Employer Action Code: Act
After more than a year of debate and discussion between the social partners (the government, unions and business), the government has released further details, in its Main Outline Memorandum, on reforms that would fundamentally alter the system for supplemental employer-provided pension plans. The memorandum is based in large part on the framework agreed upon in June 2019 (see the June 2019 Global News Brief: Sweeping pension reforms agreed). Members of the largest union, the FNV (Federatie Nederlandse Vakbeweging), have yet to vote on the measure (the vote is scheduled for July 4, 2020), but its leadership has provided tentative approval. Certain provisions, such as the change in accrual system and the new fiscal (tax) framework, would apply to all supplemental pension arrangements, whereas the new collective pension contract would primarily apply for those financed via pension funds. If approved by parliament, the legislation would take effect on January 1, 2022, with all pension arrangements required to switch to a new contract form between that date and January 1, 2026.
Key details
Changes to future pension accruals
- In all supplemental pension plans, the value of (tax-favored) annual future pension accruals — as a percentage of pensionable earnings (i.e., salary capped at 110,111 euros, less an offset) — would not be allowed to vary according to the participant’s age, a major difference from the current framework. Currently, the value of the annual accrual (i.e., the contribution rate) increases with age in almost all defined contribution (DC) plans. For defined benefit (DB) plans, currently the pension accrual rate typically is independent of age, which means that the value of the pension accrual actually increases with age; again, this would no longer be possible.
- Moving future DC accrual values to this new basis would result in flat contribution rates (i.e., independent of age); however, existing DC plans would be allowed to continue with their current design for current workers.
- Tax-favored DB accruals would cease; all future accruals would have to be in individual-account DC plans or in collective DC plans (accounting treatment to be determined, in particular under US GAAP), and new DB plans would not be permitted.
- Members’ accrued pensions would be transferred to the new contract by default, though the social partners and boards of trustees could choose to deviate if the transfer would be detrimental to certain member groups.
- Employees whose future pension accrual values are negatively affected by these changes would receive compensation from their employer(s), starting no later than 2026 and through 2036. There would be a central approach defined for calculating the negative impact, but individual employers would have to agree with workers’ representatives on the details of how and to what extent they compensate affected employees, subject to the conditions that the compensation be adequate to the employee and cost-neutral to contributors (employee and/or employer). For an affected employee, this compensation would end on termination of employment but then resume on joining a plan with a new employer during this period. The compensation from the new employer would be determined on the same basis as paid by that employer to its existing employees and could be more or less favorable for the employee than that received from his or her former employer. Further details on how this might work in practice are yet to come.
New pension fiscal framework
- Under the new fiscal rules, tax-favored total annual contributions to a member’s pension account, excluding risk premiums and administrative charges, would be capped at a government-specified percentage of the member’s pensionable earnings, which would initially be set somewhere between 30% and 33%. The rate would be derived based on the targeting of a retirement income replacement ratio of 75% after 40 years (reflecting various assumptions); it would generally be subject to change every five years, though for stability purposes the memorandum calls for holding the initial rate fixed through 2035 (unless the derived rate moves by at least five percentage points). The new rules would apply from the time of the plan’s transition to the new accrual system.
- It remains unclear whether risk premiums, especially in the case of industry-wide pension funds, would be determined and levied according to age. The first seems inevitable, since the price of risk cover is highly age-dependent.
- For a period of 10 years after moving to the new pension accrual basis, a tax-favored additional contribution of 3% of pensionable pay would be allowed as part of the compensation to the employee described above.
New pension contract type: DC with collective investments
From January 1, 2022, a new type of collective DC contract would be an option available to pension funds, in which:
- There would be a collective investment pool with no actual individual member accounts.
- An investment “solidarity reserve” to help smooth inter-generational fluctuations in investment experience would be required. The reserve could be built up through contributions (up to 10% of total contributions) or a portion of “excess” investment return (up to 10% of return above a defined threshold). The maximum size of the solidarity reserve would be 15% of total fund assets. The rules of how and when the reserves could be distributed among the participants would have to be transparent and determined in advance.
- On an annual basis the collective fund’s investment results (after any transfer to or from the solidarity reserve) would be allocated to individual members’ notional accounts according to the members’ age-dependent risk profiles.
- Contribution rates would be fixed (although they could be reevaluated in the future) and would not be determined based on an explicit targeted level of benefits. There would be no funding buffer.
- The level of benefits paid to a member would not be guaranteed and would be adjusted up or down annually based on investment and demographic experience.
- In terms of the determination of any compensation payable to members as described above, in addition to the negative effect of moving to the new accrual basis, there would be a potentially offsetting effect for a pension fund moving to this collective DC contract to reflect that members would participate more directly from expected future fund returns in excess of (or below) a threshold risk-free rate. The net impact could be that no compensation is payable to members, though it will only be possible to determine whether this is the case once calculations for the individual fund are completed.
Transition process
Following debate in parliament, it’s expected that legislation and regulations will be finalized by the end of 2021, and that companies would be able to switch their plans to the new accrual basis starting January 1, 2022, but no later than January 1, 2026.
The memorandum contains an indicative transition schedule for pension funds, including the milestone of January 1, 2024, by which employers and workers’ representatives must have reached decisions regarding their new pension arrangement, transfer of accrued rights and any compensation. It is expected that there will be a similar milestone specified for pension plans that are not part of a pension fund.
Given current economic circumstances, underfunded pension funds with a funding ratio over 90% would not have to reduce their pensions as of the end of 2020 (as was also the case at the end of 2019).
Employer implications
If approved, as expected, by the FNV and then parliament, the transition to the new pension system would be fairly complicated as suggested by the very length of this news “brief.” The eventual outcome should result in a more sustainable, generationally “fair” pension system with more predictable costs for employers, but getting there on the most favorable terms for employers and employees will require careful planning and execution.
