The Netherlands: The right risks
Mariska van der Westen discussed longevity and other risks with Peter Borgdorff, director of the Dutch healthcare fund PFZW
Long live the Dutch: life expectancy in the Netherlands turns out to be quite a bit higher than previously thought, which means benefit payments must be made over longer periods. The impact on funding ratios has been considerable - PFZW, the €99.5bn healthcare fund, has had to shave a total of 7.5 percentage points off its solvency ratio, six of which were taken off as per 1 January 2011.
The giant healthcare fund isn't happy about that. "We can't be blamed for the fact that funding ratios plummeted due to low interest rates last summer, but longevity - that's our game," PFZW director Peter Borgdorff told IPN, IPE's sister publication in the Netherlands. "If there is anything a pension fund should be able to manage, it's longevity."
Last year, PFZW was the first pension scheme to take steps to deal with the longevity issue in a sytematic way.
"Pension contributions made in the past aren't sufficient to match today's life expectancy. The shortfall is minor for 25-year-olds, but when you get to 65-year-olds, the difference is substantial. This poses a problem for which we haven't yet found a solution. You can't very well tell people to suddenly make extra contributions to cover a shortfall in past accrual if they have never been warned that such a measure might be necessary. But if you don't, you are effectively asking today's contributors to foot the bill," says Borgdorff, outlining the dilemma.
To address the problem, PFZW has taken a temporary measure that provides a partial solution. "Last May our trustee board decided to no longer automatically pay for the risen life expectancy out of pension contributions, but instead adjust the pension arrangement for 2011. As it is not yet legally permitted to do so by raising the pensionable age, we choose the alternative: lowering pension accrual."
As of 1 January 2011 the scheme has lowered the accrual rate by 0.1% to 1.95%. The measure is taken for one year only. If made permanent, the measure would mean that current participants will have to work an additional four months to accrue the same pension, while new participants must work an additional seven months.
Borgdorff is not entirely happy with this interim solution either. "This solves the problem with regard to the future, but the shortfall inherited from the past still remains. The six percentage points we took off our solvency ratio at the start of the year is, in fact, a form of benefit cuts across the board. It would be good if we could instead find a way to finance the shortfall."
He stresses that the measure is temporary and takes an advance on the outcome of negotiations between social partners and the Dutch cabinet, which include measures to raise the pensions age. "Our trustee board cannot solve this problem all by itself. The Labour Foundation should take the lead."
Get down to business
The same holds true for the other major issue confronting the pensions sector: the design of a ‘new pension deal'. PFZW has been working towards a future-proof, sustainable pension contract since 2006 but cannot take concrete steps until the Labour Foundation - which consists of representatives of the ‘social partners', ie, employers and trade unions - and the ministry of social affairs come to an agreement on the way forward.
Although the social partners reached an agreement on principles as early as last spring, negotiations on details of the new pension arrangement are still ongoing. And as yet very little is known about the details of the new dual supervisory framework that will regulate the new plans. Pension funds are effectively put on hold, Borgdorff says. He is warning that time is running short: "It is high time the parties involved sit down to business."
This does not mean that PFZW is sitting idly by, twiddling its thumbs. Over the past year the pension fund has researched various alternative pension arrangements and taken stock of the preferences of its participants. "We see two main options. One is to lower the pension ambition, while offering more guarantees - for instance an ambition of 50% of average salary, guaranteed with a certainty of 97.5%. The second option might be called a ‘defined ambition arrangement': the pension ambition remains high, while the final pension is made conditional on the pension fund's results," Borgdorff says.
The latter approach is deemed the more preferable by experts, because it keeps open the possibility of realising a high pension result. "But, as it turns out, the average plan participant prefers the option which offers the stronger guarantees. Even if it means a lower pension at the end of the ride."
This spring, PFZW will discuss the options with its participant base but, ultimately, the decision lies with the board, Borgdorff says.
The board decision might have far-reaching consequences. While a defined ambition-type arrangement requires but minor changes to the existing system, "a contract involving strong guarantees would have an impact on our investment policy, as we would allocate less to equities and so would generate lower returns," Borgdorff explains.
Originally, the new pension arrangements were to take effect on 1 January 2012, but according to Borgdorff this timeline isn't -realistic. Social partners and the department of social affairs have yet to strike a deal, and once they have reached an agreement pension funds will need time to implement the new plans - not to mention the fact that the new pension deal requires quite a few legislative changes, and drafting new legislation is time-consuming. "I am not optimistic," Borgdorff says. "In my opinion roll-out of the new pension system will not happen until January 2013 at the earliest."
The impact on investment strategy alone will take time to process, he explains: "If we are to change to a guaranteed contract, this implies a shift from equities to fixed income. That's something you cannot do all at once. If we were to start selling equities from one day to the next this would ruin the market, and the negative effects would be magnified if all Dutch schemes do the same thing at the same time."
Whichever pension arrangement is ultimately selected, and how ever it will be implemented, one thing is clear, Borgdorff says: "Our scheme and the pensions sector as a whole have a lot more explaining to do. We need to do far more to explain the risks and possibilities of the pension arrangement, what our ambitions are and how we expect to realise them. Already, we communicate more than ever before - in the past we merely talked about how rewarding our work is, while now we also talk about the things that can go wrong. But we need to redouble our efforts to communicate with participants. Because, in the final analysis, they are what it's all about."
This and some other articles in this section first appeared in Dutch in our sister publication IPN.