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Condemning ‘beautiful’ Dutch pensions

The Netherlands’ Social Economic Council (SER) has proposed a ‘macro-stable’ discount rate for pension liabilities. This new discount rate would apply to real, conditional pensions – a new type of pension contract favored by the SER that would replace existing nominal guaranteed pension rights.

The SER – its 33 member council evenly split between Crown-appointed expert members, trade union and employer representatives – expects real conditional pension arrangements to lead to a more stable pension system. The proposed discount rate would take inflation expectations and risk premia into account and thereby enhance the new arrangement’s  stability.

In the same report the SER cautions that, as expected inflation and risk premiums “are not immediately measurable quantities” such a discount rate may give rise to different interpretations and selective application.

The council warns that the new discount rate must not have “unintended generational effects”.

According to Lans Bovenberg, professor of economics at Tilburg University and one of the expert contributors to the SER report, the proposed discount rate dovetails with the discounting method put forward in the pension act, prepared by the previous Dutch administration. With regard to real pension arrangements, the outline provides for an indexation discount and risk premium ‘mark-up’.

The new element within the proposal is that it wants inflation expectations and risk premia to be conditional on macro-economic circumstances. During times of economic recession accompanied by low nominal interest rates, low inflation expectations and high risk premia, the SER envisions a low inflation discount and high risk premium markup; during strong economic growth periods the situation might be reversed.

Bovenberg believes this will lead to a more stable discount rate, which might entice pension funds to abandon the old arrangement and switch over to the new, real pension arrangement.

Bovenberg concedes that setting the inflation discount rate and risk premium markup involves a subjective decision making process. “My proposal would be to charge a committee of experts with the responsibility of determining how the risk premium varies with different macro-economic circumstances, where the interest rate should be taken as the most important variable. Whenever new economic insights necessitate adjusting the rules, any such adjustments should leave the value of past accrued pension rights untouched, so as not to affect the funding rate,” he said.

Cardano chief executive Theo Kocken is critical of the proposal. He rejects a variable risk premium as “an unrealistic concept based on wishful thinking”.

He notes that declining interest rates do not necessarily lead to higher risk premiums – case in point, Japan. The country’s interest rates have been low for 25 years. We, too, may end up slogging through one or more ‘lost decades’ as a result of plummeting interest rates.

Secondly, risk premium forecasting is akin to reading a crystal ball. And third, installing a committee of experts to value risk premiums  – including in relation to inflation expectations – introduces a subjective element into the accumulation and division across generations of pension savings, Kocken says.

“However well-intentioned, I am convinced that this would abolish the last remaining vestiges of public faith in our beautiful collective pension system,” Kocken adds. “A variable risk premium may fit in the Dutch tradition of consensus-based political decision-making, but it is out of touch with society’s call for transparency and objectiveness in dealing with our pension savings.”

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