On 25 September 2012, DNB released notes in the form of the following ten Q&As on the September Pension Package. Changes vis-à-vis the earlier release are marked as such.
Question 1 – Adjustment of the IRTS to the UFR
In what way is the Rate Term Structure that is used to value the technical reserves of pension funds adjusted to the Ultimate Forward Rate? As of what date will the adjustment take effect?
Answer 1 – Every month, DNB publishes the latest Rate Term Structure (RTS) by which pension funds use to valuate their liabilities. The introduction of the Ultimate Forward Rate leads to and adjustment of the RTS beyond the so-called 'last liquid point' (20 years forward). The introduction of the UFR for pension funds brings the regime for funds into line with the regime applying since 30 June 2012 for insurers. The specifications of the UFR (last liquid point at 20 years, convergence period 40 years and a UFR of 4.2%) are equal in both cases.
Interest rates for maturities up to 20 years remain equal to the calculated three-month zero rates. But for maturities between 20 and 60 years, alternative zero rates are calculated on the basis of adjusted underlying 1-year forward rates. The adjustment regards a weighting of those rates with the UFR. For the calculation of zero rates for maturities over 60 years the underlying 1-year forward rates are assumed to equal the UFR.
Pension funds may continue to use three-month moving average rates. The modified RTS will be applied as of 30 September 2012. The RTS applying as of that date will be published no later than 3 October 2012, together with an explanation of the underlying methodology.
A final technical modification is applied to minimise any market interference from the UFR. In response problems reported by the sector regarding interest rate hedges in the 20-year maturity range, it has been decided to base the extrapolation of the one-year forwards on fixed (maturity-dependent) weights rather than on monthly recalibration by the Smith-Wilson method as proposed in Solvency II. Because the fixed weights are calibrated using the Smith-Wilson technique, the effects of this technical modification may on the whole be expected to remain limited.
Question 2 – UFR and regulatory own funds
Will the introduction of a UFR affect the way pension funds have to calculate their regulatory own funds?
Answer 2 – No, the calculation method for regulatory own funds remains unchanged. The introduction of a UFR does affect the valuation of funds' technical reserves. The valuation of a fund's assets does not change. What is affected is the calculation of the interest rate risk component (S1) of regulatory own funds. The interest rate risk component is calculated by estimating interest rate shocks for all maturities on the basis of the mandatory interest rate factors and the RTS (in basis points per maturity interval). The effect (S1) on the technical reserves is determined by applying these interest rate shocks to all maturities in the published IRTS (including those beyond the last liquid point). The effect (S1) on the assets is determined by applying the same shocks (in basis points) to the corresponding maturity intervals and calculating the effect on the value of the fixed-rate instruments. If, for instance, a downward interest rate shock of 60 basis points is assumed at 10-years maturity, this 60 bp shock should be applied to both the liabilities and the fixed-rate instruments at that maturity interval in calculating the corresponding interest rate risk component (S1).
The other components (S2–S6) are determined in the usual way, with due observance of the published IRTS. Since the asset valuation method remains unchanged, the shocks should be applied, as usual, to the (market-consistent) value of the assets concerned: variable-rate securities risk (S2), exchange rate risk (S3) and commodity risk (S4). In calculating the credit risk component (S5), the credit spreads should be calculated by comparing the effective yield to the relevant (credit) risk-free RTS. The insurance technical risk component (S6) should be based on the technical reserves as calculated using the published IRTS.
Question 3 – UFR and interest rate hedging policy
Can pension funds adjust their interest rate hedging policies in response to the introduction of the UFR?
Answer 3 – Yes, they can, provided they duly observe the rules concerning controlled and ethical operations and the prudent person principle. Pension funds operating under a recovery plan are subject to the added restriction that they must not increase their risk profile, as stated in Section 16 of the FTK Decree (Besluit FTK). If such a pension fund in a recovery situation wishes to reduce its interest rate risk hedging, it must do so without raising its overall risk profile. This means the fund has to find alternative compensation for its reduced interest rate risk hedging.
Question 3a – Calculation of dampened self-funding contribution
(added 12 October)
In calculating the dampened self-funding contribution using a moving average interest rate, is it allowed to use the published IRTS from previous years, adjusted by the UFR?
Answer 3a – No. This is not allowed. Under current regulations (specifically: Section 128 PW or Section 123 Wvb, the self-funding contribution may be dampened by applying interest rates across a period up to 10 years maximum. The rates in question are the yield curves as published by DNB. The UFR was introduced on 30 September 2012. Rates dating back further must use the IRTS without UFR dampening.
