E
XTENSIVE ANALYSIS OF THE COMPOSITION
OF FUNDING RATIOS AND IMPROVING
THEIR COMPARABILITY
T. Provoost
Master’s Thesis to obtain the degree in
Actuarial Science and Mathematical Finance
University of Amsterdam
Faculty of Economics and Business Amsterdam School of Economics
Author: drs. T. (Tom) Provoost Student nr: 10681299
Email: tomprovoost@gmail.com
Date: July 27, 2016
Supervisors: dr. S. van Bilsen (UvA) Second reader: dr. T.J. Boonen (UvA) Supervisors: A. Braat (TPRA)
Statement of Originality
This document is written by T. Provoost who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
This thesis examines the nature of nominal funding ratios of pension funds, based on the annual reports 2014. It has been established that individual funds report different types of nominal funding ratios. In the interest of the general public and especially participants of pension funds it is favourable that pension funds report a uniform and transparent funding ratio to enable a fair and straightforward comparison of funding ratios.
Variations that occur in the various funding ratios are caused by including different elements in the calculation of the funding ratio. These differences are encountered in both the technical provision and the assets regarding the pension schemes. It is concluded that the most
appropriate nominal funding ratio for comparison purposes is the ‘pension fund risks’ funding ratio. This ratio is based on the technical provision of which the risks are borne by the fund. In addition the assets regarding the pension scheme should be adjusted for the required equity of parts of the total technical provision that are not included in the ‘pension fund risks’ funding ratio.
Keywords
Acknowledgements
To complete this thesis I have invested both time and energy. However, I could not have finished this study without the support of several people.
First of all, I am grateful for the supervision of Servaas Houben from the University of Amsterdam. In our meetings to discuss my progress Servaas has always been positive about my progress. Where necessary he has motivated me to make adjustments in my research and he answered my questions concerning the composition of the thesis.
Secondly, I like to thank The Pension Rating Agency (TPRA). TPRA, a MoneyView initiative, compares the functioning and performance of pension funds. I have designed this thesis to understand the differences found in the composition of funding ratios and to establish a uniform funding ratio to enable a fair comparison between individual pension funds, which is in line with the goal of TPRA. I am very grateful for the flexibility of TPRA to enable me to have sufficient time to complete my thesis. My colleagues have always been interested in my progress and have been very supportive. In particular I want to mention Adriaan who has been available to discuss my progress regularly and has given several insightful comments. Last but not least I want to thank my parents and friends for their moral support. Especially Stefanie, having drinks with you is always very relaxing.
Content
Abstract ... iii
Acknowledgements ... iv
Content ... v
Chapter 1 Introduction and summary ... 1
Chapter 2 Structure of the Dutch pension system ... 5
Chapter 3 Funding ratio and required equity ... 10
Chapter 4 Design of the study ... 20
Chapter 5 Composition of the technical provision and equity capital ... 23
Chapter 6 Comparability of funding ratios ... 41
References ... 51
Appendix A ... 55
Chapter 1
Introduction and summary
1.1 The (un)certainty of old age pension
Over the last decades the general public in the Netherlands has got an increased interest in the benefit payment they will receive after retirement. Financing future benefits has become more costly due to social and economic developments. Hence, social security payments and
supplementary retirement benefits are not as extensive as they were in the past.
Pension funds have a significant contribution in the benefit payments people receive after retirement. A pension fund has to finance present and future benefit payments from its possessions, which arise from premiums and return on investments. The funding ratio is the indicator to express the ability of a pension fund to guarantee future payments. In the early nineteen nineties funding ratios of 200% were common in the market, since that point in time a downward trend is visible. In 2001 the average funding ratio dropped below 150% and since the start of the economic crisis in 2007-2008 the funding ratio of many pension funds has dropped below 100% at some point in time. [Bureau Bosch Asset Consultancy, 2011] A low funding ratio has two important drawbacks for participants. Most pension schemes have the ambition to increase accrued pensions (indexation) to compensate participants for inflation. However, when the funding ratio of a pension fund is low the pension fund is not able to award indexation, because the fund has insufficient financial assets. Secondly, when the funding ratio drops below 100% the present value of the assets is not high enough to pay future benefits. The ultimate measurement to improve the financial position of the pension fund is to reduce retirement benefits of participants. This is an unpopular measure, but has been necessary for several pension funds.
The general public realises that a low funding ratio is not beneficial for their old-age pension and hence the public debate has focused on the funding ratio of pension funds.
1.2 One pension fund, two nominal funding ratios
Pension funds are obligated to publish their funding ratio in their annual report. It is
ratio. [wetten.overheid.nl, 2014] However, in the course of 2014 it has become clear that the Pension Act as of 2015 would include a funding ratio definition, namely “the ratio between assets regarding the pension scheme or schemes managed by a pension fund and the pension fund’s technical provision”. [wetten.overheid.nl, 2015] Nevertheless, this is not yet an exact definition, because pension funds can determine more than one funding ratio, as can be seen in the following example.
Pension Fund Personeelsdiensten has recognized the fact that it can determine two funding ratios, which are both published on their website. [www.stippensioen.nl, 2015] A funding ratio of 109.7% is reported based on the financial situation at the end of September 2015. This ratio is a measure for the fund as a whole and includes the technical provision of which the risks are borne by both the pension fund and the participants. However, when they only incorporate the technical provision of which risks are borne by the fund, a funding ratio of 217.9% is determined. Both ratios are calculated at the same point in time and hence the same amount of assets and liabilities are considered, but two totally different ratios arise. Pension Fund Personeelsdiensten published several news items addressing this dilemma. Due to an update of their website these news items are no longer available.
Pension funds have a certain liberty in the determination of their funding, because there are no exact stipulations which assets and liabilities should be included in the funding ratio. This has the undesirable side effect that funding ratios of individual pension funds are not by definition comparable.
However, the general public assumes that funding ratios of individual pension funds are similar, which enables them to compare the financial health of pension funds. Furthermore, participants of individual pension funds use the funding ratio as the most important indicator for the soundness of their fund. After all, the height of the funding ratio gives an indication whether the pension fund can award an indexation or whether it might have to reduce liabilities.
When people compare the funding ratios of pension funds, erroneous conclusions can be drawn when funding ratios are based on different components. Everybody should be able to conduct a simple comparison of funding ratios, without the necessity of conducting a thorough analysis of their composition. Therefore, it is highly desirable for pension funds to have a uniform and straightforward definition of the funding ratio.
1.3 Description of the thesis
This study preforms an extensive analysis to determine the composition of the funding ratios of 241 pension funds in the Netherlands.1 The analysis is performed for each pension fund by means of a breakdown of their balance sheet at the end of 2014 as listed in the annual report.
This thesis starts with an introduction of the Dutch pension system, an outline of pension schemes that are administrated by pension funds and a description of the three types of pension funds that occur in the Netherlands (chapter 2). Chapter 3 introduces funding ratios and the elements needed to determine the funding ratio, being the technical provision and the assets regarding the pension scheme. Furthermore a description of the required equity is given. The design of the study is presented in chapter 4.
