Brans Brief number 3, year 9, March 2006

In this issue of the Brans Brief:
 

	SER report “Removing obstacles to working beyond the age of 65”
	Request for comment – Multiemployer pension plans: Moody’s analytical approach
	Pensions Act

SER report “Removing obstacles to working beyond the age of 65”

It should be possible for an employee to remain in work after he/she becomes eligible for a state pension, if this is what the employee and the employer both want. On balance, the Social and Economic Council (SER) is against making the age of eligibility for a state pension more flexible, as it explains in an opinion dated 17 March 2006. This is a response to a request for an opinion by State Secretary Van Hoof of the Ministry of Social Affairs and Employment on the removal of obstacles to working beyond the age of 65. The SER takes the view that there are no obstacles, although issues such as the continued payment of wages in the event of illness do require attention. The gross-net gap is in fact more favourable for people aged 65 and over than for those aged under 65, and as such already acts as an incentive to carry on working. The draft opinion argues that the option of dismissal when an employee turns 65 should be maintained. The Equal Treatment in Employment (Age Discrimination) Act, or WGBL, allows scope for this.

The draft opinion also contains a response to a request by the Lower House of the Dutch Parliament regarding a study into the advantages and disadvantages of greater flexibility as regards the age of eligibility for a state pension and as regards supplementary pension in general. Rather than deeming it necessary to make the state pension age more flexible, the SER actually advises against such a move. If the age of eligibility for a state pension were to be lowered, the benefit level would have to be reduced by actuarial means so that its value does not change. The SER believes that this would result in an undesirable and substantial increase in the administrative burden related to state pension, with all the accompanying expense. Moreover, the SER fears there would be greater demand for income support from people no longer able to manage on the reduced state pension. Nor does the SER feel there is a need to defer the state pension because people entitled to a pension can suspend drawing their pension if they wish, and therefore in fact achieve the same result as in the case of a deferment of the state pension. The SER does not discuss the usually undesirable concurrence of state pension and wages in this context. Such a concurrence may negate part of the reduced tax burden for people aged 65 and over. However, for the moment the number of cases involved is so small, relatively speaking, that to revise the state pension would be an overreaction. Interestingly, this currently affects 2.3% of people aged 65 and over. Of the 45,000 people aged 65 and over who are still in work, 30,000 are self-employed. Clearly, an employment relationship beyond the age of 65 is rare and, presumably, fraught with difficulties. The rules on termination of a contract require special attention. If, in principle, a permanent contract – which is not explicitly terminated – is followed by a fixed-term contract, the termination rules are the same as if it were a permanent contract. And if an employee has been subject to a fixed-term contract three times in succession, for a period of at least three years, a permanent contract applies by law. The SER does recommend that the deferment of pension beyond the age of 65 should also be an option in supplementary pension schemes. Also, people aged 65 and over should be allowed to continue building up pension rights. In our opinion, the SER is thereby placing the ball squarely in the court of the two sides of industry (management and labour), requiring them to be highly flexible in the face of an otherwise rigid state pension. Consequently, if a pension is taken earlier, the relatively small supplementary pension must bridge the state pension, which will quickly exhaust the supplementary pension pot. It is precisely partial retirement that could be encouraged if the state pension were more flexible. If a person carries on working, the reverse is true (accumulation) - and again there are few if any solutions to this that take account of tax benefits. In fact, the SER recommends making it possible to defer a pension until beyond the age of 65 in order to avoid, if desired, the concurrence of income and pension, yet is firm in its stance that the state pension should still take effect at age 65. However, one solution – if deferment is desired – may be to have the state pension credited to a blocked individual bank account, with tax not being deducted until the person concerned withdraws this money. The introduction of greater flexibility – as we wrote in the Financieel Dagblad of 15 March 2006 - would free up the first part of the state pension for use in connection with life-course plans, for example. At the moment, however, a more flexible state pension would appear to be a bridge too far for the Netherlands.

The SER recommends that policy should be geared primarily towards removing obstacles to working up to the age of 65, the point being that, nowadays, people are actually stopping work before the age of 65, when they can take early retirement or a “pre-pension”. This, then, is the first policy challenge. An age-aware human resources policy plays an important role in this regard. In our opinion, it is likely that the prohibition of age discrimination will bring about growth in the number of employees who – despite reaching pensionable age before 65 – wish to continue working. This can be enforced in most cases under the aforementioned WGBL. Dismissal on the grounds of age before an employee reaches the age of 65 requires an objective justification. To what extent this is feasible varies greatly from one company and one case to the next. The opinion argues that the current obligation to continue paying a wage for two years if an employee is ill is neither desirable or necessary for people aged 65 and over. The appropriateness of a compulsory one-year period for the continued payment of a wage in the event of illness must be investigated, bearing in mind the possibility of the person concerned returning to work. According to the SER, the fact that people aged 65 and over are excluded from employed persons’ insurance schemes is not an obstacle, precisely because that is the age at which the state pension takes effect.

For more information contact: Edwin de Jong.

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Request for comment – Multiemployer pension plans: Moody’s analytical approach

At the start of this year, rating agency Moody’s published a proposal for assessing the impact of the underfunding of multiemployer pension funds on the creditworthiness of member companies (Request for comment – Multiemployer pension plans: Moody’s analytical approach, Moody’s, January 2006). Although the proposal relates only to America, the system envisaged by Moody’s could have a bearing on the debate about how companies should incorporate such shortfalls in their annual figures. After all, International Accounting Standard 19 (IAS 19) requires pension commitments in a multiemployer pension fund to be treated, in principle, in the same way as pension commitments in a single-employer pension fund. How that should work in practice is, unfortunately, unclear. The funding shortfalls in question are always based on the criteria for minimum funding, not those of IAS 19 or the American equivalent FAS 87. Consequently, the projected unit credit method is not involved.

Moody’s is considering allocating funding shortfalls in multiemployer pension funds to companies in proportion to their contribution volume. Let us assume, for example, that a particular industry has a funding shortfall of five times the annual contribution volume. A member company making an annual contribution of $20 million would be faced with an estimated shortfall of 5 x $20 million, i.e. $100 million. Moody’s suggests that 25% of this sum on average be passed on to employees, leaving a shortfall of $75 million. This sum is then adjusted using all kinds of information specific to the company. Naturally, the greater the shortfall, the lower the creditworthiness. The American Academy of Actuaries has already responded by pointing out a number of shortcomings (Comments on proposed rating methodology for companies participating in multiemployer defined benefit plans, American Academy of Actuaries, March 2006). The method proposed by Moody’s assumes – or at least so it seems – that the current contribution level does not include a provision for recovery. This would be a fundamental problem because there is a considerable difference between the situation created if the contribution rates for the fund in question have already been increased in order to eliminate a funding shortfall within a specified period and the situation that arises if there is no such increase. Furthermore, the length of any period of recovery would have to be taken into account in some form or another. The American actuaries feel it is arbitrary to assume that the employees’ share of the underfunding is 25%, and they also raise a number of practical objections.

How relevant is Moody’s proposal to companies in the Netherlands that are members of a multiemployer pension fund? There is no doubt that the proposal was made in response to the huge underfunding that afflicts many American pension funds. The average underfunding of the funds analysed by Moody’s is 23% of the pension commitments. It is difficult to defend the amounts involved being dismissed as immaterial and no attempt whatsoever being made to estimate them. This issue is far less relevant in the Netherlands, where underfunding is very rare and there are means of ensuring that pension contributions are at the self-financing level.

As regards a company’s annual accounts, Watson Wyatt Brans & Co. regards the apportionment of shortfalls or surpluses in multiemployer pension funds to the member companies as problematic, if only because of the lack of an apportionment formula that is underpinned by theory, practically relevant and widely accepted. Unless there is evidence to suggest otherwise, a detailed form of “DB accounting” is not advisable. For that reason, we believe that it should still be sufficient for companies that are members of a multiemployer pension fund to include only a relatively simple explanatory note in their annual accounts, perhaps with a reference to the annual figures and other general information from the fund. Moody’s proposal is not about “DB accounting” but about the impact of underfunding on creditworthiness. As far as that is concerned, we concur with the comments made by the American Academy of Actuaries.

For more information contact: Roland van Gaalen.

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Pensions Act

Over the coming period we will be devoting a great deal of attention to the proposed new Pensions Act. We will be using our website at www.pensioenwetactueel.nl and our newsletter “Pensioenwet Actueel” to inform you about this new legislation and keep you up to date with developments.

For more information contact: .

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