming from that Directive and not to national – often much more strict – regulations. The Minister has since submitted a letter to the Lower House of Parliament, comparing the Belgian system with the Dutch system and mapping out the position of the Netherlands as a country in which pension institutions might establish offices.
Now that the commotion surrounding the OFPs has settled, we would like to examine the actual situation with you. We will be holding a seminar on 26 September to discuss the possibilities offered by the Pension Funds Directive, the advantages and disadvantages of the OFP system and the expectations surrounding APIs. For details about the seminar, please contact Saskia van Daalen by phone on +31 (0)20 543 3000 or by e-mail (marketing@watsonwyatt.nl).
For more information contact: Rick Crauwels.
If you have any questions or remarks concerning this issue of the Watson Wyatt Update, please let us know.
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