The European Central Bank’s recent decision to start a large-scale purchasing programme for government bonds will be bad news for Dutch pension funds, according to Mercer and Aon Hewitt.
The consultancies pointed out that the liabilities of Dutch schemes were discounted against the three-month average of interest rates under an ultimate forward rate (UFR) of 4.2%, set by regulator De Nederlandsche Bank (DNB).
Dennis van Ek, actuary at Mercer, observed that, during yesterday’s press conference in which Mario Draghi, the ECB’s president, clarified the quantitative easing (QE) measures, 30-year interest rate swaps dropped from 1.4% to 1.25%, only to settle at 1.31% in the evening.
He warned that the ECB’s €2bn daily purchasing programme would have a structural downward effect on interest rates.
“The causes of the currently low rates – low inflation, as well as the ECB’s policy of suppressing rates – are still present,” he said. “The purchasing programme will amplify this effect.”
Van Ek referred to recent DNB statistics showing that Dutch pension funds were currently no more than 37% hedged when it came to interest risk.
“This is not enough to keep up with a further decrease in interest rates,” he said.
The €156bn healthcare scheme PFZW recently confirmed that its funding fell from 105% to 102% in December as a consequence of falling interest rates.
Frank Driessen, head actuary at Aon Hewitt, agreed that the ECB’s measures were likely to come as bad news for pension funds.
“Interest rates could drop further, causing pension funds’ liabilities to rise further,” he said, adding that it was uncertain whether rising equity and bond markets could fully compensate for such an increase in liabilities.
However, Driessen indicated that his biggest concern was the potential effect of falling interest rates on the UFR for discounting liabilities.
“The application of the current UFR keeps pension funds’ coverage ratios artificially high,” he said.
“At the moment, pension funds’ funding is less than 103% on average. However, based on the market rate, the average coverage would be at least 8 percentage points lower.”
Meanwhile, Leonique van Houwelingen, head of BNY Mellon’s operations in the Netherlands, said the ECB’s measures would highlight the importance of interest hedging and increase schemes’ dependency on investment returns.
“Where the larger pension funds could already have anticipated the possible consequences coming from the ECB measure in their investment strategies, not all pension funds will have taken timely actions to amend investment portfolios to mitigate the possible impact,” she said.
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