JUNE 2017 EDITION 115. Quoted. Amending a pension agreement

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1 JUNE 2017 EDITION 115 Quoted Amending a pension agreement

2 In this edition - Introduction - Rising costs of pension agreements - Future of the Dutch pension system - Raising the official retirement age in Amending a pension agreement - Approval of employees - Position of former employees - Participatory decision-making rights - Mandatory provisions in the Dutch Pensions Act - Conclusion

3 Quoted 3 I INTRODUCTION Amending pension agreements is a high priority item on the employer s agenda. An important issue at present is the raising of the official retirement age from 67 to 68 as of 1 January Pension agreements have to be amended accordingly already this year in order to avoid the negative financial consequences of a pension agreement in excess of the tax threshold. In addition, the substantial rise in pension contributions for the execution of defined benefit agreements, whereby a predetermined pension benefit has been agreed, has also caused employers to consider further changes. For example, switching from a defined benefit scheme to a hybrid scheme or switching completely to a defined contribution scheme. Besides the rising pension contributions, the unfavourable ratio between pension contributions and the pension entitlements and pension rights is also a cause for concern. Therefore, the futureproofing of the existing Dutch pension system has been a topic of discussion since Employers are looking into new types of pension agreements as of 2020 with fewer guarantees, more investment possibilities and more freedom of choice, which would be better aligned with the current financial market and labour law and would, moreover, provide better value for money.. The legal aspects of the process of changing the employee benefit of pension are particularly important due to the relatively high risks for the employer. Apart from the fact that a pension is an expensive employee benefit, it is the case that the retrospective correction of an unlawful amendment (often) has to take place against more unfavourable current rates. The legal and tax aspects in connection with amendments to the pension agreement by the employer are the main focus of this contribution to our newsletter Quoted, whereby the table of contents can be read as a checklist for amendments to a pension agreement. Amendments to mandatory industry-wide pension schemes or CAO pension schemes that have been declared applicable fall outside the scope of this article. II RISING COSTS OF PENSION AGREEMENTS There are three types of pension schemes that employers may provide for by law, (1) the defined benefit agreement, (2) the capital sum agreement or (3) the defined contribution agreement. A defined benefit agreement is an agreement whereby, in accordance with a specific formula, a predetermined oldage pension and partner pension have been promised on the retirement date. For example, each year 1.875% of the pension base is accrued. The nature of this scheme provides the highest degree of surety for the employee. The risks that the employee lives longer (longevity risk), that a lower return is realised on the paid contributions (investment risk) and that the interest rate is lower at the time of the payment of the pensions (interest rate risk), lie with the pension administrator. In the event of a capital sum agreement, only the amount of the end capital on the retirement date is guaranteed and not the old-age pension that can be purchased with this. This means that the employees bear the longevity risk and the interest rate risk. A defined contribution agreement is an agreement whereby only a defined contribution is made available. In this case, the employee bears all (three) of the risks. The affordability of, in particular, the defined benefit agreement has come under pressure. In view of the guarantees provided, strict statutory solvency requirements apply for insurers and pension funds for maintaining buffers and the valuation of pension commitments at (largely) the market interest rate. Due to valuation at the current low market interest rate, the book value of the pension commitments is high and the pension contributions have to be raised as these have to cover the costs. Furthermore, life expectancy has risen considerably in the past ten years so that a longer benefit payment period has to be taken into account. These development have already resulted in many changes being carried out in pension agreements in recent years, in particular in the nature of the scheme (from defined benefit scheme to defined contribution scheme), the height of the pension accrual, the supplement provisions, the height of the pension contributions and the employee s contribution.

