Holland’s hybrid: defined ambition

Jan Tamerus, actuary director at PGGM, was instrumental in developing the new Dutch pension defined-ambition structure.

Back in 2006, he was involved in looking at the sustainability of the defined benefit system and in concluding it was not in fact sustainable, the idea of defined ambition evolved.

One of the key reasons for not going to a defined contribution structure is the Dutch social predisposition and, in particular, the focus on intergenerational risk sharing.

“There are two areas we don’t like about defined contribution: the risk sharing, especially the intergenerational risk, and no index targets in the system,” he says, describing defined ambition as conditional defined benefit.

“Our next area of study will be to look at ownership rights, the individual defined contribution way is more attractive to people, but we will see whether we can synthesise from defined ambition to defined contribution, and the only way to succeed in that is to have some solidarity elements in defined contribution.”

Intergenerational risk sharing defined

Tamerus concedes that defined contribution could be a more sustainable system because “you can go with the flow for more individual choices”, but he would like to see defined contribution changed in a way that will have more guidance rules about risk sharing and intergenerational risk in particular. It’s his new area of study.

“In The Netherlands we like intergenerational risk sharing, it’s very important. When we decided defined benefit was no longer sustainable, we looked at going to defined contribution, but there is no intergenerational risk sharing and no target, especially an indexed target, in the contract,” he says. “Those are the two elements why we didn’t want to go to defined contribution, so made defined ambition.

“The defined ambition structure is the same as defined benefit, but we have conditional indexed rights instead of unconditional nominal rights in combination with a policy of indexation. The focus is an indexed pension outcome instead of nominal guarantee.

“By skipping the nominal guarantee, we bring in premium stability and make the contracts shockproof – both elements of defined contribution.

“On the other hand we maintain the intergenerational risk sharing and the income-related target – both elements of defined benefit. Moreover, we make it an indexed target.

“I am very proud of the work but anxious to see it evolve. There is a struggle because some people have commented that we move the risks from the employer to the participants and at the same time take more risks, but that is not the way we will do it,” he says. “In defined ambition, the focus in the investment policy is on stable pension income in real terms,” he says. “Due to the dual focus in the current defined benefit schemes – nominal guarantee as well as an indexation policy – this will not lead to major changes. It is more the liability hedge that should be reconsiderd. Because of skipping the nominal guarantee, the nominal interest rate is less important.”

Managing the transition
The new pension legislation will be implemented in 2015 in The Netherlands, but the Pension Act needs to be ready this year. The first version of that will come out in the summer and put on the internet for consultation.

The details of the structure are such that the defined ambition target is calculated as the risk-free rate plus a risk add, which tries to measure the uncertainty associated with defined ambition compared to defined benefit, minus the indexation target.

The risk-free rate includes the ultimate forward rate, which is an estimate of what the short-term interest rate will be in, for example, 60 years from now. It is currently set at 4.2 per cent.

The indexation target means the benefits in a defined ambition structure will be indexed each year.

This factors in wage growth, so the promise is in real terms rather than nominal terms.

Dirk Broeders, senior strategy adviser at the Netherlands Bank (pictured below), which supervises pensions, says there are two things that are differentiate about defined ambition from defined benefit: it is indexed each year, and it is adjusted up and down based on realised investment returns.Broeders,Dirk-150x150

The retirement benefit in the defined ambition system is still linked to the performance of pension investments; it comes out as an income stream annually adjusted to the performance of the investments.

Broeders, who is leading the project on defined ambition advice to government and the project on the communication to the public, says in the future funds can use the nominal contract (defined benefit) or choose the real contract (defined ambition).

“Maintaining a defined benefit system is unsustainable in the future. In an ageing society where people live longer, it is too difficult to promise certain benefit,” he says.

“This is a huge transition, a huge commitment and will put pressure on administration systems to keep track of each individual. It is very complicated and costly but maybe that is the price you have to pay to update your system for the future.”