Question 3b – UFR and continuity analysis
(added 9 November)
Will the UFR also affect the expected interest rate movement in the continuity analysis?
Answer 3b – Yes, the expected interest rate development in a continuity analysis is based on the IRTS as published by DNB. From 30 September 2012, that IRTS has been adjusted by the Ultimate Forward Rate (UFR). The expected interest rate development should be derived in the usual way from the adjusted IRTS (forward methodology).
Normally, continuity analyses (including consistency tests) performed in 2012 will be based on the situation at the end of accounting year 2011, that is, the balance sheet position and the published IRTS applying on that date. Generally, an earlier starting date will be allowed only after an interim continuity analysis under Section 16 or 22 of the FTK Decree (Besluit FTK). In 2012, however, because of the introduction of the UFR, a pension fund may take 30 September 2012 as the base date for its continuity analysis and consistency test, if it can argue convincingly that this will provide for a better fit between the continuity analysis and consistency test results, on the one hand, and the current and prospective financial position of the fund on the other.
The funding ratio template must be compiled in the usual manner, on the basis of the published IRTS.
Nor does the UFR cause any change in the interest rate stochastic applied in economic scenarios. The stochastic should as always be based on historical observations.
Question 4 – Contribution respite
Which funds may apply for a contribution respite during the year 2013?
Answer 4 – Under DNB policy, a pension fund facing a funding deficit a contribution level that is sufficient to sustain the fund's recovery. This means that contributions received must be at least equal to the purchasing costs including markups for overhead and for holding minimum regulatory own funds. This policy applies to all funds facing a funding deficit, whether or not they expect to be obliged to curtail pensions so as to climb out of recovery in time. For the years 2011 and 2012, DNB offered funds that faced the need to demand higher contributions an opportunity to apply for respite. Respite means that a fund may waive a contribution increase on condition that within one year, it modifies its financial set-up so as to ensure that it can sustainably meet the minimum requirement of contribution sufficiency, even when in a situation of underfunding.
One element of the September Pension Package is the decision to offer pension funds that have neither been granted a respite so far nor been forced to apply a pension cut in 2013, one last opportunity to apply for respite. To qualify for such respite, a fund must meet the criteria that also applied in 2011 and 2012. These criteria are the following:
- During the respite year, the fund must work towards a sustainable and sound financial set-up. DNB will see to it that funds using this opportunity place themselves on a sound financial basis before the 2014 contributions are set.
- A sound financial basis, then, means an even balance between commitments and justified expectations, on the one hand, and financing on the other. The fund's financial policy must be robust and balanced. Thus the Board of the pension fund must ensure that from the 2014 contribution setting, the contribution policy is adequate and that even in times of underfunding, contributions are received that help to achieve recovery.
- The description of such a contribution policy should in any case make apparent:
- The method by which the pension fund sets the contributions.
- The method by which the pension fund sets self-funding contributions.
- The criteria for awarding a contribution cut or a refund to the sponsor.
- How the pension fund, assuming expected returns, intends to ensure that in the long run, such subdued contributions do not deviate from the average return level.
- How the pension fund ensures that even under adverse conditions in a situation of underfunding, contributions will help achieve recovery.
- By way of custom solution, DNB may decide, if a fund does not qualify for premium respite in 2013, to grant partial relief in that year. Thus DNB intends to meet half-way those pension funds that have done their utmost to remedy their financial set-up and whose financial set-up does not face structural problems.
For partial relief to be granted the following conditions must be satisfied in any case:
- The fund must, before the date the 2013 contributions are set, send a written, argued request for a custom solution to DNB. The request will then be considered with due regard to the circumstances of the individual case.
- The fund cannot qualify for a custom solution unless it has applied all measures included in the September Pension Package. This means that the following measures must have been applied in any case:
- retrenchment of the pension scheme by raising the standard retirement age to 67 (see Q&A 8 below);
- placing the burden of future increases of life expectancy with the pensioners (see Q&A 9 below); and
- modification of the fund's indexation policy by increasing the threshold funding rate for indexation (see Q&A 10 below).
The fund will not be eligible for a custom solution if it faces structural problems in its financial set-up. If even after implementation of the measures in the September Pension Package, the contribution funding rate remains below 100%, this may be an indication of such structural problems.
Question 5 – Curtailment phasing 
(added 15 November)
How does the September Package affect the system of prospective curtailments?
