Netspar: Risk-sharing beneficial but could jeopardise Dutch schemes
Inter-generational risk-sharing at Dutch pension funds is likely to improve payouts, but it also runs the risk that participants will abandon the more poorly funded schemes, Netspar has warned.
Theo Nijman, scientific director and lead researcher at the Dutch think tank, said: “Participants could desert a pension fund with a low coverage ratio if they are no longer willing to pay a high contribution for recovery, which would mainly benefit pensioners.”
He warned that “discontinuity risk” could also occur if a poorly funded scheme’s sponsor goes bust, or if the government, with the new pensions system, introduces the option of freely choosing a fund.
Nijman, who is also Prof of pensions and risk management at Tilburg University, attributed the benefits of inter-generational risk-sharing to the fact that risk decreases as the number of participants increases.
“This, for example, could be used to increase investment risk, which leads to higher returns over time,” he said.
Nijman said the boost from risk-sharing could be as high as 4 percentage points, where profits are allocated to participants in a well-funded pension scheme.
He added that the benefit of risk-sharing decreased when it had to be shared among all future participants and current participants had to make extra contributions to build a financial buffer.
If the benefit were shared among all participants, including pensioners, it would account for at least a 1-percentage-point increase of the additional pensions income, Nijman said.
He said it was up to a pension fund’s board and the social partners to determine how the benefits should be shared among participants and pensioners.
Nijman added that the outcome of risk-sharing among various generations would depend on a pension fund’s financial position, and that a board should also take discontinuity risk into account.
He warned, however, that discontinuity risk would be difficult to assess and would differ for each pension fund.
“Pension funds should therefore not focus solely on the benefits of risk-sharing,” he said.
He added that the “prosperity boost” would be greater in many case for individuals who had considered personal preferences and circumstances and had made “sensible choices”.
A dozen Netspar researchers – including Lans Bovenberg, Eduard Ponds and Bas Werker – analysed the possible effects of inter-generational risk-sharing on behalf of the Dutch pensions sector and politicians involved in the creation of a new pensions system.
One of the two options for a new set-up comprises individual pensions accrual with collective risk-sharing – on investments and longevity, for example.
The other option is a pension contract – the “target contract” – in real terms, combined with degressive, rather than average, pensions accrual.