Mercer has suggested Dutch pension funds should abandon any hope that low funding ratios will improve on the back of rising interest rates.
Commenting on the European Central Bank’s (ECB) latest monetary policy decisions, Dennis van Ek, an actuary at the consultancy, said the examples of Sweden, Switzerland and Japan gave him reason to believe the combined measures would lead to a further drop in interest rates in the coming months.
“The ECB’s announcement has taken the bottom out of the market,” he said.
“The 30-year swap rate now could even go below the 0.7% mark, which was briefly hit in April 2015.”
Van Ek noted that, on Friday morning, the 30-year swap rate – the main benchmark for pension funds for discounting their liabilities – was very volatile, fluctuating between 1.09% and 1.24%.
This was higher, however, than the 1.15% just before the ECB’s announcement and the subsequent volatility immediately afterwards.
The swap rate stood at 1.17% on Monday morning.
Van Ek noted that, in the immediate wake of the EBC decision, two of Mercer’s pension fund clients decided to hold on to their interest hedges of 65% and 75%, respectively.
“Up to then, they had been considering reducing their hedges, as they assumed the ECB would not lower interest rates any further,” he said.
The actuary made clear that a 0.5-percentage- point drop in the swap rate would lead to an increase of liabilities of 10%.
“Because pension funds have applied an interest hedge of 40% on average,” he added, “this means a funding drop of 6 percentage points.”
The pensions adviser highlighted that pension funds would also incur additional costs as a result of the announced reduction of the deposit rate from -0.3% to -0.4%.
“Pension schemes often deposit the liquid assets they have to keep as a security for their swaps with banks,” Van Ek said. “This often amounts to 10% of the swaps’ nominal value.”.
He estimated that pension funds would soon have to pay a deposit rate of 0.45%.
On a positive note, however, the consultant noted that equity markets had largely recovered from the large dip over the past months.
He concluded this meant a funding increase of a “couple of percentage points” for pension funds.