Pension benefit curtailments will slowly filter through to consumption
A new feature in the European pension stress test is a more detailed cash flow analysis, which is something we have pressed for together with the of the Dutch Pension Funds. Cash flows provide insight into annual amounts paid to individual pension fund members over the next 100 years, both under the baseline scenario and under the stress scenario, taking account of any inflation adjustments and benefit curtailments.
Under the stress scenario, pension funds suffer capital losses, forcing them to refrain from making inflation adjustments and cut pension rights. Consumers will feel the impact of these two measures at the time of payment of their pension benefits. This means the impact is not immediately reflected in full in households’ disposable income, but will be felt gradually as increasing numbers of pension fund members start receiving their lower pension benefits. Accordingly, the stress scenario features gradually diminishing cash flows from pension funds to households.
The effects of the lower cash flows were used to calculate the impact of the stress scenario on the Dutch economy through the pension sector. As lower cash flows weigh down on disposable income, households consume less, which filters through into the economy and results in a lower gross domestic product (GDP).Figure 1 shows the outcome of this simulation. Firstly, the impact is gradually reflected in annual consumer spending and economic activity. As the years progress, the benefit curtailments spread over time make themselves felt in terms of members’ disposable income. After a number of years, this income loss results in a consumer spending level that is 4% lower relative to the baseline scenario. This depresses GDP by 0.5%.