In this study it becomes clear that differences in the composition of the funding ratios have two origins. The first reason (chapter 5.1) that causes differences between nominal funding ratios is caused by the fact that not each pension fund incorporates the complete technical provision, nor a comparable type of technical provision. Different types of technical provision are defined based on the pension scheme they originate from. The second difference between funding ratios (chapter 5.2) arises from variations in the assets regarding the pension scheme included in the funding ratio. It has been encountered that pension funds include specific reserves in the funding ratio, whereas others exclude similar reserves. In this section suggestions are given to enhance the comparability of the funding ratio by in- or excluding specified reserves.
In chapter 5.1 it will be demonstrated as well that there is an actual relationship between various nominal funding ratios that can be determined by one pension fund using either the complete technical provision or specific parts of the technical provision.
In addition to comparing funding ratios this study also aims to find a uniform and
straightforward definition of the funding ratio. In the final chapter of this research (chapter 6) three different nominal funding ratios definitions are assessed based on a qualitative
discussion to eventually determine the most suitable definition of the funding ratio which can be used for comparison purposes.
1.4 Summary of the conclusions
In their annual reports pension funds report their nominal funding ratio, when comparing these ratios for various funds in 2014 differences in the method of determination become clear. The differences are caused by variations in both the assets regarding the pension
scheme and the technical provision that are incorporated in the calculation of the fund specific nominal funding ratio.
As of 2016 the Dutch Central Bank prescribes that pension funds should report the ‘complete financial position’ funding ratio, which is based on the complete technical provision. It is an important improvement that pension funds report a comparable funding ratio. However this ‘complete financial position’ funding ratio has disadvantages with regard to communication towards participants. An additional disadvantage is the fact that risks for account of the pension fund are mitigated over the total technical provision. Hence, this is not the most favourable funding ratio for comparison purposes.
The previously mentioned disadvantages are absent when the ‘pension fund risks’ funding ratio is used as the standard ratio. This funding ratio considers only defined benefit pension scheme related technical provision, ruling out liabilities at an insurance company and technical provision that originates from defined contribution pension schemes. When determining this ratio the assets regarding pension scheme should be reduced with the required equity of technical provision not included in the funding ratio.
The ‘pension fund risks’ and the ‘complete financial position’ funding ratio of one pension fund are actually related through the amount of equity capital and the fraction of the technical provision of which the risks are not borne by the pension fund. As these values increase the difference between the ‘pension fund risks’ and the ‘complete financial position’ funding ratio increases exponentially.
Based on the annual reports 2014 of 241 pension funds it has been found that a total of 110 funds possess only technical provision of which the risks are borne by the fund. Both funding ratio mentioned above are equal for these fund. The remaining 131 pension funds can
determine various funding ratios. Of this group 39 funds report the ‘complete financial position’ funding ratio; 71 report the ‘pension fund risks’ funding ratio; and finally 22 report the ‘defined benefit’ funding ratio. When determining the ‘pension fund risks’ only a few pension funds recognize a reduction of the assets with the required equity of technical provision excluded from the funding ratio.
To enable the fairest comparison between funding ratios of pension funds in 2014 the value of the equity capital of 19 pension funds has been adjusted. The consideration made to in- or exclude certain assets in the funding ratio is based on the fact whether the assets will become available to pay-out granted benefits or not.
In conclusion, for 2014 reported funding ratios are not comparable by definition. A majority of the funds report the ‘pension fund risks’ funding ratio, but do not adjust the equity capital. Additionally a significant number of funds do not report the ‘pension fund risks’ funding ratio which is most suitable for comparison purposes.
1.5 Further research
The conducted research has shown that pension funds in 2014 handle differently when determining their funding ratio. It is sensible to repeat this study annually to monitor developments with regard to the composition of the funding ratio. Subsequent studies can monitor whether pension funds are compliant with regulations and report the ‘complete financial position’ funding ratio. Furthermore, the ‘pension fund risks’ nominal funding ratio can be determined when not reported. These ratios of various pension funds can be compared to produce the most clear and straightforward comparison.
Chapter 2
Structure of the Dutch pension system
Pension funds have an important role in the pension system in the Netherlands which is based on three pillars. To understand the playing-field and the role of pension funds in this
environment this chapter gives an outline of the Dutch pension system (chapter 2.1), the main types of pension schemes (chapter 2.2) and the different types of pension funds (chapter 2.3). [Pensioenfederatie, 2012]
2.1 Three pillar system
The first pillar consists of a social security benefit. The General Old Age Pensions Act ensures that everyone who has lived or worked in the Netherlands receives a basic income after retirement. This old-age pension (AOW, Algemene Ouderdomswet) is linked to the statutory minimum wage and the number of years someone has lived or worked in the Netherlands during a period of 50 years preceding the retirement age. The AOW is reduced by 2% for each year that someone has not lived or worked in the Netherlands. After
retirement married couples and couples who live together each receive 50% of the minimum wage. Whereas a one person household receives an old-age pension that equals 70% of the minimum wage.
The AOW pension benefit is financed by a pay-as-you-go system, which means that the yearly benefits are financed from resources that are gathered in the same year. The contributions are financed by income taxes, paid by the active workforce, and additional funding from general resources of the government. In 2014 69% of the necessary
contributions where received from income taxes. [Bruil et al. (CBS), 2015]
The second pillar consists of collective pension schemes enabled by employers. In a number of specified sectors of industry, employers are by law obligated to offer a collective pension scheme. A mandatory pension fund is active in these sectors. In other sectors employers have no commitment to offer their employees a pension plan. Nevertheless, it is very common to do so in the Netherlands, because the state pension only aims to provide a social minimum. Over 90% of the employees have a labour agreement that includes a supplementary pension scheme. Although there is no obligation for an employer to offer a pension scheme, it is
mandatory to enable every employee to take part in the pension scheme when a pension scheme is present.
Pension schemes in the second pillar are administrated by either an insurance company or by a pension fund. The majority (about 80%) of the employees who are entitled to a collective pension scheme participate in a pension fund. The remaining 20% of the employees are insured by means of a collective pension scheme at an insurance company.[Bruil et al. (CBS), 2015] Benefit payments form the second pillar are financed by capital funding. The insurance company or pension fund maintains assets to ensure future benefit payments. These assets are gathered from premiums received from the sponsor of the pension plan as well as from the returns on investment.
The third pillar consists of individual insurance products. Every individual can sign a contract at an insurance company to save for an additional pension. People who are self-employed and employees who have a labour agreement without supplementary pension scheme often sign up for an individual pension product.
