Mariska van der Westen speak with Theo Kocken, who wonders whether the Netherlands might actually be better off without a new pensions deal.

Now that the Dutch Cabinet has fallen and an ad hoc coalition of five political parties has agreed on austerity measures that include speeding up steps to raise the pensionable age, the hard-fought Pensions Agreement is in jeopardy. But is that such a bad thing? Not necessarily, says Theo Kocken, professor of risk management at the Free University of Amsterdam (VU) and chief executive at consultant Cardano.

Perhaps this is the perfect moment to admit that a drastic pension system reform might not be such a good idea after all. "It may be better to simply update the existing system with a few well-chosen adjustments," he says. "That would also do away with the tricky issue of migrating past accrued rights to a new regime."

Kocken was one of the first experts to sound the alarm when the original Pensions Agreement suggested using expected long-term returns as the discount rate to value liabilities, calling the measure a "fraud" akin to a shell game.

Along with pensions experts and academics Sweder van Wijnbergen, Lans Bovenberg, Bas Werker and Theo Nijman, Kocken is closely involved in efforts to determine which discount rate the Dutch industry uses to calculate pension liabilities going forward.

Wrangling over the rate
The matter of the correct discount rate - and how it should be determined - is a contentious issue. The discount rate in large part determines just exactly how much capital pension funds need to have available to meet their pension liabilities. "A high discount rate would seem to be more beneficial, as higher rates lead to lower liabilities," Kocken explains. But although it might be tempting to adopt a higher interest rate as the discount rate, "it is really impermissible to adopt a discount rate that is artificially high, as the objective is to achieve a fair distribution of the available capital, now and in the future".

By now, most everybody in the industry agrees on the basic and essential characteristics of the discount rate that should be used by pension funds to calculate their liabilities going forward, Kocken says. The discount rate should not leave any room for arbitrage, nor should it allow any one generation to benefit at the expense of another.

"But we still do not have unanimous agreement on a number of smaller issues and details," he says. "And it is still unclear how we need to arrange for a proper transition from the old system to the new regime."

The latter is by no means a small issue. There is no way to simply convert past accrued rights by discounting them, according to new rules. And figuring out a way to switch from one discounting method to another without short-changing anyone is a major headache.

In addition, the methodology promoted by Kocken and other academics is constantly being challenged. "The newest thing is a move to get the Ultimate Forward Rate introduced as the discount rate for the longer end of the interest rate curve," Kocken says. "There is nothing wrong with that per se, but now all of a sudden there is a push to adopt a discount rate that is way above the market rate for durations of 20 years and up. We are talking about an interest rate that has a forward rate in year 30 of a whopping 4.2% - well above the current market forward rate for 30-year interest rates, but also 20-year and 10-year interest rates. The case is argued by referring to Solvency II, the European supervisory regime for insurers - a regime that is being rejected in any other way as not applicable to pension funds."

Champions of an artificially high discount rate came perilously close to winning the battle, as their proposals had been accepted by the now-defunct Dutch Cabinet. Kocken notes: "The financial agreement that almost made it included a strange passage proposing a discount rate of 4%. That is another prime example of irresponsible political interference with the private savings of the younger generation. It is a shame solutions are somehow always being sought in ways that shift the burden of problems to younger generations - preferable in such a way that it's not immediately obvious what's being done."

Tinkering will do
Considering the issues involved with converting past rights to the new system and the bitter wrangling over the discount rate, it is no wonder that implementation of the new pensions deal has run into difficulties. "Now that the political decision has been made to raise the pensions age faster than envisioned earlier, it is unavoidable that the pension deal will be called into question," says Kocken. "As the saying goes: everything liquefies under pressure."

If the Pensions Agreement is indeed scrapped, he won't shed a tear. On the contrary: he believes this may be the right opportunity to change course and drop any big plans to introduce an entirely new pension system. It might be better to strip the deal for parts and use them to improve the existing system.

"From a pragmatic viewpoint, it might be wiser to incorporate the pension deal's stronger points into the system we already have," he says. "This means spreading the pain of increased life expectancy equally. It means spreading return shocks equally by cutting benefits in a socially acceptable way - spreading benefit cuts over a 10-year period, for instance, and raising benefits as circumstances permit over the same period of time. It means allocating a part of premium contributions to guaranteed rights accrual and another part to conditional rights. All these things can be achieved through relatively minor legal adjustments to the existing Pensions Law. After all, the existing system is a conditional one anyhow. So a few well-chosen adjustments should do the job."

This story first appeared in IPE sister publication IP Nederland.