CSSPP/DNB INTERNATIONAL SEMINAR JUNE 9 – JUNE 11 2010

1. CSSPP/DNB INTERNATIONAL SEMINAR JUNE 9 – JUNE 11 2010 Supervision on Pension Funds Experience from Romania and The Netherlands

2. Supervision on pension funds Introduction to the seminar Adina Dragomir/Leendert van Driel Bucharest, Romania June 9 to June 11, 2010

3. Supervision on Pension Funds • Objective of seminar • Introduction of participants

4. Wednesday, June 9 09.00 Welcome and Introduction (Adina Dragomir/Leendert van Driel) 09.15 Review and summary of DNB seminar 2009(David Schelhaas/Leendert van Driel) 10.15 Morning coffee break 10.45 Review and summary of DNB seminar 2009 (2) 12.30 Lunch Programme Seminar

5. Wednesday, June 9 14.00 IOPS Principles of Pension Supervision (Rick Hoogendoorn) 15.30 Break 16.00 Pension Fund Supervision in Romania 17.00 End of day programme 18.30 Dinner Programme Seminar

6. Thursday, June 10 09.00 Pension Fund Governance: OECD Guidelines (Rick Hoogendoorn/David Schelhaas) 10.15 Morning coffee break 10.45 Risk Management (Paulus Dijkstra) 11.30 First Round of Investment Game (Paulus Dijkstra/David Schelhaas) 12.30 Lunch Programme seminar

7. Thursday, June 10 14.00 Investigation into investments of pension funds during credit crisis (Paulus Dijkstra) 14.45 Afternoon coffee break 15.15 Supervision in practice (Leendert van Driel/David Schelhaas) 16.00 Second Round of Investment Game (Paulus Dijkstra/David Schelhaas) 17.00 End of day programme 18.30 Dinner Programme seminar

8. Friday, June 11 09.00 Council of Europe position in respect of pension rights (Sixto Molina) 10.00 Morning coffee break 10.15 Final round of Investment Game (Paulus Dijkstra/David Schelhaas) 11.30 Seminar evaluation (Leendert van Driel/David Schelhaas) 12.30 Lunch 14.00 End of seminar Programme seminar

9. Summary 1. Pensions in the Netherlands 2. FIRM and FAF 3. Dealing with the crisis in Holland 4. Dealing with the crisis in Europe 5. Financial crisis and the impact on pensions in Europe Review seminar 2009

10. Pensions in the Netherlands Apeldoorn • The Netherlands: • Pension system • Pension supervision 10

11. Main Features Dutch pension system • Private • Capital-funded • Voluntary • Insurers only • Individual 3rd Pillar 2nd Pillar 1st Pillar • Private • Capital-funded • Employment-related • Premium paid by employer/ee • “Voluntary” • Pension funds ánd insurers • Collective • State • PAYG • Premiums via income taxes • All citizens • Mandatory 11

12. Main Features Dutch pension system • Private • Capital-funded • Voluntary • Insurers only • Individual Self-employed; Others: “the icing on the cake” 3rd Pillar 2nd Pillar 1st Pillar pension premiums are tax-deductable pension funds are autonomous; no link with sponsoring company • Private • Capital-funded • Employment-related • Premium paid by employer/ee • “Voluntary” • Pension funds ánd insurers • Collective (1) Company (2) professional (3) multi-employer industry-wide pension funds flat rate “AOW” for all Dutch citizens • State • PAYG • Premiums via income taxes • All citizens • Mandatory

13. Pensions in the Netherlands Figures 2008 second pillar • Company funds number 526/participants 850.000 • Industrywide funds number 91/participants 5.048.000 • Occupational funds number 13/participants 44.000 • Total assets Euro 688 billion/1,25 x GDP • Insurance companies 22.000 pension schemes/ 834.000 participants Total number of employees in the Netherlands: 7.200.000

14. Participation in pension schemes • Netherlands • - Indirect system: participation is mandatory through • collective agreements between employers and • employees • - Economic motives: level playing field, cost • efficiency • - Social motives: further reducing room for non- • participation • - What about self-employed? • Elsewhere • - Only 11 out of 30 OECD countries have mandatory private pension schemes • - These countries show a high participation compared to • countries with voluntary private pension schemes

