On Tuesday Rogier Swierstra will be talking about the maths of the Dutch pension reforms. I’ve been reminded of this article from Paul and Phil as it would be good to have a proper debate over coffee. You can join this session from the link at the bottom of this blog.
The two blogs are designed to give us a better understanding of where we are compared with the Netherlands but I suggest you attend our coffee morning a link for which will follow shortly!
In the meantime, here are Paul and Phil.
Paul Waters
Head of DC Markets
Phil Hardingham
Head of Digital Strategy (Investments)
Collective Defined Contribution (CDC), a new approach to providing pensions, has got lots of attention in the UK pension industry recently, particularly in the Mansion House reforms.
If the UK increasingly considers CDC, can we learn anything by looking further afield? Which risks and benefits are good to share, and which aren’t?
Dutch experience
The Dutch Pension Act, which came into force from 1 July 2023, marks a shift away from DB and CDC arrangements toward DC pension provision in the Netherlands. Notably, this is the opposite direction of travel compared to those currently being suggested by the UK government.
What has catalysed this shift in the Netherlands? Why are they reforming, when Dutch pension provision is rated as among the best in the world?* In short, members didn’t understand the risk sharing mechanisms behind the system, and this led to cries of intergenerational unfairness when difficult decisions around pension cuts arose.
Only a fool learns from his own mistakes, a wise man learns from the mistakes of others
What can we learn to avoid the same about-turn and keep the introduction of CDC on a path to success?
It will be important for those working on pension scheme design to decide which risks and benefits get shared, and which don’t. They’ll typically consider the implications of design decisions on members and it will be vital to ensure that the design leads to better outcomes.
But… this isn’t quite the same question a member’s asking. A member is less concerned about “what does this mean for all members?” and more focused on “what does this mean for me?”. And, at its heart, this is a question of fairness and transparency. Members must be happy with the pension they’ll get out, given the contributions they’ve paid in.
Importantly, fairness in isolation isn’t sufficient. It won’t wash if some members think they’re getting a hard deal and they don’t understand why, even if their lot is actuarially fair according to scheme rules. Instead, for a CDC system to be successful, members need to view the risk sharing mechanisms as transparent and equitable.
What should the pension industry do?
Split the pension scheme
Ensuring pension entitlement can be easily attributed between individual members is likely a minimum for this transparency. This needs to be explainable, too. Those designing pension systems must articulate simple, clear, responses to members’ questions. “What’s my pension entitlement? How’s it evolved from last year? Why?”
Be pragmatic about pooling
Pooling different sources of risk (investment, liquidity, longevity) is the core mechanism to improve members’ typical outcomes. However, there’s a balance to be struck between efficiency, and transparency. There will likely be cases where pooling risks across the membership may make sense ‘mathematically’, but not be worth it practically given the additional complexity and opacity it introduces.
Focus on the difficult scenarios
The challenges around intergenerational unfairness will invariably arise when there are painful outcomes to allocate. How can this possibility be communicated clearly, both before and after such a scenario? Can these explanations be tested with real-world members, to ensure they are straightforward and clear? There are a lot of exciting possibilities around alternative pension design, which may drive better outcomes in terms of security, flexibility, and income levels. However, as momentum behind longevity pooling and CDC grows, as an industry we need to avoid getting caught in a proverbial echo chamber and ensure that any design is pragmatic and simple enough to retain the confidence of the members themselves, those who we believe would actually benefit from it.
It’s a rare opportunity when you get a blank sheet of paper to design from in the world of pensions. The decisions made today could affect millions of people for decades to come. As an industry we have to get this right, and lessons from abroad can teach us a lot.
*Mercer CFA Institute Global Pension Index 2022
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You can join this session from the link below.
I have some concerns about this:
Firstly it puts “risks” as the key driver not “opportunities”.
Secondly it appears to me that the inter-generational unfairness perceived to have occurred in the Dutch system arose because members are encouraged to think about the individual to individual comparisons of a DC pension system.
An occupational pension scheme is designed to provide the deferred remuneration the employer offers its workforce – whether that is by providing a defined or targeted benefit or through a defined contribution into an individual’s pension pot (irrespective of whether that pot is held and invested in a Mastertrust, a GPP, or another Group Money Purchase arrangement). The employer who is paying a significant part, and in DB and CDC likely to be the majority, of the contributions is quite entitled to say its deferred remuneration targets a certain percentage (I hate vulgar fractions) of the current salary and that is paid to the employee and not for a non-dependant ultimate beneficiary.
If an employee wishes to increase his own pension pot for his personal purposes he has the opportunity to pay into a separate personal pension, or possibly AVCs . This why salary sacrifice distorts in favour of those can afford to make these additional contributions at excess cost to the Exchequer over the pension contribution relief.
I understand the Dutch reforms were triggered by a reduction in benefits of less than 2% after many years of above inflation increases. Is this throwing away the opportunities of the system by addressing a hypothetical risk that became a real risk in an extreme situation without considering the overall benefit to the member?
I do doubt there is really any inter-generational unfairness in a DB or CDC system. Sure the accrual cost of the benefit rises as the number of years the contributions are invested reduce but that is a collective matter and is reflected in the employer’s not the employee’s contribution. Surely it would be unfair if an employer restricted membership of its DB or CDC pension promise to employees below a certain age. Instead younger members receive revaluations to their accrued benefits which progressively increase the longer they remain in the defined or targeted arrangement. The relative efficiencies of pooled DB and DC plus the increased employer commitment over individual DC pots are likely to far outweigh any differences between the effect of the investment return on the pension from a DC pot and the pre-retirement revaluations in a defined or targeted arrangement.
I am looking forward to Tuesday’s session.
Thanks Oldie. I share your interest in Tuesday’s session. Our response to the two consultations being asked for next Wednesday and the Wednesday after focus on the need for Government to look at CDC as an opportunity to pay “more than” not a risk that occasionally they may pay “less than” people hope!
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