Tuesday, September 25, 2012

New Rules to Ease Pressure on Nordic Plans?

Sophie Baker of Financial News reports, Dutch pensions thrown lifeline by government:
The Dutch Cabinet has sent a letter to Parliament outlining a new framework that could alleviate the need for the country's pension schemes to carry out “unprecedented” benefit cuts.

The "September Pension Package" has been developed by the Cabinet and the Dutch regulator, De Nederlandsche Bank.

In a letter to the Lower House of Parliament, State Secretary Paul de Krom, the minister of social affairs and employment, said the measures put plans on “a more manageable and balanced footing”.

In February, DNB warned that 103 of the Netherlands’ 454 pension funds were facing cuts to benefits by the end of next year, because they were falling far below their funding targets.

DNB requires that pension funds have a funding ratio of at least 105%. Falling below that means they must submit a recovery plan to the regulator, detailing how they will get back to the threshold.

At the time, benefits were expected to be slashed by an average of 2.3%, with 34 of the funds looking to cut by over 7%.

The latest data from DNB shows that the average scheme in the Netherlands is 97% funded.

The package of measures will “put their financial position back in order in an accelerated and responsible manner”, according to a statement published on the Dutch government's website.

The proposals are designed to prevent unnecessary increases in pension contributions next year and will enable funds to spread the inevitable pension reductions across several years. Reductions in benefits paid will be capped at a maximum of 7% per year.

DNB will also adjust the actuarial interest rate for pension funds, using an amended method to determine the pension liabilities in 20 to 60 years’ time. This, said the letter, will make the interest rate less sensitive to fluctuations in the markets.

In the letter, Krom said: “The package means that for 2013 curtailments can be restricted to what was announced at the beginning of this year.”

However, he said that while the measures will have a beneficial impact on the funding ratios, some funds are in “very poor financial shape” and “will probably have to make further curtailments after 2013”.
In their article, Maarten van Tartwijk and Tommy Stubbington of the WSJ report, Netherlands to Ease Pressure on Pension Funds:
The Netherlands Monday announced new rules for pension funds, bringing them into line with similar investments in the insurance sector to firm up portfolios under stress from the unprecedented rally in long-term bonds.

The proposed rules, presented by the Dutch ministry of social affairs, are part of a package of measures to improve the financial position of an industry that manages more than EUR800 billion in assets.

Given that clout, the measures could hit demand for long-dated government debt, both in the Netherlands and other European countries seen as safe investments. The proposals, which still have to approved by Dutch lawmakers, would take effect in 2013.

A key element of the package is that pension funds will be allowed to use a more favorable benchmark to calculate their liabilities, which would help their capital buffers. The government also proposes giving them more financial breathing space by allowing them more time to cut benefit payments to pensioners.

The industry's funding position has sharply deteriorated over the past few years as the European sovereign debt crisis has prompted investors to snap up the bonds of Europe's safest havens, such as the Netherlands and Germany, lowering their rates of return.

That has crimped pension funds as these are effectively forced to own such bonds to meet benchmarks set by regulators.

The Dutch central bank, the industry supervisor, last week reported that 231 pension funds had a capital shortfall. Many funds have threatened to cut pension payments if their situation doesn't improve.

Recent measures announced to ease similar pressures on the Dutch insurance industry--coupled with similar moves in Denmark and Sweden--have eased the downward pressure on long-term bond yields somewhat.

The extra yield demanded by investors to hold 30-year Dutch debt compared to its 10-year equivalent has climbed to around three quarters of a percentage point from around half a percentage point before the insurance measures were announced in early July.

Pension funds and insurance providers must balance their investments against their liabilities--payouts to pensioners or policy holders that stretch decades into the future.

Right now, that balance is often calculated using a formula based on long-term interest rates. When these are low, liabilities are discounted less, requiring investors to hold more assets, and therefore buy greater piles of these low-yielding bonds.

The proposal is in line with the plan presented by the Dutch central bank in early July to ease the burden on insurers. Instead of basing the discount rate on interest-rate swaps--financial derivatives that price expectations of future interest rates--the proposals would apply a more steady, and higher, rate for ultra-long maturities where rate expectations are uncertain and volatile.

Confirmation that a similar move is in the pipeline for the large Dutch pension sector is likely to fuel this pickup in longer-term yields.

"We believe that further steepening is on the cards with some pension funds probably unwinding [positions in the swaps market]," said Rainer Guntermann and Peggy Jaeger, interest rate strategists at Commerzbank.

Such a trend in the swaps market would likely be echoed in the bond market, as higher long-term interest rate expectations make longer-dated bonds less attractive.

So Dutch regulators caved in and will allow pension fund managers to use some blended rate rather than a market rate based on long-term bonds to value pension fund liabilities. The Dutch bond market is small, so any move like this will mean a selloff in the long end, steepening the curve.

Still, it's important to put this in context. Dutch pensions are among the best OECD performers:
Dutch pension funds were among the best performers in the OECD countries last year, according to a new report by the Paris-based organisation.

Pension fund assets in OECD countries booked an average negative return of -1.7% in 2011, but Dutch funds booked an increase of 8.2%.  

Denmark was the best performer with 12.1% and Australia was third with 4.1%.

Dutch pension fund assets were equal to 138% of the GDP, the highest ratio among the OECD countries. On average, pension fund assets were 67.3%. Iceland had the second-highest ratio at 128.7%.

