Pensioners would have received between 1.5% and 3.6% in indexation in 2023 if the new defined contribution (DC) pension system had already been introduced, according to calculations by Aegon Asset Management. This is much lower than the average indexations awarded under the current defined benefit (DB) system.

Investment strategist Gosse Alserda calculated how pension benefits would have developed this year if the new pension system had been implemented in 2018.

Whereas pensions were up by an average of 7.3% in the first six months of 2023, according to figures by regulator DNB, pension benefits would have risen a lot less in both new DC arrangements – the collective defined contribution (CDC) solidarity arrangement and the so-called flexible contribution individual DC arrangement.

Last year, the reverse situation occurred as pension benefits in the new DC system would have risen by 7.6%, mainly thanks to good equity returns in 2021. Indexations under the current DB system did not come close to that level.

High pension increase partly due to looser indexation rules

The big difference in favour of the current system is partly caused by the looser indexation rules that had been introduced in the run-up to the transition to the new DC system.

If the old rule requiring funding ratios of at least 110% had still been in force, pensions would have indexed less, according to Alserda.

“I haven’t made exact calculations, but I expect that indexation would have been about two percentage points lower, at about five per cent,” he said.

Last year, investment returns were disappointing. While this was more than compensated for by an even sharper drop in the cost of pensions, in the form of a rise in interest rates, ultimately only a small pension increase remains in the new system.

Gosse Alserda

Gosse Alserda at Aegon AM

For the average retiree, the increase ranges from 1.5% to 3.6%. The exact outcome depends on whether and how much the excess investment returns are spread out over time to keep pension benefits more stable.

Alserda expects most pension funds to spread out returns over a period of between three and five years, although he expects this to be lower for the oldest cohorts of members who only have a short life expectancy.

Young people are better off

For working people, pension outcomes in DC are considerably better. Depending on their age, expected pension benefits increase between 20% and 112%.

In general, the youngest participants with the least interest-rate hedging saw the steepest rise in expected pensions.

“That’s because the new DC system allows for higher risk exposure to younger generations who can bear it. For them, expected benefits increase in line with positive developments in financial markets,” Alserda said.

He added: “Older people, on the other hand, can bear less risk.”

The flexible arrangement gives slightly better outcomes than the solidarity arrangement, because the former has a lower interest-rate hedge.

“In the flexible contribution scheme, interest-rate hedging via the matching portfolio goes at the expense of exposure to the return portfolio. That’s why we have chosen not to hedge interest rates at all for young members and to hedge less for middle-aged members,” he continued.

In the solidarity arrangement, however, young people can have an exposure of 100% of their assets to equities in combination with interest hedging because of the collective investment policy in this arrangement.

“Our calculations show that also for young people, an interest-rate hedge of 25-50% is optimal, because the volatility of the expected pension is reduced and members benefit from diversification effects,” Alserda said.

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