Search This Blog

Thursday, 5 July 2012

Minister of Social Affairs Henk Kamp seems to help the pension funds, but is in reality banking on the future. Are the Dutch youngsters going to foot the bill for this?!

It is a well-known fact that many Dutch pension funds are in dire straits currentlyhaving coverage ratios that are far removed from the levels desired by the Dutch government and supervisors.

Pension funds in The Netherlands and Europe suffer from an enduring mixture of setbacks:
·    Very low interest rates, significantly increasing the current cash value of future obligations;
·    Only moderate returns on investment for stocks, sovereigns and commercial bonds;
·    Structural vacancy and under-performance at the Dutch Residential and Commercial Real Estate markets (RRE/CRE), but also at the CRE markets in other European countries (f.i. Spain);
·    A difficult situation at the Dutch mortgage markets, as lots of houseowners are currently underwater with their mortgage, making this currently a very wobbly investment;
·    A general uncertainty at the financial markets, keeping the prices of almost all investments very low, while still offering elevated risk.

As a consequence of this explosive mixture, the coverage ratios of many pension funds have dropped well below the 105%, that is maintained by the Dutch national bank DNB and Dutch officials as the minimal, safe ratio for future payments. Some pension funds have even ratio's lower than 95%, which is considered to be insufficient. Coverage means: the capacity to pay future expenses with the yields from current savings and investments.

The coverage ratio is calculated by comparing the current capital and investments with the current cash value of future expenses. At this moment, this cash value is calculated by using the risk-free swap rate. There lies the crux of the problems of the pension funds: with this swap rate being close to 1%, the cash value of future expenses is very high.

A simple example: the estimated expenses of a pension fund for 2013 are €105 mln.
·    With an interest swap rate of 5%, a pension fund would only need an average capital of ≈ €105 mln in 2012 to maintain a coverage ratio of 105%. The cash value of €105 mln in expenses against 5% interest is only €100 mln. 105/100 = 105% coverage
·    With an interest swap rate of 1%, pension fund needs an average capital of ≈€109 in 2012 to maintain the same 105% coverage ratio, as the cash value of €105 mln against 1% interest is about €104 mln.

This simplified example shows the impact of the low interest rates for the pension funds. These funds currently need to maintain much more cash and near-cash investments than in case of an interest rate of 4-5%, which is closer to the long-term average rate over the last 25 years.

This is the reason that pension funds have been lobbying for being allowed to use a calculation rate that differs from the interest swap rate (i.e. is higher than the swap rate). If the pension funds are allowed to calculate with a higher interest rate, their coverage ratio will instantly look much better than it currently does.

As a matter of fact: It seems that their lobby work has been successful lately. The Dutch national bank DNB ( already allowed the pension funds to calculate with a weighted monthly average during the last months (see the previous link), instead of using the interest rate at the monthly fixing date.

Yesterday, the Dutch minister of Social Affairs and Labor, Henk Kamp stated that he is planning to introduce a ‘fixed’ calculation rate that might be used by the pension funds to calculate their coverage ratio in years to come.

The Dutch version of Wikipedia ( supplies a brief explanation of his plans:

The risk-free swap interest rate remains in power as the basis for a legally advised discount rate for the actual pension contracts. For obligations as far ahead as 20 years, an ultimate forward rate (ufr) of 4.2% is prescribed (proposal European Commission). The coverage ratio may be fixed, based on a 12m moving average of this coverage ratio.

Under influence of European regulation, this brings the fixed calculation rate of 4%, that had already been used until 2005, again within grasp.

This seems like a beautiful plan: it immediately increases the coverage ratios of the pension funds, which allows them to keep the premiums at the current level, without being forced to lower the pension payments to future retirees.

Also, the current interest rate is extremely low indeed, when compared to the interest rates over the last 30 years, right? Wrong! There is a substantial risk that Europe and the United States will follow the Japan scenario (see the first mentioned link). 

