Dutch Pensions Face Funding Dilemma

April 27, 2010 (PLANSPONSOR.com) - Pension plan sponsors in the Netherlands are facing their second funding challenge in the past decade, this one more severe than the first, according to a new Issue Brief by the Center for Retirement Research at Boston College.

Following the economic crash in 2008-2009, the funding levels of most plans fell below the 105% threshold set by the Dutch supervisor, De Nederlandsche Bank, which requires recovery of the minimum funding ratio within five years. According to the report, in September 2008, only 12% of Dutch pension funds had funding ratios below the required 105% level, and just five months later, the share of plans falling below this standard soared to 85%.  

The researchers said that although earlier in the decade most Dutch pension plans were restructured to include automatic reductions in benefit indexation if funding drops below given thresholds, that mechanism may not be enough to achieve recovery this time around. The researchers analyzed policy options that could help restore funding more quickly than just waiting for financial markets to recover.   

According to the report, the continuation of the fund with no additional measures is more beneficial for older participants than younger participants. While the older participants will share some pain through reduced indexation, they will continue to receive their full nominal benefits in the coming 15 years. If the fund recovers in the not-too-distant future, they will even get partial indexation.   

The working generations, however, will pay more contributions than the value of new accrued benefits in the coming 15 years because the actual indexation falls behind full indexation. At the same time, part of the contributions of the active members will be used to pay out full nominal benefits to current and future retirees and to also possibly provide partial indexation for this group.  

If, on the other hand, workers pay additional contributions of 2.5% of the pensionable wage for as long as the plan is underfunded, the redistribution from young to old increases. For the younger members, the difference between the value of contributions and the value of accrued benefits further increases, since they have to pay extra contributions without receiving any additional benefits. For the older members, the recovery of the funding ratio is accelerated, so that on balance, more indexation is paid in the coming 15 years, which means they get higher benefits.  

Another option that allows for a cut in nominal benefits after three years that equals the size of the recovery gap at the end of the three-year period reduces the redistribution from young to old considerably, as the cut in nominal benefits shifts more of the recovery burden to the elderly, according to the report.  

The researchers say the importance of the generational distribution issue suggests that structural changes in the design of Dutch pension funds may be ripe for consideration. These changes could introduce age differentiation into benefit and investment policies. For example, plans could adopt an age-dependent indexation rule that would tie indexation for younger participants to the real rate of return on some specified asset mix, such as the pension fund asset portfolio. For older plan members, it would provide (almost) certain full indexation at all times.   

Another idea researchers suggested is to move away from a uniform asset mix by replacing the current structure with a two-fund model, one for younger participants and the other for older members. The fund targeting young plan members would have a high risk profile, while the fund for the elderly would have a low risk profile. Plan participants would move gradually from the first fund to the second.   

The Issue Brief is here.