Pensions in the Netherlands

Opinions of Working People on Supplementary Pensions

Stella Hoff

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351308540
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

Like Japan, the Netherlands has an aging population. As a consequence, the affordability of old-age pensions is under pressure. The labour market is also changing, with people more often changing jobs or choosing to become self-employed. Both trends raise the question of whether the pension system in its current form still meets the needs of working people today and in the future. The Dutch Ministry of Social Affairs and Employment asked the Netherlands Institute for Social Research scp to carry out a study of the support for solidarity in the Dutch supplementary pension system. Do working people still want to build up their pension in a collective system? What social trends are relevant here? Do employees prefer solidarity or choice? And to what extent do they express a preference for collective or individual pension schemes? This report answers these questions.

1 Purpose and background of the study

For decades, solidarity between members of Dutch supplementary pension schemes was something that could be largely taken for granted: members of a pension fund form a collective and together they contributions build up a capital sum which is used to pay their pensions when they retire. The Dutch supplementary pension system still follows the tradition of being organised along the lines of recognisable occupational groups. Whether they be teachers, metalworkers or dockworkers: each group has its own collective labour agreement which among other things regulates their occupational pensions. The fact that it is compulsory to join the employer’s pension scheme is always seen as a logical element of the system. Recently, however, questions have been raised as to whether the current system is future-proof: do people still want to build up a pension jointly with other members, or has the time perhaps come to move to a system that is based to a lesser degree (or not at all) on solidarity? This debate was prompted in part by the weak financial position of pension funds, which in many cases were forced to end the indexation of pensions or even to cut pension benefits. It suddenly turned out that the security of supplementary pensions could no longer be quite so taken for granted.

The Dutch Ministry of Social Affairs and Employment launched a national dialogue in 2014 on the future of the pension system. This was intended to lead to a Framework Memorandum which - based on scientific studies and meetings with experts and stakeholders -would generate ideas for a new system. This Memorandum was tabled in the Dutch Parliament in early July 2015 (szw 2015). The Ministry asked the Netherlands Institute for Social Research | SCP to carry out a study to ascertain how important people consider solidarity in the pension system to be. The study was also to look at social trends that could be relevant for the degree to which people experience (and/or want) solidarity.

1.1 The present pension system

The Dutch pension system is currently based on three pillars: the basic state pension (AOW), supplementary (occupational) pensions and individual supplementary pension schemes. Everyone in the Netherlands receives the basic state pension; every resident aged 15 years and older automatically accrues state pension rights until their retirement age, after which they are entitled to receive a pension. State pension benefits are funded from the contributions paid by those in work. It is a pay-as-you-go system, whereby the present working generation pays for the benefits of the present older generation. Even people who have never worked and have therefore not paid any AOW contributions receive the state pension.

Like the state pension, the supplementary occupational pension is also a compulsory system. Virtually all employees in the Netherlands are subject to a mandatory requirement¹ to save for a supplementary pension through their employer. If the company or the sector has a pension scheme, which most do, employees must join it. They pay contributions and in return receive a pension when they retire.² The pension fund to which the employer is affiliated has the task of investing the contributions it receives in such a way as to generate an optimum return at the lowest possible risk. The capital built up must be sufficient to pay all accrued pension entitlements, including both those of the retired generation and the obligations in the long term.

The third pillar of the Dutch pension system consists of individual supplementary pension schemes, and is voluntary: everyone may opt to take out an annuity, single-premium policy or life insurance with an insurer or bank in order to make extra savings towards their pension.

In this study we focus on the second pillar, namely the compulsory supplementary pension.

For years, compulsory mentorship of the employer’s pension scheme has been justified by the argument that people need to be protected against not building enough pension: without the compulsory nature, many people would save too little or nothing at all for their retirement. For pension funds, the compulsory nature of supplementary pensions has the advantage that they are not at risk of members leaving if the pension fund has a funding shortfall. This enables them to invest for the long term and thus to invest in higher-yielding shares (Boender et al. 2000). The benefit for members is that fluctuations in investment returns can be spread over several generations. Any setbacks in terms of investment returns or interest rates are passed on to members less quickly, helping to keep their pensions stable.

