Jori Arts: Pension – fixed, variable or sensible?
This column was originally written in Dutch. This is an English translation.
Column by CFA Society Netherlands
The choice between a fixed or variable pension sounds simple, but requires more than freedom of choice. It requires careful guidance, transparency and an ethical compass on the part of pension providers.
By Jori Arts, Fiduciary Advisor at PGB Pensioendiensten, Chair of the Asset Liability Management Committee and member of the Advocacy Committee of CFA Society Netherlands.
The discussion about the amendment proposed by the NSC and BBB parties – which would give participants the right to choose between a fixed or variable pension for their accrued pension – touches on the core of the new pension system. However, the choice between fixed and variable is not merely a financial one; it also touches on the ethical responsibility of pension providers towards their participants. The CFA Institute's Standards of Professional Conduct – in particular the standard for Duties to Clients – provide an important framework for assessment: how do we ensure that participants not only have freedom of choice, but are also served fairly, carefully and loyally?
From an economic perspective, the concept of a “fixed” pension is misleading. Under the current system, pension fund benefits appear to be guaranteed, but previous years without indexation and (impending) cuts during the financial crisis in 2008 proved the opposite. The false sense of security that was offered came with hidden risks. Under the new system, these risks have been made more explicit: variable pensions move more directly in line with returns, while fixed pensions require expensive security structures, but both are subject to uncertainty.
The standard “Loyalty, Prudence and Care” requires pension providers to act in the interests of their customers – the participants. This means that they not only let them choose, but also guide them in understanding that choice. A “fixed” benefit may be emotionally appealing, but is often economically inefficient and can be risky in real terms in the long term. After all, inflation is more unpredictable than you might think, as we have seen in recent years. Participants must therefore be protected against misconceptions, even if those misconceptions stem from their own preferences.
In addition, the standard of “fair dealing” requires that all participants – young, old, financially literate or not – have fair access to understandable information and advice. In a complex choice between fixed and variable, transparency is crucial. Not only about returns, but also about risks, costs, sustainability and what “fixed” or “variable” means in practice.
And then there is the “Suitability” standard: the principle that an investment solution must be appropriate to the customer's situation, risk appetite and objectives. Many participants do not want maximum returns, but a predictable income after retirement. A strictly variable pension may therefore feel unsuitable, while a so-called “fixed” pension may prove too expensive or inflexible. Between these extremes lies the middle ground: stable payments with limited variation, tailored to the risk appetite and risk tolerance of participants.
A stable pension with an eye for purchasing power is therefore reflected in the transition and implementation plans of pension funds. The risk profile of the investment policy is reduced as participants age, in line with the risk preferences requested. Furthermore, the new pension system includes safety nets to cushion setbacks. These include spreading returns over several years and the solidarity or risk-sharing reserve to keep pension benefits as stable as possible in times of financial adversity.
The economic and ethical lesson is clear: instead of “fixed” or “variable”, participants need a “sensible” pension. A pension solution that is stable enough to build on and flexible enough to adapt to changing circumstances.