Solidarity components to be retained, but interest rate risks to be borne by insured employees

VS – 09/2022

In the light of an ageing society and permanently low interest rates, the Dutch parliament (second chamber) has passed a reform of occupational pensions that is to come into force on 1 January 2023. Thereafter, the current defined benefit occupational pensions will be converted into defined contribution occupational pensions. It is to be adopted by 2027.

Reasons for the reform

Occupational pension scheme is widespread in the Netherlands. For example, about 89 per cent of employees have entitlements to an occupational pension (OECD (2021): Pensions at a Glance). The occupational pension system is primarily based on defined benefit pension obligations. These are conditional benefit obligations. The insured employees acquire pension entitlements that are adjusted in line with wage or price development. This is subject to the financial position of the respective fund. Thus, pension payments may also be reduced in extreme circumstances.

This has also happened for some occupational pensions from 2010. Others were only able to avoid a cutback through a short-term relaxation in solvency requirements, i.e. own funds. Against this background, the Dutch government and the social partners agreed on the key points of a fundamental reform of occupational pensions in the summer of 2020.

The new occupational pension contract – nieuwe pensioencontract

The "new pension contract" (NPC) was drafted to maintain the previous collective nature of occupational pensions in a defined contribution system. The "solidarity reserve" is an essential element of solidarity in this context. All contributors pay a fixed proportion (up to a maximum of ten per cent) of their occupational pension contributions into this reserve. This is intended, for example, to cushion shocks on the financial markets across generations. In contrast, the low interest rate risk is no longer balanced between generations. It was precisely the long period of low interest rates and the accompanying difficulties faced by occupational pension systems in meeting their pension obligations that were the main impetus for the occupational pension reform.

Challenge: changeover from defined benefit to defined contribution occupational pensions

By 2027, the full conversion to defined-contribution occupational pensions should have taken place. This is a world first. Previous reforms usually provided for a coexistence of old and new contracts over a prolonged period of time. Only vested rights of young insured employees were converted immediately. In the Netherlands, the social partners have agreed that this conversion should take place based on intergenerational equity. The entitlements acquired in the past are valued for this purpose and transferred to individual capital accounts. However, modelling shows that different valuation methods lead to widely divergent results in terms of intergenerational equity. 

Current interest rate high triggers discussions

In the run-up to the decision of the first chamber, comparable to the Bundesrat (upper house of the German parliament), the current interest rate high has triggered a discussion in the Netherlands about the adoption of the occupational pension reform passed by the Dutch parliament (second chamber) in March 2022.

The reform was originally agreed against the background of permanently low interest rates. However, the now rising interest rates are now leading to higher pensions and declining employer contributions. However, as a result of the increased interest rates, the capital stock of the pension funds is declining. This is because pension funds are required by law to invest a significant portion in bonds. However, these lose value as interest rates rise. As a result, a renewed low-interest phase would again increase the pressure on the existing defined benefit system.

The chairman of the Dutch Association of Occupational Pension Funds, Ger Jaarsma, has therefore called on the industry and the government to stick to the reform. The aim must be to free the occupational pension funds from their dependence on interest rate developments.