4 4 III FUTURE OF THE DUTCH PENSION SYSTEM In the memorandum of the Dutch Secretary of State regarding the future of the Dutch pension system [Perspectiefnota Toekomst Pensioenstelsel], the State Secretary sets out the general lines of a new future-proof pension system as of In view of the strict solvency requirements, low market interest rates and the resulting higher contributions and (very) low cover rates of the pension funds, the necessary lowering of the pension entitlements and pension rights and supplements not being allocated, there is the intention to lay down new types of contracts in the Dutch Pensions Act as of 2020 that are less sensitive to the aforementioned negative factors. The price for surety is currently perceived to be too high causing the base of support for the existing pension system to erode. In addition, the Dutch labour market is changing. The Perspectiefnota identifies two possibilities, i.e. (1) the ambition agreement and (2) the pension agreement with personal pension capital. Both schemes do not offer the guarantee of a predetermined old-age pension; however, they do offer the real likelihood of a comparable pension. The ambition agreement differs from the benefit agreement due to the fact that no strict solvency requirements apply due to the lack of guarantees and at the same time it offers more freedom of choice with regard to investments. Returns can be converted into a higher old-age pension earlier. Modification of the scheme due to lower returns takes place spread over a period of ten years. The personal pension capital agreements are based to a lesser extent on solidarity and collectivity, there is more room for choice with regard to collectively sharing risks. If a new Dutch government introduces the possibility of new pension agreements, employers can adapt their pension agreements and solve problematic issues. Existing pension agreements are maintained. IV FAVOURABLE TAX TREATMENT OF PENSIONS AND INCREASING THE OFFICIAL RETIREMENT AGE Pension agreements that satisfy the requirements of the Dutch Wages and Salaries Tax Act, fall under the exempt-exempt taxation system (EET system). According to the EET system, the pension contributions paid by the employer are tax free and the pension contributions paid by the employee may be subtracted from his taxable salary. Furthermore, accrued pension entitlements and rights are exempt from income tax; however, pensions benefits are taxed when these are paid out. In short, by applying the EET system, it is possible to save tax-free for a pension. Tax is due on the pension benefits that are ultimately received. If a pension agreement no longer satisfies the conditions of the Dutch Wages and Salaries Tax Act, the EET system is no longer applicable and the pension will then exceed the tax threshold. As a consequence, all accrued pension entitlements and rights are included directly in the taxable wage of the employee. In view of the average size of these entitlements and rights, the principle of the highest rate of the income and wage tax of 52% will apply. In addition, 20% revisionary interest will be levied, so that the total taxation in the event of the EET system no longer being applicable would amount to 72%. This penalty is so high that the parties involved in the pension agreement consider it very important to continue to satisfy the EET system. As mentioned above, the EET system only applies if a pension agreement satisfies the conditions of the Dutch Wages and Salaries Tax Act. One of the most important conditions is that the commencement date of the old-age pension is in principle the same as the target retirement age. The target retirement age is currently 67 and only by taking that age into account will an employee be able to accrue a maximum tax-permissible pension of 75% of his average salary during a period of 40 years. For that matter, the commencement date of the old-age pension can be earlier than the target retirement age, but then it is not possible to accrue a maximum tax-permissible pension. The target pension age has been linked to life expectancy since As a result of the rising life expectancy, the target retirement age will be set at 68 as of 1 January As practically all pension agreements in the Netherlands are based on achieving a maximum tax-permissible pension, a higher target retirement age means that practically all pension agreements and regulations must be adapted before 1 January 2018 in order to avoid that the EET system would no longer be applicable. In this case, the employee and the employer can choose between (1) raising the commencement date of the old-age pension to 68, or (2) lowering the annual pension accrual so that the employee can no longer accrue a maximum tax-permissible pension.