Answer 5 – Section 6a of the ‘Regulation pursuant to the Pension Act and the Mandatory Occupational Pension Membership Act’ (the 'Regulation') prescribes how curtailment of pension rights and entitlements must be announced, evaluated and implemented by funds that have used the option to extend their statutory recovery period to five years. The annual evaluation of a pension fund's recovery plan may show the fund is unable to satisfy the minimum regulatory capital requirement within its five-year recovery period. This means the fund must then take additional measures so that it may still expect to meet those requirements in time. Conceivably, the fund may have to curtail members' pension entitlements and pension rights.
Section 6a of the Regulation is to be amended in connection with the September Package.
In the first place, the amendment explains more clearly what steps a fund must take at what moments in time to meet the statutory requirement that the funding deficit should be resolved at the end of the recovery period. The Regulation provides that a fund must determine and implement the final curtailment, if one is necessary, within three months after the end of its recovery period. The final curtailment is determined on the basis of the funding ratio applying on the date the recovery period ends. In actual practice, it must be determined within six weeks after that date, because that is the deadline for submission of the final evaluation to DNB. The final curtailment (applied in most cases from 1 April 2014) may turn out higher or lower the curtailment announced in the 2012 evaluation of the recovery plan.
In the second place, the amendment lays down the terms and conditions for spreading curtailment in time. Funds whose recovery period ends before 1 April 2014, may cap their 2014 curtailment at 7%, leaving the remainder to be implemented from 1 April 2015. Funds whose recovery period ends after 1 April 2014 may cap both the 1 April 2014 curtailment and the final curtailment, as of 1 April 2015, at 7%, leaving the remainder to be implemented from 1 April 2016.
To qualify for spreading, the pension scheme must meet the following requirements on 1 January 2013:
- The standard pensionable age is at least 67 years (See Q&A 8 below).
- Increases in life expectancy are charged to the pensions and the accrued entitlements (See Q&A 9 below).
- Indexation is not effected if the funding ratio is below 110% (see Q&A 10 below).
A fund's final curtailment, determined by the funding ratio on the end date of the recovery period, must be planned and executed unconditionally. That is, the curtailment will not be affected by financial developments taking place after that end date. The final curtailment affects pension entitlements and rights already accumulated on the end date of the recovery period. Pension entitlements and rights accumulated after the recovery period will therefore not be curtailed. Under Section 134(3) of the Pension Act, the final curtailment must be announced within two months after the end date of the recovery period. Financial reporting
Funds must include any unconditional curtailments, once finally decided, in the next financial report sent to DNB. This applies to curtailments decided upon during the recovery period as well as those decided after the end of that period.
Final curtailment decisions depend on the funding ratio on the end date of the recovery period: if a fund's funding ratio is below the required 105% minimum on that date, final curtailment is mandatory. *** The final decision on a final curtailment is, by consequence, always taken after the recovery period and therefore included in the financial reports submitted after that period. For most pension funds, the (short-term) recovery period ends on 31 December 2013, so that a final decision on curtailment must be taken in February 2014 at the latest. This final curtailment will then then included in both the end-February monthly report (submitted in early March) and in the Q1 2014 quarterly report. For better comparability, funds that make their final decision in January, will also be asked to first include their final curtailment in their and-February reports. Where a final curtailment is effected in two stages (spread curtailment), each effective curtailment must be included in the first report submitted after it has been finally decided. In line with the policy of the Council for Annual Reporting, the curtailment must be included in the annual statements. This means that the annual statements must have a technical provision on which the curtailment has already been applied. The notes explain which funding ratio forms the basis for determining the curtailment and what its effect is.
An example of a fund that operates under a five-year recovery plan pursuant to Section 6a of the Regulation
Suppose a fund's evaluation at end-2011 showed that if the fund made maximum use of its steering capacity, it would need to apply a 5% curtailment to meet the minimum regulatory own funds requirement at end-2013. This fund therefore had to announce a 5% curtailment effective from 1 April 2013. A year later, after the end-2012 evaluation, this fund will face one of five possible situations:
- The 2012 evaluation shows that even without curtailment, no funding deficit is expected to exist at end-2013. In this case, the fund will decide not to effect the announced curtailment as of 1 April 2013; so no curtailment needs to be reported either.
- The 2012 evaluation shows that a lesser curtailment, by say 2%, is expected to suffice for the funding deficit to be eliminated by end-2013. In this case, the curtailment is booked and effected in part, with pensions cut by 2% as of 1 April 2013.
