A pension reform plan recently tabled by nine industry experts in the Netherlands could very well serve as the backbone of the country’s future pension system. Their blueprint – fashioned from the often-conflicting views of leading academics, reform critics and the regulator – is meant as a contribution to the current national pensions dialogue, organised by the Ministry of Social Affairs.
Defined contribution (DC) arrangements, with personal accounts serve as a core idea within their plan. In addition, the collective sharing of risks – such as longevity or inflation – with future generations is an integral part of the suggested set-up. Collective investment and administration would also remain in their proposal, while increased transparency on participants’ stake in the collective will help rebuild trust in the system.
According to its creators – part of Netspar, the knowledge network of pensions researchers and professionals – the blueprint aims to combine the best elements of defined benefit (DB) pension funds and DC schemes, both of which are now considered inadequate. DB is burdened by an unclear link between contributions and accrued pension rights, as well as opaque cross-subsidies across the generations. The rigid rules of the new financial assessment framework (FTK) for benefits and investments are already causing friction between the old and the young. And then there is the bog-standard investment mix used by pension funds, which is not tailored for age.
The blueprint also seeks to address the drawbacks of current DC arrangements, including the mandatory purchase of annuities at retirement age, which leads to disappointing benefits if interest rates are low at the retirement date. Dutch DC schemes also lack collective risk sharing, while the experts argued that the freedom of investment choice in DC schemes is often too great, with participants having trouble making the right decision.
The proposal argues that personal accounts must reflect ownership rights, a key element in the call for transparency. Contributions would be paid into the accounts, while insurance premiums, such as for surviving relatives’ pensions, would also be paid from the balance. The accounts must make clear the ‘price’ of solidarity with other participants.
In the experts’ view, collective financial buffers would be increased following good investment results, whereas participants would receive payments from the collective during times of poor performance. Depleted reserves would be replenished through recovery contributions from participants, allowing financial shocks to be spread over the generations.
• Lans Bovenberg (Tilburg University)
• Theo Nijman (Tilburg University)
• Theo Kocken (Cardano)
• Peter Gortzak (APG)
• Ilja Boelaars
• Mark Lever (CPB)
• Jan Tamerus (PGGM)
• Dirk Broeders (DNB)
• Sacha van Hoogdalem (Ortec)
Each expert has participated in this proposal in a personal capacity.
With contribution levels remaining at a fixed percentage, investments would be tailored according to lifecycle principles. An important element of the proposals is that risk-bearing investments continue post-retirement, and after retirees have bought annuities. However, because the schemes are to remain invested in equities, the annuities would not be fully guaranteed. Alternatively, participants should also be offered the option of benefits being directly paid from their account. An additional option would be receiving higher benefits at the start, which would taper off later.
In the blueprint, pension funds would no longer have to aim for a minimum nominal funding level, allowing them to focus on the specific investment needs of their membership. Although collective investment would remain for the benefits of scale, participants would be allowed to choose their preferred risk profile.
So far, employers have responded positively to the proposals, in particular because they are based on the DC principle. In recent years, they have switched increasingly to DC, as they find that funding shortfalls are greater than initially expected. Moreover, they want to remove pension liabilities from their balance sheets. Employers also favour a fixed contribution percentage, clear ownership rights and the advantages of a collective approach, while choices for risk sharing, they argue, could also be made individually for each sector or company.
That said, industry insiders have suggested that risk-sharing arrangements could become the thorniest issue in negotiations over new pension plans, particularly as the experts have failed to agree which risks should be borne collectively. According to Lans Bovenberg, a professor of economics within Netspar, they include “unknown unknowns”, such as granting a pension fund’s board the discretion to redistribute assets or renegotiate contracts. He said the designers of the blueprint only concurred on the current practice of sharing longevity risk at an individual level – when a participant dies early, the accrued pension assets remain with the pension fund.
• Collective investment and risk-sharing to be decided by individual schemes or sectors.
• Increased transparency on pension rights, risks and level of solidarity with other participants.
• Individual accounts for contributions, returns on investment and insurance premiums.
On the other hand, trade unions have been more reluctant to embrace the Netspar proposals, with most indicating that they prefer defined benefit arrangements. However, they have not yet completely rejected defined contribution schemes. The pending advice of the Social and Economic Council (SER) is likely to be crucial for the direction of the national pensions dialogue.
Because the social partners – responsible for pension arrangements – are still divided on the issue, pension funds have refrained from commenting. This also goes for the Pensions Federation, which has said only that it is drawing up its own proposals. Only the €334bn civil service scheme ABP has given an opinion, indicating that it supports the principles of increased stability, transparency and flexibility, as suggested by the experts.
A transition to the envisaged system would face serious hurdles. For example, abolishing the disputed average contribution approach would carry a price tag of €100bn, according to the Dutch Bureau for Economic Policy Analysis (CPB). A majority of the experts and some stakeholders would prefer to increase the state pension (AOW) to compensate participants who would be affected. Another option would be to eliminate the average contribution gradually.
Consensus must also be reached on how a new system should start. Netspar has proposed converting existing pension rights into capital per individual participant, but this might raise legal problems. Closing pension funds, and continuing further pensions accrual through new accounts, would be the second-best solution, according to the experts.
Providers of individual pension schemes have been sceptical about the proposals, claiming they are little more than individual DC. In their opinion, risk sharing does not work in practice. Sharing investment risk is a ‘gamble’, as there is no certainty that interest rates and returns will ever recover to a given level, one of them argued.