5 Quoted 5 The higher target retirement age applies to pension entitlements and pension rights that are accrued as from 1 January The target retirement age was 65 up to 2014 and is 67 up to Therefore, an employee who retires may receive part of his old-age pension as from the age of 65 and may then receive a supplement when reaching the age of 67 and 68. The administration of such a pension is complicated for the employee and the pension administrator. This is why it could be attractive to raise the commencement date of all pension entitlements and rights to age 68 in spite of the absence of a statutory obligation. However, the employee retains the right at all times to stop working / have his retirement pension commence before he reaches the aforementioned age, provided that the amount of the annual benefit payment is recalculated to an earlier commencement date. This recalculation is caused by letting the pension commence earlier which on average leads to a higher number of benefit payment years. To conclude this paragraph, we would like to comment briefly on the maximum tax-permissible pension for the amount of 75% of the employee s average salary. As mentioned above, this can be achieved in 2017 after 40 years of pension accrual. However, the Dutch Tax and Customs Administration published a draft decision for defined contribution schemes on 10 March 2017 and from this draft decision, a maximum tax-permissible pension of 75% of the employee s average salary after 41 years of pension accrual can be deduced. With this, the Dutch Tax and Customs Administration appears to be anticipating an amendment which still has to be approved by the Dutch parliament. V AMENDING THE PENSION AGREEMENT Before amending the pension agreement, it must be assessed in which manner the pension agreement is regulated in the employment agreement. If the pension agreement is regulated in a CAO, other rules apply than if the pension agreement is laid down in personnel regulations. administrator (for example, a company pension fund, a general pension fund or an insurance company). employee pension administrator pension regulations pension agreement An amendment to the pension agreement between the employees and the employer does not automatically apply to the administration agreement between the employer and the pension administrator. The pension administrator has its own interest. The employer must verify whether the administrator is willing to administrate the amended pension agreement under reasonable conditions. Amendments are often carried out after the end of the administration agreement, so that an interim amendment is not necessary. However, it cannot be ruled out that amendments are necessary during the term of the administration agreement because of amendments to the pension agreement. Therefore, involvement of the pension administrator is necessary. Pension administrators have become increasingly concerned about possible liability risks, as they bear the statutory obligation to ensure the conformity between the pension regulations, the pension agreement and the administration agreement. The contents of the pension regulations must be in accordance with the contents of the pension agreement and the administration agreement. V.1 Approval of employees administration agreement employer As the 17th century adage of (most probably) Hugo de Groot that agreements shall be complied with (pacta sunt servanda) is still embedded in Dutch contract law, in principle, employers may not amend the pension agreement without the approval of the employees. In addition, it is important to note that there is triangle of legal relationships of which the rights and obligations must in accordance with each other (simultaneously). In order to protect the interests of employees, it has been determined that the administration of the pension agreement must be outsourced to a pension The approval of the employees does not require a prescribed form. This means that approval does not always have to be granted explicitly. Making use of a negative option, i.e. the option to object within a certain period, is legally correct in principle. However, it is important that the details of the amendments to the

6 6 pension agreement and the consequences thereof have been made clear to the employees. Jurisprudence is developing further in the direction that employers have a duty of care with regard to disadvantageous changes in the pension agreement to do everything in their power to avoid that employees grant their approval based on an incorrect understanding of the matter. Violation of this duty of care can result in the employer s obligation to pay compensation for damages. Consequently, communication is an important attention point. Informative meetings are therefore often held, whereby differences between the old and the new pension scheme are clarified. With regard to already accrued pension entitlements, the employer has the obligation, under certain conditions, to warn the employees not to transfer these entitlements to the new pension agreement if this would result in a (substantial) increase of the risks. V.2 Incorporation clause (CAO [Collective Labour Agreement] or pension regulations) Reference is often made in the employment agreement to the pension scheme that is included in the CAO or in the pension regulations of the pension administrator. This is an incorporation clause. Changes in the pension scheme without the approval of the employees can carry over into the pension agreement. The assessment whether the CAO or the pension regulations are incorporated in the employment agreement is of a legal nature. Such a clause is not often absent in particular at large employers that have arisen from mergers and acquisitions, with a wide variety of employment conditions. For that matter, the manner in which the incorporation clause is formulated is not decisive; the most important aspect is the intention of parties to regulate the pension agreement in the CAO or in the pension regulations. Point of departure for pension agreements laid down in the CAO is that changes that have been agreed with the trade unions involved are binding for the unionised employees based on the Collective Agreements Act or are effective in the employment agreement if the CAO is incorporated. In that case, the approval of the employees is not required for the change. However, the manner in which it is formulated in the new CAO must make it sufficiently clear that parts of the pension agreement in the former CAO no longer apply and are no longer effective. If reference is made to the pension regulations of the pension administrator in the employment agreement, the conclusion cannot be drawn directly that the employees are bound by the changes of the pension administrator in those regulations in the same manner as the pension schemes in the CAO. It must be verified whether the employees have transferred the power to make amendments, or whether the employer may justifiably assume that the employees have agreed to be bound by future changes. In view of the point of departure that employer and employee are responsible for the employment conditions and the far-reaching consequences of renouncing the right of approval, this will not readily be the case. The pension administrator s power to carry out amendments is broad and is only assessed against misuse of law or unacceptability. V.3 Unilateral amendment clause Approval of the amendment to the pension agreement is not an absolute requirement. Approval of the employees is not required if a unilateral amendment clause is included in the pension agreement. Such clauses can be general or can specify what can be amended in specific situations. It has been regulated by law since March 1998 that employers may change employment conditions unilaterally if that right is reserved contractually and there is a compelling interest for which the interests of the employees must yield. This norm has also been laid down in the Dutch Pensions Act since The threshold for unilateral amendments is not low, but the legislator has taken into consideration the interests of the employer to avoid a costly and time-consuming approval process and a fragmented (diverse) employment conditions regime. In this case, collectivity and solidarity are essential for the affordable feasibility of pension agreements. Developments in society and evolving legal convictions are not unimportant. Jurisprudence about unlawful and lawful amendments of pension agreements in the last century are therefore in principle not normative. Avoiding the negative consequences of a pension agreement that exceeds the tax threshold qualifies in principle as a compelling interest which prevails above the employees interests. In general, the employer s

