Pierre Akkermans outlines recent pension developments in the Dutch pension system
The Dutch pension system is considered to be one of the most sustainable and robust in the world, owing in large part to its three pillar structure: A state pay-as-you-go pension (AOW), which provides coverage for every person at a solid base of about €12,000 per year, a second pillar of capital funded occupational pensions, and a third pillar of tax deductible savings for those who don't have access to a full pension through the occupational route.
This system, however, has proved to be sensitive to recent financial and demographic developments. Shortly after a major reform in 2007, which resulted in a new Pensions Law, demographics and the the financial crisis started to uncover serious weaknesses in the Dutch system.
First pillar: adapting the state pension to longevity
The new Dutch government of 2010 has decided to increase the age for the state pension (AOW) from 65 to 66 by 2020, and then to 67 in 2025. Thereafter, the age will increase with developments in longevity. Many critics say however that this is too little, too late.
Second pillar: Pension Agreement
In 2010, employers and labour unions reached an agreement, the so called Pension Agreement (Pensioenakkoord). This is a breach with the prevailing system of nominally guaranteed occupational pensions mostly on an average pay basis, provided by pension funds. The market share of pension funds in the Netherlands is about 80% of all occupational pensions, representing €800bn of investments. The intention is, while retaining collective arrangements based on solidarity, to fix costs at the current level of about 20% of wages, and let the outcome vary with the return on investments and longevity developments. Accordingly, the pensionable age should increase with longevity and the pension payments should be adapted to the return of investments. In this way, the entitlements are no longer ‘(rock) solid' but ‘soft'.
To implement this kind of soft pension promise, it is necessary to adapt the current financial supervision framework (FTK). The recent concern about downgrading pension rights makes it unclear if and how this implementation will take place, but it is the intention that for pension schemes that maintain the nominal guarantee of the acquired rights, the FTK will secure higher buffers, and that for the funds that choose soft entitlements, lower or even no buffers will be required. This is because within the fund, the pension rights can be adapted to longevity and return on investments. Furthermore, the discount rate for the liabilities has to remain risk free for guaranteed rights, but can be based on the expected return on investments for soft entitlements. This will result in a FTK1 for guaranteed pensions and a FTK2 for soft pension promises.
An unsolved, but major, issue that still remains is what to do with the acquired rights and pensions that are already in payment. Can they be converted into soft rights? There are several arguments that this is possible because of the social necessity to reform the system in order to maintain a robust second pillar, and that it is not a violation of fundamental property rights as protected by the European Treaty on Human Rights. But this is not for certain.
Furthermore, younger generations fear that by using a higher discount rate for soft entitlements, resulting in lower liabilities, there will not be enough assets left to pay for their pensions in the future (the problem of apparent wealth of pension funds). Recently a discussion in Parliament specifically focused on the discount rate to be used in calculating liabilities took place in order to create a fair balance between the rights of pensioners and those of future generations.
Downgrading acquired pension rights
This possible inter-generational conflict is sharpened by the recent economic developments that caused several pension funds to downgrade pension rights. Because of the euro crisis, the risk free discount rate and the returns on investments decreased sharply, resulting in increasing shortages of the coverage ratio of pension funds. By subtle ‘manipulation' of the discount rate with permission from the Dutch Supervisor, this could be prevented for some big funds, fuelling the accusations of younger generations that there will be "nothing left for them". The outcome of the reform is becoming more and more unclear.
Revision of the EU IORP Directive
The Netherlands wants to uphold its unique pension system and carry through the necessary reforms without being hampered by European regulation. The proposed revision of the IORP Directive on pensions of 2003 is an obstacle to these reforms, because it is conceivable that guarantees and buffers similar to those applicable for insurance companies that operate DB schemes will be prescribed for the proposed soft entitlements of the Pension Agreement. The introduction of the Agreement would be unaffordable in practice, and, therefore, useless.
Traditionally, a large part of the second pillar pensions is covered by company and industry wide pension funds, possessing a capital of about 120% of GDP. The board of these funds is by law constituted of 50% representatives of the employer and 50% of the employees. Two shortcomings arose during the last decade.
First, these boards do not consist of professional and fully independent trustees, but are chosen members by the employer and employees or labour unions. Particularly in the recent financial turmoil, they were not always able to deal in an appropriate way with the problems, lacking sufficient expertise on risk management and investments in times of crisis.
Second, some stakeholders, especially pensioners, did not feel well represented in the boards. New legislation is foreseen and in part will come into effect within months, to ensure higher professional standards for trustees, and ensure that the stakeholders will be more proportionally represented in the board of trustees, starting with pensioners.
Third pillar: private savings
In order to prevent private savings being used for early retirement, tax-deductible payments are aimed at private provisions to encourage working longer. The so-called "vitaliteits-sparen" (vitality saving facility) enables savings of up to €20,000 for a sabbatical in order to facilitate longer working time. In general, tax facilities, also in the second pillar, will be aligned with longevity and aimed at discouraging early retirement.
The Dutch pension system is now in a critical phase. Since the traditional guarantees are no longer affordable, the pensionable age should increase and the risks of investments, and longevity should be shared between generations within a fixed budget - a kind of DC with soft entitlements but on a collective basis with solidarity between generations. If the necessary adaptations are not made, it is conceivable that the younger generation in particular will no longer support the system and that a shift towards more individual DC will take place, leading to the downfall of the most admired and robust pension system in Europe.
Pierre Akkermans is a partner at law firm BGA Pensions Law, a member of the Ius Laboris human resources law firm alliance