Shades of grey on Dutch CDC
Dutch collective defined contribution is mostly a uniform concept, but with important distinctions
• IFRS changes triggered the introduction of CDC in the Netherlands more than 10 years ago
• It is not recognised as a separate legal concept
• While it is seen as DC from an accounting perspective, the Dutch regulator usually regards CDC as DB
• Large company schemes have shifted to CDC in a various ways
• The Dutch system overall can be seen as CDC
It was the introduction of the employee benefits directive IAS19 in 2005, as part of the International Financial Reporting Standards (IFRS), that triggered the start of collective defined contribution (CDC) in the Netherlands. Under the new accounting rules, companies had to carry the liabilities of their defined benefit (DB) arrangements – still the predominant pensions contract in the Netherlands – on their balance sheet.
Firms wanting to offload their liabilities, switched to a pensions contract with a fixed annual contribution – initially for a five-year period, but nowadays often for a one-year term – for both employer and workers, to qualify as DC under IFRS. Sponsors often paid their pension fund a one-off extra contribution when they changed from DB to CDC.
Under the new concept, they were exempt from paying additional contributions to fill any funding gap. Pension funds, in turn, no longer have to refund the sponsor in case of a funding surplus.
The employer also had to establish a system for determining the contribution, aimed at a set pension level. The method is not permitted to have a link with financial circumstances in the past in order to exclude any financial risk for the employer. It could either be a fixed percentage of the combined (pensionable) salaries, or a fixed formula for the annual actuarial contribution for the agreed level of future benefits. The age of a scheme’s participants and the interest level are usually also part of the formula. In addition, the CDC contract may only comprise conditional compensation for inflation.
The CDC contract offered the sponsor predictable and manageable costs for its pension obligations. However, it shifted all risks to workers as a group, whose members lost their guaranteed pension as their future benefits would largely depend on interest rates and the investment performance of their pension fund. If in a given year the premium is insufficient, the pension claims for that year are reduced.
That said, the notion of a pension guarantee in pure DB arrangements is also relative, as Dutch pension funds can apply rights cuts in case of under-funding. And even in DB, indexation is typically conditional, as it depends on investment results.
As CDC in the Netherlands has evolved from DB and DC from the IFRS perspective, it does not have a separate legal status. The Dutch Pensions Act does not recognise the concept as a separate pensions contract.
CDC is not covered by national or international accounting rules either, notes Corine Reedijk. senior consultant for asset-liability management at Aon Hewitt. “For example, it doesn’t exist in the Generally Accepted Accounting Principles [GAAP] in the US,” she says.
According to Reedijk, the fact that CDC does not exist in the Dutch Pensions Act does not pose problems in practice, “as it has only been introduced because of its accounting consequences”. Under IAS19 the concept is generally accepted by auditors, she said.
Although from an accounting view CDC arrangements classify as DC under IFRS, they are actually DB, as they target a certain benefits level. Therefore, the supervisor De Nederlandsche Bank (DNB) usually considers a CDC plan as DB.
However, depending on the specifics of the arrangements and a pension fund’s communication with its participants, there are exceptions, says Wichert Hoekert, senior consultant, retirement solutions at Willis Towers Watson. “For example, if already at the start of a five-year contract period the expectation is that the set contribution level is insufficient to achieve the pension goal, DNB classifies CDC as DC.”
According to Hoekert, Dutch CDC has a quite uniform structure. “The main differences are in the system for setting the contribution level. Either pension funds apply a fixed contribution or they use a fixed formula. And some schemes have a dedicated reserve to equalise premiums if the fixed contribution is insufficient in a given year.”
The pensions contract of individual pensions accrual combined with collective risk-sharing – still being assessed by the Social and Economic Council (SER) as the potential backbone for a new pensions system – can also be considered as CDC, as it is collective in its risk-sharing and DC in the accrual phase. However, the SER is allegedly also looking into the options of a pensions contract under real terms again, as the trade unions insist on retaining the principle of collective pensions accrual.
CDC in practice
• In 2006, SPF, the sector scheme for the railways, was one of the first Dutch pension funds to switch from DB to collective DC. It simultaneously switched from final salary to average salary arrangements.
At the time, SPF pointed out that the application of the new accounting rules would have had an “enormous impact” on the balance sheet of its main sponsor, the Dutch national railway operator NS, with pension liabilities of €10bn against the company’s entire assets of €6bn. It said that it had assessed the risks for its participants as “low”, because of the pension fund’s then coverage ratio of 160%. Moreover, SPF’s new maximum contribution of 14% was much more than the 1.75% it paid under the DB plan, it argued.
• In 2014, two new pension funds – ING CDC and NN CDC – started for new pensions accrual after ING had divided into ING Group and NN Group, leaving the DB Pensioenfonds ING as a closed scheme. Both new CDC funds are now properly funded, with coverage ratios of 117% each at March-end.
• In the following year, Unilever closed its DB scheme, Progress, to new entrants and continued pensions accrual at a new pension fund named Forward. Thanks to a starting capital from the employer, Forward’s coverage ratio stood at 141% at the end of March.
• In 2013, Shell Netherlands started up a DC scheme (SNPS) with a collective element for new employees. Although the paid-in premiums are individually invested through lifecycle strategies for the account and risk of participants, they can receive benefits through a drawdown system, with the remaining assets collectively invested.
At present, almost all large Dutch company schemes have adopted CDC. Furthermore, in the opinion of Hoekert, virtually the entirety of Dutch pension funds overall can be seen as CDC arrangements as their pension promises are conditional. He says: “Most pension funds have so many older participants, that the premium as steering instrument is insufficient to make up for any deficits. If returns on investments are not sufficient either, pension funds will reduce indexation and can even cut pension rights.”
In his opinion there are shades of grey between pension funds that consider themselves as CDC and schemes that de facto carry CDC arrangements. “In general, the older their participant population is, the closer their pension plan reflects CDC,” Hoekert says.
According to the consultant, nowadays no more than 10 companies still have a duty to fully fill in a funding gap at their pension fund. “They are often multinationals reporting under US-GAAP, who usually believe that they can generate better returns than their pension fund. However, many firms have bought off this obligation and replaced it with formal CDC.”