Persistently low rates are taking their toll on pension funding levels throughout Europe.

Now they have forced authorities in three European countries - Denmark, the Netherlands and Sweden - to act to shore up pension funding, to allow providers to meet their guarantees, or to avoid benefit cuts.

The Netherlands is rushing to introduce a new discount rate methodology that it hopes will avert the benefit cuts that underfunded schemes must enact by law at the end of this year if their solvency ratio does not improve. The hope is that applying the Solvency II-inspired ultimate forward rate (UFR) will give funds the necessary fillip.

Denmark is also to introduce the UFR, which is based on long-term expectations of inflation and short-term rates, after the government announced it was in talks with the pension industry to help it manage the current difficulties. Danish 10-year yields dropped below 1% at the beginning of June before climbing to around 1.37% by 20 June.

And in Sweden, where 10-year rates fell to as low as 1.02% on 6 June, the financial regulator has proposed a temporary floor on the discount used by pension insurance companies. The regulator justified its move by saying that institutional investors would otherwise have short-sold equities and other risk bearing assets, thus adding to the current financial woes.

Yields subsequently pushed up to around the 1.4% mark, although at least one pension insurer, the labour market provider AMF, said its solvency ratio was already high enough.
The problem is that these short-term measures do not address the long-term structural problems that persistent low rates will cause for institutional pension provision. And the example of Japan tells us that ultra low interest rates, along with volatile, range-bound equity markets, can persist for a very long time.

In the Netherlands, the concern has already been raised that the UFR methodology will likely underestimate the long-term cost of the benefit entitlements of younger members - essentially just kicking the can further down the road.

In any case, as Lars Rohde, CEO of Denmark's ATP, has said, funds, employers and employees must prepare for lower benefits. This is true everywhere, of course, as pension stakeholders deal with the higher cost of securing equal benefits or lower benefits if contributions are maintained.

With contributions already topping 20% of salary in the Netherlands, and UK sponsors facing aggregate funding of less than 75%, the cost of shoring up even existing promised benefits is already a high burden for financially straitened members and sponsors alike.

Authorities have heeded the short-term alarm call sounded by ultra low rates, but we must prepare to contribute more if we are to secure the benefits we expect later in life.


This story first appeared in the July issue of IPE magazine.