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Ultimate forward rate poses risks to Dutch pension funds, MSCI warns

NETHERLANDS - The 4.2% ‘ultimate forward rate’ (UFR) recently adopted by the Dutch regulator may harbour potential risks for pension funds, according to Neil Gilfedder, managing director and head of analytic applied research group at MSCI in the US.

He told IPE: “There are two potential risks. It could give pension funds the opportunity to avoid making tough choices - with regard to their funding level, for example. And in terms of risk management, it could lead to a potential divergence of economic and regulatory risk - in other words, trustees may see the lower risk that is forecast using the UFR.”

The introduction of the UFR has led to a jump in the funding level of Dutch pension funds, with MSCI estimating an increase from an average 98.6% to 101.6%.

By making pension funds appear better funded than they actually are, this eases the pressure on them to cut benefits.

This may change the dynamics of the discussions on pension fund boards, according to Gilfedder.

At the same time, it reduces a lot of the volatility in the yield curve for long maturities and therefore the volatility of the liabilities and the surplus, meaning pension funds may decide to hedge less.

However, Gilfedder said he knew of at least one pension fund that planned to hedge on an economic basis, rather than a regulatory one.

“If the UFR obscures the economic reality, trustees may end up making decisions that are not good for the long-term health of the plan,” he said.

He said most pension funds were still trying to figure out what to do and whether to keep two sets of books, a regulatory as well as an economic one.

Furthermore, the introduction has raised the issue of intergenerational solidarity because younger generations will have to pay into the new system to ensure retirees and older workers continue to hold on to their benefits.

Behind all this, according to Gilfedder, lurks the uncertain macroeconomic environment, which has led to funding challenges for plans across the world.

Gilfedder is co-author of the MSCI Research Insight report ‘The Ultimate Forward Rate: Implications for Dutch Pension Plans’.

The UFR is used to discount pensions’ liabilities to their present value in the construction of the yield curve for cash flow maturities of more than 20 years.

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