- The 2012 evaluation shows that a more severe curtailment by e.g. 8% is needed. The fund in this case decides to book the 5% curtailment and effect it as of 1 April 2013 (funds are not required to implement heavier cuts than announced after the 2011 evaluation), announcing a further, conditional 3% curtailment for 1 April 2014.
- The 2012 evaluation shows that a more severe curtailment by e.g. 13% is needed. The pension fund meets the capping conditions and opts to cap the intended curtailment as of 1 April 2014 at 7%. In this case, the fund decides to book and implement the pre-announced 5% curtailment as of 1 April 2013, at the same time announcing two further cuts, by 7% from 1 April 2014 and by 1% on 1 April 2015.
- The 2012 shows that a more severe curtailment of, say, 13% is needed, while the pension fund does not qualify for capping.
- In this case, the fund decides to book and implement the pre-announced 5% curtailment as of 1 April 2013, at the same time announcing a further 8% cut from 1 April 2014.
By the end of the statutory recovery period (in this case: 31 December 2013), the minimum full funding ratio (minimaal vereist eigen vermogen or MVEV) must have been attained. On the basis of the funding ratio as at end-2013, the fund must evaluate whether it meets the MVEV requirement. If not, and if this can only be attained through curtailment, then the end-2013 funding ratio will determine the rate of curtailment. Unlike in the earlier evaluations, the curtailment effective from 1 April 2014 is not capped at the percentage announced after the end-2012 evaluation.
Suppose the end-2012 evaluation has shown that a 4% final curtailment is needed to arrive at the minimum required full funding ratio within the statutory recovery period. A year later, after the end-2013 evaluation, this fund will face one of four possible situations:
- The 2013 evaluation shows that the fund will have attained the minimum required full funding ratio at end-2013 without curtailing benefits. In this case, the fund will decide not to effect the announced 4% curtailment as of 1 April 2014; so no curtailment needs to be accounted for either.
- The 2013 evaluation shows that a lesser curtailment suffices for the funding deficit to be eliminated at end-2013. In this case, the fund will decide to effect and account for part of the announced curtailment as of 1 April 2013. This curtailment will be accounted for in the Q1 2014 financial report. The quarterly statements for Q4 and the annual statement as at end-2013 will show the deficit as it was at that point.
- The 2013 evaluation shows that a more severe curtailment is needed, e.g. 9% instead of 4%. If the fund meets the capping conditions, and opts to cap its 1 April 2014 curtailment to 7%, an unconditional curtailment by 7% is fixed for 1 April 2014 and another one, by 2%, for 1 April 2015. Both curtailments are to be effected unconditionally, regardless of how the financial position develops after the recovery period. The annual statements as at end-2013 will show the deficit as it was at that point. The report on Q1 2014 must show the entire curtailment (i.e. both the 1 April 2014 and the 1 April 2015 curtailment). This is because both curtailments must be effected unconditionally.
- The 2013 evaluation shows that a more severe curtailment by e.g. 9% is needed. If the fund does not qualify for capping, the full 9% curtailment is effected and accounted for as at 1 April 2014. The annual statements as at end-2013 will show the deficit as it was at that point. The Q1, 2014 report will account for the entire curtailment.
 ‘Regeling Pensioenwet en Wet verplichte beroepspensioenregeling’.
 Note: this Q&A replaces the Q&A 5a and 5b published earlier. Q&A 5b described a September evaluation in 2013 by funds whose recovery term expires at end-2013 and which do not qualify for capping. In this Q&A, item 5b has been dropped, since the Regulation pursuant to the Pension Act and the Wvb no longer requires a September evaluation.
Question 6 – Actual curtailment higher than announced
Can a higher than announced curtailment be effected on 1 April 2013? And how about stiffer curtailments on 1 April 2014 and 2015?
Answer 6 – A pension fund cannot be required to apply a more severe curtailment from 1 April 2013 curtailment than was announced in early 2012. However, a pension fund may decide, for reasons including the need to balance interests, to as yet set a higher curtailment rate effective from 1 April 2013.
Curtailments effective from 1 April 2014 and, possibly, 2015 may very well turn out higher than the earlier projections. Curtailments taking effect at the end of the short-term recovery plan (that is, on 1 April 2014 and 2015), are fixed in early 2014 on the basis of the funding position at year-end 2013.
See Question 4 for further explanation an an example .
Question 7 – Member communication on curtailment capping
If a pension fund opts to cap conditional curtailment from 01 April 2014, should a possible further curtailment at a later date be communicated at this stage?
