By Dr. Roel MehlkopfSenior Client Adviser, Cardano
The essence of Dutch pensions
In common with the UK, Dutch occupational pensions are complex and a challenge for participants and experts to understand. In essence, the Dutch system reflects an attempt to maintain some protections for members when making the switch away from DB to DC. Those familiar with the UK government’s CDC plans will recognise features of the Dutch system in the Government’s plans, in particular the plan to introduce Retirement-only CDC schemes from 2028.
Looking at two key features that distinguish Dutch ‘solidarity’ DC schemes from traditional UK occupational DC schemes:
Contributions at DB-like levels
In ‘solidarity’ DC schemes the contribution rates are set at a similar level to DB, so whilst the Netherlands has moved away from sponsor guarantees it has done so without the sharp decline in contribution levels typically seen in the UK. Dutch unions have strongly prioritised adequate contribution levels in the negotiations with employers, who in turn were happy to be fully relieved of pension risk. Moreover, Dutch pensions are paternalistic: there is typically no individual choice for employees about the contribution level, nor is there an opt-out.
The payout phase is a ‘collective variable annuity’
Dutch DC pensions are lifelong, in striking contrast with many other countries, where the switch from DB to DC has been accompanied by a shift towards drawdowns and lump sums. The Dutch, however, have kept the DB tradition of lifelong pensions, which avoids the key risk of members running out of money if they live longer than expected.
In Dutch schemes, DC pots are automatically converted at retirement into a ‘collective variable annuity’. This is a collective pool of all retirees, where all risks are shared, including longevity risks and financial risks, which allows for post-retirement investment in return-seeking assets.
The collective variable annuity is offered within the same fund as the accumulation phase. Hence no assets must be liquidated at the conversion date, which facilitates the use of private and illiquid assets.
The risk exposure of the collective variable annuities is typically an allocation of 30% to 55% towards a diversified return portfolio. The risk level is determined at cohort-level by participants, via a ‘risk preference survey’.
Lessons learned
1. The Netherlands has moved away from using the DB building blocks. Initial proposals for ‘defined ambition’ schemes were based on giving workers a pension entitlement in the form of a ‘deferred variable annuity’ and calculating the value of these liabilities with the use of a long-term discount rate. However, this triggered a fierce intergenerational debate between the elderly (who pleaded for a high discount rate to boost current benefit levels) and the young (who feared pension assets would be depleted in the long term with the use of a high discount rate). The intergenerational debate was intense and was not resolved. Eventually, the Netherlands switched to individual pension pots in the accumulation phase.
2. The Netherlands has devised various ‘safeguards’ (or ‘buffers’). In particular, Dutch pensions feature a ‘solidarity reserve’ which covers first losses if the investment returns in the collective variable annuity are below expectations. This solidarity reserve is a relatively small percentage (typically 3-5%) of the total assets of a pension fund. The use of the solidarity reserve smooths experience and drastically reduces the annual probability of pensions in payment being reduced. This has helped the Dutch government to defend accusations from the opposition that the new Dutch system is a lottery. However, the new system is still not very popular: it receives a score of 6 (on a scale from 1 to 10) in Dutch public opinion polls.
Reflecting on the changes
Ironically, Dutch pensions are domestically unpopular whilst being internationally ranked ‘best’ in the world. The Dutch have not forgotten their gold-plated DB system, but long-term demographic trends made the switch from DB to DC inevitable. The government and pension professionals are generally of the opinion that Dutch pensions have transitioned to DC in an intelligent way, by maintaining some of the strengths of DB. The general public, however, is not yet convinced and will likely draw conclusions from how the system copes with changing and potentially turbulent economic conditions in the coming years. Contact a consultant to discuss CDC from a UK perspective
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