01 May 2015

IPE: Low interest rates could increase cost of pensions by 10%

Dennis van Ek, an actuary at Mercer, estimated that pension funds would need to increase their premiums for 2016 by at least 10% to achieve their targets. As a consequence, defined benefit (DB) plans and collective defined contribution (DC) schemes that base their contributions on the market rate plus the ultimate forward rate (UFR) could see annual pensions accrual – usually 1.875% – fall by 0.2 percentage points, he said.

Mercer noted that the 30-year swap rate had fallen from 1.5% to 1.2% at the time when the ECB launched its quantitative easing (QE) programme. As of last week, the rate dropped even further to 1%. “Since the introduction of QE, the cost of pensions has risen by 10%, or 1% of the salary on average,” Van Ek said. He warned that, in the coming decades, fixed income returns could structurally fall short of the interest rates that had been factored into liabilities.

Mark van de Velde, senior client consultant at Aon Hewitt, noted that the initial effect of the interest-rate drop would be limited to approximately 2% for pension funds that apply a cushioned contribution for a 10-year period. He calculated an effect of 6-7% if contributions are cushioned and drawn from assumptions for returns. However, Van de Velde stressed that the predictions were based on the current UFR of 4.2% that must be used to discount liabilities. “If the Cabinet were to reduce the UFR as expected before 1 July, contributions must increase by an additional 5%,” he said.

Wichert Hoekert, senior consultant for retirement solutions, said: “This could lead to undesired effects if interest rates change after the social partners have agreed on a policy.”

He suggested it would be more “practical” if the interest level at the moment of the policy decision could also be the criterion for the new contribution.

Commenting on the developments, Jobert Koomans, executive board member of the €4bn pension fund for care insurers (SBZ), said its premium needed to be increased by 2 percentage points to 26% of the pensionable salary to achieve target accrual.

The Pensions Federation said it was “very worried” about the low interest rates and that it feared “disastrous consequences” for pensions.

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