Jean Frijns, former ABP chief investment officer, along with Jelle Mensonides, former ABP managing director, have warned that the new Dutch pensions agreement is not future proof and is just as sensitive to interest rates as the previous regime.
In a co-authored report first published last week in MeJudice, a Dutch financial website, the duo said that because the timing of the introduction of the new system is still unclear, a different market interest rate will give different results.
In a further interview with Pensioen Pro, Frijns added that it “is of no use if the starting situation is already unbalanced or if things change during the ride. And that will certainly happen”.
He added: “For example, interest rates can rise or stocks can underperform for a long time. Then you want to know how to make adjustments without disproportionately disadvantaging certain groups.”
For young people, the expected return is significantly higher than the risk-free rate, the report stated, adding that the expected real pension return for the elderly “does not look good”.
Frjins stressed that elderly people are hit twice. Firstly, when entering the new system, how much capital is allocated to the elderly strongly depends on funding ratios and the interest rate at the time of entry.
In a bad scenario with long-term low interest rates and a low funding ratio, their assets may be significantly lower than in a more favourable scenario, he continued.
The second disadvantage that elderly people experience, Frijns said, is that their assets are converted to an investment mix with fewer shares than their current assets in a pension fund.
They will, therefore, invest less in commercial securities and more in bonds, he added, noting that government loans will have a negative return in the coming years.
Long-term risks
The long-term risks are indeed great, the report stated. “Will the young people be better or worse off than the current elderly, that is the key question in the social discourse,” the duo noted.
Interest has unfortunately proved to be notoriously unstable and in these times of low interest rates, without a high percentage of real assets, averaged over the entire life course, pensions become very expensive.
“Shares are volatile – this applies not only in the short term but also in the medium and even long term,” they said in the report. The relevant question then is how to mitigate or control this risk.
“The risks are easy to oversee for a young person; the financial capital is still small compared to the future premium flow, as is the interest portion in the portfolio. The biggest risks lie in the future: what if interest rates do not recover and what if equities underperform for a long time?” they asked.
There is little else to do than gradually reduce the risk profile and reduce part of the nominal interest rate risk. The latter must be done with caution so as not to fall into a trap if inflation rises unexpectedly.
Continued investment is the motto in the new pensions agreement, but the question is whether members are able to bear the equity risk without the collective support, the report said.
On the other hand, investing in fixed income securities is not attractive under the current circumstances due to low interest rates and a dormant inflation risk.
“We are by no means convinced of the effectiveness of risk mitigation only via financial instruments in the new system; the potential shocks are too great for that,” the pair continued.
They both are great supporters of additional instruments that should be sought, particularly in the sphere of premium setting and the capital funding or cover mix.
“The use of the contribution instrument is essential to absorb unexpected and persistent setbacks in the intended capital accumulation, but it does not work equally for all generations” they concluded.
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