The Dutch move follows similar changes in Denmark and Sweden. In June, Frances Schwartzkopff and Christian Wienberg of Bloomberg reported, Denmark to Ease Pension Rules to Reduce Liability Burden:
Denmark’s government agreed to ease rules for the country’s pension firms to help reduce their liabilities as record-low bond yields inflate the value of their obligations.

Pension companies and life insurers will be allowed to raise the discount rate they use to calculate their liabilities to better reflect long-term growth and inflation prospects, the Business and Growth Ministry in Copenhagen said in a statement late yesterday. The decision sent yields on longer-maturity bonds soaring as the industry’s need to buy up debt assets to match their pension obligations was reduced.

“The demand for duration isn’t as strong as before,” Henrik Henriksen, chief investment strategist at Copenhagen- based PFA Pension A/S, Denmark’s second-largest pension fund with about $50 billion in assets, said in an interview. “Looking especially at the 30-year point, there’s less demand for 30-year bonds due to the new rate curve.”

The Danish move follows similar changes in Sweden, where 10-year yields surged 30 basis points on June 7 after the country’s regulator put a floor on the discount rate pension funds use to calculate liabilities. Nordic pension funds had come under pressure to increase their asset purchases as the region’s haven status from the debt crisis sent bond values higher and swelled the value of their liabilities.
‘Unusual Conditions’

“It’s key that companies have the possibility to create the best possible returns for pensioners in the future and rules and guidelines shouldn’t press companies to make short-term investment decisions due to unusual conditions in the capital markets,” Business and Growth Minister Ole Sohn said in the statement.

The yield on Denmark’s 3 percent note due 2021 surged eight basis points to 1.4 percent as of 11:51 a.m. local time. Denmark’s 30-year yield jumped 13 basis points to 2.08 percent. Yields on bonds sold by other governments perceived as havens also rose. Borrowing costs on Germany’s 2022 bond gained nine basis points to 1.51 percent, while similar-dated yields on Dutch debt increased six basis points to 2.04 percent.

The rate on 30-year swaps in euros climbed 11 basis points to 2.21 percent, widening the difference in yield, or spread, with 10-year swaps by 10 basis points to 28 basis points.
Euro Swap

“Obviously this affects Danish rates but, it is even affecting the much bigger and more liquid euro-swap market,” Anders Schelde, chief investment officer at Nordea Life & Pension, a unit of Nordea Bank AB, said in an interview. “That is most interesting.”

Even after today’s moves, Denmark’s 10-year bonds yield about 12 basis points less than similar-maturity German debt. The central bank has said it is ready to cut policy rates below zero in an effort to defend the krone’s peg to the euro and offset a capital influx.

“Denmark is still a safe haven, but the demand from the pension funds in Denmark, which were forced by regulation to buy government bonds, has eased,” Henriksen at PFA said. “Denmark is still fundamentally a strong case and people would still prefer to invest in Denmark compared to a lot of other eurozone countries.”

The Nordic country will have public debt equivalent to 40.9 percent of gross domestic product this year, compared with an average of 91.8 percent in the 17-member euro area, the European Commission said on May 11.
More to Come

The government of Prime Minister Helle Thorning-Schmidt on May 25 predicted a smaller budget deficit for this year than announced in December and the shortfall will shrink to 1.7 percent of GDP next year, well within the European Union’s 3 percent threshold, it said then.

The government’s decision to ease pension rules, signaled last week, “will reduce the industry’s need to purchase long interest-bearing assets and will lead to higher yields and a steeper curve for maturities longer than 20 years,” Nordea analyst Mik Jorgensen said in a note to clients today.

Other nations are also looking into easing pension rules. In Finland, the parliament votes today on combining pension funds’ insurance risk and investment risk buffers into a solvency capital buffer, meaning pension funds won’t be forced to sell investments that drop in value to comply with solvency rules.

In the Netherlands, the government proposed on May 31 that retirement funds be allowed to calculate financial buffers on expected long-term interest rates, making them less reliant on daily interest rates.

The changes to the Danish pension system also seek to enable companies to phase out guarantees to their customers and instead offer products that track market values, the government said.
Some pension analysts will grumble that these changes are too lenient, but the Dutch, Danes and Swedes aren't stupid, if they're making these changes, it's because they cherish their pensions and want to keep them strong and healthy for as long as possible.

It's obvious that historic low rates exacerbated by the euro crisis have been too taxing on their liabilities. But I shudder to think what would happen if US  plans had adopted similar strict pension regulations over the past decade as those enforced in these Nordic countries. Most US plans would be insolvent, shut down and taken over by the government.

At the end of the day, the Dutch and Danish plans are among the best in the world precisely because they have been matching their assets and liabilities very carefully for years, long before anyone else. These new rules won't change this. They provide some leeway in a historically low interest rate environment, but good governance and the ALM approach are still the driving forces behind the success of their pension systems.

Below, an Opalesque interview with Jeroen Tielman, founder of  IMQubator, a Dutch emerging manager seeding fund that connects institutional investors with emerging asset management talent.

Great interview, listen carefully as Tielman gives insight into IMQubator’s seeding model, which seeks to address escalating investor concerns over lack of liquidity, inadequate transparency, fee structures, and governance structures that overwhelmingly benefit managers.

The main weakness of IMQubator's seeding model is that they force managers to move to Amsterdam, severely limiting their options. In this day and age, this is simply not necessary.