Towards a new approach to retirement systems Part III - The Dutch way NOVEMBER 2017
THE DUTCH WAY By Bruce Wolfe, CFA Managing Director and Executive Director of the BlackRock Retirement Institute This is the final article in a three-part series on the evolving nature of pension systems around the world, focused on how the Dutch pension system is responding to the longevity challenge. Three key insights A particular challenge for the Dutch decision-makers is how to ensure long-term sustainability whilst retaining key features of today s world class system. While we are seeing a change in attitude, our research shows that many employees not surprisingly are ill-prepared to assume greater pension responsibility so any reform will need to be supported by the provision of guidance and financial education. Extensive know-how in the collective management of pension liabilities and the flexibility offered by new legislation proposals mean that, ultimately, the Netherlands are well positioned for success. The global phenomenon of humans living longer and healthier lives can be observed first hand in The Netherlands. According to the Dutch statistical agency, CBS, between 2001 and 2016, the average healthy life expectancy for a 65-year old man has increased from 80.90 to 83.77, while for women it has gone up from 84.72 to 86.43. This wonderful lengthening of life brings many benefits, but also challenges many of the norms for how we live our lives financially or otherwise. It also entails a shift towards greater personal responsibilities away from the State and employers given the associated funding challenge. The persistent low interest rate environment exacerbates this challenge and the risk is that Dutch pension funds will have to start curtailing payouts. What makes this transition particularly challenging for the Netherlands is the quality of the current set-up, which is widely recognized as among the best in the world, despite the obvious challenges. 1 How to marry the best features of the current system with the need for greater responsibility is part of an ongoing debate between social partners, policymakers and academics. 1 Melbourne Mercer Global Pensions index. 2 TOWARDS A NEW APPROACH TO RETIREMENT SYSTEMS
A shift in attitude Encouragingly, a growing proportion of Dutch citizens seems to recognize the need to take greater ownership. For example, in the latest BlackRock Investor Pulse survey 75% of the 1,000 respondents agreed with the statement that they retain ownership for financially supporting their retirement, albeit that they raised concern about their lack of financial knowledge to assume that responsibility. 2 This sense of greater ownership is a significant departure from the traditional reliance on the state and employer, and constitutes a welcomed recognition that today s generous pensions, the highest among developed economies are not sustainable without significant change and greater personal input. 3 Other factors driving this fundamental change in attitude include the rapidly evolving shape of the Dutch workforce more mobile and with a growing number of self-employed and a growing unease about current intergenerational transfers. Version 1.2 The Dutch have already taken first steps to adjust to the fiscal realities and demographic challenges facing the country s pension system. We have seen a raising of the official retirement age to 67, the removal of the annuitization requirement at retirement and a re-pegging of pension benefits based on average wages compared to end-of-career, to name a few. However, further reform of the Pillar II occupational pensions system seems inevitable, the extent and the speed with which this occurs is at the heart of the current debate. To assess the current state of play and the priorities to focus on, it may be helpful to refer back to the simple framework we set in our first article. In that framework The Netherlands would most likely sit in the Libertarian Paternalism bucket. 2 BlackRock Investor Pulse Netherlands, 2017. 3 OECD Pensions At a Glance, 2015 PART III - THE DUTCH WAY 3
FIGURE ONE Defined Contribution Program Framework High rate of change Liberation Paternalism Engaged Outcomes A heavy nudge Flexible direction, hard goals Less prepared environment Governments feeling pressure to make changes to the pension system yet confronted with individuals unaccustomed to actively participating in the savings and dispersion of their retirement assets will need a system heavily reliant on decision-making guidance. Incrementalism Teach them to fish Environments with the luxury of time to make changes to their retirement system can focus their efforts on creating the educational and knowledge-building infrastructure in order to better equip people to assume control over their retirement decisions in step with the ownership transition. Deep financial markets with a history of engagement by individuals to plan and save for retirement can be designed with greater decisionmaking flexibility but timing pressure warrants programs with clear goals and