Exploration of the Grey Area within DC Schemes

A significant portion of participants has a DC scheme with limited premium contributions. Read more

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Contents

Key Points 3 01 Introduction 5 1.1 Background of the exploration 5 1.2 Design of exploration & data 5 1.3 Scope of the exploration 6 02 Results of analysis 8 2.1 Approximately 7 out of 10 DC participants have an available premium percentage of 10% or less 8 2.2 Average DC participant has an available premium percentage of only 36% of the fiscal maximum 9 2.3 A quarter of all DC participants has an increased franchise 14 2.4 Relative utilization of DB participants is generally better than that of DC participants 15 03 Call to the sector 18 3.1 Attention for the white spot is good, also keep the grey spot in view 18 3.2 Ensure realistic expectations 20 Appendix 1 Maximum premium scale 21

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Key Points 3

This leads to low replacement ratios for participants. The vast majority of the more than 1 million active DC participants, approximately 80% of them, have a gross annual salary of €25,000 or more. They will likely not have enough with just their AOW (state pension) payment to cover the costs of their old age.

Almost 7 out of 10 DC participants have an available premium percentage of 10% or less

Approximately 65% of all current DC participants, more than 650,000 participants, have an available premium percentage of only 10% of the pension base or less. Of this group, approximately 200,000 participants are younger than 30 years old. For them, pension accrual at an equal premium percentage is higher than for older participants, as the premium earns interest over a longer period. However, for this group as well, pension accrual at an available premium percentage of below 10% will be relatively limited. For comparison: in the new pension system, a maximum premium percentage of approximately 30% is introduced.

• Total
• Younger than 30 years

40% 0 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000 Number of participants Available premium percentage of the pension base

45% 51% 57% 61% 58% 65%

< 5% 5%-10% 10%-15% 15%-20% 20%-25% 25%-30% 30%-35% > 35%

Key Points

The Dutch pension system stands on the brink of a large-scale reform. All pension participants in the Netherlands will build up second-pillar pension via a premium scheme (DC), including participants who currently have a defined benefit (DB) agreement. This simply means that for participants, the pension premium will soon be central within the scheme. One of the key points around this new system is reducing the 'white spot', i.e., workers who do not build up pension. The AFM welcomes this, but emphasizes that participants with limited pensions (the so-called 'grey spot') should not be overlooked in this process. The risk of limited pensions is that participants incorrectly assume they are building up a pension with which they can provide for their livelihood after retirement. This also brings risks of disappointment for participants.

Based on data that it receives annually from pension administrators, the AFM has conducted an exploration into the pension accrual of all active participants with a basic scheme within the current DC and DB schemes. For this exploration, the AFM mapped out, among other things, how much premium is contributed for each DC participant. This was then related to the fiscal space available for premium contributions. The exploration shows that there are significant differences between the pension accrual of current participants in DC schemes and DB schemes. The AFM shares some main conclusions from the exploration below and calls on the sector to take note of these analyses and engage in dialogue with each other about the responsibilities of all parties in the pension sector regarding cost-efficient, useful, safe, and understandable pension schemes.

The pension accrual of current DC participants is relatively low

The exploration shows that for the majority of the more than 1 million active DC participants, a relatively small part of the fiscal space for premium contributions is utilized. Without further individual supplementation, for example in the third pillar, this leads to low replacement ratios for participants. The vast majority of the more than 1 million active DC participants, approximately 80% of them, have a gross annual salary of €25,000 or more. They will likely not have enough with just their AOW (state pension) payment to cover the costs of their old age.

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Key Points 4

It is up to the pension sector to think about ways to reduce this risk for participants. The AFM does not advocate for a minimum required premium contribution in this exploration. There can be multiple ways to protect participants against unrealistic expectations on pension date. This can be done, for example, by informing participants well and ensuring they have realistic expectations about their pension. However, pension information cannot eliminate all risks. Pension providers also have a responsibility towards the participant. For insurers and premium pension institutions, there is a duty to go through the product development process, which also takes into account the interests of the participant. For pension funds, there is a requirement to quantitatively map out the consequences of a certain premium contribution for participants when accepting the assignment.

The AFM calls on the sector to take note of the findings of this exploration and take this into account when communicating about and developing their pension schemes.

