Keith Ambachtsheer, Director emeritus, Rotman International Centre for Pension Management
The 2008-09 financial crisis raised fundamental questions about the twentieth century sustainability of the Dutch pension system – and, for that matter, of every other pension system. As a result, the search for a sturdier pension model commenced in 2010 and is still ongoing.
Fortunately, a consensus about the fundamental problem is beginning to emerge, as is a solution to it. The problem is the Dutch tendency to love ‘solidarity’ too much. Specifically, pooling diversifiable risks such within-period investment risk and within-cohort longevity risk are welfare-enhancing and should be facilitated in pension design. But the Dutch have also tried to pool non-diversifiable multi-period investment and longevity risks, and that can’t work, even in solidarity-oriented countries such as the Netherlands. Eventually, younger generations begin to lose trust in ‘faux solidarity’ pension arrangements when they realise they are the risk underwriters.
If ‘faux solidarity’ is the problem, abolishing it is the solution. The new Dutch pension model will have clear property rights and be fair to the young and the old alike. It will recognise the Tinbergen Principle that achieving two goals requires two instruments – first, a long-term return-seeking fund to achieve the affordability goal and, second, a shorter-term life-annuity balance sheet to achieve the payment safety goal. A default protocol based on the life-cycle theory of personal finance will guide plan participants towards their pre-defined pension ambitions by first investing in the first and then gradually transitioning to the second as they age. Managing this transformation will require strong leadership. I am betting it will emerge soon.
Peter Borgdorff, Director, PFZW
It is our ambition for our pensions to maintain their purchasing power. With the new FTK, this will become increasingly difficult to achieve. But the new FTK includes a number of improvements. Our dependence on daily market values will decrease, which allows both for more stable coverage ratios and pension contributions.
Further, we can now spread financial setbacks over a 10-year period. These measures create tranquility and clarity, which is good. PFZW aims to provide its participants with pensions that have a durable measure of purchasing power but the government’s decisions will have a deleterious effect here. The desired nominal security and stability, in conjunction with the requirement for sustainable indexation, comes at a high price.
Building up adequate reserves is of great importance but at the same time we must maintain a healthy balance. An income-based pension with a sustainable measure of purchasing power does not equal absolute security. In fact, such security will prove unaffordable. Consequently, for the coming years, we will not be able to apply inflation indexation to our pensions. In part, this is also because smoothing financial setbacks over a 10-year period will slow down the process of catching up with missed inflation indexation. As a result, the participant will end up paying for the government’s plans by means of a structurally lower pension.
Roland van den Brink, Founder of consultancy TrigNum, former managing director of PME
The key problem is the transition from a system based on social values towards a technocratic insurance-like approach. This has led to alienation and mistrust among participants, disillusionment with most working within the sector and decreasing support from wider society. The new framework is proof of the above as it is not based on social needs or existing values but solely on financial theory. The latter is a sound basis but becomes a problem when it is applied for time horizons of more than 25 years and because of the size of the assets.
Dutch pension savings are roughly twice GDP, and to fully rely on a theoretical discounting method for a huge pot of savings is, in my humble opinion, inappropriate. Many people feel this but few speak up.
What should be done? It isn’t realistic to stop the forced movement towards a maximum of 100 Dutch ‘life insurance’ companies governed by far-reaching, detailed regulation. But we should communicate more clearly: to the over-45s that for the majority of schemes inflation-proof benefits are ‘game-over’; to youngsters that decreasing the contribution level will lead to substantially lower second pillar pension. Those responsible should be made aware of the side effects of the current transition to a technocratic, insurance-like system – such as the risk that stakeholders lose interest and are no longer engaged, and of an environment where box ticking replaces true responsibility, increasing the risk of fraud. And all other IPE readers should be prepared when the (social and interest rate) bubble bursts.
Tim Burggraaf, Partner, Mercer Rotterdam office
The pension system no longer seems aligned with current social reality. Employment is increasingly based on short-term contracts, younger generations (believe they) are more financially aware of their situation and there is scrutiny of traditional financial institutions.
The current second pillar is built on a high level of solidarity and on long-term employment relations, which explains the financial techniques that are applied, such as average premiums for all members. Next to that, and given the limited trust in the system, there is a noticeable call for the abolition of semi-mandatory pensions, even though these systems in general offer better outcomes for members.
This also explains why DC-based premium pension institutions (PPI) are gaining ground; the number of DC plans is steadily increasing, with some large employers leading the way. The highly DB-orientated system is trying innovate with models such as defined ambition or collective DB pensions, which are effectively DC plans with residual elements of solidarity. The industry needs to strike a balance between motivating members to take responsibility for their pension and relaxing the tightening grip in which these members are currently held.
Paul Gerla, CEO, Kempen Capital Management
Despite criticisms, the FTK has worked well because pension savings are at an all-time high. However, many pension funds struggle with low solvency ratios and are still forced to hedge interest rate risk at historically low interest rate levels. The strong focus on nominal guarantees leaves pension funds badly positioned in a scenario of rising interest rates.
The Dutch defined benefit system worked well for a long time when demographics were in its favour. One of the main problems is the supposed solidarity between young and old. Many complex rules have been devised to manage this continuous challenge, such as the ultimate forward rate approach, and this added degree of complexity further reduces the public’s understanding of how its pension is established.
Some measures in the FTK legislative proposal provide an opportunity to take a longer perspective. The focus should be on long-term, absolute return, rather than short-term interest rate risk. There should be an overall reduction in complexity of the pension product to gain trust from members.
Second, a collective life cycle approach is a proven method to deal with demographic risks. Pension funds should use life cycles to organise pensions collectively with elements of solidarity – this is not limited to individual defined contribution. Nevertheless, at the end of a life cycle approach a (nominal) pension guarantee, and some form of FTK, remains important.
