It's been a tough few years for the Dutch pension system, long praised as the best in the world. Most Dutch pensioners have seen their payouts trail the rate of inflation since 2008. Earlier this year, 66 pension funds (out of 415 total) had to cut benefits outright. The average reduction was 1.7%, but at a few funds it topped 7%.
These cuts are extremely controversial in Holland. They're a core issue for a new "50PLUS" party targeted at older voters that won its first seats in Parliament last year. The much-larger Freedom and Socialist parties have been vocal critics of the cutbacks as well.
Yet from outside the country's borders, the Dutch system still looks pretty spectacular. Its average ratio of assets to liabilities is 104%, more than 90% of the workforce belongs to a pension plan, benefits are generous by global standards, and costs are low. The Netherlands did slip behind nearby Denmark in the latest Melbourne Mercer Global Pension Index ranking of the world's pension schemes, but only barely.
Here in the U.S., which came in ninth of the 18 countries ranked in the Melbourne Mercer survey, things look a bit different. State and city pensions are in deep trouble — with Detroit's currently tied up in bankruptcy court and The New York Times reporting this week that Chicago's much-bigger system might be next in line for a funding crisis. Corporate pensions, once a major pillar of the retirement system, are disappearing, and their replacement, the 401(k), is turning out to be a woefully inadequate source of retirement income for most workers. Social Security, despite its much-discussed long-run funding shortfall, may actually be the strongest pillar in the system.
And remember, the U.S. is in the middle of the global pension pack. Most of the countries that scored lower than it on the Melbourne Mercer Index (France, Germany, and Japan among them), did so because they've set aside far too little to cover the big pension promises they've made.
So what distinguishes good pension systems from bad ones? It mainly has to do with how they allot the risks inherent in providing income for retirement. I can suss out two basic principles behind the pension systems that work:
1. Pension risk ultimately has to be borne by pension recipients. Attempts to transfer that risk to others — shareholders in the case of corporate pensions, taxpayers for all the rest — are generally destined to end in tears.
2. That risk should be shared across a lot of pension recipients. Having every worker shoulder the risk individually is not just, well, risky — it's really expensive, too.
This first principal is now widely understood, although it remains political dynamite in many countries, as well as U.S. states and cities. The Dutch system of private, mostly industry-wide pension funds quietly made the shift during the past decade from a classic defined-benefit system, in which pension funds guaranteed a specific level of income, to what's been variously called "collective defined-contribution" or "hybrid DB-DC." Now, if the Dutch central bank deems a pension to be underfunded, cutbacks of some kind usually result. Most Dutch pensioners weren't fully aware of this change, which is why the recent cuts have been so controversial. But they also mean the (in some cases smaller) pension checks will keep coming, and there's no funding crisis or taxpayer-funded bailout looming.
The 401(k) shares the characteristic that poor investment returns don't result in funding crises or taxpayer bailouts. That's a good thing. But beyond that, it's been a pretty disastrous failure in generating retirement income. To start, most workers haven't put aside nearly enough money. That's partly because of a myopia inherent to humans, which psychologists and behavorial economists have learned tons about in recent decades and even come up with tools to counteract. But it's also that wages have been stagnant and too many employers stingy with matching contributions. Then there's the sad reality that 401(k) accounts are characterized by higher fees and worse investment performance than old-line pensions — professionals really are better at this than amateurs (well, mostly). And finally, it takes much less money per person to guarantee an adequate retirement income when that guarantee is spread across a bunch of people.
This last one deserves extra emphasis. If you're 65, and don't know if you'll live to 75 or 105, you need a huge stash of money to ensure that you won't run out. Guaranteeing retirement income for 10,000 65-year-olds costs a lot less per person, because you can be sure that most of them won't make it to 105. Traditional pensions work on the latter principal; 401(k)s the former. There has been a push in recent years to get people to replicate the pension experience by putting 401(k) money into life annuities when they retire, but the process can be complicated. There is also the problem, when you give people the choice of whether to buy an annuity or not, of adverse selection — those with good reason to think they'll live to 100 will buy annuities and those with health problems won't, thus driving up prices.
The choice of a pension structure is a classic case of the alternatives countries face in choosing an economic path within the wide bounds of a global capitalist system. The Dutch pension alternative is markedly more free-market-oriented than the French one, which consists mostly of (underfunded) government-run plans. It is also markedly less free-market-oriented (or, to put it another way, more collectivist) than the American 401(k) system. And it is markedly better than both.