In addition to a low premium percentage, accrual is also limited by an increased franchise

For premium accrual, the height of the franchise also matters. The exploration shows that of the 375,000 DC participants who contribute at most a quarter of the maximum premium, 25% have an increased franchise. An increased franchise is not favorable for pension accrual, as a higher franchise leads to a lower pension base and thus a lower premium contribution.

Call: Think about responsibility towards participants

The height of the second-pillar pension is part of the employment conditions and agreements between employers and employees. Nevertheless, the AFM believes this topic deserves the attention of all parties involved in participants' pensions. The AFM calls on the pension sector, including social partners and advisors, to engage in dialogue with each other about the analyses from this exploration and to examine ways to prevent unrealistic expectations among participants regarding their pension.

The AFM sees that there can be reasons to offer pension schemes with limited premium contributions, and understands that this may lead to higher disposable income during the working life of participants. However, the AFM questions how cost-efficient pension is when premium contributions are only a few percent. The AFM emphasizes that pension awareness among participants is low and that pension information is complex for the average participant. This creates the risk that participants in pension schemes with limited pension accrual may be disappointed, as they assume that 'it is taken care of for me'. The chance of this risk is high. Consumer research conducted by the AFM in 2023 shows, among other things, that one-third of respondents cannot estimate their net income after retirement. And of the respondents who can make an estimate, almost half base this (partly) on 'feeling'.

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01 Introduction 5

of the height of the contribution. The pension agreement, which social partners have agreed upon, describes how the available annual premium must be calculated. For each DC participant, the characteristics of available premium percentage and age are known.

Based on these two characteristics, all participants were categorized into the corresponding age cohort and then plotted against the fiscally maximum premium scale. This makes it possible to determine a relative utilization rate per participant. See paragraph 2.2 for an explanation. The relative utilization rate is a ratio that shows to what extent the participant uses the current fiscal space that the legislator establishes in the form of a maximum premium scale. In this exploration, the statutory scale from article 38R of the Wage Tax Act (new) is used as the maximum for all participants. Whether the available premium percentage of the participant is derived from a premium scale or a fixed percentage does not influence the relative utilization rate. This scale (based on a 1.5% interest rate) is used as the maximum in this exploration, despite the fact that it applies after the introduction of the Future Pensions Act (Wtp). This is because under the current fiscal regime, a comparable premium scale can be used under certain conditions, see Appendix 1. This ensures a level playing field for every participant, regardless of the scheme or age, making the relative utilization rate comparable. The methodology is also endorsed in the discussions the AFM held with external parties in the context of this exploration.

DC analysis based on annual data provided by pension administrators

For the analysis regarding DC, the AFM Supervision Report Second Pillar Pension for the reporting year 2021 was used. All Dutch pension funds, pension insurers, and premium pension institutions provide data annually. This data includes information on, among other things, the type of pension, the

01 Introduction

1.1 Background of the exploration

The background of this exploration into the pension accrual of current DC schemes is twofold. First, the pension scheme largely determines the height of the accrual. A low premium contribution often also leads to a lower pension income for the pension participant. One of the goals of the Pension Agreement of June 2019 is to reduce the so-called 'white spot'. The white spot consists of workers who do not build up pension, for example because the employer does not offer a pension scheme. During the plenary debate on the Future Pensions Act (Wtp), various parties expressed not only their concerns about the white spot but also about the so-called 'grey spot': workers who build up a (very) small pension. The AFM sees the risk that participants with low pension accrual think that the supplementary pension via their employer is well arranged, while the accrual may be limited. Second, in the new pension system, pension accrual for approximately 6 million workers will shift from a defined benefit (DB) agreement to a defined contribution (DC) agreement. This means that many pension schemes will be adapted. This is the moment to review the scheme and examine whether it offers sufficient added value and does not lead to unrealistic expectations about the pension.

1.2 Design of exploration & data

In this exploration, the AFM looked at pension accrual in the second pillar. In DC schemes, each participant builds up their own pension capital, which is used to finance the payout from the pension date. The higher the capital, the higher the pension payout. The height of the pension capital built up by a DC participant is largely dependent

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01 Introduction 6

both DB and DC schemes were investigated. Under DB schemes, pension schemes with a Collective Defined Contribution (CDC) character are also understood. Under DC schemes, capital agreements are explicitly not included; these amount to only 12,000 active participants, which is approximately 1% of all active DC participants.

