The reason why the Dutch pension system is the best in the world

The Dutch pension system is again rated the best this year in the Mercer Index. Why is that and how is pension arranged in other countries? We asked two experts.

We like to complain about it, but with relatively little reason: the Dutch pension system is the best in the world. In the Mercer Global Pension Index, that compares all pension systems in the world on several crucial points, ‘we’ are rated at the top position, just like last year. “No other country scores this good on all of those points as we do”, says Rob Bauer, professor Institutional Investors at the University of Maastricht. The index assesses the adequacy, durability and integrity of a pension scheme. Are the payouts sufficient for the participants? Is it affordable in the long term? And how honest and transparent is the system?

The Netherlands scores quite alright on all of these three points, also says Onno Steenbeek who is responsible for strategic portfolio advice at APG and works as a professor in risk management of pension funds at the Erasmus University. “The entire world is jealous of the Netherlands”, he says. “What makes us unique within Europe is the fact that we have saved a lot of money labelled pension.”

America

That’s something the people in a country such as the United States can only dream about. With a ranking at the 16^th position on the international list, the US is not scoring very well. The paternalistic model of the Netherlands, in which it is mandatory for us all to save for our pension once we are employed somewhere, is just unthinkable in the US, says Bauer. Annuity, having your pension paid periodically, is in many cases a choice over there instead of an obligation, like it is in the Netherlands. That is to say, if you receive pension at all. “There has been an enormous trend in the US from collective to individual systems, or even no pension system at all. The public pension funds that still exist, are of states and cities. Some cities have already gone bankrupt.”

One of the related causes is the weak legislation, says Bauer. “There are guidelines in place, but the funds have a lot more freedom to do whatever they want. That’s a big problem. They are allowed to take too much risk which means they can achieve high yields, but also suffer major losses.”

Moreover, the funds in the US work with a much more optimistic calculation of the coverage ratio, but even with that calculation method it is way worse than in the Netherlands. Bauer: “The largest pension fund of America has a coverage ratio of approximately 70 percent. But if they would calculate the coverage ratio according to the Dutch legislation, it would only be 30 percent.”

Bauer believes that Americans find us too strict in the Netherlands. “You could say that we act as if the world is ending, while they act as if nothing is going on.”

UK and Denmark

The United Kingdom, ranked at the 14^th position, is not performing much better than the US. The UK has also made a move from collective to individual, says Bauer. About five years ago, pensioners there were given the freedom to withdraw their pension after the age of 55 in one go, instead of having it paid every month for the rest of their lives. Bauer is horrified by this ‘Lamborghini pension’. “We have arranged that a lot better with our mandatory annuity. It is the smartest choice economically speaking.”

In terms of the system, the English scheme is closest to the one in the Netherlands, according to Steenbeek. People save money through their employer and the employer also contributes. “However, a large part of the population is not covered by a pension scheme.” Where 90 percent of the employed people in the Netherlands is affiliated to a pension fund, that percentage in the UK, but also in countries such as the US and Canada, is only about 40 percent. Another fact is that the English only put 8 percent of their income aside (the employer pays half), while that’s approximately 20 percent in the Netherlands.

Denmark has a high score internationally speaking, with a second position on the ranking. They mainly owe that position, according to Steenbeek, to the fact that they have a state pension in place, the same as our AOW, a well-organized and financed collective basic pension for every resident. Besides that, most of them have a supplementary pension, linked to income and assets.”

Reforms

There are many countries that could use a thorough reform of the pension system, but it’s political suicide to bring that up, says Steenbeek. “That’s happening in France, for instance. They are doing really well over there at the moment in terms of adequacy. The pension is generous, but not durable. This system is based almost entirely on turnaround and due to the increasing ageing, less and less employed people are paying for more and more pensioners. But as soon as you start fiddling with the system and suggest that people have to retire later because it is no longer affordable, people are hitting the streets and the entire country comes to a standstill. Implementing such reform is actually only successful in times of a crisis.”

Bauer is ‘cautiously positive’ about our new pension agreement. He doesn’t expect it to jeopardize our number 1 position, but he has still to see how it will look like in practice. “The generation discussion has not ended yet with the new agreement. And will we now all of a sudden abide by all the rules we came up with to reduce the pensions if needed? If everyone – including politics – sticks to the agreements made, it is a progression.

Steenbeek also doesn’t anticipate that the new system causes us to lose points. “The problems we see in the Netherlands, are also observed in other countries. Ageing is a problem almost everywhere, as is the low interest rate. The pension paid to the current pensioners, is probably less feasible for future generations. It is no longer as evident as it used to be, but we will continue to score well on durability. The adequacy may lapse a little, but we are in quite a generous position compared to many other countries. And we will score better on clarity because the new system is much more transparent.”

The fact that we score so well right now, doesn’t mean we can rest on our laurels, Steenbeek emphasizes. “The system, in the way we came up with it, is actually not resistant to the world of today, with low interest rates, lower expected returns, an increasing amount of people who are not accruing any pension at all, and a business community unwilling or unable to pay very high premiums. We are unable to live up to the generous promises we made. We have saved an enormous amount of money, but something has to happen in order for us to continue our ranking in first position.”

How are other European countries doing?

We’ve already mentioned Denmark, France and the United Kingdom. But how is pension arranged in other European countries? The website consultancy.nl clearly maps this out.

• Germany - # 11 on the Global Pension Index

They also have three pillars beyond our eastern border. Although the first pillar - compulsory for all workers - makes up about 80 percent of all pensions in the country. Germany has been working with a points system since 2002. Every worked year earns points, which are eventually converted into pension. The more points you earn, the higher the payout. Legal retirement age? 67 years.

• Belgium - # 16 on the Global Pension Index

Just like us, our Belgian neighbors have three pension pillars: a "retirement pension" for everyone who works, an "extra-legal" pension that you collectively build up with your employer and a private savings plan. At the time of publication of the article on consultancy.nl (2017), that retirement pension amounted to an average of about 60 percent of the average earned wages and is based on pay-as-you-go: contribution payers therefore directly finance the pension benefits of pensioners. The legal retirement age is now 65 years, but will rise to 67 by 2030.

• Spain - # 22 on the Global Pension Index

Main pension scheme in Spain is a compulsory government pension. It is striking that low and middle incomes receive a fairly high percentage of their earned wages as pension: no less than 90 percent in 2017. Here, too, the pay-as-you-go principle applies: workers use their contributions to finance the pension of the elderly. Legal retirement age in Spain is 65 years, but will rise to 67 by 2031.