Dutch regulations are "killing" pension funds by using a discount rate that forces them to de-risk, said Anton van Nunen, director of Van Nunen & Partners.
Pension funds in the Netherlands use the interbank swap yield curve to discount pensions, a requirement that does not accurately reflect the amount of risk pension funds take to ensure higher returns, van Nunen said in a scathing overview of the Dutch system.
“The discount factor should give an indication to the members of the pension fund that there is risk. The Dutch legislator does the opposite. It forces people to reduce their liabilities with a discount rate of 2.5%,” said van Nunen.
Data from the OECD released in June showed 40% of the decline in funding levels from mid-2008 through to the end of the crisis, could be attributed to lower interbank swap rates used to discount liabilities. The findings spurred a flurry of discussions in the Netherlands about whether the swap rate was the best way to discount pensions.
Van Nunen argued by using the discount rate, the regulator is promoting a cycle that will keep pensions too low in the future and put in place a “poverty trap”.
“Because of lower equity prices in general, we have a low funding ratio. This funding ratio gives a signal to the regulator to dictate to pension funds to de-risk. So they de-risk. They sell equities, they buy government bonds or they buy swaps, which creates its own momentum. By selling equities prices go down lower; by buying government bonds and buying swaps, interest rates go down, so the next pension fund is in trouble,” van Nunen told delegates.
In follow-up questions after his presentation, he likened the mandate to de-risk to the systems in Hungary, where the government plans to nationalise private pension assets, and to Ireland, where the government is using National Pensions Reserve Fund assets to pay down debts.
“We are directing pension funds to buy lousy government paper, our own government paper, which is exactly the same thing,” said van Nunen. “As soon as you have legislation directing pension funds where to go, you’ve lost it. It’s not a private pension fund anymore.”
He also said the regulatory pressure to be 105% funded has forced too many Dutch pension funds into liability-driven investment programmes. He said Dutch funds have gone too far in hedging liabilities from their balance sheets.
“Pension funds need to manage risk, not throw it away. The only real asset pension funds have is risk. They should put that to work. Non-risky assets do not generate the returns required for decent, nominal pensions,” said van Nunen.
Instead, he proposed using a variable risk-free discount rate that allows for premiums of, for example, 1% each for illiquidity and risk. For a 15-year maturity, this would equate to 2.75% plus two percentage points.
“That discount rate leads to a good proxy of the liabilities’ real asset value. At that price, your liabilities can be sold, and the buyer can deliver,” he said.
But speaking in response to van Nunen’s comments, ATP chief risk officer Mads Gosvig said: “If you use an asset mixed interest rate to discount with, it becomes difficult to compare schemes. This does not yield transparency to the public.
Instead, a rate that is known to everybody should be used which allows us to compare pension schemes – this would put trust back into the system.”
He said ATP has learnt a lot from its regulators through adapting to their framework.
“We embrace regulation; we work with our regulator and try to understand the reasoning. Regulation does not come out of evil people trying to impose bad things on pension funds.”
The conference was organised jointly by the OECD and the World Pensions Council (WPC), a Paris-based think-tank focusing on demographics, actuarial science, and capital markets research for pensions and sovereign wealth funds. It was founded by industry veterans Vincent Bazi and M. Nicolas J. Firzli.
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