Abstract of advisory report:
Advisory Report on the Future of the Dutch Pension System
Advies Toekomst Pensioenstelsel (2015/01)
The most important pillars of the Dutch pension system are the Dutch State Pension Act
[Algemene Oudersdomswet] (AOW) and employee pensions. In principle, the State
Pension, or AOW (first pillar), ensures a subsistence-level income for all retired persons
and serves as a basis for supplemental pensions. This basic pension provides people
with security and ensures that there are very few elderly people in the Netherlands who
live below the poverty line. The State Pension is broadly supported.
This SER advisory report focuses primarily on the pensions in the second pillar, which
are also referred to as employee and occupational pensions. While the second pillar is
strong in the Netherlands, there are questions about the financial and societal
sustainability of these pensions. The Cabinet’s request for an SER advisory report on the
future of the pension system, which initiated a social dialogue on that topic, is evidence
of these questions.
In its advisory report, and in the context of the national pension dialogue, the Council
(the SER, the Social and Economic Council), analyses the most significant challenges
and discusses several alternatives in light of these challenges. The Council analyses the
alternatives – which are aimed at developing and strengthening our pension system –
based on several important criteria. The emphasis in this advisory report and at this
stage of the pension dialogue lies on analysing the alternatives themselves, rather than
on choosing between them. In this respect, the Council notes that, while unknown, the
‘personal pension capital with collective risk-sharing’ alternative may be an interesting
one for the future. With this shared analysis, the Council lays important groundwork for
continuing the pension dialog and wants to share its analysis with everyone involved,
including the Cabinet and Parliament. The advisory report also includes a technical
exploration of several transition problems (such as the system of average pension
premium system [doorsneesystematiek] and analyses in response to the questions the
State Secretary posed with regard to freedom of choice and customisation, the link
between pensions, housing, and health care, and self-employed workers [zzp’ers].
Supplemental pensions under pressure
The financial crisis in 2008 drew the attention of everyone involved to the vulnerabilities
of the system of supplemental pensions. Nominal pension commitments proved to be no
guarantee of a pension that would allow beneficiaries to retain their purchasing power:
automatic indexation (adjustments in accordance with salaries or inflation) became a
thing of the past and, in certain cases, pension reductions became unavoidable. This
dealt a significant blow to confidence in the system.
Current pension schemes are characterised by their high degree of interest rate
sensitivity, which could negatively affect not only the purchasing power of pension
benefits, but the Dutch economy as a whole, since it exacerbates the cyclical changes in
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the real economy. The reallocations being made between groups of members in the
current system, moreover, are not transparent and are sometimes difficult to justify.
There are various reasons for this. For example, the average pension premium system
(in which all members of a pension scheme pay the same contribution and also accrue
the same pension entitlements, regardless of their age or life expectancy) will result in a
reallocation between older and younger employees, and, through differences in life
expectancy, between those with lower and higher levels of education. In addition, it is
not always clear to members how financial shocks and adjustments to life expectancy
are allocated. This creates uncertainty about the value of individual pension entitlements
precisely when people need more transparency about pensions.
Some pension scheme members indicate that they want to have more freedom of choice
and more possibilities for customising their pension scheme. The current system takes
insufficient account of these members’ situations. Pension is accrued according to a
‘one-size-fits-all’ approach that no longer fits because members are finding themselves
bearing an increasing share of the risks despite the differences in their financial
situations and their ability to bear that risk. Another point that requires attention is the
labour market. Going forward, it would be best to harmonise the pension system with
the modern labour market: the issues that will be relevant in this regard will be the
shorter life cycles of businesses and sectors, increased labour mobility, and changing
employment relationships, such as the increasing number of people with flexible
employment contracts and self-employed workers, all of which affect the pension
position of those involved. The number of workers who are not accruing pension in a
broad sense (thus, including individual pension products, private savings, and a
privately owned home), or who are accruing insufficient pension, is growing. In addition,
the average pension premium system will result in a reversal in the current system that
will make pension funds dependent on a new influx of members, which could lead to
ageing-related problems. Eliminating this reversal will lead to lower contributions in the
long term.
The question is how we can modify the system so that it will both provide members with
more opportunities to accrue a pension that will allow them to retain their purchasing
power and so that it will be more compatible with societal developments.
Towards an adequate, future-proof employee pension
A good pension ensures that people can continue their spending pattern as much as
possible even after they retire and that their income is high enough so that – in most
cases – they can avoid having to apply for welfare benefits. In doing so, the pension
system should support the economy and be compatible with societal trends. Above, we
noted that the current system has various shortcomings. The question at hand,
therefore, is how these shortcomings can be remedied.
