Dutch DB plans look to transfer risk

(updated with clarification)

More Dutch defined benefit plans might be following the U.K.'s lead in transferring their pension risks to insurance companies through buyout or buy-in transactions, according to consultants and insurers.

“What's happening in the rest of Europe is that the buyout and buy-in markets have started to develop,” said Kelvin Wilson, associate director in the pensions advisory division at Grant Thornton UK LLP based in London. “Sponsors in other European countries are looking at the lessons learned from the U.K.”

A buyout involves buying bulk annuities to partially or completely transfer pension assets and liabilities to an insurance company. In comparison, a buy-in is usually less expensive and involves insuring the pension liabilities while keeping the pension fund on the company's balance sheet.

In addition to the Netherlands, some corporate pension funds in Scandinavia also are considering transferring their pension assets and liabilities to an insurance company, according to other sources. Irish corporate plans, which are struggling with similar issues, might be next in line.

Since 2000, the number of pension funds in the Netherlands has nearly been cut in half, to 545 as of Sept. 30, 2010. While many have merged or joined an industrywide pension fund, others have implemented insurance-based approaches such as buyouts. Exact numbers are not available, but estimates based on data from De Nederlandsche Bank, the Dutch central bank, show that as many as 250 have liquidated by transferring assets and liabilities to an insurance company.

Initially, mostly small plans — those with a few million euros in assets implemented buyouts. Now, however, sponsors of larger plans are considering liquidating through an insurance company. Among the latest is the €270 million ($372 million) Stichting Nutreco Pensioenfonds, Nutreco Holding NV's DB pension fund based in Tilburg, Netherlands.

“A lot of funds have vanished,” said Kristel Kusters-van Meurs, principal and head of the pension fund advice group at Mercer LLC based in Amsterdam. “We expect that many more (pension fund executives) are considering closing their pension funds.”

Some of the factors driving larger Dutch pension funds to consider a buyout are similar to those that occurred in the U.K. in the early 2000s. Back then, a combination of increasing life expectancy, falling interest rates and increasing market volatility caused pension liabilities to rise at the same time that stricter accounting regulations meant that pension deficits became more visible on company balance sheets.

Some Dutch corporate funds are experiencing similar challenges in the aftermath of the recent financial crisis. Although the value of pension assets generally increased among Dutch pension funds in 2010, solvency ratios have been in decline because a lower interest rate environment has pushed pension liabilities higher. Combined with significant losses during the financial crisis and increased longevity risks, more Dutch plan sponsors are considering liquidating their pension funds.

Alwin Oerlemans, director of client solutions at money manager APG NV based in Amsterdam, said there are also major differences between the U.K. and Dutch pension markets that make the insurance option less attractive in the Netherlands.

First, most Dutch defined benefit plans are still open, making them much more expensive compared to a closed plan when considering a buyout. Second, Dutch pension benefits are not required to increase at the rate of inflation, as they usually are in the U.K. However, social pressure particularly from plan members has often resulted in annual increases to account for higher costs of living.

When a pension fund enters a buyout or buy-in agreement, members may lose the right to indexation — the future increases in their benefits, according to Mr. Oerlemans and others. “Insured solutions are expensive in terms of cost, but they're also expensive in terms of the quality of indexation,” Mr. Oerlemans said. APG has about €265 billion in assets under management.

Nevertheless more are choosing the buyout option partly because some plan sponsors prefer to have “some predictability in pension costs,” said Edward Snieder, partner and director of the business advisory services division at KPMG based in Amsterdam.

At AEGON NV, the first buyout transaction was implemented in 2005 and the number has steadily risen; 10 were done last year. Most of the buyouts are between €20 million and €50 million, but the company also handled the Nutreco transaction, which was completed earlier this month.

AEGON also implemented its first buy-in transaction late last year. Hero Group, Lenzburg, Switzerland, had €44 million in its Dutch defined benefit plan, which was 100% funded at the time of the transaction.

“Hero would have had to wait three to four months in order to get approval from its members and the regulator” if it wanted to do a buyout, said Jeroen Bogers, product development manager for derisking solutions at AEGON Global Pensions based in Amsterdam. “By doing a buy-in, the price was locked without the need for member approval. The buy-in is a reversible transaction that allows the price to be set first; regulatory and member approval for a buyout can then be sought afterwards."

About 35% of Dutch defined benefit plan sponsors are considering liquidation, either through a merger or an insurance-based transfer of assets and liabilities, according to a survey published by KPMG earlier this month. The survey had 100 respondents, of which 42% had assets of €200 million or more.

In a separate survey published in 2010 by Clear Path Analysis, an independent provider of financial reports and analysis, 41% of the respondents from throughout Europe were considering a buy-in or buyout for their pension funds. Of those, about 27% were looking at a buyout. The survey involved 42 funds, each with at least $1 billion in assets, based in the U.K., Netherlands, Sweden, Switzerland, Norway and Germany.

In Scandinavia, the biggest driver for interest in buyouts and buy-ins is Solvency II, said Noel Hillman, managing director of Clear Path Analysis in London. The European directive is primarily targeted at reducing liquidity risk within the insurance industry by requiring more capital reserves for riskier investments beginning in January 2013. If applied to pension funds, the directive could make it more difficult for them to invest in riskier or more illiquid asset classes, sources said.

Ireland might be another potential new market for pension buyouts and buy-ins, said Andrew Reid, managing director and head of corporate pension origination within Deutsche Bank's capital markets and treasury solutions group based in London.

Earlier this year, Ireland's National Treasury Management Agency announced that the government might begin issuing bonds with maturities of 25 years or longer to help Irish pension funds manage their liabilities. The bonds could yield about twice as much as the current yields for German bunds. If pension fund executives could use yields on Irish government bonds to discount pension liabilities, “this may have the effect of encouraging more funds to consider pension buy-in transactions,” Mr. Reid said.

Mr. Reid is also seeing more interest among Dutch clients, although “most of the demand is still in the U.K.,” he said. But only a handful of Dutch clients — vs. about 30 U.K. clients — are “seriously working with Deutsche Bank on some form of longevity risk management,” including pension buy-in transactions.

At Mercer, Ms. Kusters-van Meurs estimated that about 20% of the firm's pension clients are considering closing their pension funds. She declined to name the funds.

“Some of our clients want to do a buyout, but they're not able to do so because their coverage ratio has fallen (since the financial crisis),” Ms. Kusters-van Meurs said. “They're now waiting for the right time.”