7 Quoted 7 objective to avoid a substantial increase in costs does not directly constitute a compelling interest for the amendment. However, the standpoint that employers must always continue the pension agreement as long as this can actually be paid for, in the event that this concerns a defined benefit agreement, is an oversimplification. Apart from the fact that some contribution increases amount to more than 40%, the relationship between the contribution amount and the pension result (value for money) can become inequitable. As a result, a compelling interest can arise to switch to a hybrid scheme (part benefit and part contribution agreement) with a real likelihood of an equal pension result. At present, with the coming into effect of the Premium Schemes (Improvements) Act (Wet verbeterde premieregeling) as of 1 September 2016, the pension agreement has been made more attractive because it is possible to continue to invest before and during retirement which could result in a higher benefit and variation in risk sharing is possible. It is not only about determining whether a compelling interest exists. The interests of the employees that have to yield to the compelling interest must also be dealt with carefully. It would be wise for the employer to examine whether the new pension agreement is well-aligned with his workforce in view of the average age and the risk appetite (second best). Disproportional or unnecessarily disadvantageous amendments should be avoided. A transitional scheme or a form of compensation could be necessary in this case. Drafting transitional or compensation schemes requires customisation. Factors that could play a role in this is the degree in which the amendment to the pension agreement is (disproportionally) more unfavourable for certain employees (younger, occupationally disabled or older employees). In this case, transitional and compensation schemes could be in violation of equal treatment laws (for example the prohibition of discrimination based on age). If the employer realises a (substantial) cost savings, it is advisable to look into how these savings can be returned to the employees. Can the employee s contribution be lowered, are there possibilities to improve other parts of the pension agreement or is a gross compensation (wage payment) desirable? There is also the question of how the already accrued pension entitlements and pension rights based on the old scheme are dealt with. V.4 Absence of a unilateral amendment clause In the absence of a unilateral amendment clause, the existence of a compelling interest is not sufficient, but maintaining the old pension agreement must be unacceptable in accordance with standards of reasonableness and fairness. This difference does not appear to be of real importance for the pension law practice. Maintaining a pension agreement that exceeds the tax threshold is generally regarded as unacceptable in view of all of the negative consequences. Creating a better relationship between the costs and the pension entitlements and pension rights or avoiding extreme cost increases can also be legitimate if no amendment clause exists. However, unilateral amendment clauses are included in most employment agreements and pension agreements. VI POSITION OF FORMER EMPLOYEES The position of former employees in the event of amendment procedures deserves special attention when a supplement provision is amended. Changes in the pension accrual no longer affect former employees. It is advisable to treat former employees as much as possible in the same manner as active employees in an amendment process. It is now established jurisprudence that the pension agreement does not end with the termination of the employment agreement. It follows from this that the unilateral amendment clause in that pension agreement applies and that therefore a compelling interest must exist. If a compelling interest exists then requesting the approval of every former employee is not necessary and the amendment of the pension agreement that is regulated in the new CAO does not apply to former employees. VII PARTICIPATORY DECISION- MAKING RIGHTS The participatory decision-making rights have changed as of 1 October The works council has a right of approval concerning the adoption, amendment and revoking of the pension agreement by the employer. The raising of the target retirement date for tax purposes is also regarded as an amendment. The amendment of the pension agreement by CAO or the amendment of the mandatory industry-wide pension schemes are excluded.

