The Dutch pension system: highlights and characteristics
World’s top-ranking pension system
For many years the Dutch pension system has been recognised as one of the best in the world. This has been confirmed repeatedly in international comparisons by ratings agencies of pension systems in a large number of developed countries. Dutch pension funds were undoubtedly affected by the financial crisis of 2008-2009, but the facts speak for themselves: in hardly any other country is poverty amongst older people so low and the difference between disposable income before and after retirement so small. This is due to the way in which retirement provision is organised in the Netherlands. A strong feature of the Dutch pension system is the combination of pay-as-you-go funding for the state pension ('AOW’) as the first pillar, and capital funding for the occupational pension as the second pillar. The system in which pension funds continue to take investment risk on a collective basis in the second pillar both before the retirement date and while the pension is in payment provides good final pensions for the participants. The same applies to the hedging of interest rate risk. At more than 1400 billion euros, capital-funded pension assets amount to twice the Dutch gross national product. This huge pension capital, along with other strong features such as a high degree of solidarity, collective risk-sharing, the not-for-profit character and permanent attention to cost control, means that the Dutch pension system is robust and scores extremely well in comparison with retirement provision in other countries.
The Dutch pension system has a strong base consisting of three pillars, each with their own features.
The first pillar is the General Old-Age Pensions Act (AOW): a basic provision instituted by the government in 1957 and paid to everyone living in the Netherlands, once they have reached the qualifying age. For decades, this age was 65 years, but in the last few years it has been raised by a few months a year. Under current plans, the age of entitlement to AOW will be 67 years in 2024, and thereafter it will be linked to the development of life expectancy. Residents of the Netherlands accrue 2% of their AOW every year for 50 years until reaching the required age. They do not have to be (or have been) in paid work to accrue AOW. The AOW should be seen as a basic provision at minimum level, and in most cases is supplemented with income from the other pillars. The AOW is administered by the Ministry of Social Affairs and Employment and is funded from tax revenues, and not from capital paid in by the recipient: it is a pay-as-you-go system.
The second pillar consists of the occupational pensions accrued by the vast majority of employees during their working lives. Employees and employers pay the contribution agreed in collective employment agreements into a pension fund to which the employer is affiliated. This may be a pension fund for all businesses in a particular industry, a fund that works for one specific company, or a fund for a group of people working in certain (often medical) professions such as doctors, physiotherapists and obstetricians. The second pension pillar is an employment benefit. Participation in an industry pension fund may be made mandatory for the entire sector by the Minister of Social Affairs and Employment. Participation has been made mandatory for most industry pension funds.
Pension funds operate on the basis of capital funding: an employee, together with their employer, accrues pension entitlements from the contributions paid in and the return realised by the pension fund over the years through the collective investment of these contributions. Tax allowances apply to pension accrual up to a certain income-related level. The second pillar in the Dutch pension system features collectivity, mandatory participation, efficient administration and is not-for-profit.
The third pillar consists of individual banking or insurance products for which contributions can be paid in for accrual of a pension, with tax allowances up to a certain level. This is important mainly for those people who do not (or have not been able to) accrue a pension in the second pillar, for instance because their employer is not affiliated to a pension fund, they are not in permanent employment or they are self-employed.
Pressure on the system
The Dutch pension system has operated successfully in this way for many decades, and has shown its ability to deal with shocks in leaner times. This success is largely due to the unique combination of pay-as-you-go and capital funding. In times of economic downturn, the AOW has provided a stable basic provision, while the capital-funded pensions have been better able to cope with demographic developments, such as the ageing of the population and urbanisation, than the solely pay-as-you-go systems that apply in some other countries.
Nonetheless, in the course of the last decade, problems that require solutions have arisen in the Netherlands. Dutch people are, on average, living longer and therefore also need a pension for longer, and, in turn, a larger pension than was previously assumed. In relative terms, the number of young people paying contributions is continuously declining. There are a lot more freelancers who accrue little or no pension in the second or third pillars and who will therefore rely heavily on the AOW as a basic provision. And with interest rates having been very low for many years, pension funds, in accordance with accounting rules and buffer requirements, have to hold high levels of capital in order to meet their current and future obligations. These developments have put such pressure on the system that many pension funds have not been able to achieve their ambition of indexing pensions for many years, and some funds have actually had to reduce their pensions.
The fact that pensions were better several years ago than they are today has led to a decline in confidence in our pension system and, in particular, public support for the second pillar has been affected. Confidence and support are essential, given the long-term nature of pensions and pension accrual. As a result, the government, the social partners and other parties in the Social and Economic Council (SER) are working hard on the further development of a pension agreement reached in mid-2019, aimed at modernising the system and making it future-proof. An important principle here is that pensions need to move more in line with general economic developments, increasing quicker in good times, and declining earlier in hard times. The Federation of the Dutch Pension Funds agrees that finding an alternative pension contract is desirable, but this needs to be with retention of the strong features of the Dutch system, such as the collective sharing of risk and mandatory participation.
The second pillar in more detail
Three-quarters of the employees accruing a pension in the second pillar do so through an industry pension fund. The remainder accrue pension with a company pension fund or an insurer. There are also around 10 occupational pension funds for people in one of the professions. In addition, there is an increasing percentage of people in work that are not accruing a second pillar pension because they are not covered by a collective bargaining agreement that provides an occupational pension. The number of pension funds has declined sharply in the past 10 years. 10 years ago, there were 600 active pension funds. In 2019, only around 200 remain. In the same period, total pension fund assets have doubled from € 700 billion to more than € 1400 billion.