1.2 The importance of buffers, investments and interest rates

As stated, the task of pension funds is to collect pension contributions and invest them to achieve the highest possible return at the lowest possible risk. The resultant investment capital is used to fund all present and future obligations, i.e. both pensions in payment to the present older generation and the accrued pension entitlements of those currently paying contributions. A key factor here is the buffer that pension funds hold (or should hold) over and above the discounted value of the future pension entitlements. The buffer acts as a first line of defence to accommodate disappointing investment results. In the past, it was usual to aim for a funding ratio of around 125-130%, meaning that a pension fund had sufficient funds to meet its obligations and also to carry a reserve of 25-30% over and above this to cover periods when the financial climate was weaker.

The size of the buffer rises and falls with the investment results achieved by the pension fund. Until the banking crisis in 2008, everything was rosy: at the end of 2007 the average funding ratio was 144% of the nominal pension obligations. A year later, however, this had fallen to 95%, with the result that in the fourth quarter of 2008 around 87% of all members were in a pension fund that had a funding shortfall (DNB 2015). Such a rapid deterioration of the buffers was unprecedented. Although funding ratios have improved since then, they are nowhere near the levels seen in 2007; at the end of 2014, the average funding ratio was 108%. At that time, there were 32 pension funds in the Netherlands facing a funding shortfall, together representing 60% of all pension fund members (DNB 2015).

If the funding ratio is below the minimum required level of 105% for an extended period, the pension fund must intervene. One of the options is to end the index-linking of pensions in payment, which means that the purchasing power of pensioners is eroded by inflation. Another option is to increase pension contributions. In that case, it is working people whose purchasing power is affected, because their net pay is reduced. A third option is not to index-link members’ pension entitlements, leading to a reduction in their future pension benefits. Finally, there is the option of simply cutting pension entitlements and benefits. This is regarded as a last resort and may only be done if the three other methods do not help (enough) to raise the funding ratio to the minimum level of 105%. The Dutch Central Bank (De Nederlandsche Bank, DNB) can then order pension funds to cut pensions, as in fact happened in 2013 and 2014.

A complicating factor in all this is the level of interest rates, which play a key role in the funding ratio. Higher interest rates mean that future pensions can be paid more easily from the investment returns, while lower interest rates raise the prospect that it will be more difficult to meet future obligations. Since the banking crisis, in particular, interest rates have been at an unusually low level (Pensioenperspectief 2015), putting pressure on funding ratios. In addition, until recently pension funds were required to base their calculations on current market interest rates, which can fluctuate on a daily basis. This made funding ratios unstable, creating nervousness among members, pension fund administrators and pensions regulators. The new Financial Assessment Framework (TK 2013/2014), which came into effect on 1 January 2015, is intended to restore stability within the pension system (see Box 1.1).

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Box 1.1 A selection of measures from the new Financial Assessment Framework (FTK)

Implementation of policy funding ratio: replacement of the funding ratio based on the actual current daily ratio by the average funding ratio during the preceding twelve months. All policy measures implemented by the pension fund must be based on the policy funding ratio.

Cutting or indexation: pension funds whose funding ratio is too low are given ten years to build up their capital again. This reduces the risk that they will have to cut pensions. On the other hand, only when the funding ratio is above 110% are pension funds permitted to index-link pensions. This means that pension funds have less freedom to set their own indexation policy. For pension fund members, this means that they will have to wait longer for an improvement in their purchasing power, but also that the indexation policy is made clear for them.

Source: TK (2013/2014)

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1.3 Solidarity at risk?

The present system of supplementary pensions is based on solidarity between younger and older employees, between men and women, between contributors and pensioners. This is because all members within a pension fund contribute the same percentage of their salary and therefore build their pension at the same percentage rate: this is the average contribution system. Members collectively build up a pension capital from which all pensions are then paid. This collectivity enables risks to be spread; poor investment results are spread across current workers, current pensioners and future workers (inter-generational solidarity). There is also an element of redistribution: people who die relatively young, for example, help pay for the pensions of people who live longer than average, so that they can be sure of receiving their pension for the rest of their lives.

One of the points that has been raised for discussion recently concerns the fact that younger workers in reality pay too much in contributions and older workers too little. This is a direct consequence of the average contribution system. Since the contributions of young people have much longer to generate returns than the contributions of older workers, they ought in reality to pay less in order to achieve the same level of pension. It has been calculated that a 30 year-old member suffers a disadvantage of between 2% and 10% of their pensionable earnings (Gradus & Vijverberg 2014). For an employee who remains with the same pension fund throughout, this is not a problem because he or she will eventually benefit themselves from the contributions of younger members.³ By contrast, someone who switches pension fund at around age 40 due to changing jobs or becoming self-employed does not enjoy this benefit and is therefore a net contributor. As the number of people changing jobs and becoming self-employed is growing, this is a problem that is set to occur and more frequently.

