Giovanni Legorano looks at how governments across Europe are reforming their pension systems following the economic crisis
In June 2009, after some two years of market turmoil which severely battered pension funds all over the world, OECD secretary general Angel Gurría summarised the debate on pensions in this way: “Reforming pension systems now, to make them both affordable and strong enough to provide protection against market swings, will save governments a lot of financial and political pain in the future.”
Talk about pension reform is not new. Longevity and demographic imbalances started to undermine pensions years ago prompting private sponsors to close defined benefit schemes to new members. By the same token, public schemes started to face funding problems as well and ended up applying, although to a lesser extent, similar measures to the ones applied by private schemes. Public pay-as-you-go systems continued suffering.
Increasing retirement age makes logical sense: since you are living longer you can contribute longer
In its Pensions at a Glance report of June 2009, the OECD urged governments to “ensure that public and private retirement income provision is socially as well as financially sustainable”.
With rising unemployment and falling tax revenues squeezing public finances, the OECD said governments of member states would face budget deficits of nearly 9% of national income on average in 2010.
Countries responded to the OECD’s call and several announced or started to implement pension reforms, after last summer.
Ireland was the latest country to go public last March with a set of pension reforms that represent a complete overhaul of the country’s retirement system. And it also encapsulates two important routes states chose to follow: creating a mandatory or quasi-mandatory defined contribution scheme to complement existing state provisions and increasing retirement age.
According to Ireland’s National Pensions Framework announced by its government at the beginning of March, Ireland will introduce a mandatory scheme for all workers in the coming years.
The state intends to introduce an auto-enrolment system for employees over the age of 22 by 2014. Employers not currently providing pension arrangements will need to enrol employees and contribute to their pensions on a mandatory basis, but employees can decide to opt out.
However, the government said it will introduce the auto-enrolment system “if it would be prudent given the economic conditions prevailing at that time”.
Employees will be automatically enrolled into the new pension scheme unless they are members of a defined benefit scheme or a defined contribution occupational pension scheme with a contribution rate equal to or greater than the minimum paid under the new scheme.
Creating a DC mandatory scheme for all
Mercer senior associate Anne Bennet said one of the biggest themes is and has been countries bringing in mandatory or quasi mandatory second pillar funding, where employees normally have the possibility of opting out.
She added: “Looking back, Hungary was the first Eastern European country to introduce a mandatory second pillar with individual accounts back in 1998. Poland was also an early example, with its mandatory second pillar introduced in 1999 – its second pillar assets now stand at around €30bn (US$40.7bn). Bulgaria is among several other Eastern European countries with a mandatory second pillar, covering all employees since 2006.”
The UK is another important example. The National Employees Savings Trust, or NEST, is a compulsory DC plan for all workers who do not have a supplementary pension and has been in the works since 2008. It will come into effect in the UK in 2012.
As OECD economist Anna Cristina D’Addio explained, the UK and the Irish reforms represent what is normally considered “major” reforms. Other reforms which change a country’s retirement income system significantly comprise moving from a pay-as-you-go defined benefit to a fully funded defined contribution system, transforming a defined benefit scheme into notional accounts and starting up a new system as a part of pay-as-you-go reform process. In contrast, increasing retirement age, although highly visible and often politically controversial, would be considered a minor reform, because it simply consists in varying one parameter of the pension system, D’Addio added.
Act against poverty
The aim of introducing mandatory supplementary systems had always been to act against pension poverty which has been extending in western countries in recent years. A report by the European Union revealed last year that on average 19% of the population over 65 in EU member states is at risk of poverty.
According to the same report, the situation in the UK and Ireland would be much worse than the European average, since in both countries one third of the same segment of the population is at risk of poverty.
In both cases the reforms foresee the auto-enrolment of employees into these schemes and the possibility of opting out, which has to be actively exercised by employees.
Talking about NEST in the UK, Standard Life senior pensions policy manager Andrew Tully said the need for change was obvious to everybody.
He explained: “It was needed because voluntary tax incentives were not working. While high earners were saving, a significant amount of lower earners were not saving. About 20 million people work for private sector employers in the UK and there were about nine million in the pension schemes.
“I think that shows that volunteerism wasn’t working. With the demographic and financial challenges that we are facing it was clear we had to make changes.”
The NEST reforms aim to tackle the problem of 12 million people either not saving enough, or not saving at all for retirement.
In Ireland, several stakeholders including the Irish Association of Pension Funds backed the reforms introduced by the government. However, the Irish Congress of Trade Unions general secretary David Begg strongly criticised the introduction of the mandatory DC scheme: “They propose to force people to hand over a portion of their wages to the private pension industry in order to facilitate gambling and stock market speculation. Given that Irish pension funds – and therefore those who manage them – have been the worst performing in the developed world, this is like a reward for incompetence.”
Retirement age increasing Europe-wide
With only a few exceptions, retirement age increases feature in all European legislative amendments to pensions introduced or discussed in recent years. Ireland’s state retirement age will be raised to 68 from 65 by 2028; between 2024 and 2046, the UK state pension age for both men and women is to increase from 65 to 68, and Spain has also announced plans to increase its pension age to 67 from 65.
France’s president Nicolas Sarkozy initiated negotiations on pension reform in April in a bid to rein in France’s ballooning pension deficit. According to data from the Conseil d’orientation des retraites (a permanent body monitoring the French retirement system), the state pension deficit is forecast to reach €10.7bn in 2010. In 2009 the deficit stood at €8.2bn and in 2008 at €5.6bn.
Sarkozy has not ruled out the possibility for France to increase retirement age, currently at 60, which is considerably lower than in most western countries.
Hewitt international benefits team principal Tim Reay explained states are facing increasing problems in financing pensions due to improving longevity and a decrease in birth rates.
He said: “Despite being separate phenomena, one magnifies the other one. The second of these problems, which means you are having imbalance in demographics, has a direct effect on state pensions since they are essentially pay-as-you-go: the contributions coming in pay for our grandparents’ pensions. If they had been based on pre-funded arrangements, then the change in the population wouldn’t have had such a direct effect.”
Faced with this, states can choose one of three possible solutions to tackle pension financing problems. They can either decrease pensions, increase contribution rates or increase the retirement age and recognise that because people are living longer, they need to retire later.
Most countries favour raising the retirement age
“Increasing retirement age makes logical sense: since you are living longer you can contribute longer. States could instead reduce benefit accruals for example, but these kinds of changes are much more difficult to communicate,” Mercer’s Bennet commented.
Mercer principal Robert Lockley added this kind of change is never immediate. “It is normally phased in, in a number of years. So when these reforms are introduced they affect people for whom retirement income is not the number one concern,” he said. Governments would then see this as a reform not only easier to implement, but also easier to communicate.
Nonetheless, plans to increase pension age are always welcomed by social unrest. Since the Spanish government talked about its plans, Spain has witnessed a flurry of protests. French workers are also bracing themselves for long strikes.
Reay pointed out states are having difficulty in convincing citizens of the necessity of increasing the pension age. He said: “People think they should retire at 65 because their fathers did it, but now people are much younger at 65 than they were years ago.
“The truth is that states should have better communicated that pensions as they were designed were unsustainable. They were modeled like a Ponzi scheme, and could only work with a continuing increase in population.”
Adding to that, the message on how states improve pension finances can only be unpalatable to retirees of any country. As Lockley put it: “It does not matter whether you are trying to make people work longer or reduce benefits. Whichever way you do it, these things are never going to be popular.”
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