Pension Reform and Robo Advice
An Institutional Perspective on Pension Reform in the Netherlands
The Netherlands is generally seen as a country with a sound tradition in pensions. The Dutch system accommodates both collective and individual pension agreements. In the aftermath of the financial crisis a review of the pension system took place, resulting in more collective defined contribution schemes (a hybrid between defined benefit and defined contribution schemes) and the introduction of a new or rather updated financial assessment framework and pension law. While this update addressed some urgent issues, it was never a fundamental review. This fundamental review was started in 2014 by Jetta Klijnsma, the secretary of state responsible for pensions. In this review, the pros and cons of solidarity between generations, and collective investments versus individual choices play an important role. In the spring of this year the Social and Economic Council of the Netherlands completed a sketch of what a new pension system could look like1. The direction is clear: although solidarity and collective still add value, a new Dutch Pension System will have at least some elements of individual accounts and will allow for some individual tailoring.
A pension system with individual accounts means that individuals will have to make their own decisions. Making the right financial decisions is complicated. As Ortec Finance, our purpose is to enable people to manage this complexity, whether they are professionals working for a large institutional investor, or private investors saving for retirement. By providing each of them with the appropriate tools and advice, they can not only better understand the consequences of their decisions, but also adjust their decisions or goals when needed, thus enabling them to become more successful in achieving their objectives. Individual decision making comes at a price though. Unlike institutional investors, individuals cannot hire their own staff to handle the complex issues. A solution to keep these costs low is to set up an automated process to guide people in defining their goals. Based on these goals and the available assets, a robo advice can be created to suggest an financial strategy. 2
The trend of digitalization – the individual perspectiveWhile the institutional market is discussing fundamental changes in the second pillar of the Dutch pension system, banks and insurance companies have their own (disruptive) developments. The trend of digitalization makes financial services available to a much larger group of people. The digitalization trends started with banks digitalizing payment accounts, followed by saving accounts; currently, most investment and insurance products have been digitalized. But investment products are more complex than payment and savings accounts. Robo advice should be used to automate the investment decisions of individuals by making information more easily available, and at the same time improve the quality of the advice. Compared to the current practice, we expect robo advice to evolve into a solution that is more client-centric. Once this step is made, the next important step we foresee is to reform investment advice into a more holistic financial advice.
Improvements needed for automated client-centric adviceTo make this automated client-centric financial advice possible, several improvements to current best practices are needed. A first prerequisite is to further improve the setting of goals. We should do much better than to present clients with a simple questionnaire (which is often just an excuse to check the regulatory box and confirm that the client’s risk appetite has been determined). We should actually support the individual in determining this appetite3 , for instance by providing feedback on the goals that are set. We should tell the client how likely it is that a certain goal will be achieved, how this expectation will change if the horizon to achieve the goal is shortened or lengthened, and so on. In our view, the process for measuring the capacity for loss can further be improved to bring robo advice to the next level.
Goals, investments and returns are of course not static over time. They are, in fact, very dynamic. A client journey, supported by robo advice, should therefore result in a process of monitoring goals and the actual portfolio that is constructed to reach these goals. Nowadays, most individuals have one account for one goal. An individual client may therefore have one or more savings account(s) and one or more second pillar pension plans. For financial advice, a holistic approach is needed. The quality of robo advice will be increased if the impact of decisions can be incorporated in a holistic view. Right now, a human advisor may still be better at taking this holistic view than an automated system. However, we expect that an improved technology and an increased availability of data, on top of lower costs and a more consistent and objective advice, will allow the robo advisor to close this gap quickly. This may lead to robo advisors taking over the jobs or part of the jobs of the current financial advisors, as predicted in the Singularity University view on financial services4. If this change happens, it can be used to make a swift transition from the current pension agreements to more individual ones of the future.