S E E I N G T H I N G S D I F F E R E N T LY

NEW PLAYERS SHAKING UP THE MARKET!2011 a decisive year for the development of the Dutch pension market

In 2009, we at Atos Consulting conducted a scenario analysis of the pension landscape in 2020. Plotted along two axes (figure 1), the findings showed four possible futures. We also described how the Dutch pension market can prepare itself for the arrival of the futures outlined. We have given early warning indicators for each scenario, which will alert us at an early stage that the scenario is materializing. Various facets of the current retirement benefits system are discussed under each scenario.

The four scenarios The four scenarios are plotted along two axes: individualization versus collectivization and government intervention versus the free market.

Figure 1: The Pension Market in 2020 (Atos Consulting 2009, www.scenario-planning.nl)

Government Intervention Free Market

IndividualizationCollectivization

The government wants to put more of the financial risk for providing for retirement on the individual. At the same time, the government does want to ensure that, in addition to the

national old age pension (AOW), employees also accrue a pension via their employer. The financially illiterate should be provided

with a certain degree of protection in this.

1. Mandatory pension commitments

The pension scheme is completely tailored to the individual wants and needs of the participant both in the accrual phase and in the disbursement phase. There is optimal freedom of

choice. The government does not impose regulations any more, but at the same time it no longer offers basic plans any more

either. Pensions are the individual’s responsibility.

2. Optimal individual freedom of choice

Studies have shown that the average Dutch person is “financially illiterate”. The government wants to protect these

people and guarantee that they actually receive adequate pensions to enjoy their retirement.

3. Government pension

More freedom of choice arises for employers within the framework of the current collective pension system.

Retirement plans on the whole become more expensive.

4. Modernized second pillar

DevelopmentsOver one year later, and with these scenarios in the backs of our minds, we will now have a look at a number of key developments in the Dutch pension market. Pension providers have come through some tough times, and they are not out of the woods yet, as some daunting challenges lie ahead. We will discuss each of these challenges and finally offer a conclusion as to what all of this means for the outlined scenarios.

A great deal of uncertainty still reigns in the pension market. This uncertainty stems from two factors:1. Uncertainty over economic and sociodemographic

trends.2. The direction of the Dutch government’s policy.At this time, there are some ongoing policy developments. This makes it a good time to have a look at what the current trends are and what they mean for the future of our pension landscape.

Pension Certainty and SolidarityIn 2010, employer and employee organizations in the Labor Foundation (Stichting van de Arbeid) closed a framework agreement on a flexible pension and the national old age pension (AOW). This agreement regulates discussions on the national and private retirement age by pegging both of them to the life expectancy.The discussion partners have also decided that as of 2012, the pension agreements and corresponding legislation must be amended to account for financial developments.

Negotiations on this agreement are still in progress. The main point of discussion is the nominal guarantee of pension entitlements. The agreement makes reference to a maximum premium for employers. This would place the risks of pension shortfalls on employees. This radical measure could make granted entitlements conditional, potentially with retroactive force.

In addition to this, we can clearly see that the discussions surrounding the pension agreement hinge in part on the issue of solidarity. There are two distinct considerations for this issue: on the one hand we have age solidarity among generations and on the other hand education and income solidarity.

These issues will be resolved to some degree in the new pension agreement, but in order to completely eliminate the disparity, more drastic measures are needed. It is inevitable here that the current forms of solidarity will disappear and make way for a much more individual form of retirement saving, which only uses collectivization to hedge major risks. With this, the trend is shifting increasingly towards individualization.

NEW PLAYERS SHAKING UP THE MARKET!

Company pensions and savings funds (OPF)

Industrial pension funds (BPF)

Occupational pension funds

Figure 2: Trend in number of OPFs, BPFs and Occupational Pension Funds – 1997-2011

1200

1000

800

600

400

200

01997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q1

Should the negotiations break down, the government is expected to take independent measures to raise the national retirement age in any case and perhaps to intervene in the weakened pension funds.

The discussion on the pension agreement and solidarity has made one thing clear: it is no longer taboo to discuss sweeping changes to the pension system.

Looking at the scenarios we can conclude that, as a result of this discussion, the trends are shifting more towards market-thinking (stimulated by the government) and increasing individualization (scenarios 1 & 2).

Number of Company Pension Funds (OPFs) DecreasingPension funds, mostly smaller ones, are having trouble meeting the strict requirements imposed on management and governance by the laws and regulations. The upcoming pension agreement will only reinforce this trend. In addition to this, changes in accounting regulations (IFRS and IAS 19) are also an impetus for businesses to end Defined Benefit (DB) plans.