The three pillars have a common purpose, namely ensuring a safe and adequate income after retirement. The volumes of the pillars differ in magnitude as pointed out by Statistics
Netherlands (CBS, Centraal Bureau voor de statistiek).[Bruil et al. (CBS), 2015] Based on data at the begining of 2014, the total volume of future retirement liabilities present in the three pillars exceeds € 2,500 billion. With 54% and 40% respectively, the first and second pillars contain the major part of peoples’ future retirement benefits. The remaining 6% is situated in the third pillar.
Pension funds are the focus of this study and are part of the second pillar. It is good to have some sense of the volume pension funds represent in the Dutch pension world. In 2014 pension funds have received a total premium of € 31.2 billion for accrual of new liabilities. [Statline, 2015, Pensioenfondsen; deelnemers en premies] In the same period the reserves have been diminished by € 27.4 billion due to benefit payments. [Statline, 2015,
Pensioenfondsen; financiële gegevens] For comparison, the state pension benefit payments equal € 34.1 billion in 2014, which has been funded by € 23.4 billion from income taxes and the remainder has been financed from general resources. [Statitics Netherlands, August 31st, 2015] It is important to realise the fact that these retirement benefits are based on different fundamentals. Benefits from pension funds are based on the funding capital system, whereas the state pension is based on a pay-as-you-go system.
2.2 Types of pension scheme
Pension funds offer their participants a collective pension scheme, which can be constructed in various manners. The most commonly encountered pension schemes are Defined Benefit, Defined Contribution and Collective Defined Contribution. The differences in the nature of the pension plans can be determined by the way the plan is funded, the method of accrual of
pension benefits and the certainty of full payment of the benefits. The different schemes are considered in this section, based on the principles applied by pension funds.
In a Defined Benefit (DB) plan the individual pension accrual is determined by the number of years someone participates in the pension plan and the salary one earns. DB plans are the predominant type of pension scheme among pension funds and they can be divided in final-pay and average-pay schemes.
In both the final-pay and average-pay pension scheme the accrued pension is equal to the pension base salary (pensioengrondslag) multiplied by the number of service years, the average part-time percentage and the yearly accrual percentage. The difference is formed in the pension base salary. For a final-pay plan the pension base salary equals the pensionable salary in the most recent year of participation minus the deductible (franchise). In the average-pay plan the pension base salary equals the average pensionable salary during participation in the plan minus the deductible. The premium necessary for the accrual in DB plans is determined by the liabilities that are accrued in a year and the purchasing factor, which is the price for each euro of a life-long benefit as of the date of retirement. Final-pay plans are in general more costly for the sponsor and hence the number of pension funds that utilize a final-pay pension scheme has diminished over the years. [Dutch Central Bank, table 8.11]
In an average-pay plan the accrued pension has no direct relation with the salary earned in the last year. To compensate participants for inflation or general salary increases many pension funds aim to increase accrued pensions yearly, which is called indexation. The indexation can, for instance, be equal to the consumer price index. A pension fund is only allowed to award an indexation when the financial position is sufficiently sound, in accordance with
regulations, or when the sponsor of the plan provides an additional premium for indexation. Pension rights that are accrued in a DB plan are said to be guaranteed, meaning that in principle there is no risk for the participant. The sponsor of the plan must ensure that the premium is sufficient to ensure the future benefit payment. However, when the assets of the pension funds are insufficient to finance future benefits, pension rights have to be decreased by law to ensure the future pensions of all participants. Many years this possibility was not considered due to the solid funding ratios of pension funds. However in recent years several pension funds have been obliged to decrease accrued pensions. Reasons that have caused the decreasing funding ratios include longevity, accentuated legislation and changes in the investment market and interest rate.
In a DB plan the participant can estimate the future benefit he or she will receive from the collective pension plan. In Defined Contribution (DC) this is not the case. Every service year a predetermined premium is paid for each participant. The premium is based on the individual salary and an age dependent percentage. Until the date of retirement the participant gathers a capital, consisting of the premiums paid and the returns from the capital invested. On the retirement date this capital has to be converted in an annuity that ensures the life-long retirement benefit.
The height of the retirement benefit becomes known when purchasing the annuity and depends on the interest rate and longevity at that point in time. Risks involved with the investments, the interest rate and longevity rest with the individual participant.
In addition to DB and DC pension schemes in recent years a third type of pension plan is used more often by pension funds. This type of plan is called Collective Defined Contribution (CDC). The Dutch Central Bank has pointed out that CDC plans have to be classified as an DB plan, but due to their nature these schemes are discussed separately. After accrual the pension benefits are treated in the same way as for the DB pension scheme. Hence,
participants can benefit from the DB pension scheme properties, including the in principle guaranteed pension benefits. However, in comparison with a DB pension scheme the financing and accrual are structured differently. Social partners determine a premium, as percentage of the salary sum, which will be fixed for a predetermined number of years. The premium aims to ensure funding of the desired accrual rate. However, when the premium is not sufficient, the accrual rate is diminished. This system prevents excessive contributions for the sponsor, while risks are shared collectively by participants.
An employer is not obligated to offer one type of pension plan. Different combination between the pension scheme types are possible and are administrated by pension funds as well. For example a DB plan for salary till € 40.000 and a DC pension scheme for the remaining salary is allowed by law.
2.3 Pension funds
In the Netherlands about 80% of the current labour force takes part in a pension fund. Taking into account previous engagements even a larger part of the population will receive part of their retirement benefit from a pension fund. Table 2.1 gives an overview of the three types of pension funds that are present in the Netherlands and they will be considered in the remainder of this section. Over the recent years the number of pension funds has reduced from 991 at the end of 2000 until 348 at the end of 2014, mainly caused by the decline of the number of corporate pension funds (883 in 2000). [Statline, 2015, Pensioenfondsen; deelnemers en premies] This development can be ascribed to relative high costs, limited premium income
Pension funds, data 2014 Number Total number of participants Technical provision (x € 1,000) Industry-wide 68 15,568,000 801,167,000 Corporate 268 1,936,000 244,394,000 For independent professionals 12 95,000 24,157,000 Total 348 17,598 1,069,717,000
and a reduction in the number of (active) participants. Pension funds that have been liquidated have transferred their liabilities to either another pension funds or the benefits have been accommodated at an insurance companies.
Industry-wide pension funds (BPF, bedrijfstakpensioenfonds) consist of funds for employees in a specified sector of industry. Most of these funds are mandatory by law. Employers in these mandatory sectors have no longer the liberty of offering a pension scheme to their employees; they have to participate in the sectors BPF. The largest pension funds are found among the BPF’s. The two largest funds are ‘ABP’ for the civil sector and ‘Zorg en Welzijn’ for the care and welfare sector. The technical provisions for both funds at the end of 2014 were 340,121 mln. and 159,024 mln. respectively. Other examples of industry sectors with a pension funds are the retail sector, health insurance companies and employees in the office of notary.
Corporate pension funds (OPF, ondernemingspensioenfonds) administrate the pension
benefits for one company or corporation. In general OPF’s are not as large as BPF’s, however individual OPF’s can contain a large technical provision. For example the corporate pension funds from ING (19,305 mln.), Rabobank (18,211 mln.) and Phillips (15,687 mln.).