Within the pension scheme, the premium contribution was investigated

The final DC pension payout is influenced by various components such as premium contribution, return, and participant choices. The height of the annual premium, together with the net return, determines the final height of the pension. The AFM focuses in the exploration primarily on the pension scheme (see red frame in Figure 1), because this prescribes the height of the annual premium and largely determines the final pension payout. That is to say, the AFM investigated the pension accrual of DC participants by looking at the quality of the pension scheme.

Figure 1: Overview of the components that determine the pension payout

Height of annual premium Participant data

• Age
• Income
• Part-time percentage Pension scheme
• Premium / Accrual percentage
• Scale / Fixed
• Franchise Height of pension Pension capital Pension payout

• =

Net return Investments, costs & choices Focus on old-age pension and built-up partner pension (after pension date)

Where this exploration speaks of the quality of the pension scheme, the AFM focuses in this analysis on the old-age pension and built-up partner pension (after pension date). For DC pension, the AFM assumes the available premium percentage and the franchise. For DB pension, the AFM looked at the accrual percentage and the franchise. The AFM did this because these are the most important characteristics of the scheme that determine the height of the final pension payout.

number of participants and scheme data such as the available premium percentage and the franchise. This information is published annually in the AFM Sector View Pension.

In 2021, 67 institutions reported more than five million DC participants. Almost 70% of these participants are no longer actively building up pension. For these participants, an annual premium of €0 was reported. The AFM excludes this group of ceased participants, as there is no longer any premium contribution. In this exploration, the AFM only looks at DC participants with a reported annual premium greater than €0; these participants are considered active. Additionally, the AFM only looks at participants who have only one registration, where this registration is a basic scheme. Participants with excess, net, or voluntary supplementary schemes are not included. In this exploration, the AFM then only investigated active participants for whom an available premium percentage was reported that was greater than 0%. In the scope of this exploration, more than one million participants remain, spread across 24 institutions; 8 pension funds, 7 PPIs, and 9 insurers.

For the DB analysis, data provided annually by pension administrators to DNB was used

For the analysis regarding defined benefit agreements, the so-called K602 FTK statement (characteristics of pension schemes) was used, which is provided annually to DNB by pension funds. This statement contains data on, among other things, the number of participants, the accrual percentage, and the franchise per pension scheme. Here, similar to the analyses on premium schemes, the 2021 year was used, and active participants in the basic scheme were included in the population. This population consists of almost 5.4 million participants, distributed over 159 different pension funds.

1.3 Scope of the exploration

In this exploration, the AFM looked at participants who build up pension in the second pillar via their employer. Accrual via the third pillar falls outside the scope of this exploration. Within the second pillar, the AFM investigated the utilization in

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01 Introduction 7

To maintain the focus on the height of pension accrual, elements such as risk coverage, own employee contributions, return, and costs were not included in the analysis. Elements such as return and participant choices require assumptions and bring uncertainty into the model, showing only possible scenarios. To provide as objective a representation as possible of the current DC schemes in the sector, only elements recorded in the pension scheme were used. Additionally, the AFM has no insight into the extent to which participants provide for income after retirement in other ways.

In this analysis, participant-bound data, such as the pensionable salary and part-time percentage, was looked at to a limited extent, as these also serve as input for the pension scheme. Participant data does determine the height of the built-up pension, but is separate from the quality of the pension scheme.

The final DC pension accrual depends, next to the premium contribution, on the net return achieved on the built-up value. This return depends on product data and choices such as the chosen investment profile, but also the costs incurred by the pension administrator. The height of the annual premium and the net return lead to a pension result. But ultimately, the premium contribution (and thus the pension scheme) is the most determining factor for the accrual of the DC pension.

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02 Results of analysis 8

accrual percentage lie in the fact that these groups are lower in the scale. For younger participants, the premium contribution (until pension date) earns interest longer.

Besides this group, it is notable that the largest part of the participants has an available premium percentage between 5% and 10%. Of these, more than 250,000 participants are older than 30 years. For comparison: in the new pension system, a fixed premium percentage of approximately maximum 30% is introduced. Just for illustration, a simplified example: a participant of 35 years old who has a fixed available premium percentage of 4% and a gross annual salary of €31,000 will, upon continuation of this accrual, have a monthly payout of an average €100 gross on top of their AOW payment upon retirement. In paragraph 2.2, the AFM goes further into replacement ratios.

