Negative interest rates and Pensions

If the interest you receive from your investments is lower than the rate of inflation, you are receiving a negative interest rate on your return. This means you are losing money by staying in that investment. Around the world, central banks have been, in order to boost economies lowering interest rates. One of the unintended consequences of this decision is on pension funds around the world and the impact these policies have on pensioners.

The following is from a story published online on the Saltwater Network, Going Dutch? Low interest rates rattle 'world's best' pension system written by Toby Sterling

The European Central Bank's (ECB) stimulus policies, which have helped drive interest rates into negative territory, are blamed in part for the impending cuts in the Netherlands and have triggered a fierce debate over how the funding of pensions should be calculated.

At the heart of the Dutch debate is a technical question over how to calculate the cost of future pension payouts while the central bank policies keep interest rates low.

Actuaries make assumptions about how long pensioners will live, count up the future payments that have been promised to them and then use an assumed interest rate to "discount" how much must be put away to pay them.

The lower this interest rate, "rekenrente" in Dutch, the more conservative the accounting, and the more it costs to meet future liabilities.

The rekenrente is derived from government bond yields -- which have turned negative across Europe as interest rates steadily fell this summer.

Each 1% fall in interest rates have led to roughly a 12% fall in the coverage ratio between assets and liabilities in pension pots, the Dutch central bank says.

That has led several funds and some experts to argue that the rekenrente, which is around 0.3%, should be raised instead. Many blame ECB policy and see its effects as temporary.

Increasing the rekenrente to 2% or 3% would restore the funds to full solvency. Corien Wortmann-Kool, the chairwoman of the 456 billion-euro ABP civil servants fund, told Reuters she opposes pension cuts as "unnecessary" for now.

Increasing the rekenrente to 2% or 3% would restore the funds to full solvency. Corien Wortmann-Kool, the chairwoman of the 456 billion-euro ABP civil servants fund, told Reuters she opposes pension cuts as "unnecessary" for now.

"We believe we can achieve good returns, now and in the future," she said, estimating a 4% return over time is achievable despite low-interest rates.

The Dutch pension coverage ratio first fell through a 95% "critical" level, below which pensions should be cut to ensure a fund has enough assets to meet its liabilities, in July. It fell to 88.6% in August before recovering to 91% in September.

But Dutch Central Bank President Klaas Knot, the country's top pension regulator, says the rekenrente is "integral" to the system.

"We will continue to adhere to the risk-free rate of interest," Knot told journalists this week.

His approach is supported by a group of 10 academics who this week wrote to parliament arguing against a change.

"Imagine you took the risk-free rate of return and raised it by 2%. Then the coverage ratio would increase at a typical fund by up to 30%. It sounds too good to be true -- and it is. Pensioners get that money paid out now, but the assets pot will be a little emptier each year, and that would go on each year for years," the letter said.

One reason the Dutch system is considered so strong is its rigorous accounting. Another is its reliance on several different sources of pensions. Its first tier is the basic state pension that is funded by current workers on the "pay as you go" a basis that is the heart of systems in France, Italy and Germany.

The Dutch system relies more heavily than most on a second tier, supplementary employer-run pension funds, the ones preparing cuts. The Dutch fight will be closely watched in the United States and Britain, which have similar tiered systems but funds sometimes use less stringent accounting rules.

The Organisation for Economic Co-operation and Development (OECD) calculates that Dutch retirees get about as much, all told, as their after-tax income while they were working.

But for Dutch pensioners, cuts estimated at up to 8% next year make no sense, given assets in Dutch pension funds have doubled since 2008 to more than 1.5 trillion euros.

This represents the most of any major industrialized nation as a percentage of GDP, as up to 90% of Dutch workers are enrolled in funds to which they and their employers contribute.