Fraudulent Role of nFTK(2007) in Pension Funds Evaluation

Abstract

This paper shows that the new financial regulation introduced in 2007 in the Netherlands, the so-called nieuw Financieel Toetsings Kader (nFTK), has several basic flaws. The nFTK evaluation cannot be trusted. The results are misleading and must not be used for policy decisions. 'Funding problems' of pension funds are exaggerated, and mainly caused by the methodology itself – the nFTK 'funding ratios' may fall even at rising asset values and constant nominal liabilities. The solvency is systemically understated at economic downturns. An artificially imposed dependence of liabilities on interest rates results in false swings of funding ratios and baseless uncertainties around pension funds. Not tradable pension liabilities cannot be priced by riskless rates by definition: unknown liquidity and model risks make ‘risk-free evaluations’ inappropriate. We show the market liability defined by nFTK rules cannot be funded by definition and funding ratios will be insufficient by default, unless contributors pay premiums for pension funds taking risks, instead of being rewarded. We prove the nFTK market liability and funding ratios are irrelevant for the solvency if actuarial discount rates are used to calculate contributions. Hence the nFTK cannot test the solvency. The ability of pension funds to meet obligations depends only on current asset value and its growth. We argue the solvency control must be based on actual performance of pension funds. It is crucial that the discount rate determining the level of contributions do not exceed the actual rate of asset returns. A proxy to liability discount rates is an average rate of pension fund returns on the duration of liabilities. Inconsistent rules and improper risk-free pricing of liabilities lead to devastating consequences for participants of definite benefit pension funds. We show that the solvency of pension funds was underestimated in 2011 by at least 15%.