Providing greater choice

Without discounting the positive elements of the much-praised Dutch pensions system, Theo Nijman, chair of the three-director team of the new pensions knowledge platform Netspar, says there is room for improvement.

"We must get rid of the ‘average-approach'", he emphasises. "The 900 pension funds in The Netherlands offer basically the same scheme: compulsory uniformity for all members, from the lowest employee to the director, and for all ages. It's the other extreme opposite of countries which allow their workers full freedom of choice."

Nijman's philosophy is simple. "Different individuals require different pension contracts," he says. "Some are willing, or can afford, to run a bigger risk on investments. People just before their retirement usually want the opposite. Or the importance of indexation can be different to employees of different age," he gives a few examples.

"In the Dutch pension system everything is fixed in principle, and often mandatory. Roughly, all workers are dealing with a defined benefit scheme, a contribution and an indexation ambition depending on a surplus or a deficit of the scheme and the returns on its investments. After retiring, they face a compulsory yearly benefit. Its all average and one-size-fits-all. There are very few choice options, although they can eg decide on a value transfer to another pension funds when they change jobs."

In Nijman's opinion, the Dutch system must also take into account cases like an employee with a partner with a substantial pension, and the worker who already has other financial assets. "Those categories can run more risk, for a larger pension, or a lower contribution," he explains.

"Their investment mix could contain a larger amount of equity, than the average pension fund portfolio of equity and bonds on a 50/50 basis. An because older workers need more security as they approach retirement age, they should be offered an investment mix with the accent on bonds."

Does Nijman want to turn the whole Dutch pensions system upside down? "Not at all", he says. "It's about more heterogeneity in contracts, not about an unlimited freedom of choice. If everybody could judge properly what is a good investment and what is not, then full freedom of choice would be a good thing. But several studies and experience elsewhere, have shown that it doesn't work. Workers lack the expertise for a balanced investment choice, or they are simply not interested.

He cites the US as an example of greater pensions choice. "In the US, for example, workers can basically do what they like as far as pensions are concerned. If they invest, they can profit from tax incentives. But if they decide to neglect their financial future after retirement, it's up to them. Many employees at Enron had invested their pension assets in their own company. When it collapsed, they lost it all, together with their job. It was the most stupid thing they could have done. Fortunately this disaster has contributed to voices in the US that plead in favour of limiting this full freedom of choice."

Sweden provides another example, he says. "Swedish workers can choose to put their pension money in 600 different investment funds. But in practice, many of them have invested heavily in their own company, or in other Swedish firms. Putting their eggs in one or a few baskets has made them vulnerable."

Research by the Dutch pensions regulator De Nederlandsche Bank (DnB) has made it clear that also most of the workers in Holland are not interested in becoming involved in pensions. This finding is supported by a recent survey by the Stichting Pensioenkijker, a body with the specific task of improving the pension-consciousness of workers.

hat is why Dutch pension funds should continue to play a central role in made-to-measure schemes, Nijman believes. "Because they are the experts, they should design the individual schemes, based on the specific characteristics of each member," he says.

Nijman suggests that other innovative options should also be considered as part of a more made-to-measure approach. He cites reverse mortgages, as a supplement to pension money for house owners, an idea recently proposed by Guus Boender, his colleague in asset liability management.

"Pension funds should more actively engage with members who - due to for example a stay abroad, inactivity or having been self-employed - are confronted with a pension gap. Their schemes should offer advice and solutions for tackling the looming deficit, and create the option of an increased contribution, with a contribution cap of for instance 25% of the worker's salary. The criterion should be a pension at 70% of the last-earned salary. At the moment, such decisions are entirely left to the employee."

The issue of life-expectancy could also be part of the discussion, Nijman says: "It is of course a fact that women on average live longer than men and, likewise, highly educated persons live longer. People should think of this too, when they make arrangements for a future pension. But we need to find out first whether this is allowed by the anti-discrimination legislation."

Nijman also has a proposal for employees who are willing and physically able to keep on working after the official retirement age of 65. "Because of the prolonged period before their retirement, this category should be allowed to choose a more risky investment mix," he explains.

Despite the changes he has in mind, Nijman wants to retain the commendable parts of the Dutch pension system, such as mandatory membership and the collectivity of the schemes. "Participation in pension funds should remain compulsory, because it creates valuable opportunities for trade between generations that do not exist on financial markets," he says.

"Collectivity is valuable, since it enables the pension funds to invest effectively at low costs. The marketing costs which are often substantial in individual schemes can be avoided. Because of their scale, pension funds can arrange deals on the financial markets, that are simply not achievable for individuals," he explains. "And collectivity also allows for solidarity, which is another cornerstone of the Dutch system.

"Being the expert, the pension fund should make the arrangements for its members. It should come up with a basic proposal, consisting of an asset mix, the ideal amount of contributions and how much risk the individual member could bear for his eventual pension. In order to avoid too much choice, the member should only be allowed to indicate which of two variants he prefers, and maybe how much risks he wants to run. That should be it."

What about people who insist on an unwise choice? "They should be protected against themselves," says Nijman. "And society should be protected from the financial consequences from them making the wrong choice by deviating from the expert's advise. If the member decides not to agree, and opts for a scheme that is not suitable in the pension fund's opinion, he or she should at least sign a guarantee from later claims against the scheme. Compare it to a disagreeing patient, who has been urgently advised to an operation by his heart surgeon."

In order to prepare members for making the right choice, the transparency of the pension system must be improved considerably, Nijman thinks. "Especially on individual pension products, risk factors and the indexation ambition, there is ample space for more clarity on the instruction leaflet, that needs to accompany the annual statement on the individual pension position," he says.

A new made-to-measure approach will make the Dutch pension system more expensive, professor Nijman admits. "But it will probably not be that much. Facts like the built-up pension rights and age are already available within the present set-up of a pension fund and the pension contract that is offered, can easily be made dependent on these. Getting additional information on other characteristics will require some more effort and costs."

Could the Dutch pensions industry benefit from Nijman's proposal in their endeavour to operate within the wider European market? "I certainly think so," he says. "It will enhance the schemes' and providers' expertise, as unbiased, low-costs advisers of individuals. This will be useful if they consider offering similar products in countries, like Germany and France, which are currently positioned at the very other end of the scale, with almost full freedom of choice for their workers."

Nijman says a change in the direction of individualised pension schemes could be set in motion by a discussion among the social partners. Once they agree on the principles, pension funds and providers should develop the tailor-made arrangements.