Premium funding ratio higher due to interest rate hedging

11 November 2020

Philips Pensioenfonds publishes the so-called premium funding ratio of the Fund in its annual report. At the end of 2019, this funding ratio was 97%. This percentage is calculated according to the method prescribed by De Nederlandsche Bank. This percentage does not take into account a decision made by the Board of Philips Pensioenfonds to hedge the 'interest rate risk' relating to the premium and pension accrual. When the interest rate hedging is taken into account, the premium funding ratio at the end of 2019 is 101%. In this news article you can read why Philips Pensioenfonds has hedged the interest rate risk and what effect this has on the premium funding ratio.

What is a premium funding ratio?

The premium funding ratio expresses how much contribution is paid for the new pension accrual. By way of illustration: if a premium of € 100 is received and a premium of € 100 is also required for the pension accrual in any year, the premium funding ratio is 100%.
At many pension funds, the premium funding ratio is currently well below 100%. This is also allowed, as long as the premium does not fall below the legal minimum. When determining the statutory minimum, account has been taken of the expectation that pension accrual can still be achieved with investment returns. Weighted by premium, the average premium funding rate of the Dutch pension funds at the end of 2019 was 84%. This means that the total pension premium paid in the Netherlands was 84% of the total required premium. 

Why has Philips Pensioenfonds hedged the interest rate risk?

In mid-2018, the social partners made agreements about the pension scheme that applies at Philips and Signify for the years 2019 to 2021. A fixed premium percentage was also agreed for that period. That premium was based on the interest at that time. With that premium, the premium funding ratio would be approximately 100%. A fall in interest rates after the moment of determination would mean that the premium funding ratio would be lower. The Board considered that undesirable. That is why this interest rate risk is hedged as far as possible by using so-called interest rate derivatives. These investments yield a profit when interest rates fall. This compensates for the more expensive pension accrual in the event of a fall in interest rates.

How does this decision affect the premium funding ratio?

The result achieved on the interest rate derivatives is seen by Philips Pensioenfonds as an amount available for financing the pension accrual. For a correct assessment, this result should be included in the determination of the premium funding ratio. Because interest rates fell in 2018, the interest hedging has yielded a profit. This means that the premium funding ratio is 101% instead of 97% if the result of the interest hedging is included.