Allianz International Pensions What’s happening in… December 2012Retirement entryage will be increasedto 67 in 2021 andafterwards pegged to lifeexpectancy. …the Netherlands ?Changes in tax Fiscal pressure and the current low yield environment drive changesadvantageous pensionsaving will lower accrual in the Dutch retirement system.rates drastically inoccupational pensions. The Netherlands are commonly depicted as having in the Dutch pension system. Dutch pension fundsCurrent low yield a role model of a modern pension system. As 90% of and their funding levels were hit hard by the assetenvironment decreasesfunding levels of the working population is covered by a quasi-mandatory price slump after the Lehman collapse. While assetspension funds, calling occupational pension system, and pension assets amount quickly recovered to reach pre-crisis levels, Dutchfor emergency recovery to 138% of GDP (Organisation for Economic Co-operation pension funds are still struggling with the burden ofplans. and Development (OECD), 2011), the Dutch pension rising liabilities which are triggered by current low yields.Emergency recovery system is perceived as being well prepared for future Furthermore, the Dutch government is faced withplans for pension funds demographic challenges. pronounced fiscal deficits (cf. Figure 1). In order to curbarrive at benefit cuts. these shortfalls, the discussed austerity packages alsoPension fund Yet the ramifications of the 2008 financial crisis and call for social security reform. ▶regulation: Movingfrom a market- the ensuing sovereign debt crisis in Europe will be feltconsistent, risk-basedapproach to a regulatory Figure 1: Dutch GDP growth and budget deficitengineered marketframework by applying 6%the ultimate forward Government budget deficit (in % of GDP) GDP growthrate (UFR). 4% 2% 0% –2% –4% –6% 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e 2016e 2017e Source: International Monetary Fund (IMF), World Economic Outlook, October 2012Pension & Retirement Update
Allianz What’s happening in the Netherlands? | December 2012 Impact of fiscal pressure entry age to 67 in 2021. The escalation will start next on future retirement year with an increase of one month per year to start with, followed by yearly steps of two, three and four The fiscal deficit of the Netherlands has amounted to months. Subsequently the pension entry age will be more than 4% each year since 2009 (cf. Figure 1) and, linked to life expectancy. The Netherlands will join a according to estimates by the International Monetary group of countries including Denmark, Finland, Italy and Fund (IMF), the Netherlands will not balance its budget Portugal, which have already introduced life expectancy any time soon. In order to comply with Maastricht criteria indexation to their statutory pension age. and secure the nation’s AAA-rating, the government is eager to reduce the structural deficit. This year, several Impact on the occupational pillar austerity packages were discussed, aimed at containing government expenditure. These discussions ultimately The austerity measures that were negotiated by the new led to a split in the Dutch minority coalition government ruling coalition also have an impact on occupational of liberals (VVD) and Christian democrats (CDA), and pensions. As was already discussed in the spring resulted in snap elections in September. agreement, the tax relief for pension savings will be reduced. The changes to the regulatory framework The new Dutch government, consisting of the liberal governing tax-advantageous pension savings, the (VVD) and social democratic parties (PvdA), agreed so-called Witteveen Framework, will lead to a drop on a €16 billion austerity package through 2017 to of 0.4% in the accrual percentage point. Prior to that, potentially cut the country’s deficit to 1.5%. Together with a decrease of accrual of 0.1% point was announced. the formerly agreed measures, the total restructuring So the maximum accrual goes from a yearly 2.25% on amounts to € 45 billion. average pay to 1.75%. Furthermore, the preferred tax treatment of pension savings will be limited to incomes Changes in the first pillar below €100,000. These reforms within the Witteveen Framework have been strongly criticized by the pensions The austerity measures will have an impact on first pillar industry. According to the Netherlands’ largest pension pensions (AOW). One of the major concerns of Dutch fund, the Algemeen Burgerlijk Pensioenfonds (ABP), politicians is the rising life expectancy of retirees. In the the measures endanger the goal of achieving a pension past decade, the life expectancy of the Dutch population amounting to 70% of the average wage. Younger has increased more than was formerly expected – in generations in particular would suffer from this change, the case of 65-year old men, by almost 2.5 years.1 To which could reduce future pensions by as much as alleviate the budgetary consequences of this faster rise 20%.2 Pressure on pension funds comes not only from in life expectancy in the future, several changes to the austerity-induced changes in the legal tax framework: retirement entry age have been discussed. The biggest challenges for pension funds and their plan participants lies in the current low-yield environment The Pensioenakkoord, which was approved in 2011, that reduces funding levels and might ultimately lead envisaged a gradual rise in the retirement age to 68 in to cuts in pension rights and benefits. the time period from 2020 to 2040. At the beginning of this year, when it became clear that the Nether- The challenges of a low-yield lands would not reach the 3%-deficit target in 2013, environment pressure arose to cut social spending even further. The former government negotiated the so-called “spring Over the past five years, pension funds in the Netherlands