I've been reading up on pensions in the Netherlands, which have been hitting the headlines here over the past year and sparking a lot of controversy. There's a lot going on. It is impossible to analyze all aspects here. I'd like to present and back up my observations in my own way. For someone outside the industry, still involves a bit of synthesizing information from various places. I hope this post will be interesting for zerohedge readers and encourages debate. I may have to come back at some point and expand the analysis as a result.
When I personally started following pension funds in more detail around the turn of the millenium, ABP, the largest pension fund in the country with assets of 246 billion euros at the end of 2011 (Wikipedia), was shifting its allocation towards equities and commercial real estate, reducing bonds and opening up an office in the US. Just before the tech bubble burst. Anyone with a cursory and open-minded knowledge of economic history could have seen that that was a risky proposition amidst the all the euphoria. We could look back in hindsight and identify why for instance financial markets and “Western-style capitalism” were on the ascendancy. ABP had decided it was time to spread country risk and take advantage of the largest and most liquid market in the world.
I suppose ABP was somewhat on the vanguard for these things, which it still may be according to Leo Kolivakis. I began reading him since finding his guest posts on zerohedge. I'm not aware of exactly why he doesn't post here anymore but I've gained quite a bit of insight into the industry from him and his blog. I will link first to a guest article written by Martin van Dalen on his blog discussing many of the factors going into the coverage ratio. This article discusses many aspects of Dutch Pensions and it is in English so it is well worth reading:
http://pensionpulse.blogspot.com/2010/09/recent-problems-in-dutch-pension-sector.html [7]
Coverage Ratio
Essentially, Dutch pensions must report on their coverage ratios, that is the amount of assets on their books that can pay for projected pension liabilities. If this ratio is too low, measures must be taken to bring it back in line, including cutting benefits and increasing worker pension premiums. There is also talk of allowing Pension Funds more leeway in determining their strategies so that they don't hedge their interest rate risk in the traditional manner. Our Minister of Social Affairs, Henk Kamp and the social partners see little chance of Pension Funds abusing this new proposal and are set to approve it.
For the calculation of their coverage ratio this year pension funds are going to be allowed by DNB to use an average of its discount rate over the past three months instead of the end of the period rate.
This will improve the reported results for 2011, I'm not sure by how much. This seems to have been designed as part of a strategy to postpone painful change for a year. That postponement will impact the youngest participants in the long run who will likely face rising contributions and declining benefits. Current retirees benefit from this and besides all the bad news about future cuts to benefits comes as a shock. The Dutch were convinced of the robustness of the system and had never faced nominal pension cuts. The news that broke out last year about average cuts of 7 percent caught many off guard.
The following link mentions the change going into the calculation of the coverage ratio:
The Dutch Central Bank, which regulates these pensions, publishes the discount rate that goes into the coverage ratio.
As you can see, the interest rate going into the coverage calculation fell precipitously towards the end of 2011. Of course this measure happens to work out well for pension funds now but it says nothing about the future.
Derivatives
In fact, just as the Dutch Social Housing Sector has been hedging its interest rate exposure towards the upside as I alluded to in an earlier post, Dutch Pensions have been using derivatives extensively to do just the opposite. According to RTLZ, they've earned 45 billion euros on their portfolio in the second half of 2011.
http://www.rtl.nl/components/financien/rtlz/nieuws/2012/10/pensioenfonds... [9]
These pension funds have mostly not closed off these positions so their 'earnings' may yet go up or down for these contracts. For a pension system now estimated to have assets of 875 billion euros, this is a nice development. For the counterparties, not so.
The RTLZ says that the funds had 415 billion euros in triple A government bonds at the end of 2011, up from 338 billion euros at the end of 2010. Of this total, 218 billion euros is invested in Dutch and German bonds. Here is a chart that shows the growth in assets over the past ten years.
Pensionable Age Rising
There has been a lot of controversy as to how to improve the viability of Pension Funds in the future, focused primarily on the effect the rising average age of pension participants. The most likely scenario is that the retirement age will increase to 66 in 2020 and 67 in 2025. There are other ideas out there to spread the burden more evenly across participants. Bas Jacobs proposes raising the retirement age each year by three months. The retirement age would then rise to 68 after 12 years.
My conclusions:
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Formal DNB oversight is set to ease regarding managing interest rate risks and calculating of coverage ratios with the pension funds and their social partners gaining freedom. One might argue that the technical proficiency of funds to manage risks has grown and the instruments available to them have increased.
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Politically painful decisions to bring the coverage ratio up to minimal requirements through increases in contributions and reductions in benefits have been largely postponed for at least a year. One could argue that there is a good chance of things looking better at the end of 2012 as the financial crisis subsides. That is not my personal opinion.
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The sector is currently benefiting immensely from derivative contracts and if it is shown that other sectors, such as Public Housing, are not and must be protected from their lack of sophistication and the general lack of regulation, it presents a an interesting political problem.
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Long term, a lot of factors seem to be conspiring against young participants in the pension system.