• How Dutch collective defined contribution schemes came about and how they differ from other schemes
Over 90% of the nearly 5m Dutch pension scheme participants were members of defined benefit (DB) schemes in 2017, according to the Dutch National Bank (DNB).
In addition, there are a negligible number of defined contribution (DC) schemes, mainly in company pension funds, and no capital accumulation schemes run by pension funds. Only those three contract choices (defined benefit, premium and capital accumulation) are available for employers, according the Netherlands Pension Act (Pensioenwet).
In DC-schemes only the contribution is pledged with no commitment as to pension income, and all risks are borne by the employee. Because DC schemes are strictly individual there is no question of solidarity, such as between generations or birth cohorts, other than to ensure equal treatment between men and women.
International accounting rules require companies to provide insight into the economic risks, including those associated with the pension contract.
In both a final salary and an average salary pension scheme the company also faces an additional funding obligation if the pension scheme is underfunded. These risks do not exist for a company if the commitment is to pay only a premium as contribution.
In the 1950s, when many industry pension funds came about, pension cuts were possible in the case of underfunding as a last resort (ultimum remedium).
More recently, industry schemes devised ‘conditional’ DB schemes with additional financing conditions to the standard legal framework, and called them collective defined contribution (CDC) schemes. In that period another change was made, from a final salary to average salary, including compensation for inflation, which later became conditional.
In a CDC-scheme the employer pays a fixed premium to the pension fund. The risk that the premium is insufficient to purchase new pension rights or to pay the promised pension lies with the collective of the participants or together with the collective of the participants, former participants and the pensioners.
The level of pension depends on premiums paid and investment results. In other words, pension rights are clear and reasonably secure, although not as secure as a guarantee.
In 2005 the International Financial Reporting Standards (IFRS) changed considerably for pension liabilities of individual companies (for more details see the article Shades of grey on Dutch CDC in the July/August 2018 issue of IPE).
It led a lot of companies to convert their DB schemes to CDC.
Types of Dutch CDC
Most CDC schemes involve an average salary basis and a fixed accrual rate, with an indirect salary control mechanism in the governing pension regulations. But the commitment is made under the condition that the funding is sufficient. The solidarity involves sharing interest rate and investment risks.
So there is a certain degree of risk spreading but with less intergenerational solidarity than in a DB arrangement. CDC also involves the possibility that risk (including investment and longevity risk) are shifted to the participants and deferred participants, albeit on a collective basis.
Given the Dutch public’s poor pension knowledge, it is doubtful that the average participant is aware of this change.
Erik Daae is chairman of Stichting Pensioenbehoud in the Netherlands
The view of the DNB, the Dutch pension supervisor*
• Can a maximum premium level be fixed for an indefinite period in a CDC scheme, as in a DB agreement where the premium is fixed for several years?
No, in a CDC scheme the premium should not be fixed indefinitely. It cannot in advance be provided with sufficient degree of certainty whether the premium is expected to be a cost-recovery premium in all cases in conformity with article 128 Pension Act.
For example, the life expectancy and the interest rate used in the discounting of obligations in the longer term, can vary from the life expectancy and interest rate at the time of determining the premium.
What is the maximum period for which the premium should be fixed for a CDC scheme?
DNB considers a fixed premium period of longer than five years to be irresponsible. Fixing the premium for a longer period this may lead to large factual deviations of, for example, the life expectancy and the interest rates used for discounting. The Actuarial Association (AG) and the Central Bureau of Statistics (CBS) publish revised mortality tables every two years and funds are obliged to work with the current life expectancy. Also, interest rates can change significantly over a period of five years or longer.
• Can a CDC defined contribution scheme an average premium on expected investment income, following article 28 of the Dutch Pension Act?
Yes, premium averaging on expected investment revenues in a CDC scheme is allowed, provided that the conditions of article 4 of the FTK are met. In addition to the requirement of ex ante cost recovery for the whole period is met.
For example, in the case of averaging based on the moving average of the interest rate, if in the chosen averaging period prior to initiation of the premium has dropped steadily before the fixed premium period, it is all clear that the cost-recovery premium will rise in the coming years.
The pension fund should take this into account when the premium is fixed. It is for the pension fund to demonstrate [to DNB] how this is done and whether it is adequate.
• Should a CDC scheme have the requirement of cost recovery checked annually?
Yes, but this check does not need to have consequences for the premium level during the fixed premium period.
It is therefore important that the pension fund shows in advance that there is a sufficiently small chance that the premium will not be a cost-recovery premium at some point during the fixed period.
In this analysis the pension fund can possibly take into account concrete control of the policy, such as a differentiated discount line, to ensure that the premium in any year is breakeven.
It is for the fund to demonstrate (to DNB) how it will comply with the legal requirements. Moreover, the split discount rate may not be used over the long-term. In any event, it is not acceptable if funds already assume that they have to apply an expected split discount rate to meet the requirement of cost recovery around the fixed premium period.
Applying the differentiated discount line is allowed only in exceptional cases and not for the entire fixed premium period.
• Should a fund that changes to a CDC scheme run an initial feasibility test?
Yes. The move to a CDC scheme is a significant policy change within the FTK. Therefore, the pension fund at such time has to run a new initial feasibility test.
*Source: Q&A’s pensioenfondsen – collective defined contribution (CDC) regelingen, DNB, 2013