A new category of pension providers entered the market in 2016: the general pension fund (GPF). The special feature of a GPF is that it can administer pensions for multiple employers at the same time, and can also take over the pension administration from other pension funds. For example, if they cease to exist and ‘liquidate’. A GPF can incorporate its pension administration in various group schemes, in which the participants share the risk. For example, with respect to occupational disability or death. But there is no solidarity between the various schemes. The pension investments of the schemes are segregated from each other, and are used solely for pension benefits to the participants in the scheme in question.
Supervision of pension providers
There are two organisations that supervise pension funds and insurers: de Nederlandsche Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). They each have their own area of supervision.
De Nederlandsche Bank NV (DNB)
The foundation of a pension provider requires permission from the DNB. The conditions include sufficient financial assets, and a fit and proper board of trustees. Under the Pensions Act and the Financial Supervision Act, the DNB closely monitors the financial and management operations of the pension providers.
The Dutch Authority for the Financial Markets (AFM)
By law, pension providers are obliged to provide certain information to their stakeholders. This obligation involves strict requirements with respect to timeliness, comprehensibility and content. The AFM checks that pension providers are meeting these requirements. The AFM also monitors compliance with the duty of care. The aim here is to advise participants, where applicable, regarding investment options.
In the Dutch collective system for occupational pensions, a participant accrues a fixed percentage of their pay each year as a future pension entitlement. All the participants pay the same contribution to the pension fund for this. No account is taken of individual differences such as age, gender, health or income when setting the amount of this contribution. This creates solidarity between groups of participants. In fact, a contribution paid in by a younger person will generate a return for much longer than a contribution paid in by an older person, but they both accrue the same pension rights for the same contribution. As part of the pension agreement, this so-called average contribution will be replaced by a system of degressive accrual, in which an older employee will accrue fewer pension rights for the same contribution than a younger colleague. The removal of the average contribution system will affect all existing pension contracts and all employees who are currently accruing a pension. The Dutch Cabinet has stated that a balanced transition to a new pension contract will only be possible if adequate compensation is offered to existing participants. Prior to the transition, the Cabinet will establish preconditions and uniform frameworks that will have to take account of the effects of the transition. The pension agreement assumes that the transition can be effected on a cost-neutral basis.
The vast majority of Dutch pension schemes are DB (Defined Benefit) schemes. If things go well, all the stakeholders will benefit. If the fund gets into financial difficulties, all the stakeholders will contribute to the recovery. This includes the employer, the employees and the pensioners.
- The pension contribution can be increased. This will increase the salary costs for the employer, and the employee's net salary will be reduced. In some company pension funds, the employer itself is obliged to pay in an additional contribution.
- Indexation can also be limited. Most pension schemes state that indexation is conditional. The board of a pension fund will decide annually whether the fund’s financial position allows for the indexation of pensions and accrued entitlements.
- There is also the extreme measure of reducing the pension entitlements, which will be effected to the extent necessary to restore the viability of the fund. For many pension schemes, both the amount of the contribution and the degree of indexation are linked to what is known as the coverage ratio, which expresses the ratio between the assets and the liabilities and is used to express the financial viability of the pension fund.
There is no mandatory membership of a pension scheme in the Netherlands. Social partners may decide independently whether they wish to offer a pension scheme. Nonetheless, approximately 90% of employees have a pension scheme through their employer. The government may make a pension scheme mandatory for an entire industry or profession if there is sufficient support. In these cases, the employer cannot therefore decide independently whether or not it wishes to offer a pension scheme. Industry pension funds with mandatory participation take out insurance so that their schemes can be administered in a cost-efficient manner. Mandatory participation also ensures a good pension provision for all employees and prevents competition on the basis of salary at the expense of a pension provision. The government’s aim with mandatory participation is to ensure mutual solidarity. It also allows employees to change job within their industry without affecting their pensions. Companies not subject to mandatory participation may incorporate their pension scheme in a company pension fund or place it with an insurer.
There are various types of pension scheme. The most common is the benefit scheme, or defined benefit (DB) scheme. In this scheme, the amount of pension depends on the number of years worked and the contribution paid. Virtually all these schemes are based on average pay, with the pension accrued always related to the income in a particular year. Average pay schemes usually feature conditional indexation. This means that the pension entitlements of both those in work and pensioners will, in principle, be adjusted each year in line with inflation or the wage increase in the sector. This adjustment may, however, not be made if the financial position of the fund is not sufficient to do so. For this reason, this is known as conditional indexation. Many pension funds, including the largest, have not been able to allocate indexation since the financial crisis in 2008/2009.
In addition to defined benefit schemes there are contribution schemes, known as defined contribution (DC) schemes. In these schemes the amount of pension depends on the contributions paid in during the accrual phase and the return on these contributions. The capital has to be converted into a periodic benefit on retirement. In principle, the employee bears both the investment risk and the interest-rate risk (the risk that the rate for the purchase of an annuity will change). A pension scheme may also include a combination of the above two systems. A person may, for example, have a retirement pension consisting of a combination of a DB scheme (up to a certain income level) and a DC part for their salary above that level. Individual DC schemes are relatively rare in the Netherlands.
In addition to DB and DC schemes, there are also hybrid schemes in the Netherlands known as Collective Defined Contribution (CDC) pension schemes. The amount of pension is based on salary and service years, as for a DB scheme. However, the contribution is fixed for a large number of years. If the contribution turns out not to be sufficient later on, the pension benefit will be lower than originally intended. CDC schemes combine a limited risk of fluctuating pension liabilities for the employer with the advantages of a collective pension system.