Myth: With current funding ratios, a renewed system would not have been needed

Published on: 4 April 2024

Much has been said and written about the new pension law that went into effect last year, yet misconceptions persist. In the series “Pension myths debunked” we examine one myth at a time. We put the sixth one - with the current funding ratios a new system would have not been needed - to Ruben Laros, strategic policy officer at APG. 


In the old system, the coverage ratio was used to see how a pension fund was doing financially. The coverage ratio is the relationship between the money a pension fund has in its coffers and (the market value of) all promised current and future pensions, also known as the liabilities. The coverage ratio is used to determine the premium that must be paid and whether a pension fund can index or reduce pensions, among other things.


The value of the liabilities is calculated on the basis of the risk-free interest rate. The interest rate has an effect on both the assets and the liabilities. The effect on the liabilities is often greater, so a low interest rate also means a low funding ratio. Laros: “The interest rate has mostly fallen since 2008. Even before the transition to the ‘new’ system, however, the interest rate rose again and with it, funding ratios as well.”

Major intervention
So was this major intervention in the pension system really necessary? Yes, says Laros. “The old system had a number of problems, including the use of the funding ratio. For example, the system tried to provide a high degree of nominal security (security of a certain, non-inflation-adjusted benefit level, ed.) as well as to provide a pension with purchasing power. With a low funding ratio, neither goal is achieved, while that same funding ratio limits a pension fund in how it can invest."


The precise way the coverage ratio works also proved difficult to explain, Laros continued. “Because the value of some investments actually increased due to low interest rates, a situation arose where pension funds had huge assets while coverage ratios were low. It proved very difficult to explain that those assets could not be paid out, because that would mean transferring assets from young people to older people.


The funding ratio also had the problem that measures taken based on the funding ratio - such as indexing or reducing pensions - took years to implement. As a result, the consequences of a shock in the financial markets were not felt by participants until years later and then they could no longer place them properly.”


Risk attitudes of different generations

The revamped system largely solves these problems. This is because the funding ratio no longer plays a role in it. As a result, financial results can be reflected sooner in the personal pension assets and pension benefits of participants. In the renewed system, windfalls can therefore be distributed sooner, and at the same time there will be effective instruments to achieve stable pension payments.”


Laros concludes: “In the new system, the risk-free interest rate will continue to play a major role. But pension funds will have more room to design their investment policy to fit the (risk) preferences of different generations of participants. The system makes it possible to gear interest rate risk and investment risk to the risk attitudes of different generations and to allocate them to the generation best able to bear the risks. In other words, there is no longer a single investment policy for all participants, as in the old system.”



In the “Pension myths debunked” series, our basic premise is the solidarity premium scheme (SPR), one of two contract forms from which funds can choose in the renewed system. All the funds APG works for have opted for the SPR.