The Promise of Occupational Pensions: 

Lessons from the Netherlands

Casper van Ewijk 
Chairman, Network for Studies on Pensions, Aging and Retirement (Netspar), University of Tilburg; Professor, School of Economics, University of Amsterdam 
2014-02-10 From：Boao Review 

The pension system in the Netherlands is inter- nationally appraised as being one of the best systems in the world. Yet, recently there are some scratches to the shining image of the Dutch system.

The Dutch pension system is a typical multipillar system. The government provides a basic pension equal to about 80 per cent of minimum wage to all citizens. In addition, individuals build up supplementary pensions in employer or occupation-based plans. These occupational pensions are linked to individual earnings; for the average family they constitute more than half of the total pension . 

More than 90 percent of the total working population is covered in occupational pension plans. Total pension assets amount to over 120 per cent of GDP, higher than in any other country . Pension funds invest in a broad portfolio, both in equity and in bonds. The portfolios are internationally well diversified.

Following the crisis in financial markets average funding ratios of Dutch pension funds plunged from a solid 150 per cent before the banking crisis to below the critical level of 100 per cent in 2009 . More than half of the pension funds were put under direct supervision of the pension authority, and pensions were threatened to be cut in nominal terms.

Since 2009 the funding ratio has hovered around the critical level of 100 percent. Fear of pension cuts caused unrest among pensioners, and has led to a political de-bate between young and old on who has to pay for the loss in pension wealth, and more fundamentally on the merits of the collective pension system. In the elections for the Dutch parliament a new “50+ party” success-fully exploited this fear among the elderly, and gained a number of seats in the parliament.

The fall in funding ratios was caused by the decline in stock prices in the first place. But there was an-other important factor as well which relates to the liability side of the balance sheet. As interest rates were driven down by the ECB during the crisis, the price of pension annuities went up drastically. A two per cent decline on average in interest rates in every 15 to 20 years easily explains a 30 to 40 percent increase in the value of the liabilities, and thus a similar fall in the funding ratio.

In these circumstances, policy makers and pension fund governors have become painfully aware that keeping up a fixed pension promise (‘defined benefit’) is unsustainable when financial markets are volatile. The underlying concern is, population aging makes it increasingly difficult for pension funds to manage the pension promise.

A number of measures have been taken to improve the performance of pension funds in the Netherlands.

First, retirement age has been increased from 65 to 67 in 2025, and linked to the evolution of life expectancy from then on. This primarily affects the first pillar of public pensions, but it also helps to contain contribution rates in the second pillar of occupational pensions.

Furthermore, the government has un-folded plans to mitigate the effect of current low interest rates on the valuation of liabilities, by allowing for smoothing in interest rates, and using effectively longer periods for recovery.

Both measures help to stabilize funding ratios of pension funds in the short term. For the longer term the government envisages a more fundamental debate on the pension system. The Netherlands should find a solution for the unsustainable notion of pensions as a fixed guarantee.

At the same time one must be careful not to throw the baby out with the bathwater. The Dutch pension system has a strong tradition of collectively organized pensions. The mandatory nature of pensions allows for a cost effective system of risk sharing between generations. It also avoids individual mishaps of undersaving and misinvestment. The central idea is that one should start thinking in terms of pension ambition rather than a fixed nominal pension promise. This requires a mind-shift among participants as well as policy makers. A first requisite is that pension funds should be transparent about risks and returns of pensions. A good pension is a risky pension; pension funds should embrace risk and exploit the risk premium on financial markets in order to provide adequate pensions at a reasonable price.

Private pension plans based on pre-funding and mandatory participation should help individuals to optimize saving and risk taking over the life-cycle. Individual ac-counts, which register each member’s position in terms of wealth and risks, may serve to make the system transparent. Further-more, organizing these plans on a sufficient scale yields substantial efficiency gains by saving on transaction costs and concentrating expertise. In this way, private pension plans based on capital funding may offer an appealing model as an alternative to individual DC plans and traditional DB plans.

Pensions are necessary for providing income when citizens get old. But pension systems are also important for the allocation of macroeconomic risks in society. This latter aspect is often underrated in the policy debate. Pension systems should help to diversify risks on a national basis. Optimal international and intergenerational risk sharing yields considerable welfare gains—it reduces the costs of risk, and thus helps to promote economic growth.

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This BLOG  looks at pensions and their impact on what are called Public Private Partnerships or P3’s these are not really about private funding at all but about two streams of public funding, pensions and government with private capital a third partner.

We will also deal with other pension matters, such as Defined Contribution Plans (DC) vs Defined Benefit (DB) PLANS, the weakness in private plans, the need for pension reform in public pensions to have shareholder rights, directorships and ethical investment directives and policies. 

Finally taking the long view we will show how these funds are forms of evolving social capital that is dominating private capital as we evolve into socialization of capital. 

Click HERE to read more....