Dutch pension funds face serious challenges

Problems facing pension funds: the causes

The Netherlands has a relatively well-established second pillar pension sector. Second pillar pensions supplement the basic state pension available to all Dutch Residents over 65. They are built up as part of the terms of an individual’s employment. More than 90% of all employees participate in the second pillar. At the end of 2010, the capital base of around 600 pension funds totalled €831 billion. The sector consists of industry-wide funds, company pension funds (especially for bigger companies) and so-called insured schemes placed with an insurance company. Employer and union representatives manage the industry-wide pension funds jointly. With respect to company pension funds and insured schemes, employees have a voice through the works council.

Prior to 2000, second pillar pensions were relatively stable. This changed at the turn of the century due to the dot-com crisis, and again in the wake of the credit crisis. Pension funds are facing problems which have a number of causes, the most significant of which is demographic: the ageing workforce and a rapidly rising life expectancy. These factors are leading to an increasingly unfavourable ratio between the total wage and salary bill on one hand, and pension obligations on the other. This ratio rose from 2.8 in 2009 to 2.9 in 2010, and is expected to reach 3.7 by 2040.

The second factor presents itself in the shape of historically low interest rates. These serve to increase pension obligations. Pressure from the unions and a majority of the House of Representatives (albeit temporarily) to use a higher notional interest rate to calculate pension fund obligations was rejected by the Dutch Cabinet in November 2010. Minister Henk Kamp of Social Affairs and Employment refuted the argument that the rate has been kept artificially low by the central bank since the onset of the credit crisis.

The third cause lies in the investment losses suffered by the pension funds since the crisis. This has strengthened the call for further professionalism in managing the funds. These developments have resulted in many pension funds no longer being able to comply with the coverage ratio between available resources and long-term obligations of 105%, as required by the supervisory authority.

Possible solutions

In principle, the financial problems facing the funds can be resolved in different ways. The first would be to raise pension premiums. Such a step is considered unpopular, among employer and employee representatives alike. Employees would receive less pay and labour costs would increase for employers. What’s more, because premiums have already gone up significantly since the dot-com crisis, there is little leeway for further increases. Premiums have been raised by 0.1% this year at the biggest Dutch pension fund, the General Pension Fund for Public Employees (ABP), which, with an invested capital of €231 billion, is also a major player internationally. Expectations are that there will be a further increase with effect from 1 April. Premiums had already been increased on 1 August 2010.

The second potential solution would be to refrain from indexing pensions and/or accruing pension benefits for existing fund participants. This would diminish wealth, directly for retired employees and in time for active employees. Several funds have adopted this measure, over a number of years in some cases. At ABP, for example, recent years have seen pensions and accrued pension benefits lagging by 8% in relation to wages in the sector in which the participants work. The shortfall amounts to 6% for the Netherlands’ second biggest pension fund, the Pension Fund for Care and Well-Being (PFZW) with 2.3 million participants, and 6.6% and 4.38% respectively for employees and retired employees (metalworkers) of the third biggest pension fund, PMT.

Only funds with an adequate coverage ratio will apply indexation, including KLM Royal Dutch Airlines’ three pension funds. The coverage ratio for ground crew rose to 122% by the end of 2010. Retired ground crew receive a 1.4% higher pension. The pension for flight crew (with a coverage ratio of 134.5%, one of the wealthiest in the Netherlands) is expected to increase by 0.7% in 2011.

A third, more extreme variation of this option is to lower pension payouts. This scenario threatened to unfold for 14 pension funds at the end of 2010. While most of these funds were relatively small, bigger funds for the metal industry found themselves under threat too. In the end, the supervisory body, the Dutch Central Bank (DNB) forced seven to lower their payouts. Almost 50,000 participants were confronted with a drop of between 2% and 5.9%.

The fourth option would be to raise the retirement age. Effective from 2011, employees in the care sector will be required to work four months longer in order to accrue the same pension benefits as before. While stopping work earlier remains an option, it results in a lower pension. New participants joining the fund will have to work approximately seven months more. The measure will apply provisionally for a year. A fifth option would be to change pension conditions, particularly by converting final wage schemes to average wage schemes. A vast majority of pension funds already took such a step during the 1990s.

Finally, in the case of company pension funds, the employer could make additional payments. While in some instances this is compulsory on the basis of a contract or regulations, this is not always the case. Dutch towage company Smit International threatened to lower pensions by 13.2% from1 January 2011. Participants threatened to initiate legal proceedings when it appeared that several years prior (according to those involved, ‘somewhere in the last five years’), Smit had scrapped the obligation for the company to make supplementary payments if any shortfalls should emerge in the fund. The company had also made withdrawals from the fund in the past. Further commotion among the participants was fuelled when it appeared that dredging company Boskalis, which had taken over Smit in 2010, had in fact offered to supplement the pension fund shortfall at the time. Three times Smit rejected the offer in favour of diverting more funds to shareholders. Legal proceedings were averted in the end because Boskalis topped up the pension fund by €30 million.

Greater role for retired employees in pension fund management

Retired employees notice if pensions are partially indexed or not (and certainly if the nominal pension is lowered) directly in terms of their financial resources. The consequences for other fund participants (active and former employees who have yet to reach retirement age) are sometimes less visible – of course, with the exception of steep pension premium increases. For a long time now, it has been problematic for retired employees to assert any influence. In July 2010, the House of Representatives adopted a legislative proposal that would serve to strengthen the position of retired employees in the pension funds. The Senate of the Dutch Parliament has yet to deliberate on the proposal.

Risk shifts to employees

Rising premiums and the option of supplementary deposit obligations are increasingly prompting employers to make employees responsible for pension risks, in part or in full. This is amplified for listed companies, given the disclosure obligations stipulated in International Financial Reporting Standards (IFRS). Shifting risks can be achieved in different ways. Usually a choice is made to convert the existing defined benefit scheme to a defined contribution scheme consisting of both individual and collective elements. In relation to risk spreading, while intensive consultations are under way between employers and the trade unions within the context of closing new pension contracts, the results are not yet entirely clear (NL1007019I).

Robbert van het Kaar, University of Amsterdam, HSI

Kilde: EIRO