Figure 2: Distribution of premium percentages for the DC population

• Total
• Younger than 30 years

40% 0 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000 Number of participants Available premium percentage of the pension base

45% 51% 57% 61% 58% 65%

< 5% 5%-10% 10%-15% 15%-20% 20%-25% 25%-30% 30%-35% > 35%

02 Results of analysis

This chapter describes the most important results of the exploration into premium contributions and pension accrual in premium and defined benefit agreements. It has appeared that more than a third of participants within current premium agreements have low utilization of the fiscal space for their pension accrual. As an indicator for low utilization, the AFM chooses when there is at most 25% utilization of the total fiscal space. The fiscal space is designed with the starting point that the pension to be built up is comparable to the pension accrual in a DB scheme with fiscally maximum accrual (at a pension target age of 68, this is 1.875% of the pension base per year of service).

The DC participants who utilize at most 25% of the fiscal space also most often have an increased franchise in the scheme. This can lead to limited accrual and consequently a possible risk of disappointment upon retirement. Existing defined benefit agreements (DB) show a different picture. For DB participants, the fiscal space is utilized better; for them, almost 95% of participants have a relative utilization of at least 75%.

2.1 Approximately 7 out of 10 DC participants have an available premium percentage of 10% or less

First, the distribution of premium percentages over the more than 1 million DC participants in the population was looked at. In Figure 2, it can be seen that approximately 65% of all DC participants, more than 650,000, have an available premium percentage of only 10% or less.

Within this group, approximately one-third of the participants (200,000 participants) are younger than 30 years old. For this group of participants, the cause of a low

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9

Because the market interest rate has shown a declining trend, the legislator allows a premium scale based on an interest rate of 1.5%. However, a fiscally maximum premium scale based on a 1.5% interest rate has not yet been published by the legislator, meaning each pension administrator sets this themselves. Because the legislator publishes a premium scale of 1.5% interest rate during the system revision (article 38r of the Wage Tax Act), the AFM uses this in this exploration.

One third of DC participants build up no more than a quarter of the maximum allowed pension

The AFM mapped out for all more than 1 million selected participants what the age of the participant is and the height of the available premium percentage. The participants were then divided into age cohorts of 5 years and ranked according to the available premium percentage.

Subsequently, the AFM determined for each participant what the so-called 'relative utilization rate' is. At a utilization rate of 100%, the pension accrual is (fiscally) maximum. The relative utilization rate is determined by setting the height of the available premium percentage (of each participant) against the maximum allowed available premium percentage. As explained above, this maximum depends on the age and the interest rate. In a formula, this looks as follows:

Relative utilization rate (per participant) = available premium percentage maximum allowed premium percentage (dependent on age) 100%*

An example for illustration: For a participant of 26 years with an available premium percentage of 5%, the maximum allowed available premium percentage based on the maximum scale amounts to 21% of the pension base. The relative utilization rate of this participant comes out to: [5% / 21%] x 100% = 24%. Whether there is an age-dependent premium scale or a fixed percentage does not influence the relative utilization rate of a participant. For this participant, in the year 2021, their premium contribution amounts to 24% of the allowed maximum premium contribution. This means that the premium contribution for this participant is limited compared to what may be contributed fiscally. The higher the relative utilization rate, the better the pension accrual is.

DC participants with a fixed percentage have an average available premium percentage of 6.7%

The available premium percentage of DC participants can be designed in a pension scheme as a premium scale or as a fixed premium percentage of the pension base. With a premium scale, the available premium percentage increases with the age of the participant. This aims for a constant annual pension accrual. With a fixed premium percentage, the available premium percentage is equal for all participants. The premium contribution is then age-independent. The premium contribution leads to a higher pension for a younger participant than for an older participant. In this case, one speaks of a degressive pension accrual. In the new system, the degressive pension accrual is the starting point.

In Figure 2, participants with both a premium scale and a fixed percentage of the base are included. Of the more than 1 million DC participants, approximately 70% have a pension premium based on a premium scale and 30% based on a fixed percentage of the base. When looking at the approximately 300,000 participants with a va

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