The solutions to these problems must make the pension system less sensitive to interest
rates and more compatible with today’s more dynamic labour market. Other issues that
may be considered in this respect are the desire for more choice and customisation, and
making the pension system easier to understand.
The challenge in finding methods to strengthen the pension system is that those
methods cannot detract from the strengths already inherent in that system. In principle,
the Dutch system comprises a strong combination of multiple pillars, with a large
number of members in the second pillar. This, along with a contribution amount that
corresponds to the relevant ambition level, guarantees a pension benefit that will be
paid throughout the member’s lifetime, low administration costs, collective risk-sharing
(in its various forms), tax treatment of pensions, opportunities for a long-term
investment policy, and adequacy of pension income. The pension system must be
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restructured without impairing the ambition to keep pensions affordable and ensure the
sufficiency of pension income.
Various scenarios explored in more detail
In this advisory report, the Council examines various alternatives aimed at achieving
better prospects for the pension system in the medium term. The alternatives are:
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Administration agreement with declining accrual;
National pension scheme;
Personal pension capital with voluntary risk-sharing;
Personal pension capital with collective risk-sharing.
The Council examined whether and how the strengths of the current system can be
retained while still remedying the shortcomings of that system. The alternatives were
assessed based on several crucial criteria, such as the ultimate pension result,
compatibility with societal trends, macroeconomic effects, and transition problems.
The Council notes that none of the alternatives can remedy all of the problems
simultaneously, which means that choices will have to be made. The Council is aware
that the situation will involve several significant dilemmas or trade-offs:
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possibilities for choice versus sufficiency of pension income;
risk-sharing with future generations versus transparent ownership rights;
risk-sharing versus freedom of choice;
uniform policy versus customisation.
Personal pension capital accrual with collective risk-sharing: interesting but unknown
The Council finds the alternative that provides – within a collective scheme – for
personal pension capital with collective-sharing to be interesting, but still too unknown.
The analysis of the alternatives indicates that a well-considered transition to this
alternative may offer good opportunities in the future to retain the strengths of the
system while eliminating its weaknesses. This alternative will have to be fleshed out and
explored before it can be properly evaluated and assessed in more detail. This
alternative will also have to include different types of pension contracts allowing the
accrual of personal capital and collective risk-sharing.
The elements that still need to be fleshed out are:
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A sufficient opportunity to gear contributions to a lifelong pension that will allow
beneficiaries to retain their purchasing power. Agreements on this issue would be
made in the negotiations on employment conditions.
Capital accrual in the active phase in the form of personal pension capital. From a
tax perspective, it must also be possible to supplement this capital with private
savings in the second pillar.
The possibility to continue sharing risks and mandatory participation suitable to this
purpose. The social partners at decentralised level can determine which risks can be
shared and to what degree this would be desirable and feasible.
Abolition of the average pension premium system.
A conditional pension in the benefit phase. Under normal circumstances, this will
achieve a better pension result than a nominal benefit, but the risk will be
correspondingly higher.
A contract with personal pension capital and collective risk-sharing will prevent conflicts
from arising between the need younger members have for higher-risk investments (with
a chance of a higher return) and the need older members have for safer investments.
Contracts involving personal pension capital and risk-sharing allow more leeway for
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customisation when it comes to members’ benefit and risk profiles. Ownership rights can
be better defined.
Contracts with personal pension capital accrual and collective risk-sharing will also
continue to make it possible to implement a long-term investment strategy, but without
the need to hedge interest rate risks in order to guarantee nominal security (or the
appearance thereof). Moreover, in the event of a financial shock, the amounts in capital
will be adjusted in this alternative, while contributions will not be affected. This will
foster macroeconomic stability, since fluctuations in contributions have a relatively
significant impact on the real economy. With personal pension capital accrual, the
pension system need no longer hinder the requisite dynamics of the economy. The
accrual of capital will go hand in hand with permanent opportunities for sharing risk and
continued investment in the post-active phase, which will increase the chances of
achieving a pension that will preserve members’ purchasing power.
It is for these reasons that the Council is interested in a contract allowing for personal
pension capital and collective risk-sharing. At the same time, it is an alternative that
would be new to the Netherlands. There are examples in other countries of pension
systems with personal pension capital, but these tend to restrict opportunities for
collective risk-sharing. The Council’s view is that, in principle, it would be both desirable
and possible to spread and share the risks in such a system. This would be particularly
true when it comes to sharing the longevity risk, occupational disability risk, and the
income risk created by the death of a partner (surviving dependants’ pension). The
primary question, however, is whether the power of collective risk-sharing and
spreading investment risks and the macro longevity risk (the average life expectancy is
increasing) can be shared between various generations and how this could be
structured.
