The Netherlands: Is this what our system needs?
Dutch pension reforms are constantly shortsighted. To be sustainable the system needs vision and decisiveness, argues Corine Hoekstra
In the last decade, economic and financial circumstances have put pressure on the Dutch pension system. Current market conditions and the effects of increasing longevity have shown that defined benefit schemes, with their high solvency requirements, are not as safe as we all assumed.
If we have learned one thing in recent years, it is that long-term guarantees are too expensive. Many external factors influence pension schemes, such as financial markets, longevity, ageing and legislation. These factors can all change dramatically between the start of the pension accrual and pension date, for example, the current low interest rates.
The Dutch government and its social partners have come to the conclusion that action is needed to preserve the collective pension system and to prevent a massive move to individual defined contribution schemes. Years of research by several commissions of wise men and negotiations between government and social partners finally led to the publication of a high level report in May 2012, with the purpose of creating a sustainable, collective pension system.
This report outlined a new solvency framework, FTK2, which was to become effective on 1 January 2014, but which has been delayed by one year.
In addition to the existing nominal pension contract which focuses on guaranteeing nominal pensions, the new framework offers social partners the possibility to opt for a real (indexed) pension contract. If a pension fund opts for the indexed contract, a complete and ‘clear’ contract is negotiated, in which it is decided beforehand which steps the pension fund managers must take.
A key element of this new contract is that the pension benefits are explicitly conditional. Market effects and the effects of increasing longevity will automatically lead to a revaluation of pension benefits.
These effects – positive as well as negative – can be spread over a 10 years. By spreading the effects of market volatility and longevity, the effect of any benefit cuts will be lower. The pension ambition is defined as a price-indexed pension, without any guarantees on or after pension date.
If social partners decide to continue with the nominal contract, the new framework imposes stricter solvency requirements than the current framework.
The report on the new financial framework also introduced a new standard for calculating the pension obligations – the ultimate forward rate (UFR). Although we are still awaiting the bill containing all elements of the new framework, the regulator, DNB, has already published a new rate-term structure for pension funds as of end-September 2012, which for the first time applies the UFR.
With this new rate-term structure, the basis pension funds use for calculating their future liabilities becomes less sensitive to market fluctuations. The effect is already noticeable; the necessary benefit cuts in April this year will be less drastic than expected. Good news for pensioners, but in the end, there is no such thing as a free ride, and younger members fear that they will eventually pay the price.
The report on the financial framework contains a number of measures that together form a well-balanced package that effects both young and old scheme members equally. Cherry-picking by the regulator is putting pressure on the already fragile solidarity between generations.
In order to keep our pension system sustainable, a transition from a nominal to a real contract is necessary, according to the government. However, moving to the new, real contract will not be a legal requirement – each pension fund and its social partners will have to decide for themselves the best option for the fund.
Also, accrued rights will not be automatically transferred into the new contract, thereby limited the short-term effects of the new real contract. Pension fund managers are, however, hesitant to decide on transferring accrued rights from a guaranteed, nominal contract into a conditional contract. It is feared that scheme members might start litigation to protect their rights, as such a transition might be considered as an infringement of property rights under the European Convention on Human Rights.
Now that the idea of a new framework has had time to settle, questions arise whether this is really what our pension system needs. The report leads to relatively small changes to the system, but introduces extraordinarily complex rules.
What the Dutch pension system needs in order to maintain sustainability is vision and decisiveness. However, our current government appears to lack any vision with regard to pensions. The long-term consequences thereof could be drastic. Reforms necessary to our pension system are constantly delayed.
Perhaps even more devastating for our system is that the current EET (exempt, exempt, taxed) rule will be restricted by lowering the tax friendly treatment for pensions savings.
Public finances might profit in the short term, but it will lead to a loss of (tax) income for the state for years to come. With this short-term outlook, the new government seems to forget that we are facing an even more structural ageing crisis. Expenses for old-age provision and other related areas, such as healthcare, will increase massively. Encouraging people to save more, using the EET rule, can help cover an important part of these costs.
It is time to start thinking outside the (pensions) box when drafting a future-proof pension system – one such example is incorporating healthcare and mortgage elements in pension schemes.
At present, some people end up with a high pension and a high mortgage when they retire. If we want a sustainable pension system and an acceptable level of healthcare in an ageing society, it is almost a no-brainer to somehow link pensions, healthcare and housing.
The IORP Directive offers this possibility. In 2009, the Dutch government was not prepared to discuss this possibility, but perhaps now is the time to rethink this stance.
Corine Hoekstra LLM, is a pensions lawyer at Bergamin & Gielink Pensions Law, Rotterdam. Bergamin & Gielink Pensions Law is a member of Ius Laboris, a global alliance of leading law firms providing specialist advice in relation to employment, employee benefits, immigration and pensions law