Dutch Masters on Unfamiliar Turf.
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Once the envy of the defined benefit (DB) pension world, the financial crisis has left the Netherlands in an unfamiliarly tricky and underfunded situation -- one from which its investment managers are trying to find a way back by making some tough decisions.
ABP, the largest pure pension fund in Europe, announced in February that it would have to cut its pension benefit payments and raise the contributions it received from both the employer and members in 2013. This measure would enable it to just make sure it reached its 105% minimum coverage ratio set by the country's central bank by the end of 2013. At the end of 2011 it was barely touching 94%.
How times have changed. In 2007, ABP was 140% funded and allowed its members benefit increases in line with inflation. A perfect storm of volatile markets, ever-sinking interest rates (dictated by the European Central Bank), and a twisted dagger of increased longevity assumptions has meant the civil servants, for whom the fund provides retirement benefits, are looking at a less rosy future.
ABP is not alone. During a trip to the Netherlands in January, we heard many voices bemoan the fall from grace by the country's pension system and the problems it faced, at least in the short term. While any other nation running DB schemes would be cheered with an average 98% coverage level at the end of last year, this was not good enough -- either regulatorily or philosophically -- for the Dutch.
Ronald Wuijster, Chief Client Officer for Asset Management at APG, the pension delivery organization that split out of ABP in 2009, said: "In the 1970s most schemes were underfunded. In the 1980s and '90s pension funds had good investment returns and there were more assets than what was perceived to be needed, so pension funds granted contribution holidays."
The largest problem for Dutch pension funds -- and one that is noted by everyone -- is that the risk-free rate against which they discount their liabilities has been drastically reduced. Down from 4% just over 12 months ago, against which most railed at the time, CIOs must now deal with 2.4%. This assumes that some of the most sophisticated risk managers and asset allocators in the world will make a return that doesn't even beat inflation. "It is unlikely that we will only make 2.4%, despite yields and dividends being very low, the return on equity could be 8%," according to Wuijster.
"Investment returns have not really been the problem; it has been the liabilities. Now it is being considered who should bear the brunt: employers, active members, or retired members? The so-called "social partners" -- government, employers' organizations, and the unions -- have been negotiating over this. Also, in light of the new Pension Agreement on this, it has stirred up the debate on intergenerational solidarity."
APG and others have asked the Dutch National Bank (DNB) to consider using a rate measured over a longer time span, which should increase the discount rate and push liabilities down. So far, it has been shifted out to three months. For many, it is not enough.
John Van Scheijndel, Chief Investment Officer at A&O Pension Services, said: "Declining interest rates have increased the value of the liabilities substantially for our client, the industry-wide pension fund of the painters, BPF Painters. It should not hurt in the long term, but the solvency ratio is a very important ratio for the DNB and the pension fund board. We do not want to be dependent on interest rates and market movements," he added. "Major events may or may not happen. In the short term, developments are unpredictable. The investment strategy of the fund should be robust in different scenarios." Like the majority of pension schemes in the Netherlands, BPF Painters had to put a recovery plan in place to show how to bring the solvency ratio back to the required 105% coverage level by 2013. At the end of 2011 the solvency ratio was already at 107%, the level the investment team and pensions board have targeted it to remain at until 2013 -- otherwise, benefits may have to be cut.
It is apparent in the Netherlands that cutting benefits is the absolute last thing CIOs want to do. The mantra of "Solidarity and Collectivism" does not ring hollow when it is quoted by all of them. However, many admit that while coverage ratios were well into triple figures, there had been a certain amount of laurel-resting. Wuijster at APG said there had been a communication issue that had led to the Dutch population believing they had a guaranteed pension that would continue to rise no matter what. This was not the case.
Relatively speaking, things are not too rough in the Netherlands. "We are not in the situation where it warrants starting a totally new system," Wuijster concluded. "If we look back in five years' time, we will probably see this all as a lot of noise and not really that bad."