The Dutch pension system is set to undergo a switch from DB to DC - and to facilitate operational challenges, more digital working is expected between different parties.
An expert pension group set up by asset servicer Caceis has published recommendations for how players in the evolving Dutch pension system will manage operations, specifically for how they communicate financial details about members’ pensions.
Pension fund members in the Netherlands are set to take on more risk as the country’s system changes from employer-guaranteed funds to schemes with no guarantees.
In 2022, the Dutch government submitted draft legislation that will overhaul the Netherlands' pension system. Parliamentary approval for the Future of Pensions Act [Wet Toekomst Pensioenen] sees a shift from defined benefit (DB) pensions, to defined contribution (DC).
The Act is expected to be implemented next year but with four years for employers and pension schemes to adapt.
Like in many countries with mature pension systems, changing employment trends, an increasing elderly population and falling interest rates are putting the Netherlands' pension economy under duress, and transition from DB (where the employer – who underwrites pension payments - takes the risk that investment returns will not cover the liability) to DC (where the risk falls on the pension scheme member).
The government’s proposal to phase out the DB model and replace it with DC schemes means participants shoulder the risk for their retirement provision. Although with DB the employer provides a pension guarantee, these schemes are seen to offer limited transparency. The reformed pension law allows participants to track the value of their pension assets and manage their investments actively.
This places a greater challenge for the main actors in the pensions chain to communicate more effectively.
Two contract forms
In the new Dutch model there are two contract forms: Solidarity Pension Scheme (SPR) and Flexible Pension Scheme (FPR).
Pension funds under the SPR model will invest on behalf of their members with a focus on collective investment outcomes, while the FPR model will focus on individual investment outcomes.
With the introduction of a premium system tailored to individual circumstances, the government plans to abolish the system of average premiums, whereby one premium is paid for all employees, regardless of age.
Life-cycle investing, the starting point in both contracts, is a new feature that allows younger employees to take more investment risk than senior employees. Employees can also withdraw 10% of the pension capital on their retirement date.
Research conducted by the Chain Challenge Expert Group gives a glimpse of what lies ahead.
Bridging the communication gap: Seamless and unambiguous communication between pension funds and their ‘chain partners’ (including pension administrators, asset managers, ALM advisors and asset servicers) is indispensable for sound pension administration. This ensures that the three core tasks of running a pension fund — pensions administration (including inflow and outflow), financial management (asset management), and information provision — are executed successfully.
Connecting sub-processes: Developing a target operating model can facilitate mutual coordination between the chain partners and the pension fund management. Operational risks can be mitigated with robust technological and management support, especially in the event of outsourcing. Pension administrators must upgrade their expertise to minimise disruptions in workflow.
‘Middle administration’: Industry insiders envisage the need for a ‘middle administration’ that not only calculates a participant’s pension from data all data sources, but also acts as the communication linchpin. Another role is that of a transfer agent who calculates indicative net asset values (NAVs) for the administrative funds and plays a coordinating role in asset management.
Unitisation vs Decomposition: Allocation of pension assets and financial results to participants is executed through ‘unitisation’ (dividing into fractions) and ‘decomposition’ (taking apart and allocating) methods.
Unitisation – which is less common in a DB environment, the Expert Group notes - involves the division of a defined set of financial assets and liabilities into units, allowing the pension participant to share pro-rata in the financial results of that set.
Decomposition, on the other hand, involves pension funds decomposing financial results into all relevant claims and liabilities and for allocation to pension members.
Findings suggest that decomposition works well with the solidarity contribution scheme, while unitisation works better with the flexible contribution scheme.
Mitigating high implementation costs: Instrumental to reducing operational complexity and costs, the expert group says standardised connectivity (or ‘intelligent process automation’), exchangeable data files, and quality controls are among the necessary components. So is terminology that is in tandem with multi-party contracts – i.e, between the pension fund, pension administrator, asset manager, custodian and ALM advisor.
Tackling transition: The more complex a chain is, the higher are the number of incidents and associated risks involved in the pension fund. Decision-makers can overcome this challenge by deploying advanced technology or different forms of self-administration.
Decongesting bottlenecks: The sudden spike in capacity requirements as the new Act becomes effectives is bound to form a bottleneck in the system, the expert group says. All chain partners will be supporting different schemes with limited resources. However, this can be decongested by establishing uniformity in concepts, in tandem with the development of intelligent process automation and/or APIs.
SPR vs FPR: As mentioned, decomposition would be a wise choice for pension funds implementing the SPR exclusively. Pension funds implementing the FPR, on the other hand, should consider the unitisation method if they want to facilitate the investment profiles of pension participants. The ones willing to implement both schemes would benefit from unitisation.
The goal is to uncomplicate the allocation of financial results to recipients in a flexible and “compliance-poor” fashion. Experts also recommend that stakeholders set aside at least nine months to establish a working operating model within which the pension fund, pension administrator, asset manager, custodian and ALM advisor can interact seamlessly.
The Chain Challenge Expert Group includes representatives from pension funds ABP and Pension Fund for Rail & Public Transport. Asset managers include Aegon and Cardano. The full report is entitled Direction in Pension Execution.
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