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From our perspective: Pensions and the black box

When the UK, Dutch and Swedish pensions ministers met in January, an odds-on bet is that they discussed their respective pension reforms. The proposed overhaul in the Netherlands involves the likely move away from the intergenerational ‘black box’ of an overly complex pension system. Conversely, the UK is trying to bring back a more palatable form of risk sharing with its plans for collective defined contribution (CDC) schemes, which are to be introduced in legislation currently before Parliament.

In the early years of this century, the Dutch system moved from a final salary to an average salary system. Subsequent regulatory intervention has led to pension rights cuts for members, the effect of which has been to move away from a pure defined benefit system, leading to much dissatisfaction about the resulting uneasy compromise.

For its part, the Dutch Social and Economic Council in a recent report on the country’s pension system specifically puts forward the Danish and Swiss models for consideration, citing their strong social partner models for second-pillar pensions, including individual contribution rates plus collective risk sharing – for instance, of biometric risks. 

But while many funds in Denmark still offer a minimum return guarantee, there are increasing moves to pure DC. In Switzerland, the hybrid system has become increasingly unsustainable following the rejection by referendum in 2010 of a proposal to lower the pension conversion rate from the current 6.8%, although there are once more moves to lower it. A recent proposal also paves the way for Swiss pure DC funds.

Indeed, while it is admirable that the Netherlands wishes to retain many of the hallmarks of its pension system, including collectivity and intergenerational solidarity, the current proposals emerge at a time when there is increasing focus on individual defined contribution pensions in so many other European countries. 

The UK also moved away from final salary DB in the early years of the 2000s onwards when DB funds were closed to further accrual, a trend largely driven by mark-to-market accounting standards and the statutory requirement for indexation. A key problem in the UK has been the low level of contributions to the new generation DC schemes that followed. There has also been a lack of high quality DC schemes with leading-edge default investment strategies or with sufficient scale to offer institutional level fees. The advent of master trust schemes may help to overcome these hurdles.

And Dutch observers might raise their eyebrows at the fact that the UK wishes to introduce CDC pensions at all since it is precisely the system that the Netherlands has been seeking to overhaul for so long, in part because of the opacity of risk sharing. Experts warn against replicating the perceived ‘black box’ opacity of the Dutch system, which has eroded the trust of both younger and older generations. 

While individual contribution-based accounts may bring transparency to the contribution phase, a key area for future development will be innovation in the payout phase. Here Denmark, where some pension funds are creating their own variable payout strategies, could be a model to follow. Danish citizens, like their Dutch and and UK counterparts after all require good, stable retirement income in a system they trust. Despite the many differences, there is much good practice in policy and procedure to share in the design of new systems that avoid black boxes.

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