“If we look at the U.S., state pension funds are now facing a funding gap of about $3 trillion because of past mistakes in calculating liabilities and so persistently paying too much pensions to retirees,” said Theo Kocken, CEO of Cardano Group, based in Rotterdam. “The Netherlands will be following that route if (the new pension agreement) is implemented in its current form. I'm hopeful that discussions ... will lead to adjustments of the proposal that may actually provide a better system than we have today.”
The broader pension agreement, which will be voted on by a federation of trade unions on Sept. 12, will effectively push the €790 billion ($1.1 trillion) Dutch pension industry one giant step toward a collective defined contribution model — also dubbed "defined ambition' by some proponents, according to several consultants and pension experts.
“When the Dutch decide to make major changes to their pension system, the rest of the world should pay attention,” said Keith Ambachtsheer, founder and president of pension management consulting firm KPA Advisory Services, Toronto. “The questions they're asking are in the context of how to change that system so that it continues to be sustainable. This is a struggle for everybody in the world, but the Dutch — more than any other country — are trying to deal with those realities in a fair and transparent way.”
While the Dutch pension system is considered one of the most stable, it's not without problems, added Jelle Beenen, head of investment strategy consulting for Belgium, Netherlands and Luxembourg at Mercer. “The recent crisis pointed to its vulnerabilities, leading the public to lose some confidence in the pension system as well. This wake-up call was one of the factors that led to the new pension agreement.”
The proposed accord includes increasing the pension calculation age to 66 from 65, and placing a ceiling on contribution rates. Members would also give up “nominal guarantees,” or a minimum level of pension benefits before taking into account inflation-linked payments. Instead, payments could be higher or lower than the current nominal benefits, and are subject to changes in market conditions, life expectancy forecasts and the risk/return profile of the fund's investment portfolio.
Liabilities, meanwhile, “will no longer have to be based on a risk-free discount rate, but rather that the expected return on the portfolio can be used as the maximum basis for the discount rate,” according to a draft of the proposed pension agreement.
Critics argue that with the proposal as currently written, pension fund executives might be tempted to lower future liabilities by raising the expected returns of the portfolio, which can be accomplished by shifting into riskier assets.
“In the airlines business, whether you calculate the height above sea level based on feet or meters doesn't change the actual height. It's the same with coverage ratios: Changing the calculation method doesn't leave you with more money in your fund,” said Toine van der Stee, CEO of the Blue Sky Group, a fiduciary manager with about €13.5 billion ($19.47 billion) in assets under management, mostly from the KLM Royal Dutch Airlines pension funds.
“We need reforms, but not drastic reforms,” Mr. van der Stee said. On average, the coverage ratios of the KLM pension funds fell about five percentage points in August to hover between 115% and 130%, but all remain above the 105% legal threshold before a recovery plan is required.
Under the current system, pension funds are required to remove risk, raise contributions or potentially cut benefits if their funding levels fall below 105%. Because it's more difficult to cut benefits or raise contributions in the current political environment, pension officials are more likely to take risk off the table, which in turn makes it even more difficult to recover, sources said.
Pension officials say they don't expect the proposed agreement to immediately affect the current asset allocation. However, the current pensions framework — which discounts liabilities using interest rates that are low because of the flight to quality to Dutch bonds — might force some pension funds to make significant allocation changes that could hurt members, said Alwin Oerlemans, managing director of the institutional business at APG, which has about €275 billion in assets under management.
“If you start derisking a portfolio of assets, you're effectively agreeing to much lower expected returns,” said Mr. Oerlemans, whose company is the fiduciary manager of the €242 billion Stichting Pensioenfonds ABP, Heerlen.
But if performance falters, a fund in the decumulation stage — as many Dutch plans are — would struggle to recover. In comparison, a fund in the accumulation stage has a relatively higher rate of contributions and a longer-term investment horizon to cushion short-term volatility. Furthermore, adding risk to a portfolio in decumulation might harm members, said Jean Frijns, professor of investment theory at VU University, Amsterdam.
“If you follow a higher-risk strategy, there's almost no upside for retirees. But in the worst-case scenario, if (the funds) end up on the wrong side of the risk taken, the nominal pension rights will have to be reduced,” said Mr. Frijns, who chaired a 2010 committee on pension reforms commissioned by the Dutch Ministry of Social Affairs and Employment.
Mr. Ambachtsheer of KPA said a flaw in the proposal is the assumption that “a collective risk profile” can be established to take into account the individual risk tolerances all members, young and old. He proposed using separate “risk-taking and risk-shedding” investment pools in allocating assets according to customized risk/return profiles for individual members.