Low market interest rates affect your pension

(original publication in Special July 2019)

Market interest rates have been low for years, and over the past quarters they have declined even further. This means the risk that NN CDC Pensioenfonds will need to lower or cancel indexation and/or cut back future pension accrual has grown. This article explains why.

The NN CDC Pensioenfonds pension plan is based on an average salary system under which the risks are borne by its participants. Neither your pension accrual nor your future pension benefits and indexation are fixed.

Discount rate and market interest rates
The Dutch central bank (DNB) determines the discount rate that pension funds must apply when calculating their pension commitments and accrual rate. The discount rate is derived from market interest rates for low to very low-risk investments. The lower the discount rate, the higher the total value of the pension commitments.

Over the past quarters, the value of the fund’s pension commitments (all current and future pension benefits payable by the pension plan) increased more than the value of its investments. This has resulted in a lower funding ratio and policy funding ratio. The funding ratio is equivalent to the pension fund’s investments divided by its pension commitments. It is determined on the last day of every month. Given that the funding ratio is volatile, the 12-month average – referred to as the policy funding ratio – is used. 

The low discount rate also pushes up the cost of pension accrual. 

Impact on indexation
The policy funding ratio determines how much indexation a pension fund is allowed to grant by law. If the policy funding ratio declines, the fund needs to lower its indexation rates or cancel indexation altogether. This why in recent years NN CDC Pensioenfonds has only been able to grant part of the targeted indexation.

Based on the fund's policy funding ratio as at 30 September, the board decides whether any indexation will be granted. If the policy funding ratio is higher than 110%, the fund is only allowed to grant partial indexation. Under current law, the fund is only allowed to grant full indexation if its policy funding ratio is higher than approximately 124%.

Impact on pension accrual
Low market interest rates result in a low discount rate, which in turn has an impact on the cost of pension accrual. As a result of low interest rates, the cost of your pension accrual has gone up. This means there is a higher risk that the 30% pension contribution agreed upon by the social partners for 2020 might not be enough to fund your pension accrual.

NN CDC Pensioenfonds’ pension plan is targeting an old age pension accrual of 1.875% of the pension base per year, starting on 1 January 2020. As at 30 September, the fund will determine whether the 30% contribution will be sufficient to fund this target, and if it is insufficient, whether your pension accrual will be less than the targeted pension accrual. This will depend on how market interest rates develop. In the fourth quarter of 2019, the fund will inform you of your pension accrual for 2020.

More information
For more information regarding the financial situation of NN CDC Pensioenfonds, check the website for news and quarterly updates on the funding ratio, investment results and developments in the financial markets. Click here for more information on indexation and the rates granted over the past five years.