Back in July, ING, the Dutch financial services group,
announced that it was to transfer its Netherlands-based employees into a collective defined contribution (CDC) pension scheme. Effective from 1 January, the planned migration signalled the closure of one of the few remaining final salary defined benefit (DB) funds in the Netherlands.
At first glance, the move was further evidence that the era of DB is well and truly over in the Western developed world. But perhaps more importantly, it showed a continued willingness from the Dutch to provide its working population with the best possible alternative to the dying DB model.
CDC schemes have been recognised as that alternative. Constructed to group investment, inflation and longevity risk, they not only aim to replicate DB benefits outcomes as closely as possible, but also to eliminate much of the risk that individual DC savings accounts pose. Michiel van Leuvensteijn, a senior policy advisor at APG, is closely involved in discussions to improve CDC schemes, through Netspar, the Network for Studies on Pensions, Aging and Retirement , which APG partially funds.
Involving academics, policy makers, pension funds and social partners, the debate has centered on solving the complex issues that arise when transferring a country from a DB to a DC system. Crucially, says Van Leuvensteijn, the Netspar platform allows all parties’ interests to be heard. This has resulted in a measured shift from DB to DC in the Netherlands and fostered a breeding ground for CDC.
WORK IN PROGRESS
Some elements are commonplace. Schemes aim to provide benefits based on career average earnings, but the delivery of such nominal benefits and their subsequent indexation is based on a CDC scheme’s funding status. So if a fund finds itself under distress, then benefits are cut for all scheme members, a consequence of the inter-generational risk sharing found in CDC. A fixed contribution rate, for at least a five-year period, is another frequent feature. The pooling of investments, a crucial part of the scheme, allows the mitigation of investment risk through diversification, lower transaction costs and the elimination of one of the problems of individual DC – the need to move assets into cash prior to decumulation to avoid any sudden losses.
“In collectives, there are two types of risk you can share,” explains Van Leuvensteijn. “There’s systemic risk: inflation, interest rates, longevity; and you also have the idiosyncratic risk, [such as] the risk that you will die.You can collectively pool idiosyncratic risks together in the decumulation phase and diminish them.”
But it is with systemic risk, particularly that associated with longevity, where work still needs to be done. “There may be a higher premium for the working population in the fund at that time and some may have to work longer than expected, to smooth out the risks over 10 years, between the generations.” says Van Leuvensteijn. “But the mechanisms are not settled yet.”
WHY CDC SCHEMES COULD WORK IN THE NETHERLANDS
Firstly, both systemic and idiosyncratic risks can be better shared due to the sheer weight of numbers involved. Some 95% of the employed population in the Netherlands is in a second pillar pension fund. Secondly, the average Dutch employee saves about 20% of their income into one. Van Leuvensteijn believes that high participation levels are so vital that mandatory pension saving should reach further than industry-wide schemes, to include the whole workforce. A third factor that could aid success is more flexibility around retirement ages.
As Van Leuvensteijn points out, it is now common for people to aim for widely varying retirement ages. “More and more, pension schemes have to be alert to individual needs of people,” he says. Permitting “people to retire later or earlier will become more important to allow for flexibility in the labour market.” Such freedom would not only help if a pension fund had to absorb a shock, such as a spike in longevity, but would also give workers stronger faith that they can work longer to accumulate more savings if they wish.
This is even more important given the fact that there are no guarantees in a CDC environment. “It’s more about a pension fund setting an ambition with regards to the return they make, rather than guarantees,” says Van Leuvensteijn.
On the other hand, setting one up, albeit a minimal one, may be a good idea, he suggests. “There are advantages in having some sort of minimum guarantee.” “One of these is that you could communicate to the participants that there is a part of the scheme that is secure. And that is probably clearer than when you are just discussing ambitions, because some of the participants could take those as a guarantee.” Whatever the eventual shape of the typical Dutch CDC scheme, one thing you can guarantee is that it will be one that has the employee’s best interests at heart.