A special type of OPF was introduced in 2010, the multi-OPF. This gives the pension fund the ability to be more (cost) effective. An important feature of multi-OPFs is that their individual assets must be administrated separately, referred to as ring-fencing, hence each ring has its own funding ratio. Mainly due to governance requirements multi-OPFs have not become very popular, one example of a multi-OPF’s is Transavia Pension Fund.
The last group of pension funds consists of pension funds for independent professionals (BRF, beroepspensioenfonds). When a BRF is present in a certain branch, for professionals with an identical occupation, then these professionals are obliged to participate in this pension fund. Among these occupational groups there are pension funds for veterinarians and
Chapter 3
Funding ratio and required equity
Pension funds in the Netherlands are required to publish their funding ratio. Article 1 of the Pension Act 2015 defines the funding ratio as the “ratio between assets regarding the pension scheme or schemes managed by a pension fund and the pension fund’s technical provision”. [Dutch Central Bank, May 2015 | 1] In chapter 3.1 the general principals of the technical provision will be discussed and in chapter 3.2 the assets regarding the pension scheme will be considered. Chapter 3.3 describes the fundamentals of the funding ratio which can be deduced from these two elements. Finally the required equity which is related with the funding ratio is considered in chapter 3.4.
3.1 Technical provision
Article 2 of the Financial Assessment Framework (FTK, financieel toetsingskader) describes how to determine the technical provision (TP). The technical provision is based on the present value of the expected future cash flows resulting from unconditional pension benefits that are accrued on the date of the determination.
The determination of the technical provision depends on the type of pension scheme used for the benefits. The TP of future payments in a defined benefit scheme depends on the interest rate term structure (IRTS), actuarial assumptions and cost provisions. In a defined
contribution scheme the TP depends on the value of the assets on the date of determination, this capital will eventually be utilised to purchase pension benefits at the age of retirement. To determine the present value in a DB pension scheme the future payments are discounted based on the IRTS which is published by the Dutch Central Bank. The technical provisions as of December 31st, 2014 that are considered in this study are stated in the annual report. The
IRTS that is used on that date to determine the technical provision is depicted in figure 3.1. [Dutch Central Bank, table 1.3.1] Interest rates are depicted as forward rates, the expected one-year-interests based on the spot rate curve at that point in time.
FIGURE 3.1: IRTS as published by the Dutch Central Bank.
Figure 3.1 depicts the IRTS as of December 31st, 2013 to compare the IRTS curves of 2013 and 2014. It can be concluded that interest rates at the end of 2014 are in general lower than in 2013. This results in a higher present value of pension benefits at the end of 2014. The second observation that can be drawn from figure 3.1 is the convergence of the two curves for
durations over twenty. This is caused by the methodology used to construct the IRTS. Both curves incorporate market information for the first twenty years. Subsequently the ultimate forward rate (UFR) technique is applied, which models the IRTS between the last liquid point after a duration of twenty years until a duration of sixty years, at which point the forward interest rate is presumed to be equal to 4.2%.
For completeness it is good to realise that both curves incorporate an interest that is a three-month-average. This method has been prescribed by the Dutch Central Bank to stabilize the (monthly) progression of the funding ratio. This stabilisation becomes clear when the results of the three-month-average IRTS are compared with the IRTS without averaging.
The technical provision of a fund increases when interests diminish over a three month period. Hence, the funding ratio will become lower. However, with the three-month-average IRTS the decrease of the funding ratio goes not as fast as in case of the IRTS without
averaging. This is favourable for the financial position of the fund. In a scenario with increasing interests the opposite will be seen. The technical provision will become smaller when the interest increases and therefor the funding ratio will increase. The growth of the funding ratio, when using the three-month-averaged IRTS, will not be as fast as in case of the IRTS without averaging.
The technical provision is further based on (prudent) actuarial assumptions. The main element in these assumptions is the average life expectancy. The base for the life expectancy is the mortality table as published by the Actuarial Society of the Netherlands. Pension funds correct this mortality with a fund specific mortality experience, because the general table is based on life expectancies of the general population. Due to this methodology each fund incorporates different assumptions, which fit the fund.
0.00 1.00 2.00 3.00 4.00 0 10 20 30 40 50 60 Fo rwa rd in te re st ra te (% ) Duration Dec. 2013 Dec. 2014
A simplified example of the calculation of a technical provision can be presented as follows. A participant has an expected benefit of 5,000 euro that will be paid only once (assumption), after 20 years. The probability that the participant is alive after 20 years equals 0.88
(assumption). The zero coupon interest rate for a duration of 20 equals 1.657% (IRTS
December 31st, 2014) resulting in a discount factor of 0.720 (= 1.01657 -20). Consequently, the technical provision equals € 3,168 (= 5,000 * 0.88 * 0.72).
In practice pension funds also maintain a cost provision. It is excluded in the example above, because it does not give additional insight. The cost provision is an extra reserve used to cover future expenses and is in general expressed in terms of a percentage of the main technical provision seen above.
3.2 Assets regarding the pension scheme
The assets a pension funds has regarding their pension scheme can be deduced from the balance sheet. These assets consist of all possessions a fund has available, at a certain point in time, to ensure future benefits. The value can be calculated by deducting all liabilities that are not related to the pension scheme from the sum of the assets. The assets can consist of
investments, claims at an insurance company, working capital, debt-claims, accrued income, fixed assets and others. The non-pension related liabilities can consist of positions in
derivatives, collateral, deferred income and other liabilities.
The former method is a technical approach as prescribed by the Pension Act. In practice a second method can be used, which is in fact implemented in this study. The value of the assets regarding the pension scheme can be determined as well by adding the equity capital of the pension fund and the technical provision regarding the pension scheme. This method is somewhat more straightforward. The equity capital is derived from the assets and liabilities and therefore both the technical and the practical approach determine the same value of the assets regarding the pension scheme.
3.3 Funding ratios
Based on Article 1 of the Pension Act and chapters 3.1 and 3.2 the generic formula for the funding ratio is:
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So far when the term ‘funding ratio’ has been mentioned in this thesis it actually concerns the nominal funding ratio. In the annual reports of 2014 this nominal funding ratio has to be published in accordance with the Financial Assessment Framework (FTK, financieel
of 2014. The main feature of the nominal funding ratio is that the technical provision has to be based on the IRTS at the end of 2014, as published by the Dutch Central Bank (DCB), which includes the UFR technique and three-month interest rate averaging. This IRTS has been depicted in figure 3.1. Pension funds also refer to the nominal funding ratio as the FTK funding ratio or DCB funding ratio, due the relation with the IRTS.