Answer 7 – Yes. Funds that on the basis of the 2012 evaluation have fixed a provisional curtailment will have to inform their members of this. They must communicate a (capped) curtailment effective from 1 April 2013 and also any deferred curtailments effective from 1 April of years 2014 and 2015. The funds concerned have to do so no later than two weeks after receiving DNB’s opinion on their recovery plan evaluation.
Question 8 – Regular retirement age 67
(update 12 October)
One of the conditions for a pension fund to qualify for deferred curtailment after end-2013 is that the fund has raised its regular retirement age as stated in the pension scheme to 67, effective from 1 January 2013. What is DNB's criterion as to whether this condition has been met?
Answer 8 – This condition is satisfied if the fund demonstrates to DNB that the pension scheme will meet the constraints of the Witteveen framework, mandatory from 1 January 2014, as early as 1 January 2013, except as regards maximum accumulation rates. DNB will instead test for compliance with the maximum accumulation rates set in tax legislation, which continue to apply until end-2013.
Any modifications in the pension scheme that need to be made if it is to comply with the Witteveen framework must be set down in the pension scheme rules and the administrative agreement before 1 January 2013. pursuant to Section 103 of the Pension Act, the pension fund must send the modified documents to DNB within two weeks of implementing the changes. Given the short notice at which the changes must be made, DNB can accept it if a final agreement, duly signed by parties authorized to alter the pension scheme, is submitted to DNB before 1 January 2013. The pension fund Board must agree to the change in the pension scheme and implement it in the Regulations with effect from 1 January 2013.
Question 9 – Shifting the longevity burden to rights and entitlements
(modified 6 September)
One condition for permission to use the option to smoothe curtailments after end-2013 is that a provision shifting the burden of rising life expectancy to members and pensioners is included in the Pension Regulations. What form should such a provision take? What is DNB's criterion as to whether this condition has been met?
Answer 9 – Should life expectancy go up further, then the technical provisions will increase proportionately. The Pension Regulations must provide for the following:
- If pension assets are higher than the minimum own funds, (current and future) indexations are curtailed in such measure as to shift the full burden of increased life expectancy to the (dormant) members and pensioners. The curtailment may be spread out across several years.
- A fund facing a technical reserves shortage or a funding deficit will provide no or less than full indexation – often according to a graduated scale. The Pension Regulations must provide that the path to full indexation will, if possible, be slowed down further (see also Question 10 on the 110% lower boundary) so that the risen life expectancy is discounted against (present or future) indexation. This process may be spread out across several years.
Rising life expectancy may cause or exacerbate a funding deficit. This may mean that (part of) the rise cannot be absorbed within the statutory recovery period by indexation cuts as referred to under 2. In such a case, the fund will have to absorb the impact of increasing longevity by applying curtailment of pension rights and entitlements.
The Actuarial Society of the Netherlands has recently increased its life expectancy figures, and Statistics Netherlands (CBS) is to present a new projection later in the year. The resulting effect must be absorbed by the new longevity adjustment mechanism if a pension fund is to qualify for curtailment smoothing.
To qualify, the fund must include the amendment of the pension scheme in the pension regulations and the administration contract before 1 January 2013. Under Section 103 of the Pension Act, the pension fund send the modified documents to DNB within two weeks of implementing the changes.
Given the short notice at which the changes must be made, this condition will be taken to have been met if a final agreement, duly signed by parties authorised to alter the pension scheme, is submitted to DNB before 1 January 2013. The pension fund Board must agree to the change in the pension scheme and implement it in the Regulations with effect from 1 January 2013.
Question 10 – Indexation above a 110% funding ratio
In order to qualify for curtailment smoothing from end-2013, a pension fund must include in its pension scheme the provision, effective from 1 January 2013, that conditional indexation will be awarded only if the funding ratio is above 110%. What is DNB's criterion as to whether this condition has been met?
Answer 10 – To qualify, the fund must include the amendment of the pension scheme in the pension scheme rules and the administration contract before 1 January 2013. Within two weeks of implementing the changes, the pension fund send the modified documents to DNB under Section 103 of the Pension Act.
Given the short notice at which the changes must be made, this condition will be taken to have been met if a final agreement, duly signed by parties authorised to modify the pension scheme, is submitted to DNB before 1 January 2013. The pension fund Board must agree to the changes in the pension scheme and implement it in the Regulations with effect from 1 January 2013.