NETHERLANDS - What nobody had thought possible for the much-praised Dutch pension system, until recently, has become reality. With several pension funds announcing benefits cuts, the sector - dominated by its capital-funded mandatory pension schemes - has just entered a new phase.
Whereas indexation had already become a rare phenomenon, at least six schemes now must apply rights cuts of as much as 9% on 1 January to get a fair chance for recovery. One pension plan saw its coverage ratio already drop to 80.5% compared with the minimum required funding of 105%. Only a tiny minority of the 570 pension funds in the Netherlands can still claim having the required financial buffers, equating to a 130% coverage.
The dire position of many schemes has mainly been caused by the low long-term interest rates, which is the criterion for discounting liabilities. In addition, new predictions for longevity have forced pension funds to increase their liabilities by approximately 7%.
The six pension funds were part of a list - issued by the social affairs department - of 14 schemes that had already indicated a discount could be part of their recovery measures. Some of the 14 funds were able to convince regulator De Nederlandsche Bank (DNB) that their improving position did not justify an early discount, while others were bailed out by their sponsoring company, albeit under the condition of placing their pensions with an insurer.
Many pension funds have fought tooth and nail to minimise or avoid cutting benefits in the belief that rising interest rates and a better investment climate will soon improve their financial position. However, the wish seems to be the father to the thought. Long-term interest rates are likely to stay low for a long time, as the DNB, the Financial Markets Authority (AFM) and many other financial experts have argued. And rising longevity is also here to stay. Shifting the problems into the future is likely to make them more difficult to solve.
Next year will be crucial, as all 340 recovery plans need to be evaluated for the next discount deadline of 1 April 2012. Because the coverage ratio of Dutch pension funds is about 100% on average at present - and not all schemes have yet factored in the full longevity forecast - there might be a few unpleasant surprises. Recently, the Organisation for Economic Co-ordination and Development (OECD) suggested that restoring the financial health of Dutch pension funds would require cuts of 8% on average, as well as a two-year rise of the retirement age to 67.
The severity of the next round of benefits cuts will depend on how pension arrangements can be re-shaped. The social partners of employers and employees are currently looking into how pension contracts can be made future-proof, probably by shifting risks to pension funds' participants.
Meanwhile, the DNB and the department of social affairs are developing a new two-track financial assessment framework. This must offer schemes the option of providing their participants either nominal security against larger financial buffers or arrangements that target a real coverage ratio, but depend on market developments and longevity.
Also of great importance is how and when the official retirement age of 65 will be raised. Although the government - depending on support from anti-immigration party PVV - has a one-year increase in mind in 2020, leading economists have argued that an increase to 67 is paramount, and that a gradual introduction should start as soon as possible.
Decision-makers will need a lot of courage and wisdom if they truly want a future-proof pension system. Doing nothing - or merely referring to pension funds that have been hit harder elsewhere - is not an option.