As rare as black tulips
Pure-bred defined contribution (DC) corporate pension schemes managed by pension funds remain as rare as black tulips in the Netherlands. Most DC schemes have been grafted on to defined benefit (DB) schemes to create a Dutch speciality – DC hybrids.
For cultural and historical reasons DB schemes have flourished as the dominant type of corporate pension plan, both in terms of employees covered and assets under management.
Jeroen Steenvoorden, the director of the Dutch Association of Company Pension Funds (OPF), explains: “One reason for the predominance of DB among occupational pensions is that in the past most of the industry-wide schemes were DB schemes. So even if you had your own company pension scheme in an industry sector, these schemes had to be at least equal to the industrywide schemes.”
Another reason is that the Netherlands has been able to modernise its existing DB schemes. “Transferability, for example, is not an issue in this country. If you move from employer A to employer B then you can transfer your pensions rights to your new employer,” he says.
Even the drive to control rising pension costs has been achieved by a shift from final salary to average salary schemes rather than a move to DC. Around a third of Netherlands’s DB schemes have made the switch to career average in the past few years.
However, Steenvoorden says the OPF does not favour DB above DC in its lobbying. “As an association we don’t prefer one system above the other. We think the type of scheme should fit in with the organisational structure and the company policy both DB and DC can be appropriate if they fit the situation.”
DC schemes likely to be more appropriate to new industries are ones like IT, which have a young and mobile labour force. “It fits very well with human resources policies of these companies to have a DC scheme, especially if the company is a subsidiary of an Anglo Saxon company.”
Steenvoorden says it is still difficult to design a pure DC scheme on the lines of the US$401(k) plans in the Netherlands, chiefly because of the bias of the legislators towards the DB system. “Pension law and tax rules for pension funds are based on a DB type thinking. The legislators think and dream about DB schemes and they then fit their laws to DC schemes.”
However, cracks may be appearing in the DB dyke. Hans Nibbering, partner at Palladyne Asset Management in Amsterdam says: “There is less solidarity today. Over the past five or six years young people have become more individualistic, more Anglo-Saxon. With growing wealth, Labour politics has less of a hold.”
This is reflected in the market place for pensions. “We are beginning to see some cracks in the existing structure. The smaller companies are more likely to arrange pensions for their personnel directly instead of linking up with the existing pension fund schemes. Of course the large pension funds will try to keep the money in but it will become more difficult to do that.”
One change that could add to their difficulties will be the government’s plan to allow non profit-making organisations to leave the large industrywide pension schemes if the schemes under perform over a certain period. However, this is unlikely to lead to a wholesale switch to DC, says Nibbering. “We still have a background and a history of taking care of people. It’s not like America where if you consume everything today you’re on the street tomorrow. The government will keep in place specific rulings and I think that will translate into a combined defined benefit and defined contribution system with DB at the base and DC on top of it. In this way, people are protected from consuming everything today and therefore creating a problem for others in the future.”
This is effectively the Dutch approach to DC: hybrid schemes where a basic DB scheme is topped up or supplemented by a DC scheme. The DB element offers security but no flexibilkity or investment choice. The DC element offers flexibility and investment choice but no security. However, there are drawbacks to this arrangement. Members of hybrid schemes whose income is above the threshold are compelled to take on inbetsment risk that they may not want.
A new DC hybrid pension fund introduced by ABN AMRO Bank attempts to get round this problem by offering the option of investment choice irrespective of income. Lex Heijnis, manager of the new fund, says the scheme has been designed to combine the most attractive features of DB and DC systems: “It combines the traditional care and solidarity function of the DB scheme with the possibility of flexible and individual options in a DC scheme. The employee alone selects what best suits his circumstance, regardless of their income. “
Each month the bank pays an age-linked and income-linked premium to the pension fund on behalf of an employee. If the employee decides to pay all the premium into the standard provision, then they will be promised a certain pension on the retirement date. The fund and employer bears all the risk.
Under the new scheme, the employee can also choose to invest a part of the premium in individual investment funds. For that part of their accumulated pension, the employee takes on all the investment risk, and can no longer claim the security provided by the standard provision.
The clear demarcation line between the risk borne by the fund or company and of the risk borne by the individual may become blurred in the future. In the new pensions law that will be discussed by parliament in the spring, the government is proposing that companies that have a DC scheme with investment options must guarantee to pay out at least the premiums that have been paid in.
Some pension providers have anticipated this development with new products of their own. Robeco, which provides its Flexioen DC plan to 85 pension fiunds in the Netherlands, launched a guaranteed fund called KapitaalPlus in November.
KapitaalPlus is a savings account linked to an options fund. Every quarter, the interest from the savings account is paid into an options fund. When the options expire, half their value is paid into the savings account and the other half is used for further participation in the option funds, together with the interest of the savings account.
Ad van Hulst, manager of institutional business development at Robeco Asset Management in Rotterdam, says: “The aim of using options is to reduce the volatility. So it’s a very neat way of achieving guaranteed investment.”
However, he points out that guaranteed funds could limit investment choice. “Whose responsibility is it if the member is investing unwisely? Until now it is the individual. But what will happen when the new regulation comes in? What is to stop someone investing 100% in an emerging markets fund. If it goes wrong the company pays. If it goes right, the individual benefits.”
Van Hulst believes that this will dissuade companies from offering anything the standard ‘default’ funds with a balanced asset mix. Whatever happens, guarantees seriously weaken the idea of a DC scheme, where investment choice is the chief attraction. Whether this will further slow the development of DC in the Netherlands remains to be seen.