The nominal funding ratio is the main focus of this thesis, but there are other types of funding ratios. For example:
o Market value funding ratio: in this ratio the technical provision is based on the IRTS in which both the three-month-averaging and the UFR methodology are excluded. Subsequently the ratio is calculated in the same way as in the case of the nominal funding ratio.
o Real funding ratio: in this ratio the technical provision is based on an adjusted IRTS. The IRTS is adjusted for expected future price inflation, for example by a parallel downward shift of 1.5%, a pension fund can define its own expectation of the inflation as long as it is a prudent assumption. This results in a technical provision which ensures participants to maintain purchasing power. A real funding ratio can be determined using either the IRTS published by DCB, or the market value IRTS. o Policy funding ratio: this ratio is prescribed by the Pension Act as of 2015.
[wetten.overheid.nl, 2015] Although the policy funding ratio does not apply to pension funds in 2014 it is interesting to realize that the methodology is different compared to the ratios previously discussed. Each month a nominal funding ratio is determined, based on the technical provision and the assets regarding the pension scheme. The average funding ratio over the period of the twelve most recent months is equal to the policy funding ratio.
The goal of this new funding ratio is to create a more stable ratio that does not depend on one IRTS at a certain point in time. The three-month interest averaging had a similar purpose, but as of January 2015 this three-month-averaging is no longer applied. Additionally, as of July 15th, 2015 the UFR methodology no longer applies a fixed ultimate forward rate of 4.2%. Due to changing economic conditions the new UFR methodology incorporates a floating ultimate forward rate, which is determined based on the average twenty-year-forward interest rate, of the previous ten years. Yearend 2015 the ultimate forward rate was only 3.2%.
Table 3.1 depicts various funding ratios from the corporate pension fund of the ING company, as published in their annual report 2014. Funding ratios for this particular fund have increased in the year 2014. The policy funding ratio is introduced as of 2015 and has not been
determined at the end of 2013. For the ING Pension Fund there is a difference of 15.0
percentage points between the nominal and the market value funding ratio, at the end of 2014. It can be concluded that both the three-month-averaging technique and the UFR methodology have favoured the height of the funding ratio.
The policy funding ratio is the average nominal funding ratio over the twelve most recent months, because the nominal funding ratio has increased over time during 2014, the policy funding ratio is somewhat smaller than the nominal funding ratio for December 31st, 2014. The ING Pension Funds reports the real funding ratio based on market value. It can be
concluded that the fund estimates it will need 40.7% (= 130.1% – 89.4%) of the market value technical provision to award adjustments for inflation.
ING Pension Fund At the end of 2014 (%) At the end of 2013 (%) Nominal (FTK) funding ratio 145.1 128.2 Market value funding ratio 130.1 125.3 Real funding ratio (based on market value) 89.4 81.3
Policy funding ratio 139.3 not published
TABLE 3.1: Various funding ratios of the ING Pension Fund.
Beside the fact that there are different types of funding ratios two other characteristics should be taken into account when comparing funding ratios of pension funds. These facets are the type of pension scheme used and whether or not pension benefits have been placed with an insurance company. Both these characteristics are part of the risk that a pension fund faces. For example, in case of a (hypothetical) pension fund that exclusively executes a DC pension scheme and the fund does not facilitate the benefit pay-out phase for the participants after retirement, then the risks of the pension fund are nil. As discussed in chapter 2.2 and 3.1 the technical provision is equal to the assets that are present, hence the theoretical funding ratio is 100%. Returns on investments have a proportional effect on the provision and hence the funding ratio of 100% is not affected by the returns on investments. This theoretical fund might possess additional equity, but in principle this is not related to the pension scheme, because the risks (e.g. longevity and investment risk) are borne by the participants.
In case of a DB or CDC pension scheme the risks are taken completely by the pension fund, because the participants are promised a certain pension benefit. This is an obligation which, in principle, is not affected by risks. However, the ratio between assets and the technical
provision of the obligation can be influenced by risks like longevity, investment and interest rate risk. Hence the funding ratio in these pension schemes will fluctuate, and can also become smaller than 100%.
A pension fund has the possibility to transfer risk to an insurance company. In the case of full reinsurance all obligation towards the participants and the risks involved are transferred to a third party, the insurance company. Theoretically the risk of a fund becomes nil, comparable to the DC pension scheme example. Whether or not a fund has an insurance contract is an individual choice, which is influenced by, for example, the amount of costs that are in the contract and whether or not a fund wants to bear the risks involved. Small pension funds are
in general more likely to have an insurance contract. The impact of a negative risk can have a relative large impact on the result of a small fund as a whole, because they have less
participants and capital to spread negative risks.
In practice it appears that individual pension funds cope differently when determining their funding ratio. Firstly variations can be caused due to the fact that not each pension fund incorporates the complete technical provision in the funding ratio calculation. Some pension funds for example exclude the technical provision of DC pension schemes, and others include it. A second type of variation can be found when looking at assets that are either excluded or included in the determination of the funding ratio.
To determine which part of the technical provision and the assets are included or excluded in calculating the funding ratio, one has to look at the determination of individual funding ratios in detail. Pension funds handle differently and this study aims to map the similarities and differences applied by pension funds.
So far the required equity has not been taken into account. Required equity is a requirement for the pension fund to have a certain amount of capital. The value of the required equity ensures there is only a small possibility that the assets in one year time are not high enough to cover the technical provision of the fund. In the next section, chapter 3.4, the required equity will be discussed more extensive. At this point it is important to know there is a required equity, because it is necessary to understand the following example about the funding ratio of the Deloitte Pension Fund.
The Deloitte Pension Fund reports a funding ratio of 105.4% in their annual report 2014. The composition of this ratio is depicted in table 3.2 and is based on the technical provision of the DB pension schemes and the equity capital (line c.). The technical provision has been split in two components, the technical provision of the active insurance contract (line a.) and the technical provision from former arrangements (line b.). Both types of technical provision are accommodated at an insurance company and the fund gives a more elaborate insight in the impact of the insurance contract on the funding ratio.
Deloitte Pension Fund At the end of 2014
a. Technical provision of the active insurance contract € 656,068,000 b. Technical provision of former arrangements € 8,930,000
c. Equity capital € 35,794,000
d. Nominal (FTK) funding ratio ( (a+b+c) / (a+b) ) 105.4 % e. Required equity of lines a. and b. (1.0%) € 6,650,000 f. DC pension scheme (TP = assets) € 323,591,000 g. Required equity attributed to DC pension scheme (1.0%) € 3,236,000 h. Nominal funding ratio, excluding required equity of the DC pension scheme ( (a+b+c-g) / (a+b) ) 104.9 %
Due to poor investment results the contract at the insurance company does not have sufficient assets to cover the liabilities. However, the insurance company has given the guarantee that all liabilities will be covered and therefore the fund has a claim of € 173.145.000, equal to the deficit, upon the insurer.
