The UK and the Netherlands have arguably the most significant funded occupational pensions systems (relative to GDP) within the European Economic Area.
Whilst the UK Government has on a number of occasions considered how the UK pensions system could be developed to mirror the better aspects of the Dutch set-up, to date we have seen little appetite for action.
The Netherlands government has been undertaking a fundamental review of their occupational pension system, which the UK ought to be watching carefully. Indeed, shadow pensions minister Alex Cunningham has recently called for changes to legislation to allow UK companies to set up Dutch-style collective schemes – part of a structure that Mr Cunningham notes is “recognised as one of the best in the world”.
"Following a review which began in earnest in around 2010, the Dutch government has been increasingly concerned with inter-generational subsidies. "
The Dutch method
Before now, Dutch occupational pension provision has primarily been in the form of uniform-contribution, uniform-accrual and industry-wide collective plans. This system that dates back to the post-war industry-wide Pension Fund Act of 1949.
Under this system, employers and employees pay a fixed proportion of salary into a pension plan, in the same way they would for a Defined Contribution (DC) plan. However, assets are pooled and there is also a service-based target pension for a Defined Benefit (DB) arrangement. Unlike in the UK, this target benefit (for both past and future service) can be moved according to the assessed funding position of the scheme over time. These arrangements are subject to requirements for clear member communications and regulatory oversight.
Following a review which began in earnest in around 2010, the Dutch government has been increasingly concerned with inter-generational subsidies. Younger members in collective arrangements significantly subsidise the greater cost of providing future pensions to older workers, (even after allowing for member contributions rates that may step up in age bands). The Dutch government therefore announced, that going forward its preferred approach would be to replace fixed-contribution / uniform-accrual plans with uniform-contribution / decreasing-accrual arrangements.
Neither the existing nor the proposed new Dutch structures are commonly found in the UK. The critical difference in Netherlands pension law is that Dutch companies can retain substantial discretionary elements within their schemes’ benefit structure, most notably around deferred pension revaluation and pension increases in payment. These arrangements, which need to be formally agreed between employers and employees, provide the pressure valves that allow Dutch schemes to be both “DC” (i.e. pension contributions expressed as a percentage of salary) and ''DB'' (i.e. fixed annual accrual rates). However, significant negative experience can mean that base benefits become unaffordable (even without allowance for escalation) and so either increased contributions or reduced benefits have been necessary for Dutch pension plans.
The new Dutch approach is expected to be phased in from 2020 (although some doubt this timescale remains achievable by the new diverse coalition government). This replaces uniform-accrual rates with an age-related scale, so younger members will have a higher accrual rate reflecting the lower present value of their more distant pension payments. To ensure that accrual rates are of equivalent value to the contributions paid, this actuarial calculation represents a reduction in risk-sharing compared to the past. Crucially, there will be less of a subsidy of older members by younger members. However, substantial risk-sharing will continue with regard to market movements. This is so that the experience of those who retire when asset values and/or interest rates are high, is smoothed with those whose retirement dates fall less favourably. Significant demographic subsidies will remain with regard to genetic longevity, marital status and lifestyle factors such as smoking.
This is a move further away from UK-style DB. It is clear that UK scheme design would be considered financially unsustainable in the Netherlands. Of course, the UK generally shares this view, as most DB plans closed to benefit accrual and expensive pension promises are being gradually transferred to the insurance market. Many UK-based sponsors would say that if they had known that the level of guarantee would be ratcheted up by the cumulative effect of pensions legislation, then they would not have considered DB provision in the first place.
"With attempts to introduce Dutch-style middle-ground between DB and DC in the UK so far falling flat..."
In the UK the only real alternative, for now, is individual DC retirement saving. However, individual DC with no risk-sharing at all is considered undesirable from both an economic and social perspective in the Netherlands. It is uneconomic as it is inefficient for each individual to manage their own retirement investment account and the aggregate individual investment strategy will be less productive than a collective one. Due to the wide range of outcomes it is also anti-social even after allowing for the effects of “lifestyle” strategies.
Indeed, it is telling that individual DC does not seem to have been considered as a realistic option for the occupational pension pillar in the Netherlands and it was considered necessary for as much risk-sharing as possible to remain. Furthermore, it highlights that individual DC is more accurately described in the UK now as “lifetime savings”, which is more directly comparable to other savings vehicles than a collective pension plan.
With attempts to introduce Dutch-style middle-ground between DB and DC in the UK so far falling flat, we are left with the current trend to buy-out the remaining DB schemes when possible and for new provision to be DC-based lifetime savings. So, unlike the Netherlands, there is no plan to maintain collective occupational pension provision for the next generation in the UK.
This greater emphasis in the UK on individual accountability going forward compared to collective solidarity is arguably consistent with other social trends, as demonstrated by the outcome of the Brexit referendum. We are heading towards greater individual retirement responsibility at the same time as a progression to greater autonomy for the UK. Those that believe in the value of solidarity would argue that the outcome will be a less wealthy UK pensioner population overall.
It will be interesting to see whether the new pensions system of the Netherlands will be sustainable, or whether it will reduce its risk-sharing further over time to become more individualised. Alternatively, if the Dutch approach is a success, then maybe the volatile outcomes of DC lifetime savings will lead to increased demand to return to collective retirement provision in the UK. In this case future provision would surely need to be in the Dutch style of risk sharing as opposed to a return to historic UK DB provision.
In the meantime, Mr Cunningham’s call may or may not fall on deaf ears in Whitehall.
When the White Paper is published later this year we will find out if the debate is to be brought to the fore again anytime soon.
Ewan Miller contributed to the writing of this blog post, with thanks also to the input of leading Dutch pension consultant Joop Rietmulder.