Individual DC would save Dutch pension system, academic says

Shifting from the Dutch pension system’s predominantly defined benefit (DB) arrangements to individual defined contribution (IDC) would make it “much less complicated”, according to Bas Jacobs, a professor of economics and government finances at Rotterdam’s Erasmus University.

Speaking at the recent Pensioenforum in Scheveningen, he argued that an IDC approach would solve most of the system’s current problems.

Jacobs said the proposals of state secretary Jetta Klijnsma for an updated financial assessment framework (FTK) were an “incomplete and very complex mixture” of a guaranteed nominal pensions contract and a soft contract under real terms.

By contrast, a mandatory IDC would deliver a transparent and complete contract, with the paid premium also producing the future benefits, he said.

In such an approach, the negative redistribution effects, as a consequence of the current average pension accrual and contribution, would disappear, he said.

The same would go for the “subjective” criteria for risk premiums, the discount rate and the ultimate forward rate (UFR).

Jacobs noted that the proposed FTK legislation – with an increased threshold for indexation – would leave an unpaid bill of €300bn, and predicted that the conflict over risk sharing between generations and other groups of participants would continue.

Referring to the combination of longevity risk, inflation and financial risk that pensions funds currently faced, Jacobs concluded that schemes were trying to “insure something that is actually impossible to insure”.

The professor also claimed that the pensions system would remain procyclical following the prescribed “asymmetric” recovery periods, and reminded his audience that the procyclical character of the current system had greatly contributed to the deep recession in the wake of the financial crisis.

In his opinion, the nominal guarantee under the new FTK will result in too little investment risk for young participants and too much risk for older participants.

He stressed that a mandatory DC system would allow for a correct age-dependent investment mix, without a conflict between generations.

“In addition, there won’t be funding shortfalls or a procyclical policy for investments, contributions and benefits,” he said.

However, Jacobs acknowledged that the lack of risk-sharing among the generations, such as longevity risk, would be one of the disadvantages of a DC scheme.

He said that, under IDC arrangements, participants should be offered longevity insurance, and be protected against “short-sighted” investment decisions.