Dutch Pensions Hit as Regulator Moves Discount Rate

Coverage ratios tumble in the Netherlands, a nation once lauded for its well-funded pension system.

Some of Europe’s best funded pension funds have been pushed towards long-term deficit as their national regulator has changed the measure of coverage ratios.

The Dutch National Bank (DNB) announced Tuesday that it would move the ultimate forward rate (UFR), which is used by the country’s pension funds as a discount rate for liabilities, from 4.2% to 3.3%. The new measure was put into effect immediately.

“Given the past decade’s history of interest rates, this new UFR method will put downward pressure on coverage ratios for the next 10 years.” —Bernard Walschots, RabobankThe DNB said this number was “more realistic” but despite having signalled its intentions for some time—although not with such specific detail—the move was met with criticism from industry figures.

The Dutch Pension Federation said it was “very disappointed” with the UFR decision, saying it would “lead to higher premiums, a decrease in coverage ratios, and put pressure on the accrual rates”.

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“Calculations by the Pension Federation show [the move] will increase the cost-effective contribution to pension funds by an average of 5 percentage points,” the federation said in a statement. “For the average funding ratio of pension funds, the introduction of this new UFR means a gradual reduction of up to 10 to 15 percentage points in 2020 compared to the coverage [they had at] the end of May 2015, depending on the extent to which pension funds have hedged their interest rate risk.”

The federation said the problem would be more acute for pension funds with a younger membership as they have to take account of longer maturities.

Additionally, the organisation questioned the rationale of the DNB, given the backdrop of the ongoing Eurozone crisis, the region’s persistent low interest rates, and recent quantitative easing package.

“The Pension Federation finds it illogical that DNB, precisely at this time, [chooses a method] which focuses more on the market,” the federation said.

PFZW, the country’s second largest pension, announced yesterday that it had already submitted a new recovery plan to the DNB at the start of the month as its previous one had “expired”. The fund set out a range of measures it would have to undertake in its efforts to bring its coverage ratio up, but warned it would probably not reach 110% by the end of the year.

In a column for CIO last year, Rabobank Pension CIO Bernard Walschots outlined the impact such a move would have on funds.

“From 2015, the UFR will be a 120-month moving average of the one-year forward rate of a maturity of 59 years, instead of the fixed rate of 4.2%. In practice this means that liabilities will be calculated using lower interest rates,” said Walschots. “Given the past decade’s history of interest rates, this new UFR method will put downward pressure on coverage ratios for the next 10 years.”

Walschots said this would, in turn, put pressure on the perception of the Netherlands’ pension system as being safe and sustainable.

Related: Dutch Pension Funds in 2014: A Lament; Bigger Might Not Be Better for Pensions, Dutch Regulator Claims; I Don’t Want to Be a Role Model

What Are You Hedging?

Three asset owners talk to CIO about protecting their portfolios from the actions of central banks.

Asset owners need many hands to count the number of risks their portfolios face right now. But which of them can be hedged—and which should be?

Conflicting commentaries from asset managers, consultants, columnists, banks, and regulators have told us in recent weeks that: Greece is about to exit the Eurozone—and that it will definitely stay; China is the biggest worry out there right now—and it’s just a bit of equity market volatility; and the Federal Reserve will raise its base interest rate for the first time since June 2006—okay, we’re all pretty sure that will happen in September.

Instead of adding to the billions of megabytes of speculation about what really is the biggest risk, CIO asked three top asset owners (two Power 100 members and a Forty Under Forty alum) what they were hedging, how, and why.

Interest rates: Anders Hjælmsø Svennesen, CIO, Danica (Denmark)

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  AndersSvennesen Art by Chris BuzelliSince joining the €41 billion ($45 billion) Danica pension fund in December 2014, Anders Svennesen has wasted no time in making his mark on the portfolio. The former ATP co-CIO was tasked with building a strategy “from scratch”, and is making full use of the academic approach he learned at his previous employer.

Danica’s team is hedging against both falling and rising nominal interest rates, Svennesen tells CIO.

