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The supervision of funded defined benefit schemes

Learn about the key elements of a healthy pension system, the importance of full funding, and the solid supervisory toolkit used in the Netherlands. Explore future challenges and the need for effective communication and education for pension beneficiaries.

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The supervision of funded defined benefit schemes

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  1. The supervision of funded defined benefit schemes Dr. A.C.F.J. Houben

  2. Agenda • Overview Dutch system • Key elements of a healthy pension system • A solid supervisory toolkit • Future challenges

  3. Agenda • Overview Dutch system • Key elements of a healthy pension system • A solid supervisory toolkit • Future challenges

  4. Dutch three pillar system • State pension (pay as you go) • Employers and trade unions negotiate supplementary pension deal (usually defined benefit, funded) • Individual pension savings (insurance products, funded)  Diversification benefits from different finance structures

  5. Key figures second pillar (Source: DNB)

  6. Advantages Dutch second pillar • Consumption smoothing over the life cycle • Typical defined benefit arrangements • Stable and relatively certain income after retirement • Very high participation level • Over 90% of employees has supplementary pension arrangement • Well capitalized • Key figure: funding ratio = assets / liabilities • Current funding ratio 140% with respect to nominal liabilities  100% measured against indexed liabilities • Low costs • On average 0.25% of total assets per year

  7. Agenda • Overview Dutch system • Key elements of a healthy pension system • A solid supervisory toolkit • Future challenges

  8. Why full funding is important • Funding is a hedge for ageing society • Underfunding has a price • High and volatile recovery costs: prevention cheaper than cure • Uncertainty reduces consumption and increases savings • Funding contributes to confidence in pensions • Employees who spend a lifetime working will be more confident that their pension will be there when they retire • Influences labour supply: facilitates retirement planning • Encourages labour mobility: facilitates transfer of accrued rights

  9. What full funding requires • Transparency, checks and balances • Balance between input (contributions) and output (pensions) • Contributions are invested bankruptcy remote from sponsor • Adequate supervision

  10. Maintaining healthy pension funds • Management • Fit and proper test for board and management • Assets • Prudent person principle: no quantitative restrictions • Limited investment in plan sponsor: reduces ‘double default’ risk • Liabilities • Definition: accrued benefit obligations • Marked-to-market valuation: realistic view of funding ratio

  11. The importance of marked-to-market valuation

  12. A solid approach to supervision • Risk-based supervision: focus on where the risks are • Likelihood of a (negative) event • Impact of that event • Efficient and effective use of supervisory resources • Flexible allocation of resources • Always a minimum level of supervision • Bigger risks require more intensive supervision • Thematic: e.g. private equity investments

  13. Agenda • Overview Dutch system • Key elements of a healthy pension system • A solid supervisory toolkit • Future challenges

  14. Supervisory toolkit Liabilities Pension deal PremiumsInvestments Two supervisory tests: - Solvency test: fully funded in the short term - Continuity analysis (ALM): fully funded in the long term

  15. Solvency test • Aim and characteristics of solvency test • Safeguard guaranteed pension commitments • Capital funding includes pre-payment of risk of under funding • Non matching position requires higher solvency level • Strict minimal levels • Confidence level  97.5% over twelve-month period • Required funding ratio for average pension fund ± 130% of nominal obligations

  16. Continuity analysis • Stochastic evolution of funding position • What is the expected value of future indexation? • What funding is needed to fulfill indexation ambition? • Early identification of imbalances

  17. Stochastic analysis funding ratio 2.5%

  18. Possible funding ratios(regulatory intervention levels)

  19. Agenda • Overview Dutch system • Key elements of a healthy pension system • A solid supervisory toolkit • Future challenges

  20. Pension funds navigate between…

  21. Challenges for the future • Recovering inflation protected funding levels • Currently 100% • Managing asset – liability risks • SWAPS, Swaptions, portfolio insurance, alternatives, diversification,… • Retaining defined benefit system • General trend is shifting risk and decision making towards individuals who are less equipped to manage retirement savings • Communication and education of pension beneficiaries • Need to increase pension awareness and understanding

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