Going Dutch on Pensions?
Imagine a place where pensions were not an ever-deepening quagmire, where the numbers told the whole story and where workers could count on a decent retirement.It's about time the media in the United States starts looking more closely at pensions and what is working around the world. You can read a primer on the Dutch pension system here.
Imagine a place where regulators existed to make sure everyone followed the rules.
That place might just be the Netherlands. And it could provide an example for America’s troubled cities, or for states like Illinois and New Jersey that have promised more in pension benefits than they can deliver.
“The rest of the world sort of laughs at the United States — how can a great country like the United States get so many things wrong?” said Keith Ambachtsheer, a Dutch pension specialist who works at the University of Toronto — specifically at its Rotman International Center for Pension Management, a global clearinghouse of information on how successful retirement systems work.
Going Dutch, however, can be painful. Dutch pensions are scrupulously funded, unlike many United States plans, and are required to tally their liabilities with brutal honesty, using a method that is common in the financial-services industry but rejected by American public pension funds.
The Dutch system rests on the idea that each generation should pay its own costs — and that the costs must be measured accurately if that is to happen. After the financial collapse of 2008, workers and retirees in the Netherlands took the bitter medicine needed to rebuild their collective nest eggs quickly, with higher contributions from workers and benefit cuts for pensioners.
The Dutch approach bears little resemblance to the American practice of shielding the current generation of workers, retirees and taxpayers while pushing costs and risks into the future, where they can metastasize unseen. The most recent data suggest that public funds in the United States are holding just 67 cents for every dollar they owe to current and future pensioners, and in some places the strain is palpable. The Netherlands, by contrast, have no Detroits (no cities going bankrupt because pension costs grew while the population shrank), no Puerto Ricos (territories awash in debt but with no access to bankruptcy court) and nothing like an Illinois or New Jersey, where elected officials kicked the can down the road so many times that it finally hit a dead end.
About 90 percent of Dutch workers earn real pensions at their jobs. Their benefits are intended to amount to about 70 percent of their lifetime average pay, as many financial planners recommend. For this and other reasons, the Netherlands has for years been at or near the top of global pension rankings compiled by Mercer, the consulting firm, and the Australian Center for Financial Studies, among others.
Accomplishing this feat — solid workplace pensions for most citizens — isn’t easy. For one thing, it’s expensive. Dutch workers typically sock away nearly 18 percent of their pay, most of it in diversified, professionally run pension funds. That compares with 16.4 percent for American workers, but most of that is for Social Security, which is intended to provide just 40 percent of a middle-class worker’s income in retirement.
Dutch employers contribute to their system, too, but their payments are usually capped. While that may seem a counterintuitive way to make sure that pensions are well funded, it actually encourages companies to stick with pension plans. If the markets drop, Dutch employers do not receive urgent calls to pump in more money — the kind of cash calls that have prompted so many American companies to stop offering pensions. In the private sector, only 14 percent of Americans with retirement plans at work have defined-benefit pension plans — the ones that offer the most security — compared with 38 percent who had them in 1979. And if the markets rally and a Dutch pension fund earns more than it needs, the employers are not allowed to touch the surplus. In the United States, companies have found many ways to tap a pension surplus. The problem today is that there usually is no surplus left.
Dutch companies, as well as public-sector employers, typically band together by sector in big, pooled pension plans, then hire nonprofit firms to invest the money. Terms are negotiated sectorwide in talks that resemble American-style collective bargaining.
This vast collaborative process may sound too slow, too unwieldy and maybe even too socialist for American tastes. But standing guard over it is a decidedly capitalist watchdog, the Dutch central bank. More than a decade ago, after the dot-com collapse, a director of the central bank warned of a looming pension funding crisis. In response, the central bank in 2002 began to require pension funds to keep at least $1.05 on hand for every dollar they would have to pay in future benefits. If a fund fell below the line, it had just three years to recover.
American public pension funds have no such minimum requirement, and even if they did, there is no regulator to enforce it. Company pensions are bound by federal funding rules, but Congress has a tendency to soften them.
