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Benefits of intergenerational risk sharing 'have been exaggerated'

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The benefits of risk sharing among generations in the Dutch pensions system have been exaggerated, according to Theo Kocken, director at Cardano and professor of risk management at Amsterdam’s Free University (VU).

He estimated that it would generate a “wealth advantage of no more than a couple of percent, at best”.

Speaking at the FD Pension Pro IPE congress in Amsterdam, he said the much more positive figures often cited were based on “an unfair comparison between a utopian defined benefit scheme and a bad defined contribution plan, based on current legislation that does not allow for proper DC”.

According to Kocken, the limited benefits of intergenerational risk sharing are more than offset by its considerable disadvantages.

“The current system contains much unnatural interest risk and does not allow for tailor-made age differentiation,” he said, adding that the system was complex and lacked transparency.

He said it was also increasing distrust between the generations.

“Moreover, the system is very susceptible to political decision-making – about parameters, for example,” he said.

“I am not opposing solidarity, but rather the way all kinds of solidarity are lumped together in the current system.

“This is not social, and therefore I call for less solidarity.”

Presenting his proposals for a dual pensions contract – a combination of DB and DC, “without room for risk sharing between generations” – every participant accrues a collectively managed individual pensions pot, without rights transfers between generations.

Until the age of 50, participants invest 100% in equity, but after that a gradual purchase of annuities must ensure a nominal pension.

The older the participant gets, the more of his assets are invested in nominal investments, such as bonds, Kocken said.

The share of risky investments would be gradually decreased, but continue after the retirement date.

This way, the participant could even make returns – for indexation, for example – during retirement.

Kocken placed the benefit of intergenerational risk sharing at approximately 10%, rather than 40%, and suggested that this could also be achieved through a smart DC plan.

Under current Dutch legislation, one disadvantage of DC schemes is that a full annuity must be bought at retirement, which makes participants very vulnerable to interest rate movements, Kocken said.

In addition, investments in DC schemes are made fully risk-free at the retirement date.

Kocken said he also wanted to deal with the “illogical” solidarity between rich and poor.

He proposed homogeneous pension collectives and suggested that individual longevity should be taken into account for new entrants.

As a consequence, higher educated participants would pay more contributions than lowly paid workers, who usually have shorter lifespans.

“My proposal requires a big transition to a new system,” Kocken said. “But if we don’t do anything, we will be forced to adopt a bad DC system, as has happened in the UK.”

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