Pension Funds: How they really work, we do not know!

Consider this: those who lend their money for ten years to the Dutch State, pay a fee of 0.28 percent. Those who lend their money for seven years to Dijsselbloem pay an additional 0.06 percent per year. And recently, the mortgage rate (ten years) came below 2 percent first time in history.

On the day I wrote this article, 24 February 2016, there was more news. The Central Bureau of Statistics reported that the Dutch national wealth has grown.   This was especially due to increase in the pension pot (funds plus insurance) which nearly tripled from € 615 billion to € 1700 billion during the period 2008-2015.

The crisis
Earlier, there was news that four of the five major pension funds threatened to cut pensions next year. This means that pensioners could receive even less money from next year onwards. Try to explain that. The pension pots overflow, but pensioners lose out.

In fact, the pensioners have lost out during the whole crisis, because the indexation never happened.  Since the outbreak of the crisis, their pensions have become fifteen percent less valuable due to the effect of inflation. At the large metal funds PME and PMT, this was topped up with a discount of seven percent. That produced a backlog of around twenty percent.  This implies that for the retirees, there is a shortage of one week in a month. For employees, it applies that their build-up for the future is reduced in real terms. They pay the bill later.

Meanwhile, the Netherlands always ranks as the best pension funds in the world. At the same time politics, youth organizations and scientists call that our system has to change rapidly.

The role of interest
The problems being faced by the pensions sector are numerous and disjointed.  But, everything begins and ends with the interest. In our system, we need to convert all liabilities at market rate (and above 20 years the UFR, a system of discount rates). And the market interest rate is negligible, ever since European Central Bank chief Draghi deployed its monetary easing policy.

So is it possible that on one side of the balance the pension’s funds is rising – but on the other side the liabilities have increased to unrealistic heights as well. The consequence: Health and Welfare pension fund has seen its assets double in the crisis, but is in a coverage ratio of 90 percent. The coverage ratio is the thermometer for the health of pension funds and is sacred in the financial assessment frame of the government. However, it is too bad that this thermometer is broken.

The weird thing is that the capital increase is also, in part, due to the policies adopted by Draghi. Funds invest in bonds, which have risen rapidly in value through the decrease in interest rates. To what extent the stock markets owe their appreciation to the low interest rate is not clear. But the stock prices have risen certainly.

A wonderful world
We do not know what really is going on with the pension funds. But as the interest rate increases, the liabilities of the pension funds decrease twice as fast. In short: there is less money, but the coverage increases! Welcome to the wonderful world of the pensions. We live in an absolute virtual, abstract world, which has little to do with reality.

Except for pensioners. They have been at a disadvantage during last few years and can only expect further reduction in their purchasing power during the next ten years.  This is because even when the pension funds perform better, they do not get the benefits of indexation.  And they eventually receive a discount, which is far from beneficial.

That seems unrealistic to me. I advocate to do nothing until a year after Draghi has finished manipulating the market interest rate. Only then we will know the state of the pension world. Older people understand that we have the crisis behind us. But as State Secretary Jetta Klijnsma wants to restore confidence in the pension system, discounts will put and end that trust. Because this can no longer be explained.

Willem Reijn is policy advisor pensions of seniors organization ANBO