Risk spread and ambition level in existing pension contracts

Statistical News Release
Date 19 August 2011

In the public debate about flexibilisation of pension agreements two aspects are at the forefront; adjustment of the risk spread between member and pension fund, and adjustment of pension funds’ ambition levels. Data from De Nederlandsche Bank (DNB) show that in the present pension agreements 27% of company pension fund members bear investment risks.

For sectoral pension funds the risks of being able to fund the nominal pension entitlements rests almost entirely with the fund. It further appears that more than 90% of the total number of members fall under a conditional indexation policy, which means that wage or price compensation depends on the fund’s financial position.

In 2010, pension funds reported 834 schemes toDNB. The risk spread between member and pension fund in these schemes strongly depends on the type of agreement. There are three types of agreements, defined benefit agreements (DB), defined contribution agreements (DC) and combinations of these. In the case of DB agreements, the risks are primarily for the account of the fund. Still, members, too, may run some risk because indexation can be conditional and, as a solution of last resort, pension benefits may be curtailed. For DC agreements, the risks run during the build-up phase are for the members, but in the benefit phase, for the fund. In combination agreements, the risks are more or less shared between member and pension fund. In this respect, there are considerable differences between sectoral and company pension funds. Sectoral pension funds mainly have DB agreements; for company pension funds approximately 27% of employees build up pension rights via DC or combination agreements (See Chart 1).

Members according to type of pension agreement
Pension funds' ambition level is partly determined by the indexation policy, the height of the accrual percentage and the height of the franchise. Various choices in these three areas result in a higher or lower ambition level. Several years ago, adjustment of the ambition level started with the switch from final pay to average pay schemes. For average pay schemes, conditional or unconditional indexation (wage or price compensation) is important. In 2010, this was conditional for more than 90% of members. Whether or not indexation of pensions takes place for these members depends on the fund’s financial position. In a system of conditional indexation, the ambition level of a pension fund can be tempered.

The height of the accrual percentage may vary strongly per scheme. Over 4.6 million members have a scheme for which the accrual percentage lies between 2 and 2.25%. Recently, several pension funds reduced their accrual percentages. These pension funds are anticipating new legislation, which will set lower maximum accrual percentages. But even apart from this, some pension funds reduced the accrual percentage and, as a consequence, their ambition level. However, the height of the accrual percentage must be regarded in combination with the height of the franchise, the part of the salary for which no additional pension is built up. The height of the franchise is often linked to a pre-determined measure, such as the state pension (AOW) for singles or couples, or to a fixed amount. The most common combination is a franchise between EUR 12.000 and EUR 14.000 and an accrual percentage of 2% or more (See Chart 2).

Number of schemes according to franchise and accrual percentage
The higher the franchise and the lower the accrual percentage, the lower the funds’ ambition level. After all, pension is built up over a smaller amount and with a lower percentage. Chart 2 also shows that for higher franchises the amount of schemes with a low accrual percentage actually increases.

For further information please contact Kees Verhagen (tel. +31 20 524 2272, +31 6211 23 922).