Discount rate change to increase chances of pension cuts at Dutch schemes
The chances of Dutch pension funds having to apply pension cuts have increased following a committee’s advice on adjusting the discount rate for liabilities and assumptions for future returns.
The committee – chaired by former finance minister Jeroen Dijsselbloem – recommended adjusting the method for calculating the ultimate forward rate (UFR) as part of the discount rate, and reducing return parameters.
In a letter to parliament, Wouter Koolmees, the minister for social affairs, said the UFR proposals would cause pension funds’ coverage ratio to drop by 2.5 percentage points on average.
Koolmees recently agreed to a temporary reduction to the minimum required funding level from 104.2% to 100%, in order to reduce the chances of pension discounts during the implementation of pension reforms.
In his letter, the minister added that the minimum funding level required for schemes to grant full indexation would be increased by 2.7 percentage points to 126.9% as a consequence of the committee’s recommendations.
Both the government and pensions supervisor De Nederlandsche Bank (DNB) endorsed the proposals.
Ultimate forward rate
The UFR is designed to resemble long duration risk-free interest rates as closely as possible, as these rates are susceptible to shocks in market demand and supply.
The committee recommended an extension to the first smoothing point of the UFR from 20 to 30 years, and to establish the UFR level as the 10-year moving average of the 30-year forward rate.
It said it had refrained from adopting the UFR method used by European regulator EIOPA “as it was insufficiently linked to market data”.
DNB will introduce the new UFR as of 1 January 2021. It said the new method would bring pension funds’ financial position “in line with the financial-economic reality”.
The UFR is to decrease from 2.3% to 2.1% and would reduce pension funds’ advantage on liabilities, relative to market rates, from 2.7% to 0.3%.
The Dijsselbloem committee also recommended reducing the maximum permitted figure for assumed future returns on listed equity by 1.2 percentage points to 5.8%, including costs of 0.2%.
It decreased the parameter for other securities, including private equity, to 7.5%, including 1.9% of costs. For commodities, the committee proposed to limit return assumptions to 3.5%.
It also advised using a 1.9% inflation assumption, drawn from the consumer index, as well as salary inflation of 2.3%.
Pension funds must take these parameters into account when establishing contribution levels spread out over several years.
The committee said it expected the new parameters to lead to a increase in pension contributions of at least 3%. The new parameters will come into force as of 1 January 2020.
Commenting on the proposals, the Pensions Federation said it feared that the figures could upset trade union members, who were set to vote on pension reforms.
Citing the “significantly negative impact on costs-covering contributions and coverage ratios”, Gerard Riemen, the trade body’s director, said it would have been better if the changes had been shared during recent negotiations regarding pensions reforms.
Agnes Joseph, actuary at Achmea, warned that future cuts as a consequence of even stricter rules could undermine faith in the pensions system.
However, the unions said the new parameters would not affect the core of the plan agreed with the government, highlighting that they had made a clear agreement about “results on the perspectives for indexation” as well as on “fairness for all generations”.
“If this doesn’t materialise, the accord is off,” Tuur Elzinga, chief negotiator for the largest union FNV, told IPE’s Dutch sister publication Pensioen Pro.
The metal and engineering sector schemes PME and PMT – which are most at risk of benefit cuts – said that the predicted funding drop of 2.5% would apply on average, and that they had to look into the exact impact of the changes. Their coverage ratios are hovering just above 100%.