(June 4, 2013) – Smoothing strikes again: The average coverage ratio of Dutch pension funds at the end of May was 104%, despite market rates increasing last month, according to consultant Aon Hewitt.
The coverage ratio drop has been caused by a surge in liabilities, driven by a lower average interest rate over a three-month period and the Dutch smoothing mechanism.
In order to discount liabilities, Dutch pension funds are made to use the three-month average of the interest-rate curve. However, assets are calculated using mark-to-market valuations.
Interest rates rose in May, which would normally be a good thing. However, the three-month average no longer includes February, which had a higher rate than March, April and May.
This means the new three-month average uses lower rates to calculate what the Dutch call their Ultimate Forward Rate, resulting in an increase in liabilities and a worse coverage ratio.
If the May market rate alone had been used to calculate the UFR instead, the value of the liabilities would have actually declined (and therefore the coverage ratio would have increased), but the forced use of a three-month average actually saw it increase (and the coverage ratio decrease).
The fall in average interest rate resulted in an increase in the value of the liabilities, of approximately 1.5%.
The 104% reported by Aon Hewitt’s Pensioenthermometer is worrying as by law, Dutch pension funds are required to have a minimum coverage ratio of 105%.
The rise in market interest rates in May also resulted in a drop in the value of the fixed income portfolio of 3.5%, although this was partly offset by good results in the US and European exchanges.
ABP, Europe’s largest pure-play pension, admitted earlier this week that despite an investment return of 13.7% in 2012, its overall funding ratio only improved from 94% to 97%, because of liabilities increasing by 10.7% and persistently low interest rates.
The pension giant was one of several big-name Dutch funds forced to reduce the payments made to pensioners in order to shore up its balance sheet this year.
ABP Chairman Hennk Brouer warned further pensioner payment cuts may be necessary if conditions don’t improve.
For an up-close-and-personal look at what is happening in the Dutch pensions sector, read about aiCIO‘s recent visit in the next edition, which is published later this month.