Implications of Dutch Pension Reform at Home and Abroad

Asset Owner Academy | Insights Series 

Implications of Dutch Pension Reform at Home and Abroad

Asset Owner Academy | Insights Series 

March 2022

By Xavier van den Brande and Marvin Vervaart

With the looming Dutch pension reform on the horizon, the benefits and challenges of which were detailed in the recent BNY Mellon Aerial View article “The Changing Face of Dutch Pensions,” pension funds are taking action: asking questions, taking stock of the risk appetite of their members and proactively talking to custodian and data partners to better understand the implications of this transformational shift.

Preparing for this shift is not only a key strategic priority for the Dutch pension market but also, the design and execution of it will be closely monitored by pension markets across the globe looking to adopt best practices.

 

“Pension funds are increasingly looking at their service providers to help them orchestrate solutions and streamline information across investment and operational processes to ensure strategic objectives are being met in the midst of this massive transition.” said Rohan Singh, Global Head of Asset Owners, Asset Servicing and Digital at BNY Mellon.

 

The Dutch government’s proposal to transition away from a defined-benefit (DB) model in favor of a defined-contribution (DC) model in various forms is expected to require a four-year transition period and anticipated to take full effect January 1, 2027.

 

Dutch pension funds have the option to select either the "Solidaire Pensioenregeling” (SPR or Solidarity Pension Scheme) or the “Flexibele Pensioenregeling” (FPR or Flexible Pension Scheme). Pension funds under the SPR model will invest on behalf of their members with a strong focus on collective investment outcomes. Pension funds under the FPR model, which is comparable to the DC models known in the Anglo-Saxon markets, on the other hand, will have a stronger focus on individual investment outcomes. Deciding on the right option and how to administer the new plans have sparked important questions to consider.  

Figure 1: Preliminary preferences of Dutch Pension Funds*

*Based on feedback received from pension funds and fiduciary managers.

In Q4 2021 and Q1 2022, BNY Mellon engaged with approximately 50 market participants, including pension funds and their administrators, fiduciary managers, and technology companies, to obtain their views on the most pressing questions around the implications of Dutch pension reform.

  • How frequent should (two-way) communication with individual pension members be and through what channels?
  • How will the change towards the SPR and FPR models impact existing investment models? Specifically, what will be the impact on risk/return, environmental, social and governance (ESG) and active or passive investment strategies?
  • What is the impact on fund structures -- specifically, how will pooling structures be organized to support newly defined age cohorts?
  • What is the impact on data models given that the new structure will lead to increased complexity from enhanced reporting requirements and more investment options?
  • What will the impact of these changes be on the existing Dutch ecosystem in terms of consolidation, partnerships across the value chain, and the role of custodians?

Discussions with market participants have helped form preliminary answers to these important questions viewed through three key lenses: pension member engagement, investment models and operating models. 

Pension Member Engagement

 

Pension funds will need to reconsider content and frequency of engagement with members leading up to and through the enactment of the pension reform to secure its success.

  • Balance member preferences and pension funds’ own investment beliefs and policy: Members will likely seek more frequent and detailed pension information with a stronger appetite for influencing investment decisions.
  • Mitigate excessive risk taking through member education, as well as restrictive measures where possible: Some individuals’ risk appetite may be misaligned with the principles for prudent risk management put forward by pensions and public authorities. Pension funds may need to consider maximum bandwidths for certain asset classes.
  • Optimize member communication: Pension funds should deploy consumer-centric technology such as mobile applications to enable more accessible communication with members. If appropriate technology expertise is not available in-house, outsourcing to a technology partner will be a logical solution.
  • Customize information sharing by demographic: The needs of members will differ, for example, across age cohorts or personal investment experience; members who require more information can obtain a special service at a higher membership fee.
  • Upskill and educate call center employees: Increased information to members may lead to an increase in questions for member administrators and their call centers. The nature of questions from members is anticipated to change from a liability to an investment focus.  
  • Disclose ESG data in individual member accounts: Younger generations in particular, will likely seek increased transparency around responsible investments, driving additional ESG data needs throughout the value chain.

 

Investment Models

 

While pension funds must consider how their investment and hedging strategies may change, the transition to the new DC model is not expected to lead to dramatic changes in the overall asset allocation across the Dutch pension fund assets above and beyond existing megatrends, such as search for yield through alternatives and emerging markets.

  • Concentrate assets within a small number of age cohorts and/or model portfolios: Discussions revealed that most pension funds will look to form an average of three such model portfolios — each with distinct risk parameters, asset allocation, and hedging policies — based on the mandatory surveys of members to determine their risk appetite.
  • Individual asset liability management (ALM) may emerge as a new service: There will be less focus on funding ratios and ALM at total fund level as one of the leading investment factors. However, members may have an interest in greater transparency into their own asset and liability profile, creating demand for individual ALM as a new service.
  • Aim to retain a captive investment model without relying on open architecture: While DC models are internationally often associated with open architecture investment structures, the largest Dutch pensions will likely aim to retain a largely captive investment model, including in a FPR model, to leverage their investment expertise and control members’ costs.
  • Prepare for “invaren” (asset transfers): To secure their ability to seamlessly transfer all assets from the existing DB schemes to the new plans, pension funds are considering whether to retain their long-term investment strategy or to introduce temporary risk measures to safeguard existing positive funding ratios. If assets cannot be transferred because of insufficient funding ratios, this could lead to the unplanned emergence of closed schemes with a far less diversified investment model; as evidenced in the United Kingdom where there are nearly 3,000 DB funds that are either closed for future accruals or are winding down due to both regulation and evolution of the market.

Operating Models

 

The shift to DC will likely result in wider market consolidation to achieve greater economies of scale and operational efficiencies. Service providers will also need to adapt their value propositions from front to back according to the needs of the pension funds, noting that individual components are mostly already in existence today.

  • Choose an operating model to accommodate both SPR and FPR: The largest pension funds may want to retain the ability to pivot towards FPR over time, even if they prioritize SPR in the medium term.
  • Expect further consolidation and more partnerships: Even the largest pension providers may not have the capabilities to operate the entirety of the value chain needed to successfully implement the reforms. Consolidation and/or industry partnerships could be utilized to close gaps (e.g., specialist providers for FPR member platforms, custodians as the central orchestrator for holistic data management).
  • Use virtual pooling to satisfy new investment and reporting requirements:  The additional focus on unit administration is unlikely to lead to a dramatic change in existing pooling structures. Age cohorts and model portfolios are likely to  be constructed as virtual asset pools (composites).
  • Updated accounting standards could lead to higher costs: On-demand access to information may include a daily investment accounting and reporting process which could likely increase costs, at least in the near-term.
  • Introduce a new non-mandatory depository function: While legislation does not prescribe the mandatory appointment of a depository, some industry participants argue that an independent “second line of defense” is recommended to better protect members’ interests.

Most pension funds expect the start of the transition to begin in Q1 2023, with legislation expected to be finalized later this year. In the meantime, market participants, including BNY Mellon, seek a continuous dialogue to help anticipate likely investment and operational outcomes, as well as the preferred member engagement. This is particularly important given that 2023 and 2024 may give rise to implementation bottlenecks as market participants put their plans into action at the same time.

Learn more by visiting BNY Mellon Asset Owner Academy, a platform to share bold ideas, insights and learnings to help asset owners stay agile as they transform their operating models.

Xavier van den Brande

Head of Asset Owners, Europe

Marvin Vervaart

Client Solutions Manager, Asset Owners 


 

Asset Servicing Global Disclosure

 

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