agreement”, which included a faster rise in the state have been in a financially vulnerable position. With the pension entry age to 67 and a peg to life expectancy. beginning of the financial crisis, funding levels dropped But the implementation stalled due to the split in the significantly and mostly remained below the minimum government. funding requirement (cf. Figure 2). The short-falls of the funding requirements only partly refer to the asset price1 Cf. Statistics Nevertheless, the new government is following the slump during the 2008 market turmoil. Meanwhile,Netherlands (CBS), as of idea of the spring agreement to increase the retire- pension funds are contending most of all with the current09/07/2012 ment entry age faster. The VVD and PvdA both agreed low-yield environment, as they have to value their2 Cf. IPE 11/01/2012 in their coalition talks to gradually raise the pension liabilities on a mark-to-market basis. This refers to the ▶ 2
Allianz What’s happening in the Netherlands? | December 2012 Figure 2: Funding levels of Dutch pension funds 160% 160% 150% 150% 140% 140% 130% 130% 120% 120% 110% 110% 100% 100% 90% 90% 80% 80% 2007 2008 2009 2010 2011 2012 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Target funding level Minimum funding level Funding ratio Source: De Nederlansche Bank (DNB), October 2012 risk-based regulation framework that was introduced in pension benefit cuts, several ad-hoc measures have 2007 (cf. Figure 3). Since then, future liabilities of Dutch been implemented as part of the regulatory framework pension funds have to be discounted by a risk-free market in the last few years. rate which has been defined as the Euro swap rate. With falling yields, especially at the long end of the curve, the It began shortly after the financial crisis, in the spring present value of future liabilities has risen steadily, resulting of 2009, when it became clear that pension funds in today’s low funding levels. In order to mitigate the would not meet minimum funding levels (cf. Box) in liability burden of the pension funds and avoid severe the requested one-year period, and the emergency ▶T h e r eg u l ato ry fra m e wo r k o f D utc h pe n s i o n fu n d sThe regulatory framework of pension funds Financiele Toetsingskader (FTK) was introduced in 2007. It represented a major shift as theNetherlands was one of the first countries to adopt a risk-based regulation for pension funds. Key features of the framework which issupervized by the Dutch central bank (DNB) were:1. The minimum assets of pension funds must be sufficient to cover 105% of accrued benefits (minimum funding requirement)2. Within a confidence interval of 97.5%, pension funds are required to remain above the minimum funding level. This translates into a target funding ratio of 130% for pension funds3. The liabilities of the pension funds are valued on a mark-to-market basis by discounting them at the market interest rate (Euro swap rate)If a pension scheme fails to meet the minimum or target funding requirements, sanctions are introduced by the regulator. If the pensionfund does not fulfill the target funding requirement, it has to introduce a recovery plan with a maximum time period of 15 years to closethe funding gap. Should the pension fund not meet the minimum funding level, an emergency recovery plan has to be implementedwithin one year. This plan includes measures such as the intermission of indexation of pension benefits, increase in pension contributionsand, in a worst-case scenario, the curtailment of pension benefits. 3
Allianz What’s happening in the Netherlands? | December 2012 Figure 3: Liabilities of pension funds vs. long-term swap rate (20 years) 06 07 8 8 0 9 09 10 11 11 12 20 20 .20 0 00 .20 0 .20 20 .20 .20 12. 07. .02 9.2 4 1.2 6 01. 08 03 31. 31. 29 3 0. 0 3 0. 0 3 0.1 3 0. 0 31. 31. 31. 6 1000 Liabilities of pension funds in EUR billions 5 900 20-year Euro swap rate in % 800 4 700 3 600 2 Several funds 500 announce benefits 1 cuts for the 400 Pension funds subsequently following years start to raise contributions ↗ 0 300 Introduction of risk based FTK framework Change in discounting methodology Extension of recovery plan period Collapse of the government coalition Introduction of UFR, September pension package 20-year swap rate Pension liabilities Source: DNB, October 2012 recovery plan period was first extended from one market conditions, the regulator decided to introduce to three and later to five years. Within the same time comprehensive reforms to the regulatory framework frame, pension funds started to raise the average of Dutch pension funds, known as the September contribution rate from 16.9% to 17.5%, although the pension package. DNB allowed pension funds to apply for a contribution respite.3 Despite the new rules and a higher contribution The September pension package rate, pension funds were not able to significantly raise their funding levels. Although the indexation of pension The September pension package was designed by benefits was removed for the vast majority of pension the Social Ministry and the DNB to mitigate the effects funds during 2011, more severe measures had to be of the possibly severe benefit cuts that pension funds taken: Benefit cuts of up to 7% were announced in would be obliged to make if the current regulatory order to comply with the minimum funding level in framework should persist. It institutionalizes some of the fall of 2011.4 the implemented ad-hoc measures and furthermore aims to make the pension schemes more “future proof.” To avoid such drastic effects, the DNB introduced a new The newly implemented measures are widely regarded methodology of how to value the liabilities of the pension as a transitional stage for the new financial assessment fund in December 2011: Instead of using end-of-period framework which