In Japan, the interest rates have been close to zero for almost 20 years, as a consequence of deflationary forces. Under influence of these forces, low interest rates are becoming a trap.

When a country or region comes in a deflationary situation (i.e. a situation of debt destruction), this can last for a very long time: 20 years is no exception. The reason that this situation lasts for such a long time, is that politicians and supervisors are often very reluctant to allow the process of debt destruction to do its destructive, but curative job.

Instead, governments and supranational bodies choose for the medicine that takes away the symptoms: lowering the interest rates and increasing the amount of liquidity. When there is only a short economic hiccup and the underlying social mood among the people is positive, then such an interference can have positive effect.

However, when there is an enormous overload of debt and the social mood among people and companies has deteriorated significantly, lowering the interest rate and increasing the liquidity amount will have virtually no effect. It doesn’t make people to accept more debt after all, as people are already overloaded with it.

I truly believe that the Dutch and European economies are currently in such a situation.

When the interest rate has been lowered to levels close to zero and the amount of money in the market is almost maximized by the central bank(s), but this still doesn’t have the desired effect of spurring the economy, the bullets of central banks' bazooka's have almost gone.

If the central banks would raise the interest rates again beyond the 2%, the little economic growth that is present, would be destroyed again. When the interest rate is almost zero, further lowering it is either impossible, or doesn’t have any effect whatsoever.

So, what the Central Banks can do is virtually ‘nothing’: the economy gets in a comatose state, until the debt destruction has slowly done its job. Only after this process of debt destruction, the economy can grow significantly again. The Japanese economy is – after 20 years – still in such a comatose state.

This is also a threatening situation for The Netherlands, as the Dutch economy is currently following the Japanese economy of the nineties in its footsteps: too much private and corporate debt, interest rates that are too low, very large real estate bubbles which have a lot of money invested in it and a government that shies away from the real solutions.

Therefore it is my firm opinion, that the gamble of Minister Henk Kamp to use a higher calculation rate for the coverage ratio, is indeed a gamble; and a bad one.

The enduring mixture that I described in the first paragraphs of this article will be very much present in the (near) future and it makes future earnings of pension funds highly questionable.

However, the payments to future retirees are artificially raised, as a consequence of this enlarged coverage ratio. This will exhaust the future financial means of the pension funds, which will suffer from the double whammy of reduced income and increased expenses.

The current youngsters, who will retire in 30 to 40 years might be the victims of this political decision that will pamper the baby-boom and 50-plus generation, at the expense of younger workers.

That I’m not alone in my criticism is proved by the following article from Dutch business radio BNR (, where a genuine pension expert is quoted:

“Kamp is irresponsible with his softening of the pension agreements”. Pension expert Theo Gommer states that he considers the interest trick to be ‘too risky’.

According to newspaper Het Financieele Dagblad (, the large-scale pension reduction in 2013 can be ditched, as Minister Kamp is aiming at softening the calculation rate for pensions. “Kamp is playing a Jedi mind-trick with the interest rate. The money is not there and it won’t be there, as a consequence of this trick. This goes at the expense of the youngsters”, according to Gommer.

The method means that the long-term calculation interest will be extended to a higher level. The higher the interest rate, the lower the level of required cash and near-cash investments that a pension fund should maintain for future obligations. The interest rate adjustment means that the coverage ratio of the funds will increase by as much as 10%. This is calculated by the Pension Fund Zorg en Welzijn (healthcare industry).

Chairman Theo Gommer thinks that Kamp takes an enormous gamble, by artificially raising the calculation rate: “when you can’t make the yields in the future that you planned to make, it means that you will hand out money that you don’t have in reality. When you spend it anyway, it means that money meant for youngsters goes to the elderly”.

I have nothing to add to this sensible statement…

This is a bad plan of Henk Kamp. It is probably meant for electoral purposes (the next Dutch elections will be held at September 12), but it takes a gamble with future expenses. In my opinion, it will be a bad gamble indeed. 

No comments:

Post a Comment