Even the Netherlands, proud bearer of one of the most superior pensions models in the world, is struggling to cope with an ageing population and beleaguered financial markets. In a ‘wake-up call’ to pension funds, the Dutch pensions and insurance supervisory authority, PVK (Pensioen- & Verzekeringskamer), has issued a letter to the Netherlands’ 1,000 pension funds, requesting that they take steps to “remedy any threatened disturbance of their financial stability”. But many Dutch pensions participants feel the terms to be unreasonable.
Poor investment returns over recent years due to flailing equity markets have resulted in an erosion of pension fund reserves as a percentage of their liabilities. In 1999 fund reserves as a ratio of pension commitments averaged around 150%. This figure shrank to 140% by the end of 2000 and 125% at the end of 2001, with one tenth of funds already seeing their cover ratio fall below 110%.
Given that equity portfolios have produced an average negative return of 20% over 2002 so far, as many as 200 funds could now have insufficient reserves to cover their commitments – amounting to a shortfall of around e2bn. If the Dutch equity index, the AEX, should fall to 300 points, then it is estimated that 300 funds would have an inadequate cover ratio, and the shortfall would then amount to almost e23bn.
But weak investment returns are not the only factor behind the low cover ratios, say PVK. In 2001, overall premium contributions of just under e11bn were still some e5bn short of the premium revenue required in actuarial terms to purchase pension increments. And even though the resources position of some funds is sound enough to warrant premium discounts, that is certainly not the case for all funds whose premium level does not cover costs.
With these figures in mind, and no firm clue as to which direction equity markets will take next, PVK asked the boards of management of pension funds in its 13-page letter, to accurately look at their financial position and to present a plan within three months of how they intend to tackle the issue of shortfalls. Funds will then be given one year to bring themselves up to a 100% cover ratio, before the authority will intervene.
PVK has also given schemes between two and eight years to build up an adequate financial buffer. Under present legislation, schemes are obliged to keep sufficient reserves to cover a 35% fall in their equity holdings. This has been increased so that schemes must have a sufficiently large buffer to cover a 40% drop of the highest valuation of their equity holdings have reached in the last two years.
Funds are also required to be able to cover a 10% drop from the lowest valuation their equity holdings have reached in the last year.
Says Loek van Daalen, spokesman for PVK: “the criteria laid out in the letter is nothing new really. We have simply reiterated and, hopefully, made clearer the laws that are already in place. The cover ratio should be 100% by law, and funds should have a buffer, the size of which will depend on the amount invested in equity and real estate.”
Many participants feel the deadlines to be too short.
“A pension scheme has a horizon of between 20 and 40 years. Monitoring performance on a quarterly basis is fair enough, but PVK cannot expect managers to perform on such a short-term basis when boards take a long term view. It does not fit,” says one Dutch consultant.
His opinion is echoed by Jeroen Steenvoorden, director at the OPF, the Dutch Pension Fund Association for Corporate Schemes: “The time limit is too short. Funds need a longer transition period.”
Van Daalen disagrees that the deadlines are too close: “We are giving funds one year to bring up their cover ratio to 100% - that is nine months longer than stated in the current pension law. Ordinarily, schemes would have three months after submitting their plan in which to fulfil this target.
“As for the two- to eight-year period in which to increase pensions reserves – this is enough time to restore the buffer. We expect progress to be made every year.”
In the letter, signed by PVK chairman, Derek Witteveen, measures that would ensure PVK’s criteria are met are suggested.
Addressing the boards of management, Witteveen writes: “you will possibly deem it necessary to increase premiums temporarily by an extra margin in order to alleviate any imbalances that have occurred. For many funds it will be impossible to continue granting premium discounts or premium rebates financed from reserves, that is to say without these being offset by premium revenue or investment income. In that light you may equally want to reconsider your indexation policy or deploy other resources if these are acceptable to the PVK, for instance a subordinated loan.
“Where some 40–50% of pension fund investments were in equities, events of recent years have again made doubly clear that a solid financial buffer is essential. You will have to consider new norms for cushioning falling prices and for the associated risk management and investment policies, revising them in line with the present situation and current perceptions.”
Says Steenvoorden: “The tools suggested by PVK in order to ensure a funding level of at least 105% are all credible – raising premiums, reconsidering conditional indexation policy, reconsidering investment policies, subordinated loans. But once again it comes down to the time limit.
“If funds are forced to increase their reserves when the stock markets are still weak, then they may have to put in additional premiums, which will hit company profits and influence labour negotiations. If stock markets do not recover over this time period and premiums are continually raised, then it could trigger a change in the pensions system from DB to DC.
“We are not against DC schemes – if the motives are right. Moving to DC schemes solely because of the issue of too strict funding rules for buffers, however, is not favourable.
“With regard to changing investment strategy – well, looking at the asset mix is important. But switching out of equities will not necessarily increase reserves, especially if the stock market picks up. It tackles the issue of reducing risk but not of underfunding.”
Says a Dutch consultant: “The vague suggestion that funds should possibly sell their equity positions is absurd. A long-term view must be taken. There are three things a fund could do – raise premiums, lower cash outflows or increase the retirement age. This last point will ultimately have to be addressed soon enough anyway, and it would give schemes more time.”
PVK insists it is not telling funds exactly what to do. “How the funds restore their cover ratio and buffer is up to them. Every fund is different.”
The letter itself has been widely welcomed, however, even if some of its suggestions are deemed unrealistic.
Mark Rugte, the state secretary for the Ministry of Social Affairs and Employment has praised PVK’s action. At a parliamentary sitting he stated that although he felt the Dutch pension system to be solid, it was “very wise” of PVK to take action and call on pension funds to examine their balances more closely.
The OPF is also pleased that “policies have finally been laid out and communicated in a clear way”.
But why did the PVK not address the situation earlier?
Says Steenvoorden: “it is somewhat disappointing that PVK did not address the matter sooner – say when the markets were more stable. Surely it is better to be strict when conditions are favourable, to allow for flexibility when the environment is tougher.”
He is not alone in his opinion – PVK has often been criticised for doing very little, but van Daalen believes that the situation has not been considered serious enough to warrant action.
Just what PVK plan to do though if the criteria is not met is unclear. “The regulatory authority can only advise. It does not have the full power to step in and take over,” says one Dutch consultant.
“That said, schemes are hearing PVK loud and clear. The authority could create huge waves by means of press coverage for those funds that do not appear to be dealing with the issue of insolvency. The intervention would then come from the disgruntled employees themselves. There is no doubt that schemes have to comply with the letter’s stipulations.”