is announced for 2014 but will swap rates, pension funds could use a three-month probably be delayed until 2015. average to discount their liabilities. Again, this measure did not bring the expected relief, as yields continued to One option that is again offered to pension funds is the fall. Based on the situation in June 2012, 154 pension contribution respite for pension plans that do not comply3 In case of the funds were expected to conduct curtailments in April with the minimum funding requirement. This option is25 largest funds, source:DNB 08/02/2012 2013 to comply with the funding requirements after the conditional on not having applied for a respite in earlier4 Cf. DNB, February 2012 end of the emergency recovery plan time period which periods. Furthermore, given that a pension fund has to had started in late 2008 for most of the funds. More than cut pension benefits and rights, it is offered the option5 Cf. Ministry ofSocial Affairs, AV/ half of these curtailments would amount to more than to spread necessary curtailment: The cuts which have toPB/2012/14554 7%.5 In order to comply with the current “abnormal” be carried out next year can be limited to the extent ▶ 4
Allianz What’s happening in the Netherlands? | December 2012 of those already announced at the beginning of 2012. cuts for current retirees in an attempt to buy time for In case the year-end assessments of the funding status a potential improvement of the financial position of should require deeper cuts, they can be deferred until pensions funds. On the other hand, the introduction 2014. Moreover, if the funding situation of pension funds of the UFR can be seen as a shift within the regulatory deteriorates further, curtailments that would occur for paradigm: Moving from a market-consistent, risk-based 2014 can be limited to 7%, on the condition that additional approach to a regulatory engineered market framework. cuts are undertaken in 2015. The future cuts should be This has major implications for pension providers and accounted for in the balance sheet end of 2013. future retirees. The pensions of younger generations are valued at a different level than the pensions of older Should a pension fund want to make use of either the generations, because the longer the liability is away in contribution respite or the curtailment spread option, the future, the higher the interest rate on the UFR-curve the regulators will ask the pension fund to raise the will be. Possibly this move will put the solidarity between retirement age of their plans from 65 to 67 in 2013. This generations under pressure. is one year earlier than required, as a general increase in the retirement age is required in 2014. In addition, the Back for good? minimum funding requirement for granting indexation of pensions is raised to 110% instead of 105%. Even before the introduction of the FTK framework, Dutch pension funds used an actuarial discount rate The most frequently discussed change in the regulatory to value their liabilities, which was set at 4%. From the framework which also has a direct influence on funding view of the regulator and the pension funds, the major levels is the introduction of the so-called ultimate advantage of the use of an actuarial discount rate forward rate (UFR). The UFR is an adjustment of the long such as the UFR is the lowered volatility of the funding end of the yield curve. The idea behind the UFR is that position, leading to a higher predictability of future due to liquidity constraints, there is no reliable market contributions and benefits. With the UFR, movements at data for rates beyond a maturity of 20 years (last liquid the long end of the yield curve do not have an effect on point). Therefore, the discount rates beyond a 20-year the valuation of the liabilities and the funding level. On maturity are gradually adjusted over a 40-year horizon the other hand, by directing the discount rate, the actual to the UFR, which is set at 4.2%. This particular rate economic reality is disguised. Whereas the 4% pre-FTK consists of two components: The long-term expectation rate was implemented when long-term yields were of inflation and short-term rates which are assumed way above this level and the 4% discount rate served as to be at 2%, respectively 2.2%.6 The implementation of a measure of prudence, the UFR which has now been the UFR methodology follows the Solvency II insurance introduced aims at preventing cuts for current retirees regulation, which might also be applicable with some and does not account for economic low-yield reality. meanderings in the future for pension funds. The introduction of the UFR leads within current market A pension fund seeks to meet the current and future conditions to a divergence between the market rate and obligations of retirees. Changes in the regulatory the discount rate that pension funds use to value their framework do not have an influence on the capability liabilities.7 As the discount rates obtained via the UFR of the pension fund to meet these promised pay-6 Cf. Technical method are higher than the prevailing market rates at ments. Although Dutch pension funds might improvespecification QIS 5 the long end of the yield curve, the present value of the their disclosed funding levels and therefore obviate7 The three-month pension funds liability decreases while the funding ratio curtailments, by just changing the valuation methodaverage will be increases. According to PIMCO, the application of the of liabilities, the actual financial position of the fundmaintained when valuing UFR method as introduced in the Netherlands will lower does not change. If the current low-yield environmentliabilities. the current value of liabilities by roughly 4%.8 The Dutch prevails for longer, the cuts are simply postponed to8 PIMCO: TheUltimate Forward Rate: regulatory authorities expect that with the introduction future generations.Implications for LDI of the September pension package the number of fundsStrategies, July 2012 with curtailments for 2013 will almost halve to 81 funds, Furthermore, if the yield curve is regulated by politicians,9 These funds already with only seven of them cutting benefits by more than 7%.9 pensions funds are increasingly exposed to political risk.announced that they The absolute value of the UFR and the extrapolationwill not opt for thecurtailment phasing; cf. The respite and curtailment spread options aim at method are at the discretion of the regulator. WhereasAV/PB/2012/14554 limiting the direct financial effect of already announced interest rate risk is in general hedgeable for pension ▶ 5