This alternative would also involve transition problems, and it will require further study
and exploration before reaching a final judgment. The Council will be working on this,
taking into account the scheduling of the Cabinet’s upcoming framework memorandum
on the future of the pension system. This is important because the Council’s exploration
will also discuss the aforementioned transition problems and the desired role of the
government in solving them.
Below, the Council highlights several areas that will be addressed during this more
detailed exploration. First, the Council outlines the points that are relevant to exploring
a contract with personal capital accrual and collective risk-sharing; afterwards, the
Council lists the points that will merit attention during the exploration of the transition
problems. The most important issue, of course, is whether this contract will enable
members to receive better pensions.
Points relevant to exploring collective risk-sharing for personal pension capital
Risk-sharing is crucial when nominal security can no longer be offered and members are
bearing an increasing share of the risks. Risks have to be taken for pensions to retain
their purchasing power, making it important to explore whether and to what extent risksharing can be arranged in contracts involving personal pension capital. It may desirable
to spread financial and demographic risks among the current members. Risk-sharing
with future generations, perhaps through collective buffers, may also yield benefits,
although increasing ageing will limit these. These benefits will increase along with the
number of generations involved in the risk-sharing, but this will also increase the risk of
discontinuity, since future generations will not be part of the decision-making.
Intergenerational risk-sharing in certain sectors is being complicated by the increasing
dynamism of the economy: from a pension perspective, the declining life cycle of
businesses and sectors is increasing the risk of discontinuity at business and sector
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level. This means that there must be possibilities for customisation in this respect. One
fund has a large membership with good prospects for continuity, while another has a
small membership with an uncertain influx of new members. Members involved with this
type of risk-sharing (i.e. intergenerational risk-sharing) will require clear allocation rules
and transparency about those rules. In addition, assurance must be provided that
enough members of new generations will continue to join these schemes and that no
structural transfers will be made between generations.
Taking all of this together, it will be important to explore the following points:
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The possibility to continue to share risks between generations in an even more
dynamic economy that is making the influx of new members more uncertain.
The possibilities for solving the aforementioned problem and ensuring more
continuity through upscaling; the concept of a “general pension fund” may be
relevant in this respect.
Structuring risk-sharing between generations while retaining transparency and clear
allocation rules and avoiding systematic transfers between generations.
A type of mandate that is suitable for the degree of risk-sharing agreed by the social
partners and the role of the government and regulators in this regard. This will
involve mandatory participation in the scheme (as an employment condition) and/or
mandatory administration (with the desired risk-sharing as the solution).
In addition, the governance and regulatory consequences of a scheme with personal
pension capital and collective risk-sharing will have to be investigated.
Points meriting attention while exploring transition problems
Depending on the structure, the above-described medium-term perspective will entail
transition problems relating both to the possible conversion of prior rights to pension
capital and to the abolition of the average pension premium system. One important
point to which attention will be devoted is the desirability and possibility of keeping prior
and new pension accruals united in a single fund.
The Council wishes to examine the implications that various age-linked alternatives for
establishing contribution amounts for employees (in addition to a fixed, age-dependent
contribution from employers, as agreed in the negotiations on employment conditions)
will have for transition problems, pension capital accrual, and the labour market. In this
respect, the following points merit attention:
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the effect on older employees’ labour market position, and
the impact on the total pension result for various groups of members.
The social partners will need the coordinating capacity of the government in order to
resolve the transition problems. The government will have to provide a statutory
framework that will both abolish the average pension premium system and, if possible,
convert prior rights into pension capital.
Points to be explored in respect of the possible abolition of the average pension
premium system
There are a variety of reasons for replacing the average pension premium system with a
system that, from an actuarial perspective, will be more and fair and balanced. The
latter would be better suited to a dynamic labour market. It could also make and keep
the pension system attractive to young people. Moreover, it would make it easier to
implement freedom of choice and prevent the undesirable redistribution from lowereducated people to higher-educated people. The abolition of the average pension
premium system would entail high transition costs, however. Many pension funds are
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already suffering shortfalls in the current situation. If the average pension premium
system were immediately abolished, it would affect the generations who – in addition to
the transition costs – are already burdened with the cost of compensating for current
shortfalls. Given this, any transition would have to be well-timed and carefully
implemented.
The prerequisites for abolishing the average pension premium system are:
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A balanced allocation of the transition costs among all interested parties to prevent
any particular generation from being unduly benefited or burdened;
A good foundation in terms of legal sustainability.
An investigation into whether the transition to an alternative system would leave
enough solidarity within the system (and whether it could be sustained in the future
without generational effects) to enforce a suitable form of mandatory participation in
this regard.
