Dutch pension plans' funding still a risky business

Most Dutch pension funds have returned to their required 105% minimum funding threshold, but fund officials are not out of the woods yet, consultants say.

A year after the collapse of Lehman Brothers Holdings Inc. and subsequent free fall in solvency levels, pension coverage ratios are still not stable “because markets are still very volatile,” said Arnold Jager, senior consultant at Hewitt Associates LLC based in Amsterdam. “On the liabilities side, it is also not very secure because liabilities are calculated based on (long-term) interest rates, which are also still volatile.”

Pension fund officials are left in a bind — if they decide to take less risk to lock in the improved coverage ratio, they might miss out on future market rallies. If they maintain the risk/return profile or add risk to portfolios and the market goes the wrong way, the coverage ratio will plunge below 105% again. (In calendar year 2008, it dropped to 95% from 144%.)

“If the funded ratios decline, the risk budget also declines, and that could force (pension fund officials) to take risk off the table and miss out on future upturns,” said Dennis van Ek, senior consultant at Mercer LLC, Amstelveen, Netherlands. “The problem is (pension officials) don't know which way the market is going and they don't want to be the rabbit caught in the headlights.”

De Nederlandsche Bank, the Dutch central bank and regulator of pension funds, requires that funds submit a five-year recovery plan if their coverage ratios — or the funding level needed to meet liabilities — fall below 105%. Funds must file a 15-year plan when their solvency levels drop below about 120% to 125%, depending on the risk profile of the investment portfolio.

In the first quarter of 2009, the majority of some 650 pension funds in the Netherlands were required to file a recovery plan to the DNB after their coverage ratios had dipped below the minimum 105%. By the end of the third quarter of this year, however, solvency levels had risen dramatically, averaging around 107%, according to estimates by several consultants.

Among the pension funds now at or above the minimum solvency level:

• The €180 billion ($267 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands, reported a 105% coverage ratio as of Sept. 30, vs. 90% at year-end 2008;

• The funding level for the €81.9 billion Pensioenfonds Zorg en Welzijn, Zeist, jumped to 107% at the end of September, from 92% at the year-end 2008;

• The €8.2 billion Pensioenfonds voor de Grafische Bedrijven, Amsterdam, recorded a 110% coverage ratio as of Sept. 30, vs. 97% at year-end 2008;

• The coverage ratio of the €1.9 billion Stichting Pensioenfonds TNO, Rijswijk, Netherlands, improved to 111% from 101% during the same period; and

• The €4.1 billion DSM Nederland Pension Fund, Heerlen, had a funding level of 112% compared to 98%.

Pensioenfonds voor de Grafische Bedrijven is tackling uncertainty by dramatically diversifying its portfolio. Fund officials hope to boost alternatives exposure to a third of total assets by around 2012 from 17% at the end of last year, according to the fund's recovery plan for 2009-2014 made public in October. Equities, which made up 43% of total assets at the end of 2008, will be reduced to one-third of the fund; fixed income, at 40% of total assets, also will be cut to a third.

PGB's alternatives portfolio — which consisted solely of real estate in 2000 and accounted for 4% of total assets — more than quadrupled through 2008, with assets in infrastructure, commodities, hedge funds, private equity and environmentally sustainable investments added to the mix.

CIO Dirk Wieman could not be reached for comment, but according to the recovery plan, the shift into alternatives is meant to reduce risk over time. The goal is to eventually reach a coverage ratio of 150%.

Other funds are not altering their strategic allocation significantly, believing that the worst of the financial crisis is already behind them, consultants said. At TNO, officials already shifted into safer assets such as bonds in the first half of 2008. The current asset allocation is about 50% bonds, 25% equities, 10% each in real estate and private equity, and the remainder in hedge funds.

“We can't be too confident, but we really don't expect huge changes in our investment portfolio,” said Joop T. Ruijgrok, managing director. “We've already made the changes in time for the crisis ... and we're planning to stick to our long-term strategic policy.”

Unlike other pension fund officials who decided not to rebalance into equity in the six months ended March 31, TNO did rebalance and was able to profit in the following six months. Its coverage ratio had escalated by about 10 percentage points to 111% in the nine months ending Sept. 30. Of the increase, five points came from investment returns and 3.5 percentage points were from a decrease in liabilities. The remainder was due to additional contributions and premiums.

“A lot of (pension officials) held on through the difficult times,” said Henk Radder, director in the institutional strategy and solutions group at Russell Investments Ltd., Amsterdam. “They endured a lot of pain by doing so, but they were also able to benefit from the recovery.”

Furthermore, the majority is still a long way from reaching 120%, the higher of the Dutch government's the two coverage ratio requirements. As a result, there is probably more — rather than less — risk appetite in the current environment, according to consultants.

“There is a danger that (pension executives) might believe that it's all plain sailing going forward, since markets — particularly equities — have improved,” said Frits Bosch, director of Bureau Bosch, an independent institutional investment consultant based in Nuenen, Netherlands. “This is simply not the case.”

DSM is also among those not planning to significantly reduce risk. The current target asset allocation is 35% equities, 37.5% fixed income, 12.5% inflation-linked bonds, 5% real estate and 10% in other alternatives.

“We are planning to basically maintain the current asset allocation,” said Dorien Mikkers, senior actuarial consultant at the fund. “The reason is simple: We think the worst of the crisis is over. ... We will continue to look at our strategic allocation and make sure that what we invest in still fits into our (short-term and long-term) plans, but we don't expect big changes.”

The speedy increase in funding ratios was due largely to two factors: a recovery in worldwide markets since March; and a drop in liabilities due to the rising long-term interest rates used to calculate those liabilities.

PFZW had reported returns of 8.4% and 9.1%, respectively, in the second and third quarters of 2009. Meanwhile the long-term interest rate had climbed to about 3.87% in the third quarter compared to 3.55% at the end of 2008.

At ABP, the coverage ratio improved by 7.3 percentage points in the quarter ended Sept. 30, according to spokeswoman Jos van Dijk. “When we looked at the causes of that increase, we can see that an increase in assets accounted for the larger part of that development,” Ms. van Dijk said in an e-mail response to questions. Like its peers, ABP also benefited from higher interest rates that reduced liabilities. She declined further comment on possible asset allocation changes because ABP is in the midst of a strategic investment review, which is expected early next year.

“Unlike their U.S. or U.K. peers, most Dutch pension funds are still open,” said Mr. Radder of Russell. “The ongoing concern is that they want to improve funding levels in order to keep (employee and company) contributions at a sustainable levels. They are aware they have to generate returns.”