Probability & Partners: How to ensure a balanced transition to the new Dutch pension system?

February 27, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Maurits van den Oever and Ronald Sijsenaar, Quantitative Consultant and Partner at Probability & Partners respectively

The transition to the new pension system must be done in a balanced manner, as prescribed by the Ministry of Social Affairs and Employment. But how do you, as a pension fund, determine what a 'balanced' transition is?

This is a nuanced story, because the route to the new pension system has many turns and the definition of the concept of 'balanced' can be determined from different perspectives. The Balance Guidance from the Ministry of Social Affairs and Employment prescribes in any case that the principle of balance must be applied to all aspects of the transition. How can you, as a pension fund manager, best deal with the concept of balance throughout the transition process?

Definition of the concept of balance

Despite the fact that the concept is frequently used, a concrete definition of balance is lacking in legislation and regulations. This is understandable, since the interpretation of balance is highly dependent on the characteristics of the pension fund. The composition of the participant base and the level of the coverage ratio are important factors in this. This has an effect on the distribution of the buffers in the event of entry and on the distribution of returns in the new pension contract.

In practice, most pension funds deal with balance by implementing it based on the principles of the pension fund and more concrete objectives of the transition. These objectives also depend on the characteristics of the pension fund itself. For example, a pension fund with a diverse participant base will pay more attention to minimizing redistribution between generations. The distribution of age cohorts within the participant base also has an effect. Younger participants will attach more importance to long-term pension expectations, while older participants will probably pay more attention to how the amount of the entitlement will work out immediately after the transition.

The financial condition of the pension fund also has a major influence on the objectives of the transition. Pension funds with a lower coverage ratio have stricter legal requirements and therefore have less room to achieve objectives. The feasibility of the transition goals is therefore also important. In addition, they must be ordered by priority. This can be achieved by drawing up priority rules. Goals that cannot be achieved immediately may be achieved later after the transition. An example of this is the later replenishment of the solidarity or risk sharing reserve, if the initial filling after the transition is not enough.

Linking balance to metrics

After formulating and ranking various goals, the choices surrounding the entry route can be made. Determining how the effects of the transition are measured is the first step. The choice of metrics that are maximized logically affects the final distribution. A pension fund that wants to minimize intergenerational effects can, for example, look at (delta) net profit. A pension fund that wants to maximize the purchasing power of the participant looks more at the expected benefits. A pension fund that is more risk averse can nuance this outcome by paying more attention to the spread of expected benefits in good and bad weather scenarios.

Completing choices with a view to balance

There are many options available during the pension transition. These may concern the entry itself or the details of the pension contract after entry. The entry itself may concern the request for entry by the social partners, the method of entry, the use of the transition FTK, and any compensation for the abolition of the average system. Some choices match certain standards better than others. For example, if a lot of attention is paid to minimizing intergenerational effects, the VBA method of entry is better than the standard method.

When fleshing out the new pension contract, there are also plenty of choices that have an impact on balance. Examples of this are the lifting of the borrowing restriction, the filling of the solidarity or risk sharing reserve, the inclusion of catch-up indexation, and the distribution of protection and excess returns. For example, a young pension fund may choose to fill the solidarity or risk sharing reserve more for better risk coverage in the long term. An older pension fund may choose to increase short-term pension expectations by putting less money in the reserves.

Conclusion

Completing the pension transition in a balanced way is a nuanced story with many choices regarding the entry itself and the completion of the new pension contract. We propose to introduce a common thread of balance throughout the entire process, which starts with the objective and principles of the fund, continues to the standards, and then ends with the entry choices and the choices surrounding the new pension contract.

Probability & Partners is a Risk Advisory Firm that provides integrated risk management and quantitative modeling solutions to the financial sector and data-driven enterprises.