Prevention of labour market disruptions. This will require a certain uniformity and an
adequate compensation structure for the generations whose pension accrual will
suffer as a result of the abolition of the average pension premium system.
Maintenance of labour market neutrality. This means that members cannot suffer
negative tax consequences from transitioning from one pension scheme to another
and that they cannot gain tax benefits from such a transition and thus accrue excess
pension.
All of this makes it clear that the transition problems will require thorough analysis. This
advisory report is a contribution to that analysis. The challenge of the proposed
exploration will be to map out a feasible route based on the prerequisites formulated
above. The most important of these, of course, is the allocation of the transition costs.
Based on this, a final decision can be taken regarding the abolition of the average
pension premium system. The division of responsibilities between the government and
the social partners will also play a role in this.
Below, the Council discusses the request for an advisory report on the possibilities for
more choice and customisation, housing, health care, and self-employed workers.
Freedom of choice and customisation: considerations
Freedom of choice and customisation are recurring themes in the societal discussion
about the system. Being able to make choices generally enables people to better tailor
their pension to their individual situation, which can benefit them; it can also increase
their involvement in their pension. The ability to choose the effective date of one’s
pension is generally viewed as positive. The ability to make choices in other areas –
such as whether or not to become a member of a scheme – could also result in a loss of
benefits in situations involving illiteracy or procrastination. Therefore, when it comes to
freedom of choice, a distinction will have to be made between the various pension areas
and the possibilities for managing those choices through an option framework (for
example, with well-developed standard values).
In assessing freedom of choice, the Council also considers it important to point out
several trade-offs (sufficiency of pension benefit, possibilities for risk-sharing, costs).
Trade-offs usually have to be made if the ability to make choices leads to strategising or
if people are short-sighted in their actions. Choices are already being offered in the
benefit phase (such as with regard to effective date of one’s pension and opting to
receive a higher pension benefit earlier in exchange for a lower benefit later), and these
may also be expanded (such as with regard to investment profile, indexation policy in
the benefit phase). Flexibility in the benefit phase allows people to better tailor their
pension to their personal situation.
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Conversely, withdrawing pension capital in the benefit phase could result in strategising
at the expense of the possibility for sharing the longevity risk. This type of freedom of
choice could also result in extra costs for the government if people exhaust their pension
capital prematurely in anticipation of income-linked schemes. For these reasons, the
freedom of choice in the benefit phase must be dealt with carefully; making an adequate
distinction between the various areas and formulating a suitable option framework will
be essential. The trade-offs for being able to make choices in the accrual phase
(contribution/investment, administrator, risks, solidarity base) are more pronounced.
These are limited by the retention of collective elements.
Whereas freedom of choice can sometimes conflict with risk-sharing, this need not be
the case for customisation. Conceivable alternatives for customisation might involve
pension administrators making a distinction in their policy based on characteristics that
can be easily derived from pension records. These types of customisation generally
result in higher administration costs. In principle, a system with personal pension capital
would create more possibilities for offering members customised options regarding their
benefit and risk profile.
Accruing capital for pension, health care, and a privately owned home
An alternative that includes personal pension capital generally offers possibilities for
linking one’s pension to one’s health care and housing. In certain situations, this can
work to the benefit of the member in question (such as when the member has used part
of his pension capital to make his home more compatible with the physical limitations of
ageing). Any such possibilities will have to be handled carefully in order to preserve the
ability to continue sharing the longevity risk (given the undesirable forms risk selection
can take) and it will require a great deal of detailed analysis and a thorough option
structure. Spending pension capital during the accrual phase can quickly undermine an
adequate pension later, despite the latter being the best guarantee of being able to
afford health care later in life. Moreover, people consider linking housing, pension, and
health care to one another to be a very complicated matter. If housing, pension, and
health care are ever linked, good communication will be crucial.
Self-employed workers and pensions
The pension position of self-employed workers (and groups of self-employed workers)
merits attention. In this respect, it is important to keep in mind that these groups are
extremely heterogeneous. Some of them are more than able to arrange adequate
pensions themselves, while others are not. It is therefore important for us to gain a
better understanding of the pension position of various groups of self-employed
workers. The ongoing interdepartmental policy survey of self-employed workers can be
expected to provide this understanding and information. The Council considers it
advisable to include this information in its further assessment of the pension position of
self-employed workers and possible policy options. In that context, it is also relevant
that the Cabinet is considering submitting questions to the Council in 2015 regarding the
continued growth and cooperation of self-employed workers in the context of the
changes taking place in labour and economic activities.
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Translation: Balance, Maastricht/Amsterdam