The new pension agreement is a big step forward, in our opinion. At last everyone will build up a pension in a transparent and personal manner. We applaud the pension funds for this move and welcome them to the DC family. But we’re not quite there yet. Now is the perfect time to take the last step: give people the option of aligning their pension with their personal situation.
After a decade of wrangling, the pension funds are entering a new world. Our world. From a Defined Benefit (DB) scheme to a Defined Contribution (DC) scheme. What’s the difference? A DB scheme currently promises a guaranteed minimum pension. The amount of the guarantee (which is provided in advance) depends on the salary and the length of employment, and not the pension fund’s investment results.
In the past 10 years it has become clear that these ‘guarantees’ of a minimum pension were, in fact, not guarantees. The interest kept dropping and life expectancy kept increasing. In practice, employers were primarily dependent on a fund’s investment returns. More and more people started realising that promises were not being kept. Guarantees will be eliminated in the new contract, with only the premium contribution being fixed. The pension benefits depend on the value of the investments. The premium paid by the employer will be invested collectively. The investment earnings will be deposited to a personal account. In the new system returns will no longer be equally distributed across all ages. The risk of the investments will be adapted to age. The closer an employee is to retirement, the less risky the investments will be. This will make the pension more stable. Such as the lifecycle method, which we have employed for over 10 years already.
Personally monitoring your pension
In the new system employees can see what their premium is and personally monitor the pension they have accrued. The system will become more transparent and employees will know exactly how they are doing. In the old system they didn’t have enough insight into their own pension fund. There was one joint pension fund totalling about € 1,500 billion. What part of that was yours? Well, that was unclear. The move to personal pension capital should re-establish trust.
Solidarity reserve fund
But isn’t it more complicated than that? What about this pension system’s solidarity? The answer: Even this isn’t all that complex. The trade unions have enforced their demand for 10% of the total capital to be kept separately. The goal of this ‘solidarity reserve fund’ is to cushion the impact during times when investments aren’t doing so well. So that one age group doesn’t receive a lot more than another or the pension of older employees isn’t more stable.
As far as we’re concerned, the pension funds are making a wise decision. And that’s why we say: Welcome to the DC family. Finally, a modern-age pension for everyone. The times when people worked for one employer for their entire career are over. That’s why it is good that the ownership of the accrued capital is now being shifted from the group to the individual. No more discussions about redistribution, older employees who believe they are entitled to indexation and younger employees who are afraid that the pension capital will be used up when they retire.
The new system is aligned with today’s labour market and is less complex at its core. There will likely be some glitches when switching to the new system, like ‘integrating’ the old pension accrual into the new scheme. But in essence the new system for future accrual is quite simple. No more notional interest rate that leads to generative discussion, no minimum funding ratio and no hard promises, but rather your own pension capital.
A personal pension fund will help people regain trust in the pension system. Just look at Denmark. This is the country with which we have held a top position in the pension world rankings for years. Trust in pensions is quite a bit bigger there than it is here, even though they are struggling with the same problems: low interest and increasing life expectancy.
What’s the big difference? The Danes have been working with personal pension funds for years now. They can personally monitor how their money is growing. And they aren’t fed empty promises about the ultimate amount of the pension benefits. They receive forecasts, with an emphasis on the fact that these forecastsare not a sure bet. Because there are no promises, the end result is less disappointment.
Self-empowerment through choices
The only step that pension funds can take now is empowering people by aligning their pension with their personal situation. What investment risks are they willing to take? Do they want to invest offensively or defensively? How permanently should their pension contribution be invested? Do they want to contribute an additional premium? And do they want fixed or variable annuities on their retirement date? All this will help create a more tailored pension solution. If you don’t do this, an average investment risk per age group will be specified. And that isn’t appropriate for everyone.
At BeFrank we’ve been offering these options for 10 years. We make pensions transparent and personal with a handy app. Participants can monitor their pension accrual in real time and be in control. How high can the contribution be? What is the preferred kind of investment? They see the costs, the returns, the investment policy. What’s more, they don’t have to choose – but they can. Customer satisfaction surveys among employers who use our services show that employees who regularly check how their pension is doing are more satisfied.
From trust to involvement
When employees see which premium is being paid for them and how much money this actually is, they tend to appreciate this benefit more. When they then see their pension fund growing, they have more trust. And when they can influence the choices, practice has shown that they become more involved in their pension.
The new pension system is a major step forward. But we are also appealing to the pension funds to cross the final hurdle and give people the option of aligning their pension with their personal situation. And you will see that not only will their appreciation increase, but their trust and involvement as well. Finally, you can influence your own pension.
This article appeared in the FD on 8 October 2020.