outcomes. Deeper Foundation Behavior building The ideal situation whereby time constraints are not overwhelming and the market is fairly well equipped to embrace necessary changes creating an environment able to experiment, build lasting skills and minimize disruptions. More prepared environment Low rate of change Source: BlackRock Retirement Institute. One reason for this placement is our finding that the Netherlands holds the top ranking globally for responding no idea when individuals are asked about being on-track to achieve their desired income in retirement; and this despite most being aware of the availability of the pensions dashboard, mijnpensioenoverzicht.nl. 4 This finding is not surprising considering the extent to which employees depend on their employer and the state for building up their retirement income. In addition, the concept behind Libertarian Paternalism implies a strong institutional understanding of the actions required to guide a retiree s asset and liability management over a lifetime. The Netherlands pension industry is extremely well equipped to support this role. 4 BlackRock Investor Pulse, 2017. 4 TOWARDS A NEW APPROACH TO RETIREMENT SYSTEMS
Redesigning the system Moving beyond the broader framework, the re-design phase for a pension system based on BlackRock s global analysis can be distilled into four key elements: Contributors, Accountability, Longevity risk and Integration. The second article in this series explains these design elements in detail, but they can be summarized as: Contributors: sources for retirement income usually originate from the state (Pillar I), employer or industry-based retirement plans (Pillar II) and voluntary / private savings (Pillar III). Accountability: level of engagement and participation by investors in making decisions about their retirement savings and eventual income distribution. Longevity risk: range of product solutions to mitigate longevity risk. Integration: defined contribution product solution approach to managing the entire lifecycle in a single arc or by bifurcating the retirement savings and spending phases. Figure Two incorporates the Netherlands current and directional positioning within these four design characteristics. FIGURE TWO Defined Contribution Design Characteristics Contributors Accountability 0 PILLAR I MANDATORY SELF-RELIANCE PILLAR II PILLAR III Longevity risk Integration INVESTMENTS INSURANCE INDIVIDUAL PHASES INTEGRATED LIFECYCLE Source: BlackRock Retirement Institute. PART III - THE DUTCH WAY 5
Contributors The overall pension system has historically targeted a 90% or greater replacement ratio 5 but has already taken concrete steps to reduce absolute state benefits, shift the risk-sharing equation within defined benefits (DB) plans and consolidate DB funds. As expected, employees believe 27,500 in annual retirement income or a replacement ratio is reasonable according to our research. 6 Very high indeed. Fortunately, a growing number of employers and some industry plans have defined contribution (DC) platforms in place that can serve as a mechanism to supplement any such reductions as well as redistribute responsibilities. This transition could also present an opportunity for the state to address a growing population of self-employed workers not covered by a private pension scheme today. However, any state initiative should first decide what the right target replacement ratio is for future retirees, what portion should be generated from each of the savings alternatives, and what constitutes an equitable intergenerational transition. International comparisons also show the importance of stimulating longer careers by creating smoother transitions into retirement. Countries such as Japan can provide useful insights from this perspective. Accountability Shifting retirement savings responsibility to the individual may appear to be an easy solution to combat demographic challenges but can prove counter-productive without proper financial education and guidance. Reverting back to the lack of preparedness in the Netherlands retail investor community, early solutions should favor less active decision-making by, at least, pending retirees. Auto-enrollment, but also escalation of contribution rates linked to factors such as age or time to retirement can help given the low-level of investor financial knowledge today. Longer-term, though, financial education needs to become a higher priority within the school system. For those closer to retirement, financial advisers (FAs) should assume a more prominent role. With the industry reforms led by the Wet financieel toezicht, FAs are in a better position to gain the trust of those investing for retirement and begin to raise historically low engagement levels. 7 Longevity risk The Netherlands sits in the enviable position of being a world leader in managing the collective longevity risk of its population through programs at Pillar II level. At a minimum, expert collective risk-sharing seen within DB plans today should alleviate many of the transition pains to DC experienced by other countries. In fact, top-up schemes, i.e., excedentregeling, are a good example of DB and DC co-existing. Solutions that continue to leverage the investment expertise and benefits associated with managing assets into and through retirement for aggregate groups could be an effective option to provide meaningful longterm capital appreciation for a longer living population. The Premie Pensioen Instelling (PPI) 5 OECD Pensions At a Glance, 2015; Individual s gross income after retirement compared to their gross income before retirement. 6 BlackRock Investor Pulse Netherlands, 2017. 7 BlackRock Investor Pulse Netherlands, 2017. 6 TOWARDS A NEW APPROACH TO RETIREMENT SYSTEMS
