The performance of Dutch public pension funds has proven robust despite the impact of the Ukraine crisis on the European economy, but a sharp decline in yields across asset classes will challenge their ability to defend funding ratios while raising pensions in line with inflation.

The challenges facing Netherlands’ widely celebrated public pension funds industry are a signal that weaker players in the industry in other parts of the world will struggle to meet the needs and expectations of policy holdings, particularly the US where most public pension funds have an average funding ratio of 75% and a US$1.3 trillion total shortfall, according to recent Global SWF research.

A recent change in Dutch law requires pension funds to maintain the current and policy funding ratios at a minimum of 105% in order to index pensions to inflation. Yet, even well-funded schemes like PFZW are struggling to keep up with Europe’s cost of living crisis.

The Netherlands’ Pensioenfonds Zorg en Welzijn (PFZW), the pension fund for the care and welfare sector, has proven resilient with its current funding ratio up 2.8 percentage points to 113% and its policy funding ratio growing 3.5pp to 106.2% in Q2 despite a dismal -11.5% return for the quarter.

In common with many other public pension funds and sovereign wealth funds, for the full first half the fund was down 17.6%, losing EUR68.7 billion in value. The biggest losses in H1 were in government bonds (-21.1%), listed real estate (-18.9%) and listed equities (-16.6%), while gains were seen in private real estate (+8.4%), infrastructure (+2.9%), credit risk sharing (+2.5%), and private equity (+1.7%).

PFZW stated that the increase in the funding ratio was mainly caused by an increase in the market interest rate, which had a positive 18.0% impact on the ratio and offset negative impacts from the interest rate hedge (-8.1%), investments excluding interest rate hedging (-4.5%) and indexation of pension payments (-3.0%). Indexation and a healthy funding ratio enabled the board to increase pension payments by 2.7% from October, in line with 2021 inflation rates. With inflation running at 8.6% in June, pensioners under the scheme will see a 5.9% real terms reduction in their pension income.

Dutch public pension funds may, however, struggle to index pension payments from 2023 amid the impact of market turmoil and poor returns on funding ratios as well as high inflation. Joanne Kellermann, Chairman of the Board of PFZW, said, “The funding ratio, which represents the financial health of the fund, is the most important factor and improved due to the sharp rise in interest rates further improved last quarter. Still, financial markets are doing extremely badly. We lost this year already almost 18% of our assets. We sincerely hope that we will be able to increase pensions again on 1 January 2023, but that is still very uncertain.”

Managed by APG, Dutch civil servants pension fund ABP saw its coverage rise to 122.7%, up 5.3pp over the quarter. At the beginning of July, the fund increased pensions by 2.4%. ABP saw similar trends to PFZW in terms of yields with losses in fixed income (-14.1%), equities (-14.2%) and real estate (-3.7%) only partly offset by growth in commodities (+32.8%), hedge funds (+21.9%), private equity (+5.0%) and infrastructure (+4.8%). In total, ABP has lost EUR65.7 billion in value over H1, representing a return of -11.9%. At the end of this year, ABP will study whether pensions can be increased in 2023.

ABP Chairman Harmen van Wijnen said, “It has become impossible for most participants to follow. ABP’s coverage ratio is rising and its financial position is improving significantly, despite the poor performance of the financial markets and the frequent use of the words recession and crisis. This has everything to do with the rise in interest rates. Because this means that we need to keep less capital to meet our liabilities. For many years we had good returns and were unable to increase pensions. And yet in 2022, which has been hallmarked by negative returns so far, we were able to increase pensions. This paradoxical situation underscores yet again why we need to shift toward a new pension system.”

Other pension schemes run by APG, covering industrial workers, also have funding ratios well above 105%, which theoretically give them the opportunity to index pensions to inflation, including PME (112.4%), PMT (109.3%) and bpfBOUW (137.0%). Yet, all have warned that the ability to raise pensions in line with inflation is challenged by an uncertain market environment.

Related funds APG PGGM
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