The financial position of Dutch pension funds did not improve in June, according to data from Aon and Mercer.
The current funding ratio of schemes largely remained the same, but the average policy coverage ratio dropped further. Coverage ratios are the main factor in deciding whether schemes can link benefits to inflation, or even whether they must cut pension payments.
Aon’s data showed that the average policy funding ratio was 107%, but given the sharp drop in coverage in May the consultant stated that pension cuts were becoming increasingly realistic.
The policy funding ratio, which is a rolling 12-month average, would “decline even further in the coming months, since the higher funding ratios of the first half of 2018 will no longer be taken into account”, Aon said.
Mercer, which uses a different method to calculate the coverage ratio, has already observed a 1% drop in the policy funding ratio to 106%. The average funding ratio based on the pure rate of market interest is now at 98%.
Aon calculated the actual coverage ratio as 104%, while Mercer arrived at a figure of 102%. Aon argued that the current coverage was able to remain at the same level during June due to the recovery of stock markets, which offset the negative effect of the decreasing interest rate.
Both consultants noted that the interest rate in June fell by about 20 basis points. According to Mercer, the 30-year euro swap rate was 0.73%. Aon remarked that the ultimate forward rate, with which pension funds calculate the value of their liabilities, had a somewhat dampening effect on falling interest rates, and remained at 2.3%.
Due to the drop in interest rates, however, liabilities increased on balance by more than 3.8% according to Aon. Mercer reported an increase of 3.4%.
According to both advisers, developed and emerging market equities rose by 4% in June due to the expected easing of monetary policy by the European Central Bank and the US Federal Reserve. Investors who had hedged half the currency risk on the dollar, pound and yen would have recorded a gain of more than 5%.
Aon stated that all risky investments increased in value last month. Corporate and high-yield bonds generated 1.6% and 2.5% respectively, due to falling credit risk and interest rates. As the value of long-term government bonds increased, fixed income allocations gained by 3.9%.
Aon emphasised that the risk of cuts to pension entitlements was still real, especially for the big funds with a coverage ratio of around 100%. This was despite the relaxation of the rules for pension cuts introduced as part of the new pension agreement.
Pension funds with funding levels under the required coverage ratio for five successive years – and with a ratio below 100% at the end of this year – will have to implement unconditional cuts in pension entitlements to enable them to return to 100%, the secretary of social affairs Wouter Koolmees stated in a letter to the Dutch parliament.
This scenario is particularly likely for metal and engineering sector schemes PMT and PME, which had policy funding ratios of 101.2% and 100.2% respectively at the end of May.
In May Dutch pension funds were faced with a drastic deterioration in their funding levels, as interest rates dropped by 10 basis points and stock markets fell, dragging down the average actual coverage ratio by 3 percentage points.