AEGON Global Pensions | December 2013
WHY THE NETHERLANDS IS LOOKING TO CHILE FOR A NEW PENSION SYSTEM (WHEN THE UK IS LOOKING AT THE NETHERLANDS)
Erik Schouten, International Legal Tax Consultant, Aegon Adfis
In a recent paper on occupational pension reform in the UK, the Pensions Minister Steve Webb proposed that the UK look at introducing Dutch-style Collective Defined Contribution (CDC) plans.1 At the same time, in the Netherlands a cross-party group of young politicians - backed by several prominent Dutch economists – is calling for the Netherlands to move away completely from its present collective occupational pension system to a personal Defined Contribution pension system, similar to the Chilean pension system. Why would young Dutch politicians be looking to terminate the renowned Dutch collective pension system and what does the Chilean system have to offer?2
Why the move?
On 26 May 2013, the youth wings of three major Dutch political parties (VVD, PvdA and D66) published a joint plan for a new Dutch pension system.3 The youth parties proposed a new system in which each individual is obliged to save into a personal retirement plan with the savings being invested collectively in separate cohorts according to age group. The introduction of personal accounts is intended to remove any possibility for intergenerational conflict. Potentially, the proposal spells the beginning of the end for the Dutch collective pension system.
What was proposed?
The new proposal has ten elements:
1 Compulsory enrolment – all working Dutch adults should be obliged to save a minimum percentage of their salary for a pension. The percentage should be set by government and be sufficient to obtain an adequate pension.
2 Participants should be given some freedom to choose when they will retire and to save more than the minimum required up to a certain limit.
3 Employers are obliged to automatically retain their employees’ legal minimum pension contributions and deposit it into their employees’ individual retirement savings accounts.
4 The employees are free to decide which of the regulated pension providers will administer their individual retirement savings accounts. The pension providers invest the funds collectively and limitations are placed on switching funds.
5 In order to improve efficiency and reduce costs, the number of pension providers should be strongly reduced.
6 The government will provide regulation to ensure that risk is managed in a way that ensures that each age group invests in a way that is appropriate.
7 Regulation should ensure that participants are informed on how much they have saved, what their expected pension will be and the risks that they run.
8 New pension providers have to meet certain requirements and costs have to be clear and transparent. Regulation will be passed to limit the costs that can be passed onto participants.
9 Mortality risk will remain collective. If participants die prematurely, their savings will be used to provide pensions to participants who live longer than expected.
10 Once the new system for pensions is implemented, all future pensions must be provided using the new system. Established pension rights built up under the present system would remain untouched.
All but the last two of these points are identical or nearly identical to the present Chilean pension system, introduced in 1981 (and reformed since). What is it about the Chilean pension system that appears so attractive to the younger Dutch generations?
What does Chile have to offer?
At first glance, it may seem surprising that the Dutch are looking to Chile at all. The Melbourne Mercer Global Pension Index 2013 ranks the Netherlands’ pension system second with the Chilean system trailing in eighth place (out of 18).4 The Chilean system presently suffers from an insufficient minimum contribution level and an insufficient minimum pension level, as well as too few options for annuitizing pension savings on retirement. None of these criticisms are intrinsic to the system itself. What attracts the young Dutch politicians to the Chilean system is its considerable freedom of choice, personal ownership of funds, lack of intergenerational transfers and the low costs. According to the young politicians, the creation of personal retirement funds will remove intergenerational conflict and be fairer and cheaper for all.5
How can the Chilean system help the Netherlands?
Compared with participants in the Netherlands today, pension savers in Chile have a lot of choice. They are free to choose their provider (after the first two years of saving during which time they are obliged to choose the cheapest provider) and they are free to choose the funds in which they invest. The retirement date is not firmly established and can be brought forward or delayed. Upon retirement, retirees have different choices available on how they wish to use their retirement savings to fund their retirement. And perhaps the strongest case can be made for the efficiency of the Chilean system: it has been calculated that a Dutch car mechanic will receive on average 2.5 times in pension what he or she has saved; a Chilean car mechanic will receive on average 3.8 times what he or she has saved.6
The Chilean system quite simply costs less and delivers more. It also removes any question that one generation will retire on the savings of another generation. As the Dutch population ages, this fact will become increasingly important. The Chilean system benefits from the scale of a collective system but removes the risk of intergenerational transfers. We may expect the younger generations of employees to increasingly favour such a system.
The Chilean pension system7
In 1981, the Social Security system in Chile was replaced by a mandatory individual account system, administered by private pension fund management companies called ‘Administradoras de Fondos de Pensiones’ (AFP), which collect and distribute the funds of Social Security. All participants who were involved in the old system had the option of retaining their existing coverage until 1 May 1986. At that time, if still actively employed, they were obliged to join the new system. New employees hired as of 1 January 1983 were required to join the new system.
Under the new system, contributions are paid entirely by the employee, thus changing the system from pay-as-you-go to a new savings-based arrangement. The contribution levels, up to an indexed ceiling, are 10% of monthly salary for the pension, and, on average, 3% of monthly salary for survivors’ and disability annuities.
Employees in Chile are also able to make additional, voluntary contributions up to 10% of their monthly salary. All contributions are tax-deductible. In order to compensate for the fact that employees are required to pay all contributions, there was a one-time salary increase for all employees equal to 17% of salary as of 1 March 1981.
Under the present mandatory pension scheme, workers establish an individual capitalisation account (ICA) with one of six authorised AFPs and can transfer their accounts from one company to another. The administration of AFPs is closely monitored by the government, especially with concern to allowable investments, minimum rates of return, and reserve levels.
AFPs are authorised to operate five different types of funds, A to E, each having a different investment risk profile. The funds are differentiated according to a minimum and maximum limit allocated to variable income vehicles.
Reforms introduced in March 2008 have sought to encourage additional voluntary retirement savings for employees and widen the scope of cover with the inclusion of the self-employed.
Chilean employers may also provide additional contributions to a voluntary group plan (known as ‘Ahorro Previsional Voluntario Colectivo’ - APVC).
At end of 2012, assets under management of the AFPs were reported as CLP 77.5trn (USD 159.3bn). The majority of assets were invested locally and all five of the funds produced positive returns.
1 The full consultation document Reshaping workplace pensions for future generations is available at https://www.gov.uk/government/consultations/reshaping-workplace-pensions-for-future-generations.
2 This article provides a summary of an article to be published in Dutch in Tijdschrift voor Pensioenvraagstukken.
3 The pension proposal (in Dutch) can be found at www.nieuwpensioenstelsel.nl.
4 For the Mercer Melbourne Global Pension Index, see http://www.globalpensionindex.com/.
5 Shell in the Netherlands has for similar reasons decided to close its Defined Benefit pension plan for new entrants and also to move to individual DC pension plans with the option of collective investment.
6 The calculations made by the Dutch Pension Federation were quoted by Annemarie van Gaal in the Dutch Financial Daily newspaper, Het Financieele Dagblad in her article ‘Chileense aanpak’ on 16 July 2013.
7 Axco, Social Security & Employee Benefits: Life & Benefits, 2013.