Nine pension specialists* outline a model for the future of the Dutch pension system
With an ageing population, changing social views and shifting employment patterns, occupational pensions have become a timely and controversial policy issue in the Netherlands. Indeed, the Dutch government has started a national dialogue on the future of pensions. Concurrently, it is exploring ways to improve occupational defined-contribution (DC) schemes – for example, by allowing collective risk sharing in these schemes.
Netspar – the Network for Studies on Pensions, Ageing and Retirement – brought together nine pension experts to contribute to those initiatives by formulating policy options and trade-offs. This article summarises the analysis of these experts as well as their policy positions on the trade-offs. Many of the authors’ positions overlap, but sometimes they differ.
The reasons behind diverging positions are explained. The key messages are as follows:
1. A sustainable occupational pension system requires three objectives to be met:
• Achieving stable and satisfactory pension benefits at affordable contribution levels.
The pension system’s principal objective is to smooth consumption over time and across various circumstances in members’ lifetimes.
• Reinforcing trust by providing transparency about the values of members’ individual pension wealth.
Beneficiaries must be given insight into the value of the pension wealth set aside for them, as well as the factors that cause this wealth to change over time. This helps to eliminate the perception that ‘there will be nothing left for me by the time I retire’.
• Providing more tailor-made and flexible solutions.
Tailor-made solutions ensure that risk profiles are appropriate during the various phases of a member’s life cycle. In particular, such solutions prevent retirees from being excessively exposed to interest-rate and investment risks or the biometric risk of higher life expectancies among active participants. Conversely, tailor-made solutions allow young participants to benefit from risk premia by bearing enough investment risk. Tailor-made solutions may go together with – but not require – more individual freedom of choice. Flexibility means that risk and benefit profiles can be adjusted if macroeconomic developments allow. Tailor-made solutions also allow each collective to set the desired scope of risk sharing based on its own specific preferences and circumstances.
2. A sustainable occupational pension system is based on a collective approach.
A collective system featuring compulsory insurance pools offers professional management, economies of scale and access to risk sharing. Regarding the extent to which risks are shared within a collective, a trade-off exists between the larger degree of risk sharing that a collective system provides, on the one hand, and the drawbacks of collective decision-making, on the other.
The authors differ in their positions on this trade-off.
Some authors advocate extensive risk sharing, arguing that this yields more stable and higher pension benefits (objective A). These authors prefer future generations to share in current investment and interest-rate risks by means of recovery contributions and buffers. In addition, solidarity groups should be allowed to share risks that cannot be traded in financial markets, such as longevity and inflation risks. Finally, discretionary adjustments in pension contracts can accommodate unforeseen circumstances.
Other authors, in contrast, favour tight limits on risk sharing in order to contain governance and discontinuity risks. They argue, for example, that safeguarding the interests of future generations is difficult if these generations are involved in the pension deal.
“Regarding a collective approach, some authors advocate extensive risk sharing, arguing that this yields more stable and higher pension benefits. Other authors, in contrast, favour tight limits on risk sharing in order to contain governance and discontinuity risks”
All the authors agree that micro longevity risk should be shared in compulsory insurance pools.
3. All authors call for registration of accrued personal pension wealth.
Pension providers should report personal pension wealth of members and how personal pension wealth develops over time as a result of contributions, realised investment returns, and solidarity agreements, including any discretionary adjustments to those agreements. This transparency strengthens members’ trust ( objective B).
4. Solutions can be more tailor-made to personal circumstances (objective C) by defining individual ownership in terms of financial assets (ie, capital) with supplementary insurance and other solidarity agreements.
This applies to the accumulation phase, but possibly also the decumulation phase. This variant can in fact be viewed as a defined-contribution scheme augmented with collective risk sharing. Defining individual ownership in terms of personal financial assets allows the board of a pension fund to tailor financial risk, the time pattern of benefits and the risks that are shared to members’ diverging characteristics. Moreover, it either eliminates complex and politically sensitive valuation issues involving the choice of the discount rate or defers these controversial issues to the decumulation phase, when the impact of these choices is smaller. Last but not least, it offers each insurance pool discretion in setting the extent of collective risk sharing in accordance with its own specific preferences.
5. The authors advocate that contributions should not depend on age, once defined-benefit schemes have been converted into defined-contribution schemes with collective risk sharing.
Hence, compared with current age-related contributions under defined-contribution schemes, higher contributions are paid at a young age. This lengthens investment horizons so that members benefit longer from risk premia. Compared with the current uniform accrual of variable annuities under defined-benefit schemes in compulsory sectoral schemes, contributions of young workers accrue fully to their own pension wealth rather than raising the pension wealth of older workers.
6. The transition from defined-benefit schemes (in which individual property rights are defined in terms of variable annuities) towards defined-contribution schemes (in which individual property rights are defined in terms of personal investment accounts) involves two major transition issues.
Firstly, phasing out uniform pension accrual under defined-benefit schemes and age-related contributions under defined-contribution schemes generates adverse impacts on the transitional generations in the absence of additional compensation measures. The transitional impact can be more evenly spread across generations in alternative ways – for example, by gradually phasing out the age-related nature of pension contributions in defined-contribution schemes and the uniform pension accruals in defined-benefit schemes.
Alternatively, the generations in transition could accrue additional publicly funded pension rights to supplement AOW state benefits. A second transition issue is that accrued pension rights (in terms of variable annuities) need to be converted into financial assets. The authors prefer current pension rights to be converted into personal pension wealth by establishing the economic value of these variable annuities in the best possible manner.
* Ilja Boelaars, Lans Bovenberg, Dirk Broeders, Peter Gortzak, Sacha van Hoogdalem, Theo Kocken, Marcel Lever, Theo Nijman and Jan Tamerus.
The authors are members of a Netspar working group on Dutch pensions and views expressed in this article are those of the authors. Participating in a personal capacity, the working group members do not represent the organisations they are affiliated with. This article is abstracted from a paper, available at www.netspar.nl