The Dutch central bank also imposed a rigorous method for measuring the current value of all pensions due in the future. Pensions are not supposed to be risky, so the Dutch measure them the same way the market prices very safe bonds, like Treasuries — that is, by discounting the future payments to today’s dollars with a very low interest rate. This method shows that a stable lifelong benefit is very valuable, and therefore very expensive to fund.
Notably, the Dutch central bank prohibited the measurement method that virtually all American states and cities use, which is based on the hope that strong market gains on pension investments will make the benefits cheaper. A significant downside to this method is that it lets pension systems take advantage of market gains today, but pushes the risk of losses into the future, for others to cope with. “We had lengthy discussions about this in the Netherlands,” said Theo Kocken, an economist who teaches at the Free University in Amsterdam and is the founder of Cardano, a risk analysis firm. “But all economists now agree. The expected-return approach is a huge economic offense, hurting younger generations.”
He explained that in the Netherlands, regulators believe that basing the cost of benefits today on possible investment gains tomorrow is the same as robbing tomorrow’s workers to pay for today’s excesses.
Most public pension officials in the United States reject this view, saying governments can wait out bear markets because governments, unlike companies, don’t go out of business.
For years, economists have been calling on American cities and states to measure pensions the Dutch way. And, in fact, California’s big state pension system, Calpers, sometimes calculates a city’s total obligation by that method. When Stockton went bankrupt, for instance, Calpers recalculated and found that the city owed it $1.6 billion. Of course, Stockton is insolvent and does not have an extra $1.6 billion, but Christopher Klein, a bankruptcy judge, has said that federal bankruptcy law permits it to walk away from the debt. Calpers disagrees, setting up a clash that seems destined for the United States Supreme Court.
But most of the time, when someone in the United States calls for Dutch-style measurements, pension officials suspect a ploy to show public pensions in the worst possible light, to make them easier to abolish.
“They want to create a false report, to create a crisis,” said Barry Kasinitz, director of government affairs for the International Association of Fire Fighters, after members of Congress introduced a bill to require the Dutch method.
The Dutch say their approach is, in fact, supposed to prevent a crisis — the crisis that will ensue if the boomer generation retires without fully funded benefits. Their $1.05 minimum is really just a minimum; pension funds are encouraged to keep an even bigger surplus, to help them weather market shocks. The Dutch sailed into the global collapse of 2008 with $1.45 for every dollar of benefits owed, far more than they appeared to need. But when the dust settled, they were down to just 90 cents. The damage was so bad that the central bank gave them a breather: They had five years to get back to the $1.05 minimum, instead of the usual three.
American public plans emerged from the crisis in worse shape, on the whole, and many allowed themselves 30 years to recover. But 30 years is so long that the boomer generation will have retired by then, and the losses will have been pushed far into the future for others to repay.
It’s a recipe for disaster if the employer happens to be a city like Detroit. The city’s pension system used a 30-year schedule to cover losses but reset it at “Year 1” every year, a tactic employed in a surprising number of places. In Detroit, it meant the city never replaced the money that the pension system lost. When Detroit finally declared bankruptcy last year, an outside review found a $3.5 billion shortfall, one of the biggest claims of the bankruptcy. Manipulating the 30-year funding schedule had helped to hide it.
“This happening in the Netherlands is totally out of the question,” Mr. Kocken said.
While the Netherlands has a stellar reputation for saving, that doesn’t mean pensions have been without controversy there; in fact, a loud, intergenerational debate is occurring about how to manage pensions. The financial crisis raised new calls for reform, Mr. Ambachtsheer said. Retirees were shocked and angry to have their pensions cut by an average of 2 percent after the crash. That had never happened before, and many had no idea that cuts were even possible. A new political party, 50Plus, sprang up to defend the interests of older citizens and won two seats in the national Parliament.
