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 8 October)
How will the system of proposed cuts operate after implementation of the September package?
Answer 5 – Article 6a of the Regulation on the Pensions Act and the Occupational Pension Scheme (Obligatory Membership) Act specifies how any curtailment of pension rights and entitlement must be announced, evaluated and implemented in the case of pension funds that have exercised the right to extend the statutory recovery period to five years. The annual evaluation of the recovery plan may show that a pension fund cannot meet the minimum regulatory own funds requirement within the statutory recovery period of five years. A fund must then take additional measures to enable it to meet the requirement after all within the statutory recovery period. If necessary, a pension fund may have to curtail pension rights and entitlements.
In keeping with the September package, the Minister of Social Affairs and Employment amends article 6a of the Ministerial Regulation.
First, the amendments clarify what measures a fund must take and at what moment in order to comply with the statutory requirement that any funding shortfall must have been eliminated by the end of the recovery period. Accordingly, a fund should, where necessary, determine and implement a final cut in benefits within three months of the end of the recovery period. The determination of the final cut will be made on the basis of the funding ratio on the last day of the recovery period. This should occur in practice within six weeks of the end of the recovery period as funds must file their final evaluation with DNB within this period. The final cut determined by the fund (for most funds on 1 April 2014) cannot be lower or higher than the projected final cut announced on the basis of the evaluation of the recovery plan for 2012.
Second, the Ministerial Regulation specifies how and on what terms pension funds may spread any cuts over time. In the case of funds whose recovery period ends before 1 April 2014, the cuts are capped at 7% in 2014, after which the remainder must be implemented on 1 April 2015. Funds whose recovery plan ends after 1 April 2014 may provide that the cuts to made on 1 April 2014 (on the basis of article 6a (3)) and the final cut in 2015 are to be capped at 7%, after which the remainder can be implemented on 1 April 2016.
To spread the cuts over time the pension scheme must meet the following three criteria on 1 January 2013:
- The regular retirement age is at least 67 (see Q&A 8).
- The burden of any increases in life expectancy is passed to the members and pensioners (see Q&A 9).
- Indexation is not awarded where the funding ratio is under 110% (see Q&A 10).
The final cut in benefits determined by the pension fund on the basis of the funding ratio on the last day of the recovery period must be booked and executed unconditionally. In other words, the cut will not be affected by financial developments taking place after the end of the recovery period. . The final cut affects pension rights and entitlements already accrued by the end of the recovery period. Pension rights and entitlements that accrue after the recovery period will therefore not be curtailed. Under section 134 (3) of the Pensions Act, the final cut must be announced within two months of the end of the recovery period.
After final decision-making, pension funds should include unconditional cuts in the next financial report drawn up for DNB. This applies both to cuts finally decided upon during the recovery period and to those decided upon after the end of that period.
As regards the final cut in benefits, this means that it may appear from the funding ratio at the end of the recovery period that the minimum regulatory own funds requirement is not yet met. The fund bases its final decision to make unconditional cuts on this funding ratio. This final decision is therefore always made after the end of the recovery period and also after the end of the recovery period specified in the financial reports. For most pension funds the short-term recovery plan will end on 31 December 2013 and a final decision on cuts in benefits will have to be made in February 2014 at the latest. The final cut will then then included in both the end-February monthly report (submitted to DNB in early March) and in the Q1 2014 quarterly report. For the sake of comparability, funds that make their final decision in early January will also include their final cut in benefits in their monthly report to DNB at end-February. Where a final cut is made in two stages (i.e. where the pension fund spreads the final cut over time), both cuts should be included in the first report submitted after the final decision has been made. In such a case the annual statements on 31 December 2013 should show the shortfall that exists at that time (i.e. without incorporating the cut).
