Pensions In The Netherlands | 43
Can they have their cake and eat it?
In their search for a sustainable pension system, the Dutch are exploring ways to combine DB
and DC. Theo Kocken shares his vision with Mariska van der Westen
Interview Theo Kocken, Cardano
A
s the discussion about the Dutch pensions
system moves on to fundamental issues, a
realisation is taking hold that a sustainable system must find middle ground between the
traditional model of an unwieldy collective with
opaque, mandatory solidarity and the ‘modern’
need for freedom of choice, tailored solutions
and transparent risk-sharing. The best way to
do so is by integrating elements of collective DB
and individual DC, according to Theo Kocken,
CEO of Cardano and a prominent Dutch pension
thinker.
In the current second-pillar pension system,
participants’ pension savings are pooled and
individual plan members have no way of knowing at any given moment what share of the pot
is theirs. That wasn’t considered a problem as
long as plan participants could be sure of exactly
what their payout would be, as in ‘defined benefits’. Besides, pooling all assets does have its
advantages, including risk-sharing across the
generations.
“But, lately it is becoming obvious that the
benefits of such risk-sharing in our current system are limited to just a few percentage points.
And since the financial crisis, it has become
abundantly clear that one cannot be sure of the
payout,” says Kocken. “When people have no
clear view of what is going on inside the pot of
pooled assets and neither be sure of the outcome
the pot produces, they are bound to lose faith in
the system.”
Proposals to resolve the problem have focused
on two extremes – a system of conditional rights,
ensuring the possibility of a higher pension outcome but offering no security at all, or a system
featuring high capital buffers to bolster security,
but ensuring a lower outcome. Neither of these
extremes really cuts the mustard.
The industry and the Department of Social
Affairs and Labour are currently hammering
out a compromise – a financial framework that
features both higher capital buffer requirements
and the provision that financial shocks must
be accounted for without delay, while allowing such shocks to be absorbed over a 10-year
period. Although most agree that such an interim
financial framework is needed, this compromise
doesn’t offer a lasting solution.
“Such a solution must be found in a dual system comprising two components,” says Kocken.
“Presently two very different functions – the
accumulation of assets and the disbursement of
pension benefits – are combined within a single
fund. A simple separation of the two functions
would go a long way.”
In this dual system, contribution payments
would be deposited in a ‘pension accumulation
fund’, where assets are pooled and managed
collectively, allowing for the most cost-efficient
approach. Plan members would participate with
individual accounts, so each knows exactly what
share of the fund they own at any given moment.
Benefit payments would be managed by a second
component – an annuity fund – which does not
invest in risk-bearing assets, but instead focuses
“When people have no clear
view of what is going on inside
the pot of pooled assets and
neither be sure of the outcome
the pot produces, they are
bound to lose faith”
Theo Kocken
on cash flow matching of benefit payouts, so
participants can be completely sure of the benefits they will receive. “Transparency during the
accumulation phase and security with regards to
the payout: these are considerable advantages as
compared to the current system,” says Kocken.
As they age, plan members would gradually
decrease their exposure to risk-bearing assets
by exchanging their units in the asset pool for
risk-free annuities at market rate. “That way one
can gradually buy more security, while retaining
the option to keep some exposure to the risky
asset pool even after retirement. That is a big
advantage compared with the current ‘PPI’ DC
schemes, which are legally required to keep their
plan members fully invested until retirement,
at which point they must transfer the lot to an
insurance company.”
Kocken notes that the timing and rate at
which risky assets should be exchanged for riskfree annuities needs to be regulated to prevent
people from hanging on to risky assets during
bull markets, increasing the risk that they will be
left empty-handed if markets crash as they are
about to retire – a known problem in similar systems. “Our economic knowledge is limited, but as
humans we tend to believe we know more than
we actually do, so we need robust solutions to
protect us from our own hubris.”
The dual system that Kocken proposes would
also solve the problem of interest rate sensitivity
that plagues the Dutch system. Under the present
system, young participants are allotted annuities
that are sensitive to interest rate changes and
fluctuate over a lifetime. Even when they are
older, plan members remain vulnerable to this
problem, as older members are not exempt from
interest rate sensitivity in the current set-up, he
explains.
But as the proposed new system will only
begin allotting annuities at a later age, the interest rate sensitivity of the system will be greatly
reduced. In addition, the component that does
remain sensitive to interest rate changes will be
fully guaranteed and protected. “This will largely
do away with the uncomfortable split between
real and nominal policy objectives,” he adds. •
Designing better DC
Olaf Boschman
The research institute Netspar has launched
two working groups to explore sustainable
pension contracts. One of these specifically focuses on DC and the first findings
are expected this spring. According to
Jacqueline Lommen, director of European
pensions at Robeco and a member of the DC
group, the trend towards DC is a fact of life:
“Rather than remaining in denial, our efforts
should go towards guiding the trend.”
Among other things, this means finding ways to reconcile past accrued defined
benefit rights with a new defined contribution regime. “The objective in the Netherlands is to design a DC contract that offers
a fully-fledged, worthy DC alternative to DB
pensions, so that past accrued rights can be
transferred without anyone being disadvantaged disproportionately.” This approach
is intended to avoid mistakes made in the
UK, where DB schemes were simply closed
without offering an equal alternative.
One of the issues the working group will
look into is how to assign individual ownership rights, and the related issues of average
premium contributions and intergenerational solidarity. Another issue concerns
the problem that DC scheme members are
legally required to buy life-long annuities
upon retirement, an issue Theo Kocken
addresses in his proposal above.
