What Makes the U.S. Retirement System a Bad Example
(Bloomberg View) -- The headline from the Dutch business newspaper Het Financieele Dagblad caught my eye on Twitter a few weeks ago: “America is the example of how not to do pensions.” The quote was from an interview with Angelien Kemna, who stepped down on Nov. 1 from the top finance job at APG Groep NV, which manages the Netherlands’ biggest (and world’s fifth-biggest) pension fund. After reading it, it struck me that it might be useful to let U.S. readers know what one of the leading figures on the global pension scene thought was wrong with the way this country handles retirement savings.
The Dutch retirement savings system, considered one of the world’s best, is built around defined-benefit workplace pensions -- as the U.S. system used to be. But while some pension funds are affiliated with a single company, such as Royal Dutch Shell PLC or Koninklijke Philips NV, industry-wide pension arrangements are the norm. APG manages ABP, the 405 billion-euro pension fund for workers in the public sector and education, and several smaller funds.
Before joining APG as chief investment officer in 2009 (she was promoted to chief finance and risk officer in 2014), Kemna was chief executive officer of ING Investment Management Europe and worked in various jobs at Dutch asset manager Robeco Groep NV. From 2007 to 2009, she taught part time at Erasmus University Rotterdam, where she got her Ph.D. in finance, while living in Atlanta, where she got some firsthand experience of how the U.S. handles retirement. I spoke with Kemna by phone in mid-December. What follows is an abridged and edited transcript of our conversation.
Justin Fox: Why is America the example of how not to do pensions?
Angelien Kemna: What I saw living in the United States was that so many people not only lost their jobs and houses during the financial crisis, they also lost more than half of their pensions, because their pensions were 401(k)s. These are individualized pensions with high fees. People don’t understand the risks they take, they do not share risks over generations. It makes them extremely vulnerable in an area that is very important for them -- their future life and safeguarding their future life.
I think that financial services organizations made a lot of money selling these things. People have extreme difficulty understanding pensions at all, and it’s very easy to convince them to do things that might actually not be good for them.
That is something that I have been fighting against my whole life in the Netherlands, the shift to an individual system. You can top up individually if you want to, but the basis pension should be risk sharing between people of various ages.
JF: One thing that seems under-understood here is that it’s not just the competence issue of whether individuals are good at investing for retirement, it’s that in theory -- and I think in practice in the Netherlands -- it’s cheaper to do it collectively, right?
AK: Oh, absolutely. And yes, we also suffered from the crisis as pension funds, but de minimis. We’ve totally recovered from the crisis, and I would say that the system has been shown to be pretty robust under market crises. Our system is less robust under longevity risk.
JF: That’s every pension system in the world. I was just rereading a Bloomberg View piece by Satjayit Das on Australia’s pension system, which is pretty highly acclaimed. The gist of his argument was that maybe none of these pension systems can actually work with the way populations are developing in wealthy countries, with people living a long time and also relatively low growth in the working-age population.
AK: Yes, exactly. I think none of the pension fund systems are robust enough against that. But in our system, we can cut off some at the top. We did that a couple of years ago where you don’t get all these benefits from pensions and taxes if you make more than 100,000 euros a year as remuneration, and we could lower that. If you don’t have to take the top, top, top salaries, that makes the pension system as a whole more affordable and more solid, more robust.
There are some ways to overcome the negatives of our current system. But what will certainly not overcome the negatives is to go individual and to be basically very unprotected.
JF: In the U.S., the place where there are still defined-benefit pensions is mostly with state governments, and there’s lots of pressure politically for the states to go individual, in part because they’ve done a pretty poor job in general of setting aside enough money. It seems like the Dutch and a few other Northern European countries have this unique mix of a sense of “We’re in this together,” but at the same time a really hard-nosed accounting tradition. That’s hard to replicate.
AK: Yes, the majority of the state defined-benefit systems in the U.S., if they would have to apply our regulatory rules, they would be seriously underfunded. It’s very hard to invest your way out of that, so they do need to do something.
If you go individual, that’s easy. You just let go of your responsibility. But basically you’re not only vulnerable for longevity risk, you’re also vulnerable for market risk, much more than in a risk-sharing arrangement. I would encourage those state pension funds to look around in the world and see what alternatives there are that would actually be somewhere in the middle between their current system and a 401(k).
I know it’s hard for people from the U.S. to actually see that other systems might teach them something. But I would encourage them.
JF: There’s definitely something of a movement here to try to push the 401(k) in the direction of a pension, with more default deductions, more contributions by employers, more options for annuitization upon retirement. But in the Netherlands, what you’ve been doing is taking this defined-benefit system and making it a little less defined. During the crisis, how was it adjusted, by not giving inflation adjustments for a couple of years?
AK: Yes, that was the majority of the adjustment, and only in one or two specific cases we cut the pensions, but that was in one year by 1 percent. It’s politically incorrect to say so, but this enabled us to actually catch up with the investments to cover for the rise in longevity risk.
The elderly people were a bit upset that they didn’t get the inflation coverage, but I think that was actually fair. Normally you work for 40 years and you live another 15 years and that’s the fair pension payment. But if you now only work 35 years and live 25 years longer, then of course you get a lot more from your pension than you’ve actually saved in the past.
JF: In both these systems, unexpected things happen -- you have a market crash or life expectancies keep growing. The advantage of a 401(k) system is that it’s supposedly not the government’s problem, although they might end up with a lot of very poor 80-year-olds 20 years down the road. With the defined-benefit system, if you can make adjustments like that, that’s the better way to go. I think the problem with state pensions in the U.S. is that both politics and, in Illinois, the state constitution are preventing them from making even the slightest adjustments.
AK: It takes us forever, but over the years, continuously, adjustments have been made so that our pension system would stay affordable. We went from a pension based on your last earned income to pensions based on average income over your lifetime. That’s a huge difference, but it went pretty smoothly. Now we’re not giving extra pension if your income is above 100,000 euros, and that also went pretty smoothly. So it’s not easy, but being able to have some flexibility is necessary.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
My translation of "Amerika is voorbeeld van hoe het niet moet met pensioen." I was an exchange student in the Netherlands many years ago, which is why I can read Dutch. My conversation with Kemna was in English, though.
I wrote a column earlier this month on how the U.S. retirement system compares internationally
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