The Dutch affinity with defined benefit schemes has limited the take-up of defined contribution, writes Nina Röhrbein. Could the PPI vehicle change this?
Defined contribution (DC) schemes made up 5% of the Dutch pensions market in 2008, according to the Dutch Central Bank. The latest statistics show that fell to 4.6% in 2011.
As DC pension products from insurance companies are not included in those figures, they are slightly misleading, but there is no denying that the majority of Dutch employees - 87% - participate in a defined benefit (DB) scheme, compared with only 13% that belong to a DC scheme.
However, the rise in the volume of DC contributions (premiums) from 1% in 2008 to 1.3% in 2011 signals the advance of DC, as DB schemes close and hybrid schemes are lowering their DB threshold.
"The Dutch DC market is growing, albeit at a slow pace," says Pieter Kiveron, managing director of the Holland Financial Centre for Retirement Management. "The market is, to a large extent, regulated by collective labour agreements, which is why there is not much room to manoeuvre through mandatory participation. The unions dislike DC, particularly individual DC, although the collective DC market now boasts about 30 schemes. Employers, on the other hand, fancy DC because, according to international accounting standards, these schemes cause less volatility on the sponsor's profit-and-loss account."
The slow growth in the DC market is largely attributed to the country's affinity with the solidarity and security of DB schemes. But with corporates such as Shell and Rabobank switching to DC, others will follow, especially since running costs of pension schemes have been increasing to around 17% of an employer's overall budget over recent years.
"But the money from industry-wide schemes is unlikely to shift to DC, as industry-wide funds are not accounted for in the balance sheets of the participating employers," says Tim Burggraaf, principal at Mercer in the Netherlands.
Another obstacle to the advance of DC is the rigidity of the Dutch pensions legislation. "Once participants reach retirement age, they have to buy a lifelong annuity with their accumulated capital," says Kiveron. "This means locking in their entire pension capital and the yields on their DC investments for the rest of their lives with one provider. Other countries have more liberty in deciding when to buy longevity and participants are able to withdraw from their capital in the meantime. If you take into consideration the key characteristics of the Dutch system - mandatory participation, collective organisation and solidarity over the generations, it is always leaning more towards collective DC or defined-ambition plans."
In January 2011, the government created a third alternative to DC pension funds and insurance products - the Premium Pension Institution (PPI).
Three parties were initially granted a permit for PPIs - asset manager Robeco as well as pension providers BeFrank and Brand New Day. Over the past couple of months the number has almost tripled, as insurance companies and asset managers launched their own PPIs to create a total of eight providers.
"PPIs could be one of the accelerators of the DC market because they are considered cheaper and more transparent," says Burggraaf. "Employers have come to the conclusion that having DB and DC in one fund is a bad idea because ring-fencing is not allowed in the Netherlands. This leads to cross-subsidising between the DC and DB members or, more precisely, DC members subsidising DB benefits. PPIs could be the alternative."
PPIs target mainly companies that do not have access to industry-wide pension plans and in the past were only able to access insurance solutions.
Although from a technical point of view there is nothing a PPI adds to what a DC scheme with an insurer did not already offer, the PPI offers a more unbundled approach. "Theoretically you can have a contract with one administrator, with another insurer and another investment management company to manage the individual assets," says Edwin van Tricht, marketing director corporate clients at ING Insurance Benelux.
"The PPI is regarded by the public as a new vehicle, without the heritage of distrust which has tarred existing providers of pensions," adds Kiveron. "Furthermore, it is designed to facilitate cross-border pensions, and at least three of the current eight providers already actively promote the PPI outside of the Netherlands, although the PPI has only had its licence for just over a year. There is also interest by foreign providers to serve their European customers with a vehicle that is transparent and does not fall under Solvency II."
Kiveron expects a market of 24 PPIs by July 2013.
According to Burggraaf, the current DC market may not be large enough for the existing and future PPI providers, and some are likely to disappear in a few years' time.
The introduction of the PPI has made the cost structures of DC schemes more transparent. As a result, overall prices have fallen. "Where insurance contracts may have had total expense ratios [TER] of above 1%, the TER of PPIs are at around 0.5%," says Alwin Oerlemans, head of institutional business development at pension provider APG. "But, of course, the TER also depends on the type of funds and assets used, so there can be differences between various providers."
There are two reasons for corporates to opt for a PPI over a DC pension fund - their cross-border operation ability and governance, according to Eric Baltus, manager for Aegon PPI. "If, for example, a company goes bankrupt, in a pension fund the DC assets could be mixed up with the DB assets," he says. "As a separate entity, if a PPI goes bankrupt the assets are with the custodian, and they can be taken over by another PPI or insurance company."