In addition, the working group will
devote attention to lifecycle investing.
“The Dutch are pioneers in this area. ALM
experts draw on their expertise to further
develop lifecycle strategies,” Lommen says.
2014 MArch INVESTMENT&PENSIONS EUROPE
IPE MAR 14 Pensions in Neths.indd 43
12/02/2014 11:06
The asset pool component of the dual system allows for various forms of risk-sharing
including mutual insurance of longevity risks in
terms of the risk that one should outlive one’s age
cohort. The more tricky variety of longevity risk
– the risk that entire age cohorts live longer than
expected – cannot be dispatched quite so easily.
“Buying insurance from a commercial life
insurer is not a realistic option as the insurance
market simply isn’t big enough to absorb this
risk; besides, the new Solvency II rules would
make this a very expensive solution indeed,” says
Kocken. “It would be best to leave it up to plan
members themselves to absorb this risk, with the
possible exception of the elderly. In advanced old
age, part of the risk may need to be insured at
market rate.”
One option would be to design ‘investible’
insurance policies that may be bought by ‘pension accumulation funds’: the risky asset pools
that form the first component of the dual system.
Although the concept of a dual system isn’t
new, there has been discussion about the practical implications, says Kocken: “We are now
beginning to get a clear view of how such a system might be implemented.
•
“We are now beginning to get a
clear view of how such a [dual]
system might be implemented”
Theo Kocken
Making the transition from an existing pension system to a new one is never going to be
easy, Kocken realises. But the system he proposes has one huge advantage – there will be
none of the trouble associated with ‘importing’
past accrued rights into a new regime.
“As the current system already serves as
an annuity fund, it would suffice to launch
an accrual fund to be run alongside it for new
accrual. When the switch is flipped, participants
in the ‘old’ scheme may be given the option to
exchange part of their past accrued annuities to
the new accrual fund.” Such an exchange is feasible because accrued rights in the old system can
be priced unambiguously at a risk-free interest
rate. “Joining the new system should preferably
be presented as the default option, so that people would be automatically enrolled unless they
explicitly choose to opt out,” he says, adding that
a middle-of-the-road option might be added.
“As a matter of fact, the changes aren’t really
all that extensive. Instead of a single fund in
which all manner of opaque things take place,
we switch to two funds offering absolute clarity
about what everybody will get for their money.
That’s all it is.”
The role of the Dutch pension funds, will
hardly change. “Annuities basically grant the
right to a defined pension benefit,” Kocken says.
“In that regard, they are essentially insurance
contracts that people buy with the money they
have made by investing their pension contribution in the pension asset pool.
“Considering the size of the system, there is
no way to buy all the necessary contracts from
the insurance industry. As a nation, we have
accumulated €1trn in pension savings. That is
simply too much – the insurance industry can
barely manage to absorb €10bn. Only pension
funds have the wherewithal to meet this kind
of demand. Pension funds today fill the role of
mutual insurers, and they will continue to.”
Not out of danger
Olaf Boschman assesses the state of Dutch pension funds
Pension Coverage Ratios
A
t the end of 2013, the average coverage
ratio of Dutch pension funds was above
the required minimum of 105%. But,
more than 30 funds still have to cut pension
benefits this year, and the overall health of the
industry is in question.
In January, PFZW, the €134bn healthcare
scheme, decided to grant its participants partial
indexation for the first time in four years. The
fund’s coverage ratio improved to around 110%,
a few percentage points above the minimum of
104.6% required by the regulator DNB.
Although the decision is in line with the fund’s
policy to increase pensions when the coverage
ratio is 105% or above, it was an unwelcome one
for DNB.
The regulator publicly expressed concern that
pension funds would decide to increase pensions
too quickly. The objection in short: pension
funds that have just recovered from a funding
shortfall should not grant indexation and ought
to wait for ‘sustainable recovery’ as indexation
could harm their nascent recovery and it is wiser
to build up a buffer first. Some pension funds
that granted indexation back in 2009 had to cut
rights later, the DNB warned.
The regulator doesn’t mention funds by name,
but ABP was one of the funds that did so. The
€293bn civil service scheme gave its members
partial indexation back in 2009 and then, last
year, had to cut rights. The DNB declines to state
a coverage ratio that qualifies as solid or sustainable, but the concern indicates that the sector is
far from healthy.
Frank Driessen, actuary and principal at Aon
Hewitt, says the DNB has correctly expressed
“For pension funds with a
coverage ratio below 110%, it
is best to wait with indexation.
“They are exposed to equity
risk. A stock market shock has
a direct impact on the coverage
ratio”
Frank Driessen
according to Casper van Ewijk, director of Netspar, the Dutch network for studies on pensions,
ageing and retirement, and the coverage ratio is
only one of the symptoms. It only reflects nominal pension accrual and hence distorts the view
Ophélie Mortier,
Petercam SRI Coordinator
“TOMORROW’S
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44 | Pensions In The Netherlands
its concern. “For pension funds with a coverage
ratio below 110%, it is best to wait with indexation,” he says, pointing out that funds don’t have
the capacity to absorb shocks. “They are exposed
to equity risk. A stock market shock has a direct
impact on the coverage ratio.”
Shortfalls this year will be transferred to the
new financial assessment framework (FTK) that
is planned to come into effect on 1 January 2015.
“Funds that grant indexation now surrender
financial capacity they may need later this year,”
Driessens adds.
The Dutch pension system is in danger,
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