CPB Report: Pension funds in midlife crisis

These conclusions can be found in the article 'Pension funds at risk', published in the April 2003 issue of CPB Report.

The capital funded pension system in the Netherlands has always been widely praised as an economically sound basis for the future burden of ageing. Not only does the pension system offer good income prospects for present and future generations, it also takes care of intergenerational risk sharing, since both windfalls and setbacks are shared between senior and junior working generations. The solidarity among generations contributes to making the economy more resistant to shocks.

During the past ten years, pension funds increased their investments in equity from about 10% of their total investments in 1990, to 40% in 2000. As the share in risk-bearing investments continued to increase in these years, pension funds benefited significantly from the rise in share prices. However, the recent huge losses in investment portfolios, due to the creeping and persistent downfall of the stock market, have declined the funding ratio of pension funds from an average of about 130% of the total liabilities in 2000 to only 105% in 2002. Moreover, many pension funds saw their funding ratio decline to below the critical limit of 100%.

Recouping these losses will require higher pension contributions by employees and companies. For the period up to 2007, contribution rates are expected to rise from 11.1% of total wages in 2002 to 15.4% in 2007. These higher contributions will not only affect the purchasing power of people in employment, they will also affect the labour market (through the tax wedge) and the public sector finances (through the deductibility of the contributions). Labour costs are expected to rise and employment will shrink, resulting in an increase of structural unemployment by 90.000 persons in 2007, due almost fully to the account of this pension shock.

In order to avoid the macroeconomic spillovers of risks, pension funds can take three different types of measures: First, they can opt for a more conservative investment strategy and try to minimise the distorting effects on the economy. Second, the pension funds can adjust the sharing of risks and allocate more of them to the pensioners, for instance by introducing an average pay system, instead of the final pay system, which is still practiced on a large scale in the Netherlands. Finally, by reducing the target level of the mandatory pension system, the weight of the risks can be brought down as well.

Also in CPB Report 2003/1
This article, providing an overview of the current situation of the pension funds in the Netherlands and its consequences for the future, can be found in the April 2003 issue of the CPB Report. The CPB Report is a quarterly, English language magazine that reviews the most recent forecasts on the national and the international economy (see CPB press release CPB report: Dutch economic recovery tough and uncertain, dd. 27 March 2003), and highlights research activities. This issue contains articles on various subjects, including: Does an increase of public expenditure justify slower debt reduction?; A model for Dutch commuting; Do transaction costs impede residential mobility in the Netherlands?; Deliberate consumer choice in health insurance; and Diagnosis and treatment combinations in Dutch hospitals.

Diagnosis and treatment combinations in Dutch hospitals
In recent years, the Dutch government has aimed at reducing regulations in health care. In the early 1990s government emphasis was on cost control. The fee-for-service (FFS) system, which did not turn out to be an appropriate tool to achieve this goal in the 1980s, was replaced by the introduction of lump sum budgets in 1995. The new system indeed curtailed costs. It also seemed to stimulate efficiency, as more patients were treated on an outpatient basis rather than with clinical admission. However, the lump sum system has proved to be not very successful in accommodating growing demand for health care, as has become clear from increasing waiting lists.

Therefore, to reduce waiting lists, the government has initiated a shift in policy from a situation of price regulations and macro budgeting towards a system of regulated competition. Competition is regulated in order to assure the solidarity between the healthy and the sick. In this new system, insurance companies are supposed to play a key role as agents of the patient: they buy quality care that is affordable to everyone. A first step in this direction is the introduction of hospital output prices based on actual production costs rather than on budgets and financing rules. It can be expected that this approach will improve the transparency of hospital costs.
To achieve this, the concept of Diagnosis and Treatment Combinations (DTC) has been introduced. This system covers all activities that are performed to meet the demand of the patient, including the remuneration of medical specialists. For each DTC, all characteristics should be well defined and described, including the corresponding working hours of medical specialists.

The introduction of DTC-based output prices clearly improves the transparency of hospital costs structure. It is also a necessary step towards a health care system governed by regulated competition. Nevertheless, it will probably create its own problems. The combat of those problems (for example stinting: reducing the quality of care) may not only hamper the working of the system, but will also increase its operating cost.