Experts propose Dutch discount rate linked to GDP growth

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The assessment framework for pension promises in the Netherlands should be based on economic growth rather than interest rates, three pensions experts have argued.

In an article in the specialist journal for economists (ESB), Jean Frijns, Anton van Nunen and Theo van de Klundert laid out that their plan for an “economic assessment framework” (ETK). They argued that it had the advantage of being directly linked to salaries and the general health of the economy.

In addition, the system would encourage pension funds to invest for returns, rather than taking interest rates into account, as is the case under the current financial assessment framework (nFTK).

Frijns is a former CIO at the €389bn civil service scheme ABP, while Van Nunen is widely credited with launching the concept of fiduciary management. Van de Klundert is emeritus professor of economics at Tilburg University.

In the trio’s plan, liabilities are increased annually based on the expected GDP growth per head of the population. This would make the effects of economic headwinds visible straightaway, they said.

Frijns, Van Nunen, and Van de Klundert contended that such an approach would be better than the current nFTK, under which a slowing economy had a delayed impact on pension benefits through falling interest rates, which then lead to lower coverage ratios and reduced indexation.

Liabilities would be discounted against a percentage equal to the expected GDP increase, rather than the risk-free interest rate.

In the opinion of the pensions experts, this would be prudent, as diversified investments ought to generate returns at least equal to economic growth. It would also improve stability as asset growth would also depend on GDP growth.

Frijns, Van Nunen, and Van de Klundert argued that their system would encourage pension funds to further diversify their asset mix, increasing their stakes in equity and illiquid assets.

In their opinion, the current financial assessment framework was comparable to an insurance with-profit arrangement, which seldom pays out.

Once a pension fund had a low funding level, the chances of returning to higher levels and indexation were very slim as the scheme had to focus on hedging the interest risk on its liabilities, they argued.

Commenting on the proposed ETK, Fieke van der Lecq, professor of pension markets at Amsterdam’s Free University (VU), questioned how a GDP increase could be established.

“The forecast of the Netherlands Bureau for Economic Policy Planning would have an enormous impact on the valuation of pensions, while the use of historic data would trigger a discussion about the number of years taken for the historic average,” she argued.

Van der Lecq predicted that benefits would fluctuate more strongly under the proposed ETK.

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