regulation is one tangible step in this direction as are Algemeen Pensioenfonds platforms assuming changes towards greater diversity of investment managers. But as with any solution, the optimal result is usually not at the extremes neither annuity nor investments but somewhere in-between. Moreover, given the social support for collective pension systems, the Dutch system may be able to retain some element of risk sharing over the longer term. Integration Historically, private pension structures around the world, including the Netherlands, have segmented accumulation and decumulation phases in terms of product offerings. The Netherlands recent regulation allowing reinvestment after retirement, i.e., Wet verbeterde premieregeling, dramatically expands these types of retirement solutions. The Social and Economic Council (SER) has drafted a set of appealing risk-sharing pathways investors could consider approximately ten years prior to retirement. These types of solutions whereby investors explicitly make a non-binding selection based on risk preferences could be a creative option to bridge the accumulation and decumulation product divide, retain many of the DB expertise refined over decades by the Dutch and minimize the counter-productive tendency for individuals to not invest in the market and hold high allocations in cash. 8 Positioned for continued success Globally pension systems are engaged in a challenging transition as they seek to maintain their core mission of providing a dignified and secure retirement to participants that live longer and healthier lives. Many countries are now exploring interesting ideas and solutions to create a better balance between personal accountability, continued societal fairness and financial sustainability. To date, none has cracked the code, but The Netherlands may well be among the first to do so. 8 BlackRock Investor Pulse Netherlands, 2017. PART III - THE DUTCH WAY 7
ABOUT BlackRock Retirement Institute The BlackRock Retirement Institute (BRI) is BlackRock s global thought leadership platform on retirement and longevity established to enable our clients and broader community to make better decisions toward a financially secure and dignified retirement. Lifespans have shot up over the last several decades but the way the world thinks and acts to address this new reality has yet to catch up. We at BlackRock recognize this emerging revolution its challenges, its opportunities and through BRI we join our voice with the voices of other experts to create and amplify some of the best thinking on retirement and longevity. As the world s largest asset manager 9 with two-thirds of the funds we manage related to retirement BlackRock understands that our firm has a special responsibility to assist people all over the globe to live out their later years with dignity and security. An essential component of that is helping governments, institutions and individuals understand and take action in response to this new phase in mankind s history that s what BRI is here to do. 9 Based on $5.97 trillion assets under management as of 9/30/17. Want to know more? BRI@blackrock.com 877-992-5532 (1-877-99-BLKDC) This material is provided for educational purposes only and should not be construed as research. The information on this website is not a complete analysis of the global retirement landscape. The opinions expressed herein are as of September 20th, 2017and are subject to change at any time due to changes in the market, the economic or regulatory environment or for other reasons. The material does not constitute investment, legal, tax or other advice and is not to be relied on in making an investment or other decision. Note: The opinions expressed in the third-party articles or content do not necessarily reflect the views of BlackRock. BlackRock makes no representation as to the completeness or accuracy of any third-party statement. No part of this material may be reproduced, stored in any retrieval system or transmitted in any form or by any means, electronic, mechanical, recording or otherwise, without the prior written consent of BlackRock. This publication is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. 2017 BlackRock, Inc. All Rights Reserved. Prepared by BlackRock Investments, LLC, member FINRA. Not FDIC Insured May Lose Value No Bank Guarantee Lit. No. RETSYSTEM-PTIII-1117 171760T-C-1117