Erik Goris, Director of strategic consulting, PGGM
The financial sustainability of the system will be improved with the FTK. Our pensions will be better defended against the consequences of an ageing population and future volatilities on the financial markets. This is good news. However, the new FTK still has some technical discrepancies. The discord between nominal security and an indexation ambition remains. And by introducing future proof indexation, the control rules will become more complex still. The pension product will become more complicated to explain.
These technical discrepancies could perhaps be solved within the current system. But a more fundamental problem is emerging – social sustainability. Increasing job mobility, increasing heterogeneity, a desire for freedom of choice and the call for transparency will put the current system under pressure. These fundamental problems cannot be addressed within the current DB-based system. A culture change is needed and we will help ourselves greatly if we dare to think in terms of a DC-type of solution. Indeed, such a system answers better to today’s social questions. Preserving the current system’s benefits of collectivity and risk sharing will be the challenge.
Rudolf Hagendijk, CEO, MN
The economic crisis has re-emphasised some of the shortcomings of the existing FTK. For example, the volatility of coverage ratios – due to continuous turbulence on the financial markets and the dependence on daily rates – has led to substantial decreases of pension benefits for scheme participants. Further, contribution policies have come under heavy pressure. The past years have proved that risks were not acknowledged well enough in the existing contract, while scheme participants were still relying on guaranteed pension benefits.
The necessary cut-offs have taken everyone – participants and professionals – by surprise. The new FTK addresses many of thse risks and concerns. Recovery concepts have been redefined to better handle potential setbacks. Setting new standards for the required average coverage ratio is an important step towards more effective risk management for funding policies, also by dampening the disproportionate impact of daily rates.
The standard 10-year recovery plan can now be re-assessed on an annual basis and no longer requires a fixed end-date. Contribution stability will improve thanks to the application of dynamic 10-year interest rates. Greater clarity in advance about possible measures in the case of financial shocks will increase transparency for participants about developments that might affect their pensions.
Theo Kocken, CEO, Cardano
The new regulations (FTK) are an improvement of the existing regulatory framework but at the same time the Dutch pension system is unsustainable and demands a fundamental change, not gradual adjustments. The new FTK regulations are an improvement in that deficits are smoothed over a 10-year period, so pension income adjusts slowly and less painfully to deficits (and surpluses). But this ‘collective DC’ has serious design flaws that require a radical change to the system. We need to preserve the merits of the Dutch system – longevity risk sharing, mandatory saving, market risk exposure in accumulation and pay-out phase – but get rid of the unsustainable elements like the pool of people insuring each other against systemic market risks (the fairy tale of intergenerational sharing of market risks).
To achieve this, the Dutch need to move towards a ‘dual system’ with capital and annuity components. Active members use their contributions to accumulate capital by buying units in an investment pool that can generate returns. In the pay-out phase, longevity risk is shared in annuity pools but without abruptly converting all accumulated capital into fixed annuities. This is the required grand design change, under construction in the Netherland, that will make the system suited for the next 100 years.
Philip Jan Looijen, Managing director, ING Investment Management
Let’s first conclude that the Dutch pension system is functioning remarkably well. A vast majority of the population is saving for pensions in an efficient and professional structure. However, changes in society mean that three issues should be solved. The first is the lack of clear ownership of pension assets, especially the surplus. This can no longer stand in a society where people demand transparency and the ability to take responsibility for their own financial future. Giving people an individual pension savings account will solve this, and can be combined with a structure that has the same efficiency and effectiveness of the current pension system.
A second issue is that DC legislation hinders an optimal investment and savings policy over the life cycle. The mandatory purchase of an annuity at pension age limits return potential, both before and after the pension date. This requires a change in legislation, which is currently being studied by the government.
The third issue is legacy. The pension system is contaminated by constructions like the average premium system and specific transition arrangements for certain groups, which mean vested interests have become big road blocks on the journey towards a future-proof system. This ultimately requires leadership and courage from all parties involved.
Hans Rademaker, Member of the management board, Robeco
The future of the current Dutch pension system will be hard to preserve. The reasons are well known: poorly defined ownership of individual claims; average contribution rates; and the lack of ex-ante fairness of the system. The new regulations, which will come into effect in 2015, will not solve these issues. The changes are more of an evolution, rather than the necessary revolution.
Several large pension funds are looking into a blend of the best of the existing defined benefit and defined contribution systems. This represents a more individual system during the build-up phase, while the decumulation phase will be based on a collective system and will also contain longevity risk sharing.
Looking ahead, the main issue will be the transition path, as this needs to be fair. However, this is a challenge; changing the average premium system will be complex and expensive. In the meantime, the new regulations unfortunately still focus on nominal claims and will become even stricter. This will hamper some funds in making the necessary adjustments to pursue their ambitions.
Alfred Slager, Professor of pension fund management, Tilburg University
There is no coherent view on where the pension sector should be heading. In a short span of time, solvency requirements have been raised substantially and also the bar for trustees to govern pension funds. While this improves the solidity of pension funds overall, it is also an implicit call from politicians and regulators to speed up the consolidation in the pension sector.
A certain minimum size in running a fund is a good, efficient thing to have. However, without a clear vision on consolidation, the sector might drift towards an outcome with unintended consequences: a small number of pension funds managed like large financial institutions, potentially stifling much needed innovation. This might re-introduce macro-economic financial instability issues encountered with banks and insurance companies a few years ago.
Above all, the development of a coherent, long-term view is needed on where pension funds are heading, giving participants much needed comfort that funds are not turning into a political playground. The Pension Federation should have a far more visible role in shaping this view, regaining some of the ground lost to politicians and regulators.