In the new pension system, we will eventually have two types of contribution schemes:
1. a flexible contribution scheme, and
2. a solidary contribution scheme.
Much has been said and written about these schemes, but in essence they have much in common. The main difference is in the way the returns reach the participants and the extent to which solidarity reserves are used.
We do not yet know what products the pension insurers and PPIs will surprise the market with. Pension insurers and PPIs are not expected to offer solidary contribution schemes.
By: Berry van Sonsbeek, Product Market Manager Zwitserleven
Focus on the flexible contribution scheme
The solidary contribution scheme will be used mainly by industry pension funds and some company pension funds. This is why I am focusing here on the flexible contribution scheme which, as things appear at the moment, can and will be used by all market participants. What are the conceivable differences between a flexible contribution scheme at a pension insurer, a PPI and a pension fund (based on the still pending draft legislation, from the end of 2020).
1. PPI versus pension insurer
The differences between a pension insurer and PPI are wafer-thin, and really concern the details. A PPI does not pay out pension income after retirement. A pension insurer does this. A PPI is however permitted to pay a variable pension income. In practice, a participant with a pension scheme at a PPI will shop around at insurers on their retirement date and purchase a fixed pension income, a variable pension income, or a combination of the two.
There is one other important difference between a pension insurer and a PPI. With a pension insurer, the invested pension capital and still to be invested contributions may be converted into a fixed pension income during the accrual phase, from 15 years before the standard retirement age. The question is whether this is a good choice. This pension income purchased before the retirement date is guaranteed in nominal terms, but will not be indexed in line with inflation.
Furthermore, in general, the costs payable to a PPI are slightly lower than those payable to an insurer. The extent to which this applies depends on the size of the contract or the flexibility of the product offered.
2. Difference with a pension fund
During the accrual phase, all parties work with individual life cycles in the selection of the investments. We do not expect to see very significant differences in the modelling of these life cycles. The reason is quite simple: there are not that many expert parties who are able to compose lifecycles with good models that contribute to the realisation of the intended pensions. And the pension providers are more or less dependent on the expertise of these parties.
Advisers assess the various lifecycles in the market on the basis of the expected pensions and the chances of upside and downside performance in good or bad weather scenarios. Sustainable investment is also increasingly becoming a criterion. Other factors may play a role in the comparison, depending on the tool used to assess the life cycles. In practice, the competitors watch each other closely. As a result, the lifecycles of the various providers become more similar in terms of matching, the composition of returns and the way of reducing risk as a participant approaches retirement.
Where there can be a difference lies in the use of alternative investments in the life cycles and the degree of sustainable investment. Opinions differ on the use of alternative investments. I believe that with sufficient volume, alternative investments are certainly possible within lifecycles. And that they thus provide an additional opportunity for better returns through an improved return-risk ratio in the overall investment mix. The extent to which this will or will not work in favour of a pension fund, pension insurer or PPI depends on:
- the size of these providers;
- the extent to which choices are made for active investment versus passive investment, and
- the willingness to use the full spectrum of asset classes.
In the benefit phase, pension funds have so far mainly focused on a group variable pension in a flexible contribution scheme. This means that participants in a pension fund receive a variable pension income in the benefit phase as standard. All the assets of this group are treated as a single investment portfolio. Returns are divided among the pensioners, sometimes spread over a period of a few years. Without there being ample opportunity to respond to individual preferences of participants to take on more or less risk within the variable pension income. Participants who prefer to receive a fixed pension income may shop around with insurers with their capital on their retirement date.
There is a substantial difference here compared to pension insurers and PPIs. There, participants can shop around with their available capital on their retirement date and then purchase a fixed or variable pension income (or a combination of the two) from the party best suited to them. This gives individual participants more freedom of choice on their retirement date. But it also requires an additional duty of care to properly guide participants towards the most suitable solution for them.
3. Presorting for fixed or variable pension benefit as standard
One of the principles of the new pension system is that pensions will move more in line with the markets and thus with returns. This increases the likelihood that a pension income will rise, but also that it could fall. A contradictory element in the draft legislation is that if the social partners do not express a preference for steering towards a variable pension income by default, an insurer or PPI will have to assume a fixed guaranteed pension income by default. And thereby probably deprive participants of returns, possibly leading ultimately to a lower pension. This is contrary to the standard practice of a pension fund of anticipating a variable pension income.
4. Pension fund, APF, industry pension fund, insurer or PPI. What is the best option?
From a purely rational point of view, it is impossible to give a straight answer to this question. I wish to note that I am very much in favour of employers and employee representatives ultimately being free to choose the pension provider that suits them best. And unfortunately, this is not always the case in our modern world.
Whatever choice is made, in the end the interests of the participants have to prevail. In a flexible contribution scheme, all the risk is ultimately borne by the participants. And of course, as an employer, you want your employees, former employees and pensioners to receive good advice on the choices to be made, good service and quality from their pension provider and ultimately to enjoy a good and reliable retirement income.
Given the transition ahead of us with all the possibilities that are available, it is precisely for this reason that it is important for employers to start preparing now for the new system and to make decisions in good time. Partly because we want to avoid a situation in which employers do not make a decision until 2026, which could lead to difficulties in implementation because many employers and providers will be busy with all the administrative work involved. This could even affect the availability of a provider.
This article is published on 21 March 2022