Pension Reform in The Netherlands : Attractive Options for other Countries ?

The Dutch pension system is often referred to as one of the better pension systems in the world. The system is characterized by an accumulated pension capital of 1200 Billion Euro, substantially more than annual Dutch GDP. Moreover basic income for all elderly persons is provided on a pay-as-you-go basis (paid for by the current working generations). Like in all other countries, the rapid increase in life expectancy, the financial crisis and the lack of trust in financial institutions have raised concerns on the sustainability of the pension system as it is. The second pillar pension benefits that have always been perceived as guarantees by the participants have recently been reduced by many pension funds. Moreover the government has implemented a rapid increase in the eligibility age for the basic retirement income benefits implying that many workers are forced to work substantially longer than initially intended. In 2010 two government appointed advisory committees, the Goudswaard1 and Frijns committee, recommended structural changes to the Dutch pension system to keep it sustainable. Their thoughts have subsequently been supported and detailed by the employer organizations as well as the labor unions and by the government. Although discussions on the details of the adjustments are still going on, substantial changes are likely to be implemented as of 2015. These changes refl ect at least fi ve important dimensions: 1. The eligibility age for basic retirement income will increase form 65 now until 67 in 2024 and will subsequently be automatically linked to the development of the life expectancy. 2. Pension investments will be based on life cycle investing and thereby explicitly focus on the long run. 3. Pension income will as before take the form of monthly payments until death, but no minimum level of payments will typically be guaranteed. Pension income can decrease as well as increase, even in nominal (euro) terms. 4. While the benefi ts of mandatory collective schemes will be maintained, individual property rights within the collective fund will be better defi ned and protected. 5. Transparency will be increased by providing annual pension information to all participants that not only states their expected real pension income but also the (sizable) investments risks taken, by reporting pension income in pessimistic scenarios. This paper summarizes the current plans to reform the Dutch pension system and highlights elements of the new Dutch pension system that might be valuable for the (re)design of pension systems in other countries. These include: a. Insurance against individual longevity risk using mandatory annuitization. b. Explicit linkage of retirement dates and the level of retirement income to estimates of life expectancy. c. The design of decumulation products (variable annuities or draw down plans) where the income that is generated is directly linked to investment returns, interest rates and possibly to infl ation rates. d. Extension of fi nancial markets by trading risks that are not traded on fi nancial markets. e. Transparency on the implications of risk in fi nancial markets for the pension income to be obtained. The outline of this paper is as follows. Section II describes the main ingredients of the Dutch pension system to provide the required background for understanding the discussion on the reforms. Section III summarizes the main arguments to provide pension income until death (i. e. annuities) to insure against ones individual longevity risk. Section IV then turns to the risk management of reductions in over-all mortality rates, i. e. to macro longevity risk and increases in life expectancy. In Section V we consider optimal exposure to fi nancial risks in retirement products. Section VI explores how to start explicitly with a risk profi le in terms of pension THEO NIJMAN* Professor Investment Theory, Tilburg University, and Scientifi c Director, Netspar