On 25 June, the proposal for a revised FTK was submitted by the state secretary for social affairs and employment, Jetta Klijnsma. The introduction of the law is set for 1 January 2015. All pension funds will have until 1 July 2015 to comply with all requirements.
There are five bottlenecks in the existing framework that have shaped the development of the new FTK:
• Abrupt, sizeable pension reductions should be avoided. A gradual spread over time to process solvency setbacks is desirable. However, the postponement of pension reduction measures should be avoided.
• An investment policy that is aimed at achieving an inflation-indexed pension should not be restricted by the fixed term of the long-term recovery plan.
• It is desirable to avoid the influence of daily prices in the FTK, in order to maintain stability in the financial steering of funds.
• The FTK should not increase premium volatility. The requirement that the premium should contribute to recovery is discarded.
• The legal solvency certainty standard of 97.5% requires a higher buffer.
Distinction between a nominal and a real contract is not on the agenda. The starting point is one type of contract, with the existing agreement including nominal pension rights and conditional indexation forming its basis. The required regulatory buffer (RRB) will increase by an average of five percentage points to 126%.
A ‘policy funded ratio’ will be introduced, equal to the moving average of the actual coverage rates over 12 months. The effects of solvency shocks are therefore spread over a longer period. In addition, measures are taken to prevent pension funds granting conditional indexation too early.
As expected, the ultimate forward rate (UFR) methodology will be based on the advice of the UFR Commission (ie, without three-month averaging and a 10-year rolling average UFR interest rate level). The policy funded ratio and the UFR methodology should create a more stable framework. But further aspects remain undisclosed.
No conditional indexation will be allowed if the funded ratio is lower than 110%. This applies to all funds. The degree of indexation is also constrained. The average pension fund will need a funded ratio of at least 128% in order to grant full indexation. There are rules for catch-up indexation and for reversing pension reductions, making this process slower than it is currently.
Stabilising premium levels based on a (maximum) 10-year moving average of interest rates or based on expected (fixed) investment return is still allowed. However, for premium discounts, holidays or refunds, stringent constraints now apply. The catch-up of missed indexations and the ability for future conditional indexation ambition take priority over premium discounts.
A feasibility test has been introduced to replace the existing continuity analysis and consistency test.
The prudent person principle should be tested on the basis of the investment policy of the fund. Through subordinate legislation, guidance will require that each fund sets explicit policy target levels and bandwidths within its investment policy.
Transition to the new FTK
The explanatory memorandum requires all pension funds to implement the new FTK on 1 January 2015 with a clean slate. The transition will take shape by dropping existing recovery plans. For funds with policy-funded ratios below the RRB on 1 January 2015, a new FTK recovery plan should be submitted by 1 July 2015. To meet the stringent buffer requirements, funds that submit a recovery plan in 2015 and 2016, respectively, have two and one additional years for their scheduled return to the RRB. This means that for 2015, 2016 and 2017 the recovery plan should conclude in 2027.
During a recovery plan, funds may not increase investment risk above the entry level. This also applies under the current FTK, which implies that funds that do not recover before 1 January 2015 will not be able to increase the risk budget beyond the level they had at the start of the plan. The variations are large and, as such, funds do not start with a clean slate or a level playing field. Some funds entered a recovery plan with a low level of interest rate hedging and a high allocation to return-seeking assets. Others have entered with a high level of interest rate hedging and a low weighting of return-seeking assets.
We see the following key implications from the new FTK:
• The potential for adjustments will be restricted. In the Netherlands on average 10% of purchasing power has been forfeit by not granting full inflation indexation and by pension reductions. This loss of purchasing power will be consolidated after 2014.
• For many funds, premium discounts are now a phenomenon of the past.
• For pension funds emerging from a 2014 deficit, this year offers a unique opportunity to increase investment risk. Buffer requirements rise from 2015, possibly excluding an increase in investment risk beyond 1 January.
• Nearly all funds will remain tied to their maximum investment risk budget, and thus investment return potential and indexing capabilities from early 2008, until 2027. Most funds are thus not permitted to begin with a clean slate.
• At the end of 2014, pension funds may take their 2015 indexation decision based on current FTK and policy. This means, in some cases, granting indexation from a funded ratio of 104%. As from 2015, a minimum coverage of 110% is required to start indexing.
• The average funded ratio in the Netherlands was 111% at the end of July. However, three percentage points is due a three-month averaging of the discount rate, which is not part of the new FTK. Furthermore, the new UFR is currently 3.5 percentage points rather than 4.2 percentage points, decreasing the average funded ratio by 1.5 percentage points. On average, funded ratios are set to decline by 5 percentage points.
• The RRB increases on average by 5 percentage points, from 121% to 126%. However, we observe variations in this rise from as low as 2 percentage points to above 8 percentage points. In particular, credit risk is required to have a higher buffer and correlation to other risk factors. Consequently, pension funds with a high allocation to credit risk will have to increase the required buffer above the 5 percentage points average.
Pension funds have to work hard to have policies, recovery plans, documents and communications ready for the new implementation deadline.
Dennis van Ek is a consultant at Mercer