When the fund would not have a reinsurance contract a hypothetical situation can be regarded. Suppose that the technical provision and assets regarding the pension scheme are similar to the current situation, but the claim of € 173 million is absent. That would result in a funding ratio of 79.3% (= (35.8 + 656.1 + 8.9 – 173.1) / (656.1 + 8.9); in millions) instead of 105.4%. However, in reality the fund would have to take appropriate measures when this scenario would have been real and most likely the liabilities would have been reduced in this hypothetical scenario.
Besides the reinsured DB pension scheme Deloitte Pension Fund offers a DC pension scheme as well. The technical provision of the DC pension scheme (line f.) is not included in the funding ratio. In their annual report the fund mentions that the funding ratio of 105.4% can be adjusted by taking into account a reduction of the equity capital. The reduction of the equity capital is based on the required equity necessary for the DC pension scheme not included in the funding ratio. The required equity of Deloitte Pension Fund at the end of 2014 is said to be 1.0%, which is low due to the nature of the pension schemes. When the fund assumes a required equity of 1.0% for DC liabilities (line g.) and reduces the required equity in the funding ratio with this figure, a corrected funding ratio of 104.9% is determined.
Another pension fund might have included the technical provision of the DC pension fund in its funding ratio, resulting in a funding ratio based on different fundamentals. When this is done for the Deloitte Pension Fund a funding ratio of 103.6% is determined
(= (35.8 + 656.1 + 8.9 +323.6) / (656.1 + 8.9 + 323.6); in millions). In this case no required equity correction has to be made, because the total technical provision is included in the calculation.
The previous example shows that it is important to identify the composition of a funding ratio, because different determinations lead to different funding ratios. When funding ratios are not comparable incorrect conclusion might be drawn when the difference is not recognized.
3.4 Required equity
On the balance sheet a pension fund reports the value of its equity capital. Article 132 of the Pension Act requires pension funds to determine a required equity (RE). [wetten.overheid.nl, 2014] The height of the required equity has to be set at such a level that there is 97.5% certainty that the assets regarding the pension scheme in one year time are as high as the technical provision. [Dutch Central Bank, Vereist eigen vermogen, January 2015] In other words the RE is an equilibrium capital to ensure there is only a 2.5% possibility that the assets
of the fund in one year time are insufficient to cover the technical provision. The RE represents a risk criterion of the investment related risks a pension fund faces.
When the equity capital at the end of a year is smaller than the RE a fund has to hand over a recovery plan to the Dutch Central Bank, the supervisor. This plan must contain information how the pension fund will strengthen their financial position to ensure the equity capital equals or becomes larger than the RE during a specified period.
The required equity can be an important norm for participants as well. Under the Financial Assessment Framework 2014 complete indexation of liabilities is only allowed when the funding ratio exceeds the required equity. [Sprenkels & Verschuren, February 2015] When the funding ratio does not exceed the RE the pension fund is allowed to award partial indexation at best, or when the financial position is really poor indexation is not possible at all. As of 2015 the Financial Assessment Framework is adjusted and with respect to
indexation policies and regulations will become stricter. In this study complete indexation is assumed to be allowed as of the required equity level.
The required equity depends on the 97.5% certainty level and the risk profile of the pension fund and there are three model options to determine its size. The standard model is the primary choice and has a high level of precision, but might not suffice to match the risk profile of each pension fund. Alternatively a fund can develop one or more supplementary internal models. The third option is to develop a fully internal model, which has to satisfy certain requirements. Below the standard model is discussed for general understanding. [Dutch Central Bank, Vereist eigen vermogen – standaard model, January 2015]
Looking at the annual reports two different types of required equity can be distinguished. The Dutch Central Bank prescribes the strategic RE. The strategic RE is based on the
predetermined investment policy as defined by the fund in their policy documents. Each year the fund defines an objective to invest a certain amount of their assets in real estate, bonds, derivatives, etcetera. By doing this they predetermine the level of risk they are prepared to assume. However, the actual investments allocation at the end of the year can deviate from the strategic investment policy. This deviation can be caused by value changes of the
investments, but also because there is some flexibility in the strategic investment policy. Consequently funds also have an actual RE, based on the investment allocation at the end of the year. Several funds only report the actual RE, with the comment that the actual RE exceeds the strategic RE. By doing so their RE is more prudent.
To determine the required equity the Financial Assessment Framework establishes the risk profile of the fund by distinguishing ten risk categories. Each of these risk factors can be displayed as risk factor Si. The ten categories are: interest rate risk (S1); equity and real estate risk (S2); currency risk (S3); commodity risk (S4); credit risk (S5); underwriting risk (S6); liquidity risk (S7); concentration risk (S8); operational risk (S9) and active management risk (S10). When each risk factor is determined the RE is calculated with the following formula:
(A = BCD+ 2 ∙ H
The correlations of S1 and S2, and S5 with both S1 and S2 are taken into account, with ρ12 = 0.40, ρ15 = 0.40 (if S1 is based on declining interest, otherwise ρ15 is nil) and ρ25 = 0.50.
In general not all risks occur at the same time due to diversification of the investment policy. Diversification is taken into account by the square root in the formula.
In practice some risks are more important than other. The following risks play a major part in the RE:
o Interest rate risk (S1): the duration of the liabilities of many pension funds is longer than the duration of the assets. This mismatch results in a risk, because when interest rates go down, the value of liabilities increases more strongly than the value of the assets.
o Equity and real estate risk and commodity risk (S2 and S4): the value of the assets that are invested in these instruments are directly affected by fluctuations on the stock and commodity market.
o Currency risk (S3): pension funds invest in both euro and foreign currency. Investing in foreign currencies causes risks due to value changes of investments due to exchange rate fluctuations and the exchange rate itself.
o Credit risk (S5): each investment results in the possible risk that the counterparty is not able to fulfil its obligations. The fund can reduce its credit risk by investing in instruments with a high rating, which have a smaller credit risk. The fund has to be aware of the fact that credit risks of individual instruments change over time. However, reducing the credit risk might result in a lower return on investments. Investments with a high risk, might have the potential to result in a higher return on investments. The fund has to find a balance between risk and profits, which fits the fund.
o Underwriting risk (S6): this risk of every underwriting related principle. In principle mortality related risks are taken into account only. When other underwriting risks, for example disability risks, have material effects on the required equity, they should be taken into account as well.
o Active management risk (S10): the risk that is related to the degree of deviation (active management) of the actual investment policy and the strategic policy that is
determined in front.
The required equity of pension funds in 2014 is in the range from 0% up till 30%, however the majority funds has an RE between 10% and 20%.
Chapter 3.3 describes the Deloitte Pension Fund including their RE of 1.0%, which is well below the average RE. This is caused by the fact that pension benefits and the risks involved, are transferred to an insurance company. Required equity is a measurement of risks that are born by a pension fund, which mainly consist of investment risks. In case of a complete transfer of risks towards an insurance company, the risk of the pension fund is nil. A similar risk transfer happens when the pension fund offers a defined contribution pension scheme. In
this case the risks are borne by the participants and once again the value of the risk borne by the pension fund is nil.
