24 imposed by the new system that make small funds less viable, but it may reflect other causes as well. In any case, another five years may be required to conclusively observe any effects of the new rules on coverage, plan selection, and fund size.

What has happened more clearly in recent years are dramatic changes in the secondary aspects of pension scheme characteristics. While much of this is likely related to broader pressures of population aging to some extent they may be interpreted partially as a process of hedging risk exposure in response to the new more stringent solvency measures. The proportion of Dutch pension funds that provide benefits based on final pay has declined from 54% in 2002 just prior to the initial introduction of risk-based rules to about 10%. A less marked increase in the incidence of conditional indexing of promised benefits to price levels has occurred from 90% in 2002 to an almost universal 98% in 2006 although there was very little room for movement in this indicator.

As mentioned before, another area to observe the impact of the new supervisory system is in the investment patterns of funds. Two effects were generally posited in response to rules that impose high costs for asset-liability mismatches. These are a movement away from equities to fixed income and increases in the duration of fixed income portfolios. As shown in Table 8, the aggregate balance sheet information on pension funds does not appear to support the first of these expectations. The available evidence does however seem to indicate the second expected impact – the lengthening of the duration of the fixed income portfolios to better manage the mismatch exposure that is exacerbated with the volatility of the new market based discount rate. As shown in Figure 3, from the end of 2003 to the end of 2005 average duration increased by a year to more than 6 years with some funds moving to much longer durations.

It is possible that pension portfolios will become more conservative in the future, as pension funds build their internal models and reassess in more detail the impact of the new rules on their solvency position. At the same time, the absence of more pronounced shifts in strategic asset allocation could also be due to the long period of compliance. As mentioned before, pension funds are allowed 15 years to address shortfalls in the required solvency buffers. This relatively long period of compliance introduces a necessary element of flexibility, especially in view of the uncertainty regarding mean reversion of equity returns.<sup>11</sup>

**Table 8: Asset Allocation of Dutch Pension Funds 2001 – 2005 (in % of total)**

||2001|2002|2003|2004|2005|
|---|---|---|---|---|---|
|Land and buildings|11%|11%|10%|10%|10%|
|Investments, non-consolidated|1%|1%|1%|1%|0%|
|Shares and other variable yield securities|42%|35%|40%|40%|42%|
|Bonds and other fixed yield securities|36%|41%|39%|40%|40%|
|Mortgage loans|3%|4%|3%|3%|2%|
|Private loans|5%|3%|2%|2%|1%|
|Deposits|0%|0%|0%|0%|1%|
|Other investments|2%|2%|3%|2%|3%|
|Liquid assets|1%|2%|2%|2%|2%|
|Total(Euro millions)|460,777|427,297|481,811|542,112|624,881|

_Source_ : DNB data and authors calculations