September 29, 2014
In many countries occupational plans are being reformed from Defined-Benefit (DB) to Defined-Contribution (DC) designs. In a Netspar discussion paper Lans Bovenberg and I explore the case of the Netherlands, which features a particularly high ratio of occupational pension assets to GDP. Most occupational schemes are DB-funded and the value of assets in these schemes amounted to about 170% of GDP in 2013. This implies that unanticipated shocks in financial markets and longevity require large changes in pension contributions in order to shield pension rights in DB-plans from these shocks. Therefore, Dutch occupational defined-benefit plans suffer from a number of serious weaknesses, including ambiguous ownership of assets, back-loading of benefits, and lack of tailor-made risk management. In particular, an intergenerational conflict may emerge about not only the ownership of capital in the fund but also the investment profile. These potential intergenerational conflicts are especially serious in the Netherlands due to the large stocks of wealth that have been accumulated. We will therefore focus on Dutch occupational pension plans and the need for reform. Our discussion may be of interest also to other countries who are transforming their DB-plans into DC-plans.
To address these weaknesses, we propose collective individual defined-contribution plans that are actuarially fair. These schemes maintain important strengths of collective schemes, such as mandatory saving, collective procurement and pooling biometric risks. At the same time, they eliminate intergenerational conflicts about risk management and distribution through transparent individual property rights and tailor-made risk profiles. Our proposal also eliminates the implicit pay-as-you-go elements through back-loading and thus creates the familiar transitional problem associated with a move from pay-as-you-go financing to funding. Therefore, our proposals address this issue head on by grandfathering some of the implicit pension rights in the old system in order to protect the transitional generations. In the paper, we show that this transition burden can be dealt without a substantial temporary increase in contributions, if the transition is accompanied by lower administrative and investment costs.Author : Raymond Gradus