15. Funded pension schemes in OECD Funded private mandatory pension schemes in OECD Source: Pensions at a Glance, Public Policies across OECD Countries, OECD Publishing 2005

16. Why mandatory participation? • Behavioral pitfalls • Lack of self-control: inertia and procrastination • Hyperbolic discounting and myopia • Framing • - Inconsistent preferences • Financial (il)literacy • Reduce negative external effects; poverty • Cost efficiency

17. Conclusions • International comparison indicates that compulsion is attended by higher participation • Empirical evidence shows that Dutch pension savers too are prone to behavioral pitfalls • On balance the public seems to be aware of this, given the dominant preference for a mandatory system with high certainty and limited autonomy

18. Conclusions • Is our current pension system optimal? • Overall, our pension system performs well vis-à-vis that in other industrial countries, but…. • Issue requires a broader analysis from different angles • Broad spectrum from fully mandatory system to full autonomy; introducing more autonomy while at the same time preventing people from making major mistakes could be the way forward • How to improve pensions for the self-employed?

19. Contents Apeldoorn • The Netherlands: • Pension system • Pension supervision

20. Regulation • Regulation • - 1st pillar: Old Age Act (“AOW”) • - 2nd Pillar: Pensions Act (“PW”) • Regulator • - Ministry of Social Affairs: pensions • - Ministry of Finance: all other financial markets segments • Supervisor • - DNB: De Nederlandsche Bank • - AFM: Autoriteit Financiële Markten

21. Supervision • In 2004 the Twin Peaks model was introduced • - prudential supervision of financial institutions by DNB • - supervisor for market conduct (“AFM”) • Cooperation between two ‘Peaks’ is essential • - potential for overlap/white spots • - covenant between DNB and AFM • Experiences • - more effective supervision • - better grip on financial stability risks • - substantial cost savings 21

22. Supervisory approach • In practice: • Open discussions • Principle-based • Discretionary powers • Sanctioning only if dialogue fails • Focus on prudential supervision (funding and solvency) • Supervisory principles: • Principle-based / Prudent person in investments • Risk-oriented • Integrity • Transparent / ICT facilitated • Executive powers: • Quarterly and annual statements • Contractual agreements • Investment plan / strategy • Actuarial and business memorandum • Fit and proper test board & management • On-site inspections • Sanctions and redress: • Imposing a binding direction • Fines and penalties • Appointing interim managers / administrator • Replacing the Board

23. Summary 1. Pensions in the Netherlands 2. FIRM and FAF 3. Dealing with the crisis in Holland 4. Dealing with the crisis in Europe 5. Financial crisis and the impact on pensions in Europe Review seminar 2009

24. Pension right € 1000,- when retired Pension fund

25. Risk based supervision • Quantitative:Pension fund as a ´money factory´ • Qualitative:Pension fund as a company EUR 200 billion!

26. FIRM: Financial Institutions Risk Management method Intervention Protect creditors and policy holders Contribute to the integrity of the financial system Overall objectives DNB

27. FIRM Financial Institutions Risk Management Method Uniform methodology for risk analyses Applicable for all institutions supervised Standardized approach Covers ‘all’ supervisory activities Promotes objectiviness Systematic Smaller chance overlooking relevant information Supports planning Allows for allocation of scarce resources

28. Risk and control assessment Assessment of inherent risks and mitigating controls gives insight into the overall risk profile of the supervised institutions Inherent risks Net risk Inherent risks mitigated by controls = net risk Mitigating controls

29. Four-point scale to assess risks and controls Risk score Control score 1 Low risk 2 Limited risk 3 Material risk 4 High risk Unknown / Not applicable 1 Strong control 2 Satisfactory control 3 Unsatisfactory control 4 Weak control Unknown / Not applicable To identify “white spots”» Using default scores for inherent risks

30. Risk categories Matching/interest rate risk Market risk Governance Credit risk Insurance risk Business risk Operational risk Solvency management Outsourcing risk IT- risk Integrity risk Legal risk

31. Risk based supervision Outsourcing risk Legal risk Marketrisk Insurance risk Integrity risk

32. Risks, some examples • ´Qualitative´: • Bad management (governance) • Lehman as transition manager (legal) • Real estate fraud (integrity) • `Madoff´ (outsourcing) • IT systems failing (IT) • Investments in weapons or child labor (integrity) • Employee taking money from the fund (integrity)

