The supervision of funded defined benefit schemes

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The supervision of funded defined benefit schemes

• Dr. A.C.F.J. Houben

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Agenda

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

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Agenda

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

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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

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Key figures second pillar
(Source DNB)
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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

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Agenda

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

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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

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What full funding requires

• Transparency, checks and balances
• Balance between input (contributions) and output
  (pensions)
• Contributions are invested bankruptcy remote from
  sponsor
• Adequate supervision

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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

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The importance of marked-to-market valuation
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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

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Agenda

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

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Supervisory toolkit

• Liabilities
• Pension
• deal
• Premiums Investments

Two supervisory tests - Solvency test fully
funded in the short term - Continuity analysis
(ALM) fully funded in the long term
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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

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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

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Stochastic analysis funding ratio
2.5
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Possible funding ratios(regulatory intervention
levels)
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Agenda

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

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Pension funds navigate between
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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