NETHERLANDS - AS A result of the sustained decline in interest rates, many Dutch pension funds are now assessing the probability of breaching the 105% minimum funding requirement set by the new supervisory framework ‘Financieel Toetsingskader' (FTK).
A new study by the Dutch bank ABN AMRO found that the fall in interest rates at the long end has to a great extent undone the solvency gainsfrom strong equity market performances in 2003 and 2004.
Pension funds, which are beginning to revise their solvency risk as a result of the new guidelines which come into effect from January 1, 2006, are finding the new minimum funding requirement of 105% more “onerous”.
Roland van Gaalen, partner at Watson Wyatt in Amsterdam said: “If pension funds were measuring their liabilities using the old discount rate of 4%, their funding levels would have actually improved during 2004.But based on market rates, these levels have worsened, so the new requirements have had the opposite impact.”
Van Gaalen said that over 2004, the relevant long-term interest rate declined by 60bp from 4.9% to 4.3%, resulting in a 10% rise in liabilities on average.
The rates, as at mid-January, had declined further to 4%, increasing liabilities by another 5% or so.
The report by ABN AMRO said that risk reduction strategies in terms of benefit commitment levels and contribution rates have already happenedbut risk reduction on the asset side is only just beginning.
Harvinder Sian, a strategist at ABN AMRO, said: “Pension funds are finding the low interest rates at unattractive levels to lock in hedges but should still move increasingly towards such action in any case over 2005.”
Pointing to the impact of reforms on the UK and Danish markets, Sian said: “The markets in both cases were subject to herd mentality once the first big fund moved to hedge liability risk. The result was a disorderlyscramble for long end interest rate risk that pushed long end yields far lower than an orderly and timely execution would have motivated.”
The report predicts that as a result of demand from the huge Dutch pension fund sector and German insurance firms, the 30 year-10yearspread would be at just 15bp at the end of 2005.
“The market is simply not that deep at the long end, and while the market will eventually clear, it will be at a price that proves attractive for issuers, not buyers,” said Sian.
The FTK requires assets and liabilities to be valued on a marked-to-market basis and is based on a 105% minimum funding position plus a solvency margin of up to 25%. This solvency margin depends on theextent of the mismatch between the assets and the liabilities.
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