33. Risks, some examples Quantitative: • Underfunding (solvency management) • Great losses due to risky investments or credit crunch (market or credit) • Raise in obligations due to declining interest rates (matching) • People live ´too long´ (insurance)

34. Quantitative risks:Financial Assessment Framework (FAF) • FAF is part of new Pension Law (2nd Pillar) • FAF objectives:Insight in the financial position of a pension fund Market value valuation of investments and liabilities Risk based approach Risk sensitive capital requirements Structured early intervention Analysis of availability and power of policy instruments in the long run

35. Financial Assessment Framework • Market valuation • Full funding requirement • Cost-effective premium • Strict rules for premium rebates or contribution holidays • Risk based solvency requirements & recovery plans • Prudent person approach • No investment restrictions • Except for investments in the sponsoring company

36. Financial Assessment FrameworkThree questions Does the pension fund have sufficient: • 1. Assets to cover the liabilities? • Actual value (market-consistent) • Market rates, no fixed discount rate • 2. Surplus to cover risks? • Risk horizon of 1 year • confidence level 97,5%, ‘once in 40 years’ • Test available solvency to required level in solvency test • 3. Flexible policy instruments to deal with long term risks? • Continuitiy analysis • Investment, premium and indexation policy

37. 1. Possible funding ratios(regulatory intervention levels) 127% *) 105% 100%

38. Continuity Analysis Goals from perspective of regulator/supervisor: • Investigate the balance between premium-, indexation- and investment policy • Incorporate a long-term perspective • Identify possible problems at an early stage • Bring forward the moment of intervention • Stimulating risk-awareness • Tribute to more transparency and communication

39. Funding ratio

40. ´Factor analysis´

41. Summary • Many risks regarding pension rights, both qualitative and quantitative • Supervision is risk based • FIRM tool for assessment risks and controls • Financial Assessment Framework for assessment and control of quantitative risks

42. Summary 1. Pensions in the Netherlands 2. FIRM and FAF 3. Dealing with the crisis in Holland 4. Dealing with the crisis in Europe 5. Financial crisis and the impact on pensions in Europe Review seminar 2009

43. Agenda • Full funding requirement • Key developments in 2008 • Security mechanisms in the Dutch system • Long term solutions

44. Why full funding is important • Underfunding has a price • High and volatile recovery costs: prevention cheaper than cure • Uncertainty reduces consumption and increases savings • Funding contributes to confidence in pensions • Employees will be more confident that their pension will be there when they retire • Encourages labour mobility: facilitates transfer of accrued rights • Funding is a hedge for an ageing society • The ratio of retirees to workers is to double the next 30 years • Less opportunity to ‘pass on the bill’

45. How is funding measured? • Funding ratio = market value assets / market value liabilities • Assets = all assets at free disposal of the pension scheme • Liabilities = all non-discretionairy liabilities (accrued benefit obligations) discounted at the current term structure of interest rates

46. Possible deficits • Solvency deficit • Funding ratio is above 105% but • Below the required level (127% for the average pension scheme) • Long-term recovery plan (max 15 years) • Funding deficit • Funding ratio is below 105% • Short-term recovery plan (max 3 years)

47. Key developments in 2008 • The MSCI World total return index decreased by 37% • Solvency test is based upon a 25% decrease • Overall, the interest rate term structure dropped by 140 basis points • Solvency test is based upon a 100 basis points decrease • Intra year swings even bigger

48. Analysis of the change in funding ratio

49. How to safeguard pension liabilities in a defined benefit environment • Security mechanisms in the Dutch system • Regulatory own funds • Increases in the contractual contributions • One-off sponsor commitments • Adjustments in investment policy • Reduction of future indexation • If all security mechanisms are exhausted • Accrued pension rights can be reduced • Note: there is no pension guarantee fund in the Netherlands • Like the PBGC in the US or the PPF in the UK

50. Supervisory dilemma • Prevent unnecessary reduction of accrued pension benefits and cause social disorder …versus… • Delay emergency measures for too long and let the situation develop from bad to worse