The austerity measures that swept through Europe in 2010 took their toll on pension systems. Richard Lowe reports
The European pensions landscape is in a state of legislative flux. In some countries retirement ages are rising, while in others state pension payments are being frozen, tax efficiency is being eroded or pension contributions are being diverted. Many countries were already on the road to pension reform, but in some respects the financial crisis and the need for governments to cut their levels of debt have acted as a catalyst to this process. In other areas, it seems to be simply a case of bad timing, where austerity measures are coinciding with pension reforms already set in chain before the crisis.
Greece is probably the most extreme example, but only because it has one of Europe’s most generous and unsustainable state pension systems. It is now under pressure to bring its provision in line with other countries quickly. As part of its urgently required austerity measures, the country is seeking to increase retirement age, curtail early retirement and lower pension payments by calculating them over a longer period of time.
“Greece is under significant financial market pressure but at the same time is implementing a programme of budgetary consolidation – or austerity plan – coupled with a number of social reforms, including a very strong pension reform,” said Standard & Poor’s credit analyst, Marko Mrsnik. “This is a radical overhaul of the pension system in their case, simply because it goes from one extreme to another.”
According to Allianz Global Investors’ (AGI) most recent Pensions Sustainability Index, published in 2009, Greece topped the list of European countries in urgent need of reform, and was ranked third globally after India and China. “This southern European country has not yet begun initiating major pension reform even though its extremely generous pension system is about to collide with a quite serious aging problem,” the report said, claiming its pension expenditure as a percentage of GDP would increase from 11.7% in 2007 to 24% in 2050.
The report was based on data and analysis prior to the financial crisis and provides a snapshot of the sustainability of pension systems in 2008. A lot has changed since then, most notably in Greece. It is difficult to know how much the reforms in Greece, which the EU applied pressure to speed up, will have affected the country’s standing in AGI’s sustainability index when it is updated next year. The positive effect of the legislative changes could be offset by Greece’s high levels of national debt, which is just one of a number of factors that AGI considers in its analysis. “Greece has a high public debt, but on the other hand they started reforms, so both factors will enter the index,” said AGI senior pensions analyst, Renate Finke.
Doing the right thing
Meanwhile, France is also pushing ahead with reforms that will see the minimum retirement age raised to 62 and the age at which maximum state pension can be drawn increased to 67. In contrast to Greece, this is the result of a long running endeavour to reform the country’s pension system rather than a last minute response to the eurozone crisis.
“France started the other way round. It started with the pension reform and we expect it to continue with a fiscal consolidation next year,” Mrsnik said. He added that the example of Greece shows that countries “eventually do the right thing”, but it is better to “frontload” such efforts rather than be forced to make them. “You have countries that have had a significant debt burden but have been more active on the pension reform front and others that have lower debt levels but are still facing important challenges in terms of population ageing consequences,” he said.
He cited Italy as an example, which has very high levels of government debt but has phased in a number of pension reforms over the past 10 years, including a move to a notional defined contribution ‘DC’ system and culminating in the decision to raise its retirement age by three years between 2015 and 2050.
“When you look at the future challenges in terms of public finances, you can see that the two pension reforms over the past 10 years have really stabilised expectations about their growth in the future,” he said.
Spain’s pension system languished at sixth on AGI’s 2009 list of those most need in of reform. The government is looking to raise retirement from 65 to 67, as well as reducing early retirement, tightening up entitlement and lengthening the qualifying earnings base. But the reform bill has been delayed and will go to parliament for approval next year, with talk of the proposed legislation still being open to modification.
Ireland had a more sustainable pension system according to the AGI index than Greece, Spain and Portugal, but its financial distress, prompting an €85bn bailout from the EU and the International Monetary Fund (IMF), may cause this to change. In addition to the EU bailout, Ireland will also use €10bn of funds taken directly from the National Pension Fund Reserve.
That said, as part of the bail-out agreement, Ireland unveiled a four-year national recovery plan, which included a number of pension changes. These included a reduction in pension payments to pensioners in public sector schemes and a move from final salary to career-average benefits for new public sector scheme entrants. Income tax relief on pension contributions is also to be reduced from its current level of 41% in a number of stages to 20% by 2014.
The Irish government had been considering cutting state retirement pension benefits ahead of its budget announcement on 7 December, but the recovery plan announcement, prompted by the financial rescue package, shows the government has backed away from the move, although the nominal value of the state pension will not be increased over the four-year period.
But, as Brian Mulcair, senior consultant at Towers Watson in Dublin suggests, there are other ramifications for the Irish pensions industry. There could be a new regulatory regime in place, which will seek to amend the country’s somewhat inflexible funding standard for DB pension schemes. The government has already effectively suspended the funding standard as company pension scheme liabilities, based on annuity prices for pensioner liabilities, which are in turn affected by yields on eurozone government bonds, increased dramatically. This rendered funding plans that had been developed by pension schemes during the first half of the year redundant by the second half. “Many companies had to go back to their overseas parents to look for further financing and that created immense strain,” Mulcair said. New legislation is hoped to be in place by July 2011, which should help reduce the funding standard faced by schemes. But in the meantime this has led to a degree of paralysis among the country’s pension funds.
The good news, and the bad
Looking at the broader picture in Europe, there is both good news and bad news for European pensions in the context of growing austerity measures, said Craig Burnett, partner and defined contribution consulting leader for Europe at Mercer, based in Paris. One of the positive consequences is a growing “realism” over the need to protect and bolster the second pillar, which can be seen reflected in moves to introduce compulsory savings by many countries, including the UK which is introducing auto-enrolment regulations. (Click here to see how the UK is reforming its pension system.)
The “bad news” on the other hand is that some countries have taken steps that are “counterproductive to say the least” when faced with the need to reduce public spending, Burnett said. He cites as an example Hungary, which actually has a laudable 8% contribution level for its compulsory second pillar pensions, but whose government has taken the step to divert monthly contributions to these schemes back to the state for 14 months.
In late November, economy Minister Gyorgy Matolcsy said its citizens have an ultimatum: move their private pension assets to the state, or lose their state pension.
Ernst Schmandt at Towers Watson’s international consulting group in Germany, remarks that such moves highlight the fact that there can often be a “conflict between the short-term targets of the austerity measures on the one hand and tackling the more long-term issues of pensions.”
Schmandt believes there is another potentially positive consequence of the financial crisis and the pressure on European countries to cut their capital expenditure. He says it makes more people question the wisdom of relying on the DC model as the single solution to future pension problems. “The discussion is now more open to say there are possibly several approaches and it is not bad for a society to have several pillars that do not all follow the same principles,” he said.
Schmandt said the experience of recent years shows that there is a place for state organised pay-as-you-go pensions and some form of DB guarantees alongside DC pension schemes. The latter cannot be wholly relied on for the future, something highlighted by the investment losses they incurred during the financial crisis.
“Everybody now understands the risk connected with DC plans. We all talked in the pensions consultancy arena and told companies about de-risking and talked about taking away guarantees and moving towards DC plans,” he said. “What we saw in the past will lead to a lot of risk taking by the individuals and it might not be the path that governments want to take.”
AGI’s Finke agreed the financial crisis and the state of public finances in Europe have opened up the debate about the future of pensions. She said the key question for the future is how can these different generators of retirement income be combined in a way that will maintain living standards in retirement? “The discussion is on: can you set up guarantees; how can you put in risk management measures; how can you get people to save more?”
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