In case of the Deloitte Pension Fund RE is 1.0%, although investment risks are nil. This is because the RE has to be at least equal to the minimum required equity (MRE), the lower bound of the RE. Section 140 of the Pension Act stipulates that a pension fund must recover the funding ratio of the fund within six months in case the equity capital of the fund has been below the MRE for five years. Recovery implies the funding ratio should be at least equal with the MRE. The MRE is determined as follows: [Dutch Central Bank, Minimaal vereist eigen vermogen, January 2015]
o In case of investment risk borne by the pension fund, 4% of the technical provision, multiplied by the ratio of net to gross TP. In which the net provision equals the gross provision reduced with reinsured components. The lower level of the ratio equals 0.85.
o A pension fund without investment risk and a fixation of administrative expenses for more than five year, has a MRE equal to 1.0%
o A pension fund without investment risk and a fixation of administrative expenses for five years or less, has a MRE equal to 25% of the net administrative expenses
incurred in the past financial year.
o When the fund executes a capital sum upon death and / or disability scheme a supplementary additive is included in the MRE.
Chapter 4
Design of the study
4.1 Description of the pension funds used in the research
Table 2.1 gives an overview of the number of pension funds that have been active in 2014, including the technical provision as reported by the Dutch Central Bank. The group of pension funds investigated has a somewhat different composition. Table 4.1 gives an
overview of the group of pension funds incorporated in this research, including a comparison with table 2.1.2
Differences between both tables have different origins. This study only includes pension funds with an available annual report. Pension funds that are small are not obliged to publish an annual report. An auditor’s report is sufficient for these funds to confirm their work. This is the main reason for the fact that 97 corporate pension funds are not included. Only 2.54% of the technical provision as reported by the DCB is not included in this study, indicating that the group of 97 funds are relatively small.
At the end of 2014 several pension funds are ‘in liquidation’, which is consistent with the trend of the reducing number of pension funds. A fund that is liquidating, transfers its
liabilities to another fund or an insurance company. In this situation the fund might still have to deal with financial issues, but no longer have liabilities. Therefore, pension funds in liquidation are not included in this study.
Pension funds, data 2014 Number of funds in the research Number of funds not included Technical provision (x € 1,000,000) Difference compared to table 2.1 Industry-wide 62 6 801,439 + 0.03% Corporate 170 98 218,868 - 2.54% For independent professionals 9 3 23,898 - 1.07% Total 241 105 1,044,205 - 0.58%
TABLE 4.1: Pension Funds and their technical provision used in this study, compared with table 2.1
Note that the technical provision for industry-wide pension funds in the study is slightly higher compared to data of the Dutch Central Bank. The value of the TP incorporated in this study is based on the balance sheets in the annual reports. In which way the data of the Dutch Central Bank determined is not clear. Notably there are some minor differences.
Among the corporate pension funds are a couple of multi-OPFs. Each ring of such a fund is considered separately due to the fact that a funding ratio is reported for every ring.
The total of 241 pension funds does not include four corporate pension funds with an available annual report, namely BASF, HAIO (HuisArtsen In Opleiding), ING and Robeco. The pension funds of BASF and HAIO do not report a funding ratio. Liabilities that are present are based on a defined contribution pension scheme and both funds have not reported a funding ratio for these liabilities. Additionally BASF is in the process of transferring the fund to Belgium for regulatory reasons. This is a second argument to exclude the BASF Pension Fund from this study.
ING and Robeco Pension Fund are excluded due to a different reason. The balance sheet of these funds is constructed using the technical provision based on market value. Hence, the funding ratio that can be deduced from the balance sheet is the market value funding ratio. This ratio is not comparable with other pension funds, because their balance sheets are based on FTK principles from which the nominal funding ratio can be deduced.
4.2 Data collection
The data is retrieved from the annual reports 2014 of the pension funds. The primary data that is used in this study consist of the nominal (FTK) funding ratio, the required equity and the balance sheet 2014.
The balance sheet of each fund has been entered in a generic balance sheet, to ensure the diverse reports can be compared. The generic balance sheet is constructed to ensure the nominal (FTK) funding ratio can be deduced from the balance sheet. The assets regarding the pension scheme are considered by adding the equity capital and the technical provision hence the generic balance sheet focuses on the ‘liabilities and equity capital’ side of the sheet. Figure 4.1 shows the generic balance sheet.
The nominal (FTK) funding ratio as reported can be calculated with the following formula and is used as control for filling the generic balance sheet.
-./012 3450146 7 8< 0;36/Q9Q 0; 1:9 R/;Q0;S =410>
8< 0;36/Q9Q 0; 1:9 R/;Q0;S =410> Formula 4.1
Furthermore, the technical provisions that are included and excluded are divided in several subcategories. A thorough explanation of these categories is provided in chapter 5.1. The categories are defined as follows:
1) TP of which the risks are borne by the fund; a) General technical provisions;
b) TP for indexation;
c) Other technical provisions;
2) TP of which the risks are borne by the participants; 3) TP of which the risks are borne by an insurance company;
4) TP of conscientious objectors (people who don’t want to have an insurance, but put money aside for future utilization);
5) Miscellaneous technical provisions.
In case of the required equity both the actual RE and the strategic RE have been recorded separately. When a pension fund reports both values, the RE that is most prudent, in other words the highest, is used in this study.
4.3 Enrichment of the data
In their annual reports pension funds can utilize a different number of decimals for the funding ratio. In some cases the fund has not reported a decimal. In this study the funding ratios used are determined with a significance of one decimal. For those funds who report a different number of decimals the funding ratio has been recalculated.
When looking at the required equity several pension funds report the RE as a value in euro’s only. For this study it is necessary to know the percentage as well, because comparisons are based on the percentages. When the RE is not reported as a percentage, this value is
calculated using the technical provision included in the funding ratio and the RE in euro, with the following formula:
(A % = 8< 0;36/Q9Q 0; 1:9 R/;Q0;S =410>U- (€) Formula 4.2
Similar to the funding ratio every RE (%) has been determined with a significance of one decimal.
Chapter 5
Composition of the technical provision
and equity capital
The funding ratio is determined by two key elements, the technical provision and the equity capital. Formula 3.1 displays the generic formula for calculating this ratio. When the
composition of the elements is assessed for individual pension funds, variations in the components are encountered. This can result in funding ratios with different fundamentals. The aim of this study is to increase the comparability of funding ratios. The first step to achieve this goal is an analysis of the applied methods by different pension funds.
This chapter discusses the composition of both the technical provision and the equity capital of the 241 pension funds included in this study. The data of funds has been recorded based on the generic balance sheet as described in chapter 4.2. Chapter 5.1 analyses the composition of the technical provision and the impact of coping differently with the in- or exclusion of specific types of technical provisions in the determination of the funding ratio. The different approaches of calculating the funding ratio are compared with each other and a correlation between the different methods is demonstrated. The equity capital is considered in chapter 5.2 and mainly focuses on the incorporation of specific reserves when calculating the funding ratio. This subject displays additional variations between individual pension funds and the calculation of their funding ratio.
