Pension funds still face shortfalls
Many pension funds still have funding deficits, and expect to remedy them by generating high returns on their investments. This is evident from DNB's annual assessment of the recovery plans of 143 pension funds. If these returns are lower than expected, however, 3 funds in 2020 and 33 funds in 2021 may have to curtail their pension benefits. At the same time, 121 funds have adequate buffers and will be able to fully or partially index-link their benefits. Generally these funds impose higher pension contributions, hedge more against falling interest rates compared to other pension funds and hold fewer equities.
High projected returns on investments in recovery plans
Pension funds with a funding deficit – i.e. with a policy funding ratio below the required minimum threshold – must draw up a recovery plan and submit it to the supervisory authority. The recovery plan sets out how they expect to make up the shortfall within a maximum period of ten years, showing the impact of contributions, index-linking and returns on investments on recovery. They can decide to include curtailment in the recovery plan as a last resort. The 143 recovery plans show that almost all funds expect to achieve recovery based on high projected returns on investments. The maximum percentage that pension funds are allowed to use to calculate their projected returns on investments is 6.75%. Most pension funds have based their recovery plans on this maximum percentage, and not on adjusting pension contributions. In general, contributions have a negative effect on recovery, since many pension funds actually impose lower contributions than required to cover pension commitments.
Projected returns on investment have failed to materialise before
Many pension funds have had to submit a recovery plan for several consecutive years. Projected returns on investments have been the main instrument for recovery in these previous plans as well. Figure 1 shows the projected recovery in pension funds’ recovery plans for 2015 compared to the actual recovery. It is clear that actual recovery remains far below projected recovery. The recovery seen in 2017 was nearly completely cancelled out in 2018.
Figure 1 expected recovery in pension funds’ recovery plans compared to actual recovery in 2015
Index-linking
Not all pension funds are in dire straits. Some funds only have limited or no funding deficits and are able to apply partial or full index-linking.
Pension funds with a policy funding ratio above 110% are permitted to apply partial index-linking of pension benefits. Pension funds whose policy funding ratio exceeds their required funding ratio are permitted to apply full index-linking. Figure 2 shows these pension funds in yellow and green, respectively. 33 pension funds will be able to fully index-link 400,000 pensions and 88 pension funds will be able to partially index-link 4.8 million pensions.
Index-linking is not permitted for a total of 85 pension funds marked in red and orange and representing 11.7 million pensions.
Figure 2: policy funding ratio compared to required funding ratio. Each sphere represents a pension fund, and the size of the sphere reflects the pension fund's size.
Possible curtailment
The pension funds marked in red are in more serious trouble. These funds have been facing funding deficits for several years and may have to apply curtailments if they fail to achieve recovery. Under a European Directive, pension funds with defined benefit schemes must have minimum required own funds of 4.2%. Under national legislation, pension funds whose policy funding ratio has been below the minimum required rate of 104.2% for five consecutive years are required by law to take the necessary measures to bring their minimum funding ratio back to 104.2% again. Should they decide to apply curtailments, they may spread these over several years, to a maximum of 10 years. Next year, curtailments may be applied to 3 pension funds with 2 million members. For 33 pension funds with 7.7 members, the five-year term ends in 2021 and they may have to apply curtailments too.
Major differences between pension funds
How is it possible that some pension funds are able to fully index-link pensions, while others may have to curtail pension benefits? This is mainly the result of the choices that pension funds make with respect to their investments and contribution levels. Figure 3 shows the differences. The colours correspond to the colours used in Figure 2. The pensions funds in the green row, who are permitted to apply full index-linking, generally impose higher pension contributions, hedge more against interest rate decreases and hold fewer equities and other variable-yield securities. The pension funds in the red row, i.e. the pension funds with a policy funding ratio below 104.2% who may have to apply curtailments, generally impose lower contributions than required to purchase pension commitments, hedge less against falling interest rates and hold more variable-yield securities.
Figure 3 differences between pension funds’ contributions and investment policies
Individual pension fund figures
Do you want to know how your pension fund is doing? Please check DNB's website. The policy funding ratios of all pension funds are listed here, as well as lots of other information about your pension fund's investments and returns.
