The two options for the pension system are not the solution, according to Sweder van Wijnbergen. The Netherlands should look instead to the model adopted by the TIAA in the United States
Our pension system is ailing, so must we reform it? Move to a defined contribution (DC) system without sharing the risk between generations? Or maintain the present defined benefit (DB) system, with risk sharing but little transparency? The Social & Economic Council (SER) is increasing the confusion with its proposed intermediate variants, which it put forward without making a choice. The state secretary, Jette Klijnsma, has decided that there is insufficient support and is only streamlining the existing system, and has been firm on the actuarial interest rate.
Now that the low-interest-rate period is coming to an end, pressure to reform is lessening. Janet Yellen, the US Federal Reserve chair, talks of an exit from ‘quantitative easing’ and the markets are counting on US growth. Higher interest rates mean higher coverage ratios. As a result, the threat of a cut is reduced, as is the pressure to reform.
Demographics and interest-rate sensitivity are not arguments for reform. Demographics affect all pension systems, since they all do the same thing – transfer income from people working to those no longer working. Something has to happen if this relationship falls out of balance. The Netherlands has solved the problem by raising the pensionable age gradually, so that the balance between those working and those not has been restored.
DB is interest-rate sensitive, but so is DC. The interest rate level is crucial at the point where DC accounts have to be converted into a pension.
Is Klijnsma’s streamlining adequate for this? The average contribution level remains a problem. Young people pay too high a contribution, older people too little. The implicit debt of the old to the young equals €100bn, according to the Bureau for Economic Policy Analysis (CPB). This debt arises because young people sacrifice their investment returns to finance payments to older people.
But how accurate is that figure? The CPB assumes a real interest rate of 3% in making its calculation. A secure rate of interest is more appropriate, however, particularly for the calculation of the coverage ratio. And that interest rate is closer to zero than to 3%. At zero, the debt disappears; there are no investment returns to give away.
So the mandatory average contribution rate can be abolished and, with it, an obstacle to the transition to new contracts disappears. If coverage ratios move towards 100% with the rising interest rates, the discussion about the distribution of the existing buffers will also no longer apply because they will no longer exist.
The current pension system fits poorly with a changing labour market. The self-employed often leave the average contribution system at an unfavourable moment and build up too little pension provision. The transfer of accrued benefits causes problems when they change jobs. With too much coverage you do not get the buffer; with insufficient coverage you cannot get by without drastic cuts. The system of intergenerational risk sharing built into DB then breaks down. The SER’s hybrid variant proposals allow this to continue by introducing unclear buffers.
The transition to collective DC without further buffers solves this problem, but exposes individuals to financial market and inflation risk. And that is what causes considerable discontent. But there are less risky options than individual accounts. Complete security is impossible, but partial security is, as shown by the American TIAA pension plan. This is a system of hard and soft rights that match the security needs of old and young. Young people can bear more risk than older people; TIAA provides for this by gradually converting soft rights into hard rights. This is possible at market price, provided within a nominal framework. Real hard rights are preferable, but not possible as long as the Dutch government does not issue inflation-linked debt securities that can serve as collateral for real commitments.
But with a nominal framework, we are rid of impossible promises, and accommodate the increasing need for security with age without indissoluble conflicts about ownership of financial buffers with undefined proprietary rights. The TIAA concept of security is, moreover, understandable: a person’s minimum needs match the level of hard rights that they build up.
Our pension system is not about to collapse. Look, for example, at nominal combi-contracts, as with TIAA. These will link our pension system better to the changed labour market.
Sweder van Wijnbergen is professor of economics at the University of Amsterdam. This article first appeared in Pensioen Pro
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