The future of the Dutch pension system remains uncertain

In Money
Written by  Nicole Kluijtmans Friday, 19 February 2016 09:59

The Dutch pension system, which is based on guaranteed benefits, will definitely be restructured; the only question is when. Econometrician Anne Balter expects to see a different pension system by the time she retires, which will be a while. The twenty-six-year-old, one of the youngest PhD candidates at Maastricht University, is at the start of a promising career. She received her doctorate on Friday 19 February with a thesis on the model uncertainty facing today's pension funds and insurers.

After interning at AZL pension fund in Heerlen, Balter decided to pursue a master's degree in actuarial science. When she started her doctoral research on model uncertainties, she couldn't have known how topical the issue would become. The shaky pension system, a result of historically low interest rates, is in the news almost daily. As it's not clear whether the buffers built up by pension providers are enough to ensure future pay-outs, current pensions are no longer being indexed. Cut-backs are another impending threat.

'This involves pensions to be paid out in the short term, so in twenty years. We can oversee this period to some extent by studying market developments. Unfortunately, we can't say the same for pensions paid out in thirty, forty, fifty or sixty years. Pension funds use mathematical models to develop an investment strategy and to calculate how much money to put aside to guarantee future pension payments. I researched the reliability of these models and created a new investment strategy that is less sensitive to interest fluctuations,' explains the PhD candidate.

Calculation models

Balter used an economics-based model to determine the extent to which the long-term interest rates are expected to grow. This is important as it determines how the pension funds' capital grows alongside it. Because her calculation model is based on a model in line with financial theories, it results in a different curve than those based on the simplified assumptions used in current models. That said, no model can provide an entirely accurate or reliable view of the future. That's why Balter advocates using several models to determine the best investment strategy.

This conclusion is not entirely surprising. 'You can never predict what's going to happen. The world doesn't behave like the numbers in the model, which is why there's almost always a mismatch between model-based decisions and the desired effect. We're now using the ultimate forward rate (UFR) curve, which is based on an interest rate of 4.2 percent over sixty years. But my research found that the 4.2 figure is really just a guess. This method was adjusted last year and the UFR is now based on the historic average, which means it could be 2 percent or 6 percent.'

Politically sensitive

Today's low interest rates are a result of the financial crisis. By keeping interests low, the European Central Bank hopes the economy will start to pick up again. A negative consequence of this is that pension funds can no longer guarantee pay-outs. 'The most logical scenario is for the funds to let go of this notion of guarantees. The SER (Dutch social economic council) is discussing a new pension system at the moment. They may want to distribute the risks across several generations or give the policy-holders the opportunity to determine their investment risk. Whatever the case: restructuring an entire system will have a big impact. The Dutch pension system is based on the social principle that we all make a financial contribution. It's a principle we're proud of in the Netherlands and something that will be hard to let go of. It's politically sensitive; no one wants to tackle this issue head-on. As a result, it could take up to ten years for someone to address it. Once it's been addressed, extensive research will be needed to develop a new system.'

Until then, the pension funds will continue to use the calculation models. The uncertainty Balter identified may lay the foundation for determining the buffers. But calculation models can also be used to predict how much pension money will be needed in the future. 'What's great about these models is that they can also be used for risk management. Instead of interest rates, you can also calculate temperature increases. But climate change is hard to predict. Like long-term interest rates, it's an unreliable prediction.'  

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