Allianz What’s happening in the Netherlands? | December 201210 Cf. IPE 10/19/2012 funds in a market-consistent framework, political risk is not. Pension funds are therefore confronted with the problem of how to mitigate between the regulatory framework and economic reality. Outlook As of the end of October 2012, the implementation of the new regulatory measures has not shown the desired effect of the regulators. Only one out of the five biggest pension funds could rule out the possibility of rights cuts.10 Although the measures which have been introduced should decrease the size of expected benefit cuts for 2013 and 2014, with regard to the currently low funding positions and the new indexation threshold of 110%, Dutch pensioners can expect that the real value of their rights and benefits will shrink in the coming years. In order somewhat to alleviate the effect of the new legal changes and the current low-yield environment, young Dutch people in particular should consider investing in private pension schemes. Although the Dutch occupational pension system is better equipped for future challenges, the latest reforms, and current pressure from both the fiscal and capital market sides, put into question whether it will be able to sustain its formerly targeted 70% replacement rate in the future. Richard Wolf Economist International Pensions # +49 (0) 89 1220 7473 0 email@example.com & www.projectm-online.com/research 6
Allianz What’s happening in the Netherlands? | December 2012MastheadPublisherAllianz SEKoeniginstrasse 2880802 Munich, GermanyPhone: +49 89 3800-0Fax: +49 89 3800-3425www.allianz.com Recent PublicationsEditorsDr. Renate Finke, Senior Economist International Pension Papersrenate.firstname.lastname@example.org Retirement Attitudes and Financial StrategiesRichard Wolf, Economist of the Affluent 50+Generation in Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . email@example.com Routes to Private Pensions in China – A Scenario Analysis of China’s Private Pension Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012International Pensions Why Saving on a Regular Basis may be Wise! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012International.Pensions@allianzam.com Wanted: Flexibility in Retirement Entry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012 2011 Pension Sustainability Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011Closing Date Pensions in Turkey – A Race against Informality and Low Retirement Ages . . . . . . . . . 2011November 19, 2012Cautionary Note Regarding Forward-Looking Statements International Pension IssuesThe statements contained herein may include statementsof future expectations and other forward-looking statements that What’s happening in…the Netherlands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012are based on management’s current views and assumptions and Germany – Slight increase in gross financial assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012involve known and unknown risks and uncertainties that couldcause actual results, performance or events to differ materially from UK – On course for an innovative pension system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011those expressed or implied in such statements. In additionto statements which are forward-looking by reason of context, Focus: Germany – Financial assets continued to rise in 2010 . . . . . . . . . . . . . . . . . . . . . . 2011the words “may”, “will”, “should”, “expects”, “plans”, “intends”,“anticipates”, “believes”, “estimates”, “predicts”, “potential”,or “continue” and similar expressions identify forward-lookingstatements. Actual results, performance or events may differmaterially from those in such statements due to, without limitation, www.projectm-online.com/research(i) general economic conditions, including in particular economicconditions in the Allianz Group’s core business and core markets,(ii) performance of financial markets, including emerging markets,and including market volatility, liquidity and credit events (iii) thefrequency and severity of insured loss events, including from naturalcatastrophes and including the development of loss expenses, (iv)mortality and morbidity levels and trends, (v) persistency levels, (vi)the extent of credit defaults, (vii) interest rate levels, (viii) currencyexchange rates including the Euro/U.S. Dollar exchange rate, (ix)changing levels of competition, (x) changes in laws and regulations,including monetary convergence and the European MonetaryUnion, (xi) changes in the policiesof central banks and / or foreign governments, (xii) the impactof acquisitions, including related integration issues, (xiii)reorganization measures, and (xiv) general competitive factors,in each case on a local, regional, national and / or global basis. Manyof these factors may be more likely to occur, or more pronounced,as a result of terrorist activities and their consequences. Thecompany assumes no obligation to update any forward-lookingstatement.No duty to updateThe company assumes no obligation to update any informationcontained herein.