Where does CDC go from here?
Collective DC (CDC) is one innovation in Dutch pensions that has generated much discussion. In a CDC arrangement, the sponsor of a pension plan fixes the pension premium for a certain period. The plan (and its participants) bears the risk of underfunding in the event that investment returns disappoint or liabilities increase more than expected due to interest rate developments or longevity risks.
Not everybody agrees that collective DC is an innovation. Some regard CDC as a more transparent form of collective DB, since the pension fund continues to hold on to (mostly) average pay defined pension benefits. Fixing the premium is, in this respect, of minor importance since the premium is in most cases fixed at a conservative level.
In order to gain more insight, a survey was conducted at the Dutch PensionSummit in April, sponsored by Cordares, NIBC, Mercer and IPE. The aim was to find out the extent to which decision makers really value CDC. A response rate of over 40% showed that there was a high level of interest in this theme.
Participants in the survey were asked whether CDC could be regarded as a full equivalent of the current pension plan. A slight majority, 54%, did not agree. Yet 78% of the participants regarded CDC as a suitable pension scheme for company pension funds, and more than half (55%) deemed CDC a suitable pension plan for industry-wide pension funds (see charts 1A and 1B).
The level of the pension premium is considered the most important variable when deciding on CDC. Remarkably, the size of the one-off contribution by the sponsor (in case of transition) and the limitation on future sponsor contributions to the fund (in case of under funding) were seen as more important than the international IFRS treatment of CDC. Although this is disputed by some, a CDC can be treated as a DC pension plan for accounting purposes since the sponsor has no open-ended liability to the scheme.
A majority did not think that the switch to CDC would lower pension costs. Also, in case of an underfunded pension plan, 59% of participants did not regard a cutting of the ties between sponsor and fund by a switch to CDC as imaginable.
Respondents are less positive about DC from the perspective of the end-user - the pension plan participant or pensioner. A high proportion of respondents (76%) did not think that switching to CDC would add to more certain pension benefits, in terms of constant purchasing power parity. Even more worrying is that 73% of respondents thought that the ‘average’ pension plan participant does not understand the risk transfer from sponsor to participants in case of switch to CDC. Only 23% thought that participants do understand (see chart 2).
Opinion was evenly divided on the question of whether the move to CDC would in due course lead to a further transition to individual DC solutions. Also, when asked whether CDC will develop into the new blueprint for pension schemes in the Netherlands 50% agreed. However, 13% of participants gave no opinion on this statement and 37% disagreed.
Finally, participants were asked to mention three corporates that moved to CDC. Chart 3 shows that AkzoNobel is the best known example. Also, bank/insurer SNS Reaal and chemical company DSM were mentioned by more than a quarter of the respondents.
Participants were also asked to cast their votes on issues related to managing CDC. This added to the insights of the survey discussed above. A majority of 60% supported the need to hold on to intergenerational solidarity and a collective approach to pension plans. A majority of 53% agreed that the move to collective DC should not lead to a more conservative asset allocation of the fund, while 41% judged that a more conservative asset allocation was suited. Nearly three-quarters of the audience expected a further transition to collective DC.
An interesting ex aequo emerged when asked to express their opinion whether other alternative pension plan designs could be more interesting in case the additional contribution turns out to be high (when switching to CDC). 44% of respondents agreed, but also 44% disagreed.
The surveys underline the great interest in continued pension plan innovation in the Netherlands. It further stresses the broader acceptance of more transparent risk sharing mechanisms. Pension plan sponsors continue to have a great interest in good pension solutions, but there is a clear need to limit exposure to pension risks, for example through fixing pension plan contribution levels for longer periods and ending open-ended liabilities.
Finally, the pension plan participants and pensioners need special attention. The survey shows that the current changes are not regarded as adding security to participants in terms of real pension benefits (that is, in terms of fixed purchasing power). Also, pension plan participants do not seem to be sufficiently aware of the risk transfers underlying current changes in pension plan design. Especially with regard to the latter two issues, the need for further innovation is evident.
Alwin Oerlemans is associate director research at NIBC and Jeroen Tielman is managing director commerce, strategy and innovation at Cordares. The comments represent the opinion of the authors only