8 8 It should be noted that the right of approval is not limited to the pension agreement, but that it also applies with regard to amendments in the administration agreement between the employer and the pension administrator. This concerns amendments that could have an effect on the pension agreement such as the manner in which the pension contribution is determined, the conditions of granting a supplement, and the choice of the pension administrator in other member states or an insurer with a registered office outside of the Netherlands. This wider scope should be put into perspective. As the pension administrator has the responsibility to draft pension regulations that are in accordance with the pension agreement and the administration agreement, the pension agreement will also have to be in accordance with administration agreement. Nevertheless, the works council also has the right to determine this themselves. This means that the length of the approval procedure usually increases. With regard to submitting the amendment for approval to the works council, the reason and the consequences of the amendment have to be submitted in writing. The rights of approval therefore also concern the chosen transitional and compensation schemes (see paragraph V3). The manner in which approval is requested deserves attention. It can be advisable to also indicate why certain alternatives were not used. However, employers should realise that this broadens the scope of the right of approval. Not making use of alternatives is then implicitly also submitted for approval. If the works council does not approve the amendments and the employer implements these nevertheless, the works council can or may invoke the nullity of the amendment in writing within no later than one month after the employer has taken the amendment decision. Taking the risk of invoking nullity is not a path that is taken by many employers. In the absence of approval, employers can request alternative approval from the subdistrict court. The sub-district court will consider this if the refusal of approval by the works council is unreasonable or the amendment is required due to compelling company organisational, business economic or company social reasons. To this end, the sub-district court will consider the arguments of the employer and of the works council. If the arguments of the works council are more compelling, then the court will not give permission. If both arguments are equally compelling, then the sub-district court only grants its permission in principle if there are also compelling economic (continuing loss) or social reasons. Employers with fewer than 50 employees have the possibility to establish an employee representative body. From a legal perspective, an employee representative body does not have an advisory or an approval right with regard to the collective pension agreements. Consultations are usually held with the employee representative body and their advice is requested. However, this cannot lead to nullity of the amendment of the pension agreement. Finally, participatory decision-making on behalf of former employees has not been laid down in the law. Therefore a right to be heard has been granted to associations of pension beneficiaries in the Pensions Act. However, this right to be heard is limited exclusively to decisions that could have an impact on the level of the pension benefits and with regard to the administration of pension agreements by an insurer. This right to be heard is a toothless right. However, it does offer an opportunity for the association to influence the decision-making process of the employer. Approval by the works council can provide guidance for the assessment whether it concerns a compelling interest for amendment and a reasonable weighing of interests. VIII THE PROVISIONS OF THE DUTCH PENSIONS ACT In connection with amendment procedures, it is important to keep in mind that a number of provisions have been included in the Pensions Act to protect employees and former employees. Parties do not have the contractual freedom to deviate from these legal provisions. Mandatory provisions apply in the pension agreement according to established jurisprudence. An example of such provisions are the rights of option of employees with regard to exchanging old-age pension for partner pension and rules regarding equal treatment. The pension agreement must comply with such laws on penalty of nullity or voidability. If the mandatory provisions only come into effect during the term of the pension agreement, the pension agreement must be executed in accordance with the law. Whether mandatory law is involved is a legal assessment. This is not clearly