"However, there are still a lot of questions about what happens if a PPI goes bankrupt," adds Burggraaf. "A third-party risk with PPI has now become visible and the lower the costs are in the market, the higher the chances that this will happen."
PPIs can have different structures. They can be foundations, Dutch corporations or established under European law. This means they have different possibilities with regard to governance, according to Oerlemans.
Due to political pressure to let PPIs enter the market quickly, they were initially lightly regulated. But earlier this year, the regulators suggested an amendment to the Dutch parliament. They expressed concerns about the adequacy of the requirements outlined in the generic law regarding the minimum equity available and the separation of assets. The concerns relate to the operational risks of PPIs.
"Much tougher regulations followed," says Baltus. "Initially, PPIs needed to have €225,000 to start - now the required amount is estimated to be at around €3-3.5m. As we were one of the last to enter the market, we already complied with these requirements, whereas the early PPIs expect to have one to two years to fully comply."
Oskar Poiesz, manager pension providers at Robeco, which started offering a PPI in August 2011, says: "The Dutch Central Bank is treating PPIs as a DC pension fund, meaning that we have to comply with all the governance rules that apply to DC pension funds. Dutch regulation might be considered stringent but it is a big advantage because it means we have things under control."
"You cannot change the pricing of existing contracts," says Burggraaf. "But some additional requirements are on the agenda. Most parties understand that regulation is too light. And the regulator is said to have demanded additional solvency to cover potential losses in the first years of operation in one of the cases."
A law change concerning the self-employed - around 1m people - and their ability to join a PPI is also being discussed, according to Poiesz.
The PPI may be transparent, VAT and corporate tax exempt but it is not allowed to bear any risks or give guarantees. Therefore, if an employer needs to give guarantees, such as in Germany or Belgium, they need to hire the services of a bank or an insurance company as a third-party provider.
"But only a few insurers are able to offer some kind of guarantee with their PPIs - such as a guarantee on the interest rate, the pension date or a lifetime insurance for the annuity," says Baltus.
"Most PPIs offer lifecycle solutions for capital accumulation, meaning a gradual de-risking towards retirement," says Oerlemans. "At retirement, the capital needs to be transformed into an annuity provided by an insurance company and there is some demand for guaranteed products to provide this capital. However, these guarantees cannot be assumed by the PPI itself so they need to be structured into the product, which tends to be quite expensive for the low guarantees they provide. Therefore, lifecycle products are probably the better solutions, although current life cycles can be improved by extending the investment horizon beyond retirement."
"One of the strong points of the PPI is that it is a plain-vanilla vehicle," says Poiesz. "But it only allows Dutch schemes to offer lifelong annuities and no lump sum. The third pillar's Banksparen, on the other hand, facilitates regular annuities over a certain amount of time - for example, 15 years, from a fixed deposited amount. I am in favour of exploring combinations of such possibilities for the PPI instead of only offering a full annuity."
The Dutch government is also working on a so-called general pension institution (API), in the format of a modular pension fund, which will be able to do cross-border pension services as well as bear risks and grant guarantees.
"But because of those risks and guarantees it will be a more complex vehicle with greater solvency requirements because the regulator needs to ensure that all the accrued benefits are, to a large extent, guaranteed," says Kiveron. "Once we have this fully-fledged IORP, I suspect many PPI providers will transform themselves into this new fully-fledged institution."
Out-going Labour minister Henk Kamp has stated that he intends to have this modular pension fund in place by January next year, which Kiveron deems as ambitious as the legislation still needs to be written. "The participants of the Holland Financial Centre have drawn up a plan for what an API could look like and also offered their services to assist the legislator building this into the national legislation," he says.
"The Netherlands started off with a multi-pension fund for one company," says van Tricht. "The PPI followed suit and the API is next in line. The API - also called defined ambition - works slightly differently in that it states it will pay a certain amount at a certain date. But financial market and longevity adjustment systems can change the amount or starting date of the pension if average mortality or returns, for example, are different from what was expected. Whether or not our environment is going to accept these soft guarantees remains to be seen."
"It is possible to bring DB and DC together in one plan," says Oerlemans. "This can already be seen in many company and industry-wide sector funds that provide DC top-up solutions as part of the total plan. But because the API can bring together company pension plans from completely different sectors and countries and create an internationally-working IORP, governance requirements need to be flexible."
Van Tricht believes API legislation is likely from January 2014.