The search for the successor of the pay-as-you-go system

Erasmus School of Economics

Pension funds are fighting decreasing coverage ratios. This leads to a challenging question: is this system sustainable for much longer? In articles from Het Financieele Dagblad and pension fund APG, Professor of Pension Fund Risk Management at Erasmus School of Economics Onno Steenbeek elaborates on the topic and compares the current pension agreement plan with foreign options.

After ten years of negotiations, a new pension agreement has been reached between the cabinet, labour unions and employers’ organisations in 2019. Future pensions are under pressure and therefore an important political topic: in most western countries, including the Netherlands, ageing of the entire population is due. The current system in essence is a pay-as-you-go system: everyone contributes to one big fund, and people who reach the pensionable age are entitled to a pension. This system is hard to maintain when the ratio of working people to retired people decreases, which will lead to lower coverage ratios.

Steenbeek, together with Benne van Popta, former employer chairman of the second biggest pension fund in the Netherlands (PMT), researches methods that are used in foreign countries to reform their pension schemes. The Dutch Minister of Social Affairs and Employment requested their help in order to develop a general pension reform theorem. By reaching out to international pension experts, Steenbeek gathers information on effective ways to reform the system. One of the main points being emphasized by international experts, is transparency: when they are asked to look at the Dutch pension agreement, their main complaint is that the agreements are diffuse. This is problematic, since these vague formulations make a clear explanation of the plan to society bothersome.

Eye opener

The Netherlands has a unique approach to the new pension system. In his conversations with international experts, Steenbeek came to the realisation that most countries set up a completely new pension system, whereas the Netherlands transforms the system as a whole. Everyone moves to the new system, regardless of age. This means that 150 Dutch pension funds have to transform 1600 billion euros of promised pension to personal capital, a very intricate task. In other countries, people remain under the old system and the system slowly phases out. Young, new people join the new system. Steenbeek: ‘The transformation of built up rights to wealth is quite remarkable. The only comparable case is that of Denmark, but the Danes had a higher coverage ratio, which is beneficial, since pensions didn’t have to be curtailed at the moment of transformation’. Unfortunately, this is not the case for the Netherlands: many funds simply don’t have the means to give everyone what they were promised.

Foreign policy

Some other policies were evaluated by Steenbeek and Van Popta. Germany doesn’t seem to be very successful with their approach: the German equivalent of our general old-age pensions act (Algemene Ouderdomswet, AOW) turns out to be unaffordable. This results in increasing poverty amongst elderly people. The British system wasn’t changed for the better either: at once, people could withdraw all of their built-up wealth. This has lead to horror stories in the British newspapers of people who invest their money with very expensive asset management companies. Sweden intended to depoliticise their pension fund system: a committee of many involved parties was formed. Since there were many parties, it took a long time to reform the system. However, it worked, since they were forced to cooperate with each other. This leaves us with the following question: what is the ideal approach and what are we going to do? Pension think tank Netspar will deliver their definitive findings during springtime.

More information

You can download the full article from Het Financieele Dagblad, 25 January 2021, above. You can read the article from APG, 29 January 2021, here.

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