9 Quoted 9 stated in the law in all cases. For that matter, a change in tax laws does not qualify as mandatory law. Parties will therefore have to implement the amendments themselves in order to avoid a pension agreement that exceeds the tax threshold. On the other hand, accrued pension entitlements and pension rights up to the time of the amendment may not be changed. In short: the pension agreement may not be amended with retrospective effect. The contributions have already been paid for the accrual of the pension entitlements and pension rights and amendments with retrospective effect qualify as commutation (which is also not allowed). This provision also provides protection for the pensioners. This protection probably does not extend to covering the unconditional supplement right (indexation) of the already commenced pensions. Not being able to implement amendments with respect to the pensioners could be in violation of the solidarity principle and the requirement of equal representation of interests if this has far-reaching consequences for the active employees. Examples of this are the payment of a (much) higher contribution, or a substantial lower pension accrual, and in the ultimate case financial problems at the employer causing employees to lose their jobs. The unconditional supplement of the pensioners is relatively costly because this depends on the relatively high old-age pension and partner pension at the end of the employee s career. a second-best alternative for the pension agreement, whether or not with a transitional or compensation scheme and a careful information process towards the employees and the works council. About Loyens & Loeff Loyens & Loeff has ample experience with providing assistance and support in pension agreement amendment processes. Each amendment process requires a customised approach. With the tax, labour and pension-law expertise and relevant litigation experience of its lawyers, Loyens & Loeff can provide a customised solution. All relevant aspects are taken into account. We work together with external actuaries for actuarial calculations. IX RECOMMENDATIONS The target retirement age will be raised to 68 as of 1 January As a result, almost all pension agreements will have to be amended before that date. An employer may also wish to amend a pension agreement for other reasons. Amendment procedures demand a customised approach and a carefully followed participatory decision-making process. Depending on the pension agreement to be amended and the conditions laid down in this agreement, there will be fewer or more points requiring attention. In the long term, the affordability remains an attention point and new contract types in the law will take into account the desire for affordability. The most important elements in connection with the amendment of a pension agreement are careful attention to the approval right, a well-considered weighing of interests and formulating a compelling interest, finding

10 Quoted 10 About Loyens & Loeff Quoted Loyens & Loeff N.V. is an independent full service firm of civil lawyers, tax advisors and notaries, where civil law and tax services are provided on an integrated basis. The civil lawyers and notaries on the one hand and the tax advisors on the other hand have an equal position within the firm. This size and purpose make Loyens & Loeff N.V. unique in the Benelux countries and Switzerland. The practice is primarily focused on the business sector (national and international) and the public sector. Loyens & Loeff N.V. is seen as a firm with extensive knowledge and experience in the area of, inter alia, tax law, corporate law, mergers and acquisitions, stock exchange listings, privatisations, banking and securities law, commercial real estate, employment law, administrative law, technology, media and procedural law, EU and competition, construction law, energy law, insolvency, environmental law, pensions law and spatial planning. loyensloeff.com Quoted is a periodical newsletter for contacts of Loyens & Loeff N.V. Quoted has been published since October The authors of this issue are R.F. van der Ham (senior pension law lawyer) (robin.van.der.ham@loyensloeff.com) and B. Dieleman (senior tax and pension adviser) (bas.dieleman@loyensloeff.com). Editors P.G.M. Adriaansen R.P.C. Cornelisse E.H.J. Hendrix A.N. Krol C.W.M. Lieverse W.C.M. Martens W.J. Oostwouder D.F.M.M. Zaman You can of course also approach your own contact person within Loyens & Loeff N.V. Although this publication has been compiled with great care, Loyens & Loeff N.V. and all other entities, partnerships, persons and practices trading under the name Loyens & Loeff, cannot accept any liability for the consequences of making use of this issue without their cooperation. The information provided is intended as general information and cannot be regarded as advice.

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