An example of a fund that operates under a five-year recovery plan pursuant to Section 6a of the Regulation
Suppose that a fund's evaluation at end-2011 showed that if the fund made maximum use of its management instruments, it would need to make a 5% cut in benefits to meet the minimum regulatory own funds requirement at end-2013. In the evaluation at end-2012, which must be filed with DNB within six weeks of the end of 2012, five situations are possible:
- The 2012 evaluation shows that even without a cut in benefits no funding deficit is expected to exist at end-2013. In this case, the fund will decide not to make the announced cut on 1 April 2013 and no cut needs to be booked or reported either.
- The 2012 evaluation shows that a smaller cut, for example of 2%, is expected to be sufficient to allow the funding deficit to be eliminated by end-2013. In this case, the pension fund decides to book and execute part of the proposed cut; in this case there is a 2% cut on 1 April 2013.
- The 2012 evaluation shows that a larger cut of, say, 8% is needed. In this case the pension fund decides to book the 5% cut and execute it on 1 April 2013 (funds are not required to make cuts in excess of those announced on the basis of the 2011 evaluation) and to announce an additional conditional cut of 3% on 1 April 2014.
- The 2012 evaluation shows that a larger cut of, say, 13% is needed. The pension fund meets the conditions for spreading the cuts over time and elects to cap the proposed cut at 7% on 1 April 2014. The fund in this case decides to book the 5% cut and execute it on 1 April 2013 and to announce two additional conditional cuts, namely 7% on 1 April 2014 and 1% on 1 April 2015.
- The 2012 evaluation shows that a larger cut is necessary, for example a cut of 13%, but in this case the pension fund does not meet the conditions for spreading the cuts over time.
The fund in this case decides to book the 5% cut and execute it on 1 April 2013 and announces an additional conditional cut of 8% on 1 April 2014.
By the end of the statutory recovery period (in this case 31 December 2013), the minimum regulatory own funds requirement must have been met. On the basis of the funding ratio at end-2013, the fund must evaluate whether it meets the minimum regulatory own funds requirement. If a cut in benefits is necessary to achieve this, the amount of the cut will be determined by the funding ratio at end-2013. Unlike the earlier evaluations, the cut to be made on 1 April 2014 has not been capped at the percentage announced on the basis of the end-2012 evaluation.
Suppose that the end-2012 evaluation has shown that a 4% final cut is needed to meet the minimum regulatory own funds requirement within the statutory recovery period. In the evaluation at end-2013, which must be filed with DNB within six weeks of the end of 2013, four situations are possible:
- The 2013 evaluation shows that the fund will have met the minimum regulatory own funds requirement at end-2013 without cutting benefits. In this case, the fund will decide not to make the announced cut on 1 April 2014 and no cut needs to be booked or reported either.
- The 2013 evaluation shows that a smaller cut would be sufficient to allow the funding deficit to be eliminated by end-2013. In this case, the pension fund decides to book and execute part of the proposed cut on 1 April 2014. This cut will be shown in the Q1 2014 financial report. The quarterly statement for Q4 and the annual statement on 31 December 2013 will show the deficit as it was on the date concerned.
- The 2013 evaluation shows that a larger cut is needed, for example 9% instead of 4%. If the fund meets the conditions for spreading the cuts over time and decides to cap the cut on 1 April 2014 at 7%, it will adopt an unconditional cut of 7% for 1 April 2014 and 2% for 1 April 2015. The fund will execute both these final cuts unconditionally, regardless of how the financial position changes after the end of the recovery period. The annual statements as at end-2013 will show the deficit as it is at that time. The report on Q1 2014 must incorporate the entire cut (i.e. the cuts made on both 1 April 2014 and 1 April 2015). This is because these cuts must be booked and executed unconditionally.
- The 2013 evaluation shows that a larger cut is needed, for example 9% instead of 4%. If the fund does not meet the conditions for spreading the cuts over time, a cut of 9% will be booked and executed as of 1 April 2014. The annual statements as at end-2013 will show the deficit as it is at that time. The report on Q1 2014 will incorporate the entire cut.
 ‘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.