1. Introduction: The Pension Challenge
Pension systems are one of the great achievements of the welfare States in Europe in the last century and remain a key element of our social model(s) also in this century. The fact that poverty is no longer the status quo for people who stop working and that many are able to maintain their standard of living after retirement are key achievements of social protection policies.
Public provision plays a central role in national pension systems, which are very diverse among the EU27, highlighting that there is no one-size-fits-all solution. While the basic goals of access, adequacy and financial sustainability are universal to all systems, there is a considerable degree of variation in design at the national level, notably as a result of historical differences regarding preferences for redistribution or individual choice.
The dominant proportion of total pension provision in almost all EU27 Member States is organised within the general government sector. Pension systems in Europe are generally built on a general statutory social security scheme, functioning on an unfunded basis (pay-as-you-go — payg — where current resources are providing the funds for paying out current benefits).
Benefits provided by those schemes are the major share of pension income for older people. The financing can be based on social security contributions (like for instance in DE, FR, ES or IT) or alternatively on taxes from the general budget (like in DK). Those schemes can nevertheless be designed in various ways, depending notably on the earnings — benefit link, for instance including flat-rate universal benefits (like in NL) or notionally defined contributions schemes where benefits are strongly related to former incomes (like in SE).
These schemes include (or are complemented by) minimum benefits for those who did not accrue sufficient pension rights. These schemes are also often complemented by funded schemes, be they statutory, occupational or voluntary: the first two categories include funded tiers of statutory schemes and all occupational schemes (where membership has a direct link to employment, be they mandatory or voluntary), while the third category includes individual schemes (voluntary where membership does not have a direct link to employment).
In spite of differences, one can depict the European general pension provision within four main clusters:
• Earnings related payg pensions, marginally complemented by occupational or voluntary pensions (notably PT, CY, CZ, MT, EL, ES, FR, LU, AT, SI, FI, RO). A number of Member States are also building reserves for their unfunded schemes (notably FI, but also BE, ES, FR or IE);
• Earnings related payg pensions increasingly complemented by statutory funded pensions (PL, HU, EE, LT, LV, SK, BG, and SE);
• Mainly flat rate public payg pensions traditionally complemented (sometimes increasingly) by funded occupational pensions (notably IE, UK, NL, DK);
• Earnings related payg pensions complemented (traditionally and sometimes increasingly) by occupational or voluntary pensions (notably BE, IT, DE, SE).
In essence the pension challenge lies in the growing gap between two decisive parameters for any pension system: life expectancy and retirement age. The former increases continuously and the latter has declined. While it was normal to retire well after the age of 60 during the 1960’s, employment of older workers declined in the 1970s and 1980s in many countries. Despite recent increases, average ages of leaving the labour market remain well below the levels of the late 1960s (Figure 1).
Figure 1: Activity rates by gender in the EU 1970 and 2005
Source: Employment in Europe (2007), forthcoming.
The decline in average effective retirement age (accompanied by an increase in the age of entering the labour market) runs contrary to the substantial increase in life expectancy during the same period. Life expectancy at 60 for EU25 has increased by about 4 years from 1960 to 2000. The most recent Eurostat projections see life expectancy in the EU25 at 65 increasing by a little more than another four years from 2004 to 2050.
In most Member States, people are now used to retiring at the average age of 60 after having started to work at around 20. In 2004, the related dependency ratio (population over 60, as a percentage of population in the 20-60 age brackets) amounted to a bit less than 40%. According to demographic projections, this ratio would increase in 2025 to almost 60% and in 2050 to 80%. To illustrate this one can notice that in 2025, the ratio of 65+ compared to 15-64 would be around 40%, but one would need to raise the age ceiling to 70 in 2050 to maintain this ratio.
The ageing challenge is common to all pension systems as all pension systems need to compensate for the decline in employment of older workers and the continuous increase in life expectancy. Pay as you go systems are directly affected by an ageing population as their future contribution base is