Our present pension system
Our pension system consists of three pillars: a basic General Old Age pension (AOW), the pension that employees build up through their employer and voluntary individual income provisions. The present pension system has a number of vulnerabilities, which is why we need a new system. The government, trade unions and employer organisations have made agreements about this, and De Nederlandsche Bank played an advisory role.
The first pillar: General Old Age Pension (AOW)
The first pillar is the basic income provided by the government under the General Old Age Pensions Act ( AOW). Every person living or working in the Netherlands automatically builds up AOW under this government state pension scheme. Every year, the government adjusts the AOW level in line with the development of the minimum wage. When the scheme was introduced, everyone received an AOW pension from the age of 65. Now the statutory retirement age is connected to the life expectancy of Dutch pensioners, which means it is rising. For everyone born after February 1957, it has been set at 67 or over. The average life expectancy is likely to rise further over the years, and the statutory retirement age will rise with it. Changes to the statutory retirement age are announced five years in advance.
The second pillar: employment-related pension
Most employees also build up a supplementary pension through their employer in the second pillar. Both the employer and the employee contribute to this pension, which is usually administered by a pension fund. The pension fund invests the contributions received from employers and employees in for example equity, real estate and bonds and uses the accumulated assets to pay out pension benefits in the future.
The third pillar: individual supplementary pension
Some people also build up an individual supplementary pension in addition to their AOW pension and – if applicable – their employment-related pension. They can do this through life insurance or a bank saving scheme. Self-employed persons and other entrepreneurs can also choose to build up a pension in this way, since they do not build up employment-related pension through an employer.
Our role in the supervision of pension funds
In our supervision of pension funds we monitor three aspects:
- Financial position
Do pension funds comply with the statutory financial rules and regulations? For example with respect to investments and contributions, and when increasing or decreasing pension benefits.
- Operational management
Do pension funds have their administration in order?
- Board members
Are a pension fund's board members up to their job, and is their integrity beyond doubt? Proposed board members need our approval before they can be officially appointed as such.
How many reserves do pension funds need to hold?
A pension fund's funding ratio reflects its financial position: it indicates whether the fund holds enough reserves to pay out pension benefits, now and in the future. Pension funds use the actuarial interest rate to calculate the funding ratio. The higher the actuarial interest rate, the less reserves they need. The lower the actuarial interest rate, the more reserves they are required to hold.
Why do we need a new pension system?
The present pension system has a number of vulnerabilities:
- Pension funds make promises about the amount of pension benefits they intend to pay out to the fund's members. Pension funds invest to build up the necessary reserves to pay out the benefits they promised. However, making investments brings risks: if returns are lower than expected, pension funds cannot live up to their promises. If that happens, this damages people's confidence in the pension system.
- More importantly, the promises that a pension fund has made to individual groups of members are backed by the collective reserves it holds for all of its members. This could lead to discussions about which part of the reserves are paid out to whom, for example between younger and older groups of members. The current low interest rate environment has highlighted this issue, since it has caused funding ratios to fall and pension build-up costs to rise. Measures that pension funds are considering because of the low interest rates, are lowering pension benefits or increasing their pension contributions. This could lead to discussions about which part of the reserves are paid out to whom, for example between older and younger groups of members.
- By using collective reserves for all member groups, younger and older members are largely exposed to the same investment risks, while the younger members, who are further away from retirement, could bear a larger part of these risks compared to the older members.
- People no longer stay with the same employer their whole working lives. However, the pension system still presumes they do. Employees who leave the pension fund halfway through their career to start their own business, for example, build up insufficient pension compared to the contributions they have paid. In other words, the current pension system no longer matches the changing labour market.
That is why the government, trade unions and employer associations have agreed on a new pension system. De Nederlandsche Bank was an independent consultant in this process.
Our present pension system
While it is true that pension funds hold large amounts of reserves, they also have liabilities or payment obligations. Pension funds are required to hold sufficient reserves to pay out all pension benefits, now and in the future. Their funding ratio indicates whether their reserves are sufficient to do so. This ratio is calculated on the basis of the actuarial interest rate. The lower this rate, the larger the reserves they need to hold to be able to meet their payment obligations in the future.
The actuarial interest rate is based on financial market interest rates. These market interest rates are low now, and so is the actuarial interest rate.
The COVID-19 crisis has a deep impact across the globe. It also affects financial markets. As a result, the financial position of Dutch pension funds will also feel the impact. How things play out until the end of the year will determine whether pension benefits need to be cut. This is because pension funds decide on benefit curtailments based on their funding ratio as at year-end.