Another relevant point is the uncertainty about the amount of the eventual pension. The Netherlands currently has a ‘defined benefit’ system, in which the amount of pension is linked to the recipient’s salary and the number of years worked.⁴ A major drawback of this system is the lack of explicit clarity regarding the ultimate amount of pension that will be received. Whilst pension funds offer a nominal guarantee for the pension with a high degree of certainty, they are not obliged to adjust pensions and pension entitlements to keep pace with inflation if the financial situation of the fund does not permit this. If a pension fund has an inadequate buffer and/or a funding shortfall, the governing board can decide not to index-link pensions, or - as a last resort - to reduce pensions. Ultimately, therefore, pension funds cannot offer a complete guarantee of pension amounts and pensioners cannot enforce claims in respect of the indexation of and prevention of cuts in their pension. In view of this uncertainty about the ultimate pension entitlements, driven by the fact that the risks are increasingly borne by pension fund members, voices are regularly heard arguing for a system based on individual defined contribution schemes, in which the amount of pension depends on the contributions paid and the return achieved on them (Van Ewijk et al. 2014). A major disadvantage of individual schemes, however, is the absence of a buffer, so that members will feel the effects of a deterioration in the financial markets more quickly. Partly for this reason, the Dutch government has rejected the variant of completely individual pension schemes as an option for the future pension system (szw 2015: 10).

1.4 Earlier research on solidarity in pensions

Berden and Kok (2013) carried out a study for the Federation of Dutch Pension Funds (Pen-sioenfederatie) on the desirability of compulsory pension saving and views on solidarity. The findings revealed that almost three-quarters of workers support compulsory pension saving. The most frequently cited reason was that they would otherwise be tempted to put aside too little for their retirement. The compulsory nature of pension scheme membership is thus seen as an incentive to save for retirement. The study makes no distinction between methods of saving for a pension, and it is not possible to tell from this study whether people prefer defined benefit or defined contribution schemes, nor whether they would prefer to save for a pension with a pension fund or an insurer. As regards the views on solidarity, the majority of employees have no problem with the redistribution of funds that is inherent in the present pension system. Generally speaking, at least half the respondents report that they do not mind paying towards the pensions of other groups, and in a few cases this figure rises to around 70%. However, the caveat needs to be applied here that this self-reported solidarity not infrequently stems from self-interest. For example, many young people who express solidarity with older workers are found to do so mainly to avoid having to pay high contributions themselves in the future. Those whose solidarity is based on a sense of moral duty are in the minority. This is in line with findings from earlier research. For example, Van Oorschot (2000) show that a large majority of Dutch citizens (87%) say that they also have other reasons for paying social security contributions in addition to the fact that it is compulsory, and that self-interest is the most important motive. The group who say that they pay contributions to ensure that they themselves are also assured of receiving benefit when needed is greater (82%) than the group who feel a sense of moral duty towards the weaker members of society (64%) or who take the fate of benefit claimants personally (42%). In addition, research by Soede (2010) shows that 60-67% of the adult Dutch population were definitely not willing to give up an increase in their own income in order to support other groups. Only between 7% and 19% of those surveyed said they would be willing to do this. Solidarity is therefore not an unconditional given, either in general or when it comes to pensions.

One reason for this may be that the term ‘solidarity’ evokes an ideological image which people find it difficult to oppose, but do not really know what it means in practice. Using an explicit definition as in the study by Soede (2010) can then produce relatively low solidarity scores. Kuné (2004) accordingly wonders how much support there would be for solidarity if pension scheme members knew exactly what it means; Van der Lecq and Steenbeek (2006) have no compunction in arguing that many forms of solidarity exist by grace of ignorance. We shall look at this in more depth in chapter 2.

Like ‘solidarity’, ‘choice’ is a concept to which people cannot really be opposed. I...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Contents
• Foreward
• 1 Purpose and background of the study
• 2 Solidarity in supplementary pensions today
• 3 Factors influencing the support for solidarity
• 4 Study approach
• 5 Opinions on supplementary pensions
• 6 Summary and discussion
• References