With the major central banks in developed markets all currently holding their base rates at marginally above zero, hedging against further falls seems unnecessary at first. But in Denmark, they know better: the Nationalbank took its rate into negative territory in mid-2012, and—after a brief adventure above zero last summer—slashed it four times at the start of 2015 to its current level of 0.75%.

“We need to hedge our guaranteed pensions in order to make sure that we can give our customers the future pensions that we have promised them,” Svennesen says. “Furthermore, interest rates are very volatile and at current levels they can make a larger move in either direction.”

The Danish central bank has made clear its intention to peg its currency, the krone, to the euro as closely as possible. Ongoing discussions over Greece’s woes could yet be felt 1,700 miles to the north-west. While this is still the case, Svennesen and Danica will continue to use swaptions to mitigate interest rate volatility.

 The Other Hedgers

 Currency risk—Stefan Beiner, PUBLICA

 Everything—Ian McKinlay, Aviva

Currency risk: Stefan Beiner, CIO, PUBLICA (Switzerland)

  97_Profile_Stefan Beiner_EK.jpgArt by Edward KinsellaCentral banks can be challenging for investors—just ask the Swiss.

On January 15 this year, the Swiss National Bank announced, somewhat unexpectedly, that it would no longer peg the Swiss franc to the euro. In contrast to Denmark, the Swiss wanted to distance themselves from the Eurozone’s continuing problems.

Chaos ensued in the next few hours. Swiss stocks plunged in value, the franc soared relative to both the euro and the dollar, and some currency traders began to look very worried indeed.

In Bern, Switzerland, however, Stefan Beiner was less concerned. He’d expected a move like this and hedged currency risk in the majority of the CHF 37 billion ($39 billion) portfolio he oversees at PUBLICA, Switzerland’s largest public pension.

Speaking to CIO at the start of July, Beiner confirmed he was still hedging currencies “in industrialised nations”.

He does not necessarily expect another dramatic decision from his fellow countrymen, however.

“The main reason for this hedge is to eliminate risks from the portfolio that are non-systematic and, as such, not compensated, thereby freeing up a risk budget to exploit other risk premiums,” Beiner explained.

“Currency forwards are used for strategic hedging of the currency risks arising from bond and equity investments in industrialised nations other than Switzerland and to reduce the currency risk to which the portfolio as a whole is exposed,” he adds.

The Other Hedgers

Interest rates—Anders Svennesen, Danica

Everything—Ian McKinlay, Aviva

Everything: Ian McKinlay, investment director, Aviva Staff Pension (UK)

54_Profile_Ian McKinley_CB.jpgArt by Chris BuzelliOkay, not absolutely everything. But Aviva’s Ian McKinlay—who is soon to take over at the helm of Lloyds Banking Group’s £32 billion pension assets—doesn’t leave anything to chance. If he doesn’t believe his pension fund can make money from something, it doesn’t make into the portfolio—and in some cases is actively hedged out.

On top of protecting against volatility in interest rates and foreign exchange like Svennesen and Beiner, McKinlay has also hedged against inflation. In the UK, the Bank of England’s base interest rate has remained at 0.5% since March 2009 and is not expected to rise before the Federal Reserve moves. Inflation has fallen from roughly 5% at the end of 2011 to 0%.

“We use a combination of mainly physical assets, and to a lesser extent derivatives,” McKinlay says. Physical assets used include sovereign bonds, credit, and real assets.

As those who have bumped into him at CIO events in the past can testify, McKinlay deals only in certainties. “We’ve chosen these hedges to protect the mark-to-market risk of funding, and because we don’t believe we can make money in these markets,” he says.

“By doing so we protect the security of accrued liabilities, and seek to harvest sustainable risk premia on real assets,” McKinlay continues. “Boring I know, but we’re one of the best funded schemes around. We also have risk positions in markets where we believe risk is rewarded.”

It is an approach that has served McKinlay well at both Aviva and in his previous role at the Pension Protection Fund. Let’s see if he follows the same path at Lloyds.

The Other Hedgers

Interest rates—Anders Svennesen, Danica

Currency risk—Stefan Beiner, PUBLICA

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