New twist in Dutch pension reform
On 24 September, the long, drawn-out process of Dutch pension reform took a new turn when state secretary for social affairs and labour Paul de Krom unveiled the so-called ‘September package’, a comprehensive set of new rules for pension funds. The package seeks to flesh out labour minister Henk Kamp’s earlier outline of a new Pensions Agreement, while at the same time providing a number of relief measures meant to prevent large-scale benefit cuts and hefty premium contribution hikes – both of which might deal harsh blows to a still fragile economy.
According to the package, pension funds – provided they meet certain conditions – may apply for a one-year exemption from a directive issued by the Dutch regulator (DNB), dictating that premium contributions at underfunded schemes must contribute to recovery. This premium-hike holiday, together with the other measures in the package, is expected to limit contribution increases to €200m, instead of the €3.8bn increase projected earlier. The number of schemes that would have to raise their contribution level as a result of the DNB directive was thus reduced from 144 to about 30.
Pension schemes that are ineligible for the exemption from the obligation to raise premium contributions in the case of a funding shortfall may appeal to the DNB for a “tailor-made approach” to contribution hikes.
In addition, benefit cuts may be capped at 7% and spread over several years. For many schemes, the legal five-year recovery period expires at the end of 2013, at which point they must have reached the minimum coverage rate of 105%. But if additional cuts should be necessary to achieve the minimum funding level, these too may be spread, with the last cuts implemented in 2015.
If pension funds wish to apply for a “tailored” contribution solution or want to spread benefit cuts, they must agree to make a number of changes to their pension arrangement, pre-empting system changes targeted by the proposed Pensions Agreement that will take effect in 2014.
First, they must agree to raise the pensionable age as used to calculate pension right accrual from 65 to 67 in 2013, one year earlier than originally agreed. In addition, further increases in life expectancy have to be discounted in existing rights, and, starting next year, schemes cannot index pension rights until their solvency rate reaches 110%.
As expected, the package also introduces a new discount rate, applying an ‘ultimate forward rate’ (UFR) to liabilities with durations of 20 years and more. But, instead of simply extending the UFR as proposed for insurers in Solvency II to pension funds, the regulator settled on a variation on the theme. To avoid the need for complicated and costly hedges around the 20-year point, the UFR methodology differs from the one used by insurers in that market rates between the 20-year point and the 60-year point will still be taken into account, albeit with decreasing weight, with the UFR added to the mix with a gradually increased weighting.
This UFR with a twist has been welcomed by the likes of Theo Kocken, who praised the approach for minimising market disruption while limiting the value transfer from younger to older generations. The new discount rate took effect on 30 September.
Taken together, the measures in the September package will help prevent at least some of the pain of benefit cuts and contribution hikes. State secretary Paul de Krom, substituting for social affairs minister Kamp while he helps to form a new coalition government, said: “As a result of the package, benefit cuts in 2013 may be limited to those that have been announced at the beginning of this year.”
Benefit cuts as a percentage of total liabilities are expected to decrease from 4.9% to 0.8% as a result of the measures. According to the DNB, the number of schemes having to implement cuts now has dropped from 154 to 97. But all things considered, the effects are likely to be modest, adding no more than 3-4 percentage points to the average pension fund’s solvency rate – and quite a bit less in the case of schemes serving older participant populations.
The €275 civil servants scheme ABP, for instance, has to settle for a meagre 2-percentage-point increase, nowhere near enough to escape hefty cuts. The scheme may have to cut benefits by 4-5 percentage points in 2014, on top of the 0.5-percentage-point drop already announced for 2013, spokeswoman Jos van Dijk told our sister publication IPNederland.
The DNB has acknowledged that the measures offer no real reprieve and that the need for structural changes to the system is as great as ever. The average funding rate stood at 96.6% at the end of August, an unsustainable level, warned DNB director Joanne Kellermann at the regulator’s annual pension fund conference in September. “The new rules and legislation will not add any money to the pension pot,” she said. The real solution must be found in moderating overly generous pension arrangements. “The task that social partners have charged you with can in fact no longer be accomplished because the low funding rates are a result of structural developments,” Kellermann said, addressing a room full of pension fund trustees. She added that it was “inevitable” that pension funds must raise the issue of changing the pension arrangement with social partners. “If there is no other way, arrangements must be moderated. The social partners must take their responsibility in this.” She also said it was up to pension funds to take the lead. “It is not an option to either run away or do nothing,” Kellermann said. “All that is left is to take action.”
Although the need to adjust pension arrangements to a new reality of lower investment returns and an ageing population with higher life expectancy is widely recognised, the way forward is not as yet entirely clear. With a little over a year to go until the intended introduction of the new Pensions Agreement, much remains to be figured out – literally, in the case of the discount rate. The UFR as introduced in the September package merely serves as an interim rate, with a committee of experts scheduled to advise on a more permanent solution next year.
In the meantime, several pension funds – most notably, ABP – are pressing for a review of the current market-based discount rate. For 2013, the umbrella organisation of pension funds has called for a “fundamental discussion” regarding which interest rate curve is suitable as a credible indicator for the present financial situation of pension funds.