Pensions: funding ratio
A pension fund's financial position determines whether it can increase pensions or must decrease them.
What is the funding ratio?
The funding ratio reflects a pension fund’s current financial position, expressing the ratio between available assets and liabilities. In other words: it shows whether the pension fund holds enough reserves to pay out pension benefits – to its current and future members. The funding ratio is expressed as a percentage.
Funding ratio calculation
The funding ratio is calculated as follows: the value of a pension fund’s assets (the fund's investments in equity and bonds) is divided by the value of its liabilities (the current and future pension benefits to be paid out):
value of assets
Funding ratio = ────────────────────────────── x 100%
value of liabilities
The current value of a pension fund's liabilities is calculated using the actuarial interest rate.
The funding ratio determines a pension fund's options
The funding ratio is subject to statutory rules. For example, pension funds are only allowed to apply partial or full index-linking if their funding ratio exceeds 110%. Index-linking means that a pension fund is able to increase pensions to reflect rising prices. If a pension fund's funding ratio is too low, it must take measures to improve its financial situation.
Funding ratio rules:
Actions by the pension fund
Apply partial or full index-linking
What if the funding ratio is too low?
A pension fund may decide to set higher contributions in order to improve its financial position. In extreme cases, a pension fund may have to decide to curtail pension benefits – not only for current pensioners, but also for members retiring in the future. This happens in the following two situations.
- A pension fund fails to meet the minimum own funds requirement for five consecutive years. In most cases, the minimum own funds requirement equals a funding ratio of 104%.
- The funding ratio drops below the critical lower limit. This limit is different for each pension fund.
Purpose: balanced distribution
The main purpose of these rules is to ensure that pension funds distribute their pension assets in a balanced way between current and future pensioners. In favourable times, they can all benefit from rising pension benefits. If a pension fund has deficits, they must also bear the consequences together. For example, pension benefits may have to be reduced. This is of course a drastic measure, but the alternative is that the pension fund would pay out too much now, leaving too little for future pensioners.
Pension funds: current situation
Many pension funds have had insufficient funding ratios for several years. This is partly due to falling interest rates, but that is not the only reason. Their choices relating to investments and contribution levels also play a role. Some pension funds have high funding ratios. Most of them collect higher contributions or have a different investment strategy.
More time to improve their financial position
According to the funding ratio rules, some pension funds would have had to curtail pension benefits in 2020. But the Dutch Minister of Social Affairs and Employment granted pension funds that would have had to curtail benefits based on the funding ratio at the end of 2019 more time to improve their financial position – provided they had a funding ratio of 90% at end-2019. As a consequence, most funds that are in trouble do not have to curtail pension benefits.
The funding ratio in the new pension system
The government and the social partners have agreed on a new pension system. That is why, at the end of 2020, the Minister has again decided to grant the pension funds more time to improve their financial position.
By 1 January 2026 at the latest, employers, employees and pension providers must have adapted their pension schemes to the new system. The Minister has yet to decide on the funding ratio rules for the period up to 1 January 2026.
Your pension fund's financial situation
Do you want to know how your pension fund is doing? Then check the statistics section on our website. It lists the funding ratio of all pension funds, as well as information on pension funds’ investments and returns.
It is true that pension funds have substantial reserves, but their liabilities are also substantial. Now, but also in the future. If a fund spends too much money now, there will be less for future pensioners.
No, curtailments apply to current as well as future pensions. So this affects the pension benefits of current pensioners as well as of the people that are still working. The latter do not feel the impact of these curtailments immediately, however.
The government concluded a Pension Accord with the social partners (employers' organisations and trade unions) in the summer of 2020. In the new pension system, pension funds will no longer make promises about the amount of benefits they intend to pay out in the future. Instead, it is contribution-based and everyone will build up their personal share of pension assets. The pension funds keep records of these personal pension assets. So, it is no longer the promises about future pension benefits that define a pension fund's liabilities, which means the funding ratio is no longer needed in the new system. Of course, financial market developments will still have an impact on the build-up of people's pensions in the new system: it is the returns on invested pension assets that determine the eventual amount of pension benefits that can be paid out.