A recent study by KPMG shows that nearly 35% of the OPFs are looking at liquidation of their fund. The primary intention here is to merge into an industrial pension plan (BPF) or switch over to an insured plan (and in the future possibly a defined-contribution or general pension institution (PPI/API). A chart illustrating this trend is given in Figure 2.Due to the shift towards insured plans, we can say that as more OPFs liquidate, solidarity will come under pressure and the trend will shift towards more individualization and the free market (scenarios 1 & 2). Some experts are of the opinion that this development will also prompt a re-examination of the large role that mandatory participation plays in European policy.

PPI/Multi-OPF/APIThe government has decided to introduce the General Pension Institution (API) in three phases. This is a new pension provider which is supposed to take better advantage of the opportunities provided by European developments.

The introduction of the Defined-Contribution Pension Institution (PPI) comprises the first phase in this process. The 2009 scenario analysis touched on the establishment of PPIs. In late 2010 this law was passed in the Dutch Senate. This clears the way to allocate the first plans under PPIs.

The PPI takes advantage of the developments in Defined Contribution (DC) plans. The PPI itself cannot guarantee returns on investment or specific disbursement sums. This means the employee bears the pension disbursement risk.

The second phase consists of adjustments in the Dutch Pension Act (Pensioenwet), enabling mergers between company pension plans (OPFs). These multi-OPFs may be particularly useful to minimize costs for smaller funds. The Dutch Senate passed the Multi-OPF bill on 11 May 2010.

In the third phase, the API will be introduced into the Dutch Pension Act. Practically every condition applicable to PPIs will also apply to APIs. One major difference though is that APIs can in fact extend their own guarantees for benefits and/or risks. Thus, APIs can support Defined Benefit (DB) plans. Given the speed of the decision-making process, the first API in the Netherlands is not expected until late 2013 or early 2014.

The expectation on the market is that PPIs will be a great success. This is evident from the number of PPIs already established and in the process of being formed (the current count comes to more than 10 announced PPIs). Every year, between 50,000 and 100,000 participants have their pension plans moved to another insurer. So, in our opinion, given the required scale, the Dutch market can currently accommodate 3 to 5 PPIs. This means that most of the PPIs currently being set up will not be successful, or will have to find their success mostly in foreign markets. However, at this time no one can afford to miss the boat. In other words, the choice is between potential failure and not playing at all. So far, the first option has been popular.

Just as with the developments surrounding the pension agreement, the trend is shifting towards individualization. This comes in combination with strong market forces, under which new parties are entering the market and existing parties are fighting for their survival (scenarios 1 & 2).

Cost Transparency and LevelsPension funds and pension insurers are also hearing increased calls for transparency. The Dutch Pension Act imposes the transparency requirement on contribution agreements. This means that pension funds (as of 1 January 2008) and pension insurers (as of 1 January 2009) must communicate the costs involved in the available contribution schemes in a transparent manner.

The report “Pension Fund Costs Deserve Closer Attention” (Kosten pensioenfondsen verdienen meer aandacht) issued by the AFM (Dutch Financial Market Authority, April 2011) finds that many pension funds do not have any insight into actual costs. One of the recommendations here is that the funds make costs more transparent, but also that they communicate these costs to (retired) participants.

The report also states that the cost structures for the smaller pension funds are significantly higher than the costs of the larger funds (Figure 3).Costs have a major impact on the pensions benefits accrued.

If the investment and administrative costs of the plan or administration are no longer viable, then alternative cost reduction measures must be considered. These alternatives may include measures such as mergers, joining larger associations, or simplification of the plan.

The AFM states in its report that a better picture of the costs could even point the way to new visions for reforming the structure of our second-pillar pension system, in light of the ongoing discussion on this matter.

The consequence of this current trend will be a period of consolidation in the pension fund market. We will also see increased freedom of choice for employers, which will boost competition. This, in turn, will usher in a period of professionalization.

Here as well we see a shift towards market-thinking, just as with the API and PPI developments.

Economic DevelopmentsAt the time of our first scenario analysis, a large number of plans were experiencing coverage problems. The figures from the Dutch National Bank (DNB) indicate that the financial position of pension funds improved over the fourth quarter of 2010. The average coverage rate rose from 99% at the end of the third quarter to 107% at the end of the year.

This improvement in coverage rates is associated in particular with the increase in the long-term interest rate, resulting in a sharp decline in value for pension fund liabilities. The number of participants involved in a pension fund with inadequate coverage (less than 105%) fell from 4.8 million to 3.0 million. Although the coverage rate is increasing, this does not mean no problems remain. Once again pensions are lagging behind increases in wages and prices according to the Dutch National Bank based on its annual survey of the 25 biggest funds. In this way, the pension fund crisis is hitting retirees in the wallet. Employees are also being affected: lack of indexation has an impact on pension benefit accrual and pushes up contributions! As pension funds increasingly have to forgo indexation and possibly even cut entitlements, this will inevitably cause a shift away from solidarity and towards individualization in the pension sector.

