Two major reports on pensions set a challenge for the incoming Dutch government, writes Liam Kennedy
Major reforms to Dutch pension legislation were effectively put on hold in March 2010 when parliament declared most reforms off limits for the out-going government after the collapse of the fourth Balkenende cabinet in February.
Yet two reports this year signalled important step-changes in Dutch pensions - both in the calculation of liabilities and in the social framework that governs the system. Implicit is that there is room for improvement and some possibly bitter medicine to take - a novelty for the country ranked number one in pensions according to the Melbourne-Mercer Global Pension index.
The mandate of the Frijns Committee, chaired by the former CEO of ABP Investments, was to assess the investment policy and risk management of Dutch pension funds.
Published in January, the Frijns Committee report proposes a transition from a nominal to a real assessment framework for pension liabilities, in recognition of the fact that pension funds have at least an ambition to uprate of benefits in line with prices over time.
The Frijns report also concluded that deficiencies in risk management had arisen due to a shortfall in the governance of funds themselves - the so-called information shortfall.
Kees Goudswaard, professor of applied economics and social security at Leiden University, chaired a committee of the same name, whose task was to assess the sustainability of the Dutch pension system.
His committee’s report, also published in January, concludes that the Dutch system is insufficiently prepared for the future because of increasing longevity and vulnerability of funds to financial risks.
In particular, the report continues, a solution could be sought either in a limitation to the ambition of the pension promise (in other words a cut in the level of benefit that is targeted) or by approaching risk in a different manner - or in a combination of the two. For instance, some rights could become more conditional in character.
As recognised in a 7 April 2010 letter written by Piet Hein Donner, the outgoing minister of labour and social security, to the lower house of parliament, these reports represent a roadmap for Dutch social partners.
However, in that letter of 7 April, minister Donner also made clear that there were four problems with the FTK solvency regime that needed to be dealt with: the relationship between the ‘real’ inflation ambition of pensions and the nominal character of the current FTK (as outlined in Frijns), an improvement in the relationship between risk and return, the removal of the unwanted consequences of volatility of cover ratios, and the fulfilment in practice of the 97.5% confidence level implicit in the FTK regime. In particular, liquidity risk, concentration risk and operational risk should be measured according to the 97.5% scale.
On 24 August 2010 the social affairs committee of the lower house of parliament discussed the recovery plans of pension funds, as specified in the FTK after Donner ordered 14 funds to cut benefits from January 2011 in recognition of their poor coverage ratios.
Following parliamentary elections in June, the incoming government has the tricky task of putting these controversial recommendations into some form of legislative package. Particularly controversial will be the incorporation of a real assessment framework for the FTK. However, at a conference in June organised by IPE’s Dutch-language sister publication IPN, the two Dutch pension representative bodies, the VB and the OPF, formally accepted five recommendations to the new government:
• A pension arrangement is not an insurance contract: it cannot provide iron-clad guarantees and can only share risks. However, a contract based on risk sharing also requires strict supervision to ensure that the risk sharing agreement is honoured.
• Communication regarding solvency in real terms should be made mandatory, for instance by means of a real solvency ratio, to be published regularly.
• Provide a legal framework for ‘defined ambition’ (DA) arrangements, also called ‘target pension arrangements’. In these arrangements guarantees are replaced by targets, while accrued rights are subject to adjustment as necessary.
• Introduction of ‘target’ or ‘defined ambition’ (DA) arrangements requires reliable communication of expected pension results based on prudent economic expectations.
• Promote a responsible business model for financial services providers in the second pillar. Discourage pension ‘sharking’ and usurious practices.
The concept of ‘defined ambition’ is a strong candidate for incorporation into forthcoming legislation so that ‘hard’ entitlements become ‘soft’ entitlements in future.
Other important elements of pension reform have remained on track, however. The Multi-OPF Law, to allow company pension funds to join forces by creating joint boards but without legally merging their funds, came into force in July 2010. The number of company pension funds has declined by a third in the past 10 years, and many sponsor companies have opted for insurance solutions for their pension liabilities as a way to stem the rising, and unpredictable, costs of running a small, independent pension fund. The multi-OPF provides an alternative to this.
The company pension fund association, also known as OPF, has now started a ‘dating service’ for company pension funds looking to merge functions. This is set to focus on the some 110-150 such funds, of a total of 500, that face urgent challenges.
In its bid to compete with the likes of Ireland and Luxembourg for cross border pension business, two new types of fund are at different stages of the pipeline. The first, the PPI, or premium pension institution, was approved by the lower house of parliament in July 2010. Providing defined contribution type benefits, the PPI is carefully calibrated not to compete with the insurance industry, and so may not offer annuities or biometric risk coverage. Senate approval is pending.
The second planned fund vehicle is the API, or general pension institution, which be able to offer defined benefit and hybrid arrangements. It is further behind in the legislative process, although the out-going government has outlined a timetable for legislation.