5.1 Variations in the reporting of technical provisions
Different technical provision (TP) categories have been encountered in the annual reports of the 241 pension funds. The categories have been defined in chapter 4.2 and the different types are distinguished based on the bearer of the risks involved with the liabilities. Among these risks are longevity, interest rate and investment risks. Table 5.1 gives an overview of the categories, the number of pension funds reporting these types and the value of the TP present in each category.
Technical Provision
Risks are borne by Number of funds that include this TP in their funding ratio Number of funds that exclude the TP in their funding ratio Value of TP included in the funding ratio (x 1,000,000) Value of TP excluded in the funding ratio (x 1,000,000) Type 1 The pension fund
a) General TP 219 - 1,031,160 -
b) TP for indexation 5 - 62 -
c) Other TP 56 - 389 -
Type 2 The participants 14 70 1,616 4,024
Type 3 An insurance company
a) General TP 53 30 10,938 109
b) Other TP 11 30
Type 4 Conscientious objectors 6 13 10 38
Type 5 Miscellaneous TP - 15 - 30
Total of technical provisions 1,044,205 4,201
TABLE 5.1: Technical provision distributed over risk categories
It can be seen that the majority of the technical provision is of ‘type 1’ in which risks
concerning the liabilities are borne by the pension fund. However, it would be bad practice to look at the market average, because individual funds can have a totally different composition compared to the market average. Table 4.1 shows this study covers 241 pension funds, while only 219 have a ‘type 1’ TP. Subcategories b. and c. are only reported in combination with subcategory a. The 22 remaining funds consequently have their complete TP in one or more of the other TP categories. The second reason to not look at the market average is that the majority of the TP considered has to be included in the funding ratio calculation. However, looking at individual funds data the biggest outlier includes only 6.6% of their total technical provision to calculate the funding ratio.
In the remainder of this section the different categories of technical provision will be
discussed in more detail, including a detailed description for several individual pension funds.
Type 1: Technical provision of which the risks are borne by the fund
The risks concerning this TP are borne by the pension fund. This implies that liabilities associated with this TP originate from either a DB or CDC pension scheme. A pension fund is, in principal, obliged to satisfy the agreed benefit payments and has to ensure that it has enough assets to accomplish this. It is almost self-explanatory that this type of technical provision has to be part of the funding ratio. In practice all funds with TP ‘type 1’ also incorporate this TP in the calculation of the funding ratio.
For the majority (200) of the 219 funds reporting technical provision of which risks are borne by the fund this TP is the dominant TP category. Dominant in this case means a minimum of
90% of the total technical provision on the balance sheet, meaning both the TP included and excluded from the funding ratio calculation. Figure 5.1 gives an overview of every pension fund that reports a ‘type 1’ TP. It should be noted that a fund with a small percentage of TP ‘type 1’, depicted on the right side of the figure, might determine its funding ratio based on this TP only. For the Groothandel in Bloemen en Planten Pension Fund this is in fact the case, they determine their funding ratio based on 6.6% of the total technical provision, the
remainder of their TP is of ‘type 2’, which will be discussed below.
FIGURE 5.1: Number of
pension funds reporting TP ‘type 1’. The x-axis
represents the amount of TP ‘type 1’ as percentage of the total amount of TP in all categories.
Figure 5.1 displays TP ‘type 1’ as a whole. Table 5.1 indicates that subcategories can be distinguished. In their annual reports pension funds can define subcategories of TP ‘type 1’, but this is not done by every pension fund. Subcategory a. is the main category and includes the TP of the liabilities. For several pension funds, who do not report distinct subcategories, it is likely that subcategory a. also includes TP of subcategory b. or c. Therefore, subcategory b. and c. cannot be regarded separately, but they can be regarded as technical provision of which the risks are borne by the pension fund. Looking at subcategories b. and c. in more detail it can be found that:
o Subcategory b.: TP for indexation
Only 5 pension fund report a TP for indexation and include its value in the calculation of the funding ratio. Further research shows that this TP is reserved for the
unconditional indexation of specified liabilities of a small group of participants and represents less than 1% of the total TP. The risks accompanied by these liabilities are borne by the pension fund.
o Subcategory c.: Other TP
In the category other TP 67 funds report a technical provision that is included in the determination of the funding ratio. Due to the nature of this subcategory its value has been ascribed to either TP ‘type 1’ or ‘type 3’, depending on the type of technical provision reported by the funds. For a total of 56 funds this subcategory has been ascribed to TP ‘type 1’.
Other TP that is included in the funding ratio, as listed in the annual report, consist predominantly of liabilities concerned with people who have become disabled or costs related to future expenses. The risks involved in this subcategory are part of the
pension scheme and can therefore be included in TP ‘type 1’ or ‘type 3’, depending on the dominant type of technical provision of the pension fund. Pension funds who do not specify this type of technical provision, most likely have already included this in their main TP category. For the 56 funds reporting this subcategory of TP the value ranges up till 3% of the total amount of TP and one outlier has a value of 7.8% due to a 6% TP for future expenses.
BOX 5.1 ONE PENSION FUND; DIFFERENT NOMINAL FUNDING RATIOS
The funding ratio of a pension fund is the ratio between equity capital (EC) and the technical provision (TP). The technical provision can originate from one or more TP categories. When two distinct types of TP are present the pension fund can determine its funding ratio (FR) on the total TP, but in practice some funds exclude part of the TP, as will be seen in the remainder of chapter 5.1. Therefore, one pension fund can determine different funding ratios that satisfy FTK
regulations.
Consider, for example, a pension fund with a total TP of 100 and an EC of 20. The TP can be split in 90% TP ‘type 1’ and 10% TP ‘type x’. The fund can determine a FR based on the total amount of TP (FR total). However the fund can also determine a FR that only displays the ratio between the
EC and TP ‘type 1’ producing a funding ratio based on the risks for the fund only (FR fund).
!(1>146=-Y 7 8<Z[Z\] 8<Z[Z\] = DP7CPP CPP = 120.0% !(R/;Q = -Y 7 8< a1259Ca 8< a1259Ca = DP7OP OP = 122.2%
The difference between both funding ratios is 2.2 percentage points and the ratio between FR fund
and FR total is 1.0185 (122.2% / 120.0%).
When a second fund with TP total = 100, EC = 30 and TP ‘type 1’ = 50 is considered, the funding
ratios that can be calculated equal 130.0% and 160.0% for FR total and FR fund respectively. In this
case the difference between both funding ratios is 30.0 percentage points and the ratio is 1.2308 (160.0% / 130.0%).
No proper comparison can be made between two individual pension funds when one fund reports FR total while the other fund reports FR fund. This will result in an erroneous conclusion. A
