Fixed versus variable pension income.

The pros and cons of setting a default

A key principle in the development of the new pension system is that pension incomes should move more in line with returns. This desire is mainly instilled by the fact that pension funds have seen little to no indexation in recent years and a number of pension funds are threatening to lower pension incomes. The current Regulatory Framework allows an increase in pension incomes only if sufficient buffers are in place. Buffers that are mainly intended to absorb disappointing returns.

By: Berry van Sonsbeek, Product Market Manager at Zwitserleven

Fortunately, this is different for pension income paid by an insurer. Participants have either a guaranteed pension income – sometimes even with a guaranteed annual increase – or a pension income that goes up or down every year. The former is referred to as fixed pension income and the latter as variable pension income.

Under the new system, pension income from pension funds will be variable by default. How much this pension income will fluctuate every year varies from one pension fund to the next.
Pension income paid by insurers can be either fixed or variable, or a combination of the two. Pension income paid by a defined contribution pension institution (premiepensioeninstelling, 'PPI') is variable by default. How much pension income will fluctuate is different for each individual.

Default by choice
How will insurers and PPIs operate now under the new system?

The employer and its adviser together define a risk attitude for the entire group of scheme participants. The representatives of employer and employees subsequently decide in mutual consultation whether a fixed or a variable pension income most closely matches the group's risk attitude. On this basis, a default lifecycle model is set up matching the anticipated choice of a fixed or a variable pension income. Of course, the pension scheme's design may allow for deviations from this 'default' at participant level.

Deviations at participant level
We then look into the risk attitude and risk appetite of the relevant participant(s) at participant level. With the participant's cooperation, we then use this data to draw up an investor profile and offer a lifecycle that most closely matches this profile. When in doubt, a participant can check with an adviser what is really the most appropriate solution. As a pension provider, we do not have all the relevant data that influences people's choices. If a participant does not set an investor profile, the participant will automatically move to the default solution defined by the adviser together with employer and employee representatives at the employer level. This solution is not always the best choice for individual participants.

No default set by employer and employee representatives
What if the adviser and the representatives do not decide whether a fixed or a variable pension income should be anticipated by default?

In that case, I would argue in favour of a default assumption to the effect that a participant will invest in the accrual period to obtain a variable pension income in the benefit period. Any other default would conflict with the principle of the new pension system that pension income should move in line with returns. It is also consistent with current developments at the pension funds.

Role of the adviser
To avoid setting a wrong default to start from, I would argue in favour of the adviser taking the lead together with the employer, always staying in close contact with each other to discuss this issue. In fact, good advice can only be finalised if there is clarity on this point as well.

This is essentially a risk attitude and appetite investigation performed at the start of the scheme. It is smart to jointly check and evaluate it regularly. You can then make adjustments where necessary. Communication to participants must be honest and clear. It is important that they recognise themselves in the group level profile and are aware of the individual choices available to them. It immediately creates opportunities to optimally guide participants in making choices in the new system.