A changing landscape
Rajish Sagoenie and Martin Wouda comment on the fundamental changes taking place in the Dutch pension system
The Dutch pension landscape is changing rapidly and steps are being taken to make the system future-proof. We are not there yet, although we are on the verge of a number of significant changes that will affect the pension system. In future, it is likely that pension schemes will have fewer guarantees and more uncertainty.
A so-called ‘pension triangle’ – content, financing, and implementation of a pension plan – underlies occupational pensions and provides the foundation on which to overhaul the Dutch pension system. A major question is: who is taking what risk, when and, to what degree? In the creation of a new sustainable pension system, premium stability, insight into allocation of risk, and clear communication will play central roles.
• Content of pension schemes: Pension schemes are facilitated fiscally. This means pension premiums are untaxed but benefits are taxed. Due to government restrictions, pension plans have been reduced recently. Not all participants are aware that these cuts have far-reaching consequences for the ultimate payments.
In a recent study conducted by Marike Knoef, the high maximum accrual rate was assumed to be 2.25% but this has been lowered to 1.875% in the last few years. In addition, pensionable salary has been set at a maximum of €100,000 as of 2015 and many pensions have been reduced instead of indexed.
Researchers expect this will continue to worsen overall. According to Knoef’s study, 56% of the current population under 65 is not expected to attain a pension of 70% of their final salary. This used to be 49%. A pension is defined as the total income from state old age pension, supplementary pension, and the third pillar.
Only defined contribution (DC) plans are still possible beyond the €100,000 limit and on a voluntary basis. The expectation is that this maximum pensionable salary limit will drop further. As a result, pensions based on the pensionable salary above this limit – in consistent circumstances – will also drop. This pension reduction trend will lead to ‘distressing’ cases.
Perhaps a better option is complete fiscal facilitation of a so-called hybrid pension scheme, a combination of a defined benefit (DB) and a DC pension scheme. These hybrid plans are easier to administer and to explain, and are expected to eventually lead to a decrease rather than an increase of the 56% of pensioners who will not attain a 70% pension. If the €100,000 limit is reduced, we believe that mandatory participation above this limit should be reconsidered.
• Financing: Partially due to structurally low interest rates, higher life expectancy, and stringent solvency requirements (including the rising costs of guarantees), financing of pensions in the Netherlands is under increasing pressure. Rising premiums are making pension schemes expensive, and companies are searching for alternatives. These factors will lead DC and hybrid pension schemes to gain ground. The Netherlands also has a strong DB culture and a collective system in the second pillar. We therefore expect that collective systems will probably remain in future, with some type of solidarity and risk-sharing. The questions of who runs what risk, when, and to what degree, will play an important role and may lead to greater transparency and clarity of pension schemes.
“A so-called ‘pension triangle’ underlies occupational pensions and provides the foundation on which to overhaul the Dutch pension system”
A related subject is the sustainability of the average old-age pension. The main criticism is that young people contribute to the pensions of the elderly in addition to their own. In order to prevent one generation having to pay the bill for another, the transition will be complicated and expensive. According to the Bureau for Economic Policy Analysis (CPB), the cost for transition arrangements could be more than €100bn. The Dutch cabinet, meanwhile, wishes to end the ‘phenomenon’ of average premiums (one flat premium), effective from 2020, with or without a transitional arrangement.
• Implementation: Until recently, employers and employees had a choice between an insurer or a pension fund in the second pillar. Laterly, the premium pension institution (PPI) vehicle was added for the implementation of DC schemes. Premiums are age-dependent and take place via an age-dependent ‘lifecycle’. The expectation is that the number of PPIs will decrease, in part due to competition. However, investment options will increase after legislative changes.
In the near future, many insurers may offer and implement DB schemes as well as (collective) DC plans primarily through a general pension fund (APF). APF legislation came into effect in January.
An APF is defined by law as a pension fund and treated as such. This means that De Nederlandsche Bank (DNB) will set the same solvency requirements that apply to other pension funds. As a result, pensions with so-called ‘soft guarantees’ will be less ‘certain’. APFs are expected to grow in scope and quantity as existing clients of insurers with guarantee contracts voluntarily switch to them, and as employers become reluctant to pay the high guarantee premiums.
• Different advisory role: The advisory role will take on new importance in the choice of pension provider. Comparing the investment policy accompanying the ‘lifecycles’ with a (stochastic) scenario analysis can provide critical insights. Advisers are already responding by making the uncertainty of pensions more transparent and comprehensible.
• Conclusion: Our pension world is undergoing major changes, and plans will be different in the future as more pension risks are shifted from employers to employees. Pension schemes are expected to become hybrids or to take on more of a (collective) DC character, with fewer guarantees and greater uncertainty. But, there will also be more options to choose from in the implementation of schemes, not only for employers but also for employees and pensioners. Involved parties and decision-makers will have to start work on the pension awareness process now in order to take the right measures at the right time and where needed. Whatever change is coming, we must not forget that we are doing all this for the participants. Let us keep focusing on them.
Rajish Sagoenie is principal and managing director and Martin Wouda is consulting actuary and manager at Milliman in Amsterdam