But something else happened: Dutch young people found their voice. No matter their employment sector, they could see that their pension money was commingled with retirees’ money, then invested that way by the outside asset management firms. In the wake of the financial crisis, they realized that they and the retirees had fundamentally opposing interests. The young people were eager to keep taking investment risk, to take advantage of their long time horizon. But the retirees now wanted absolute safety, which meant investing in risk-free, cashlike assets. If all the money remained pooled, young people said, the aggressive investment returns they wanted would be diluted by the pittance that cashlike assets pay.
“Now the question is, ‘How do you resolve this dilemma?’ ” Mr. Ambachtsheer said. “Everybody wants safety and everybody wants an affordable system, and you can’t have both. It’s become a major public debate in the Netherlands.”
It’s a debate that is rarely, if ever, heard in the United States.
This article highlights a lot of issues I've discussed in my blog. Just last week, I went over the brutal truth on defined-contribution (DC) plans stating the following:
The brutal truth on defined-contribution plans is they're more costly and not properly diversified across public and private assets. More importantly, they will exacerbate pension poverty which is why we have to enhance the Canada Pension Plan (CPP) for all Canadians allowing more people to retire in dignity and security. These people will have a guaranteed income during their golden years and thus contribute more to sales taxes, reducing public debt.The Dutch got it right, rejecting DC plans and embracing defined-benefit (DB) plans for as many of their citizens as possible. More importantly, they take the funding of their pension plans seriously and the Dutch central bank stringently monitors and enforces funding ratios.
In my ideal world, you won't have the bcIMC, Caisse, OTPP, PSP, AIMCo, HOOPP or Bombardier, CN, Bell, Air Canada pension plans. You will only have large, well-governed public defined-benefit plans managing the assets and liabilities of all Canadians regardless of whether they work in the public or private sector. If we achieve such a monumental undertaking, we will significantly lower investment and administrative costs and do away with the issue of pension portability once and for all because people will move across public and private sector jobs knowing their pensions are safe and secure, backed by the full faith and credit of the federal government.
There are no contribution holidays for pensions in the Netherlands and no pension smoothing. Either they have attained their funded status -- 105% is what is considered fully funded -- or they're in trouble and have three years to correct their deficit, not 25 or 30 years. Some think such tight funding rules are too onerous but I submit that they make the difference between well-managed pension plans and mediocre ones which rely on a rate-of-return fantasy and hopium to attain their fully-funded status. And following the 2008 crisis, the large Dutch pension powerhousess moved back to basics.
Having said this, the Dutch pension system is far from perfect. The 2008-2009 crisis proved to be a real stress test for Dutch pensions and some argue the system needs more flexibility to address the inter-generational impact on the funding gap:
The financial crisis of 2008-09 has provided a stress test for the Dutch pension system. It appears that the more flexible defined benefit structure adopted by most plans earlier in the decade, which relies on indexation adjustments to restore solvency, may not be sufficient for the funds to recover fully. In response, policymakers should try to find approaches to compensate for the funding deficits in ways that best distribute risk among participating generations. In addition to the funding increases or nominal benefit cuts that may be needed in the wake of the crisis, policymakers should think more broadly about improving the design of pension funds going forward – through, for example, introducing age differentiation – to more effectively and fairly distribute risk by generations.While there are kinks in their pension system, there is no denying the Dutch take their pensions seriously and it's an important political topic, just like healthcare and education.
There are three pillars to a just and healthy democracy: universal healthcare, education and pensions. In Canada, we got the first two right but have yet to bolster our pension system. We have some of the best DB plans in the world but we haven't built on their success, covering all Canadians. Once we do, we will surpass the Dutch in coverage and have the best pension system in the world.
As far as the United States, their looming pension disaster is only going to get worse and they have yet to introduce much needed reforms on pensions, especially reforms on their governance. Until they get the governance right, their public pensions are doomed, exacerbating America's new retirement reality. It's high time the U.S. goes Dutch or Canadian on pensions.
Below, as cities and states across the U.S. grapple with their pension programs, PBS travels to one country -- The Netherlands -- that seems to have its pension problem solved. Ninety percent of Dutch workers get pensions, and retirees can expect roughly 70% of their working income paid to them for the rest of their lives.
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