Investment risk better taken into account
The results of the study confirm the importance of having a tailor-made investment policy as stressed in the recent Pension Accord between the government and the social partners. As Minister Koolmees of Social Affairs and Employment stated in his letter of June 2019 to the Dutch House of Representatives, “this offers older people more certainty while younger people bear the risk that is necessary to ensure they receive returns on their accrued pension.” A tailored investment policy therefore helps to ease the tension between generations.
The positive impact of a tailored investment policy is based on the differences in the extent to which pension fund members are able to bear investment risks. Young people are generally more able to bear investment risks than older people, as they can look forward to many years of labour income from which to accrue pension. Young people also have more opportunities to respond to financial windfalls and setbacks by working more or less or by adjusting their level of savings. Young people are therefore better able to take on investment risk than older people.
The current pensions system barely takes into account differences in members’ risk bearing capacity. Pension funds pursue investment policies that are uniform across all age groups. By contrast, a tailored pension policy ensures that members’ exposure to investment risk decreases towards their retirement age.
Tailored investment offers advantages for various contracts
In the new study, DNB analysed the permutations of a tailored investment policy for three pension contracts – the present contract, the envisaged new contract and a contract with personal pension assets. In all cases, a tailored approach to pension investments resulted in a higher or more stable pension benefits, or both, for all members. The welfare gains resulting from a tailored investment policy can easily add up to over 6% of the supplementary pension. In addition to the improved allocation of equity risk, the improved allocation of interest rate risk also leads to a substantial part of these increased welfare gains. As a result, older people’s pensions will be less sensitive to changes in interest rates.
The advantages that can be achieved with a tailored investment policy depend on how such an investment policy is designed. The study highlights the importance of taking into account the characteristics of the pension contract and the investment risks that the various members are able to bear. Simplified rules that distribute the investment risk between younger and older members which insufficiently take these characteristics into account could even put members at a disadvantage and result in welfare loss. Careful implementation of the agreements set out in the Pension Accord is therefore crucial to ensure that members will be able to benefit from the advantages of tailored pension investments.