By size class

Total weighted average

Figure 3: Administrative costs as a % of the balance sheet total by size class (2009)(“Pension Fund Costs Deserve Closer Attention” Financial Market Authority- April 2011)

1,2

1,0

0,8

0,6

0,4

0,2

0 0 - 10 million 10 - 100 million 100 million - 1 billion 1 - 10 billion > 10 billion

Size class of pension funds by balance sheet total (x 1 million euro)

Adm

inis

trativ

e co

sts

per y

ear a

s %

of b

alan

ce s

heet

tota

l

1,18

0,130,17

0,20

0,10

0,33

Development of the Pension LandscapeAs for the issue of collectivization vs individualization, it is clear that the current level of solidarity is not sustainable over the long term.

Further, DB plan costs are not tenable over the long term either. Many pension insurers are already experiencing issues with the profitability of guaranteed products. This will increasingly lead the various partners in CLA discussions to switch over to simple plans. The plans will be stripped of their frills to lower the cost of work.

This means that the pension system will base itself more and more on individualization (scenario 2), and pensions will no longer necessarily have fixed values. A larger third pillar will arise for those who can afford it. In addition to this, other avenues, such as home ownership, will become a larger part of saving for retirement.

Due to the pressure from these trends, it is inevitable that the government will intervene in the pension system; not to take more control for itself, but rather to adjust the system to the new realities and the demand for individualization.

Over the long term, this will give rise to a situation in which OPFs and BPFs, in their current forms, will be obsolete. Our expectation is that the large degree of mandatory participation will disappear over the coming years and BPFs will turn into pension funds that employers join voluntarily. In time, OPFs will either disappear completely or turn into PPIs or APIs.The primary objective in this will be to create economies of scale and volume for better returns on investment, discounts and lower operating costs.

So far, all of the above indicators point to a shift towards the second scenario “Optimal individual freedom of choice”.

Conclusion: Strategic choices unavoidable for pension insurers and providersOur scenario analysis clearly shows that the future lies with simple and transparent pension plans that can be administered at low costs. All frills will ultimately come at the expense of returns on investment or disbursements.

Pension insurers can offer these products via a Greenfield model: a new Defined Contribution (DC) pension insurer that is not burdened with legacy costs from the past. Given that the costs of the current portfolios are too high, these must also be dismantled and migrated over to the new DC insurer as quickly as possible.One alternative is for the insurer to go with the flow of the current market shift and set up a PPI. A pension insurer that sets up a PPI basically has two options: you can start your own PPI, possibly in a joint venture (such as Delta Lloyd with BinckBank, or ASR with Brand New Day), or the pension insurer can restrict itself to the role of provider of insurance products to PPIs (such as Generali, which is a provider to the Robeco PPI). For pension insurers, what is certain is that belts will have to be tightened in order to win the battle for the pension Euros over the coming years.

OPF plan providers will have to deliberate over their futures. The question on everyone’s mind is whether they will be able to transform themselves to meet the needs of the new pension world. Our expectation is that the number of OPFs will continue to decline over the medium term and that over the long term the OPF in its current form will cease to exist. This means that providers must first focus on consolidation, in order to retain market share, and on PPIs. Over the long term, pension providers will have to transform themselves into maximally effective and efficient providers of simple plans, which will give rise to a true price fighter’s market.

BPF plan providers are already looking at options for providing other types of plans. This is due in part to pressure from the watchdog for large providers to work in a multi-client manner from a governance perspective. Here as well we expect to see a period of consolidation to capitalize on economies of scale and cost advantages. Moreover, BPF providers will also join in the competition for PPIs: on the one hand to ‘practice’ for an open market, and on the other hand to offer an alternative for OPFs and BPFs looking for other pension vehicles.

NEW PLAYERS SHAKING UP THE MARKET!

Atos, Atos and fish symbol, Atos Origin and fish symbol, Atos Consulting, and the fish itself are registered trademarks of Atos Origin SA. June 2011

To conclude, we can say that the trends and developments outlined above will result in the pension market changing more drastically over the next five to ten years than it has over the past forty years. It is not just types of plans that will get the boot, but more significantly, the parties responsible for running the Dutch pension system.

Just as in the Dutch life insurance market, the pension market will undergo a shakeout which will result in a 2020 playing field with many new names and, most strikingly, from which many old names will have vanished.

For further information, please contact Stephan Linnenbank RM, partner and Richard Klaasen Bos, Executive Business Consultant.

Atos ConsultingPapendorpseweg 933528 BJ UtrechtThe NetherlandsPhone +31 (0)88 265 88 88info.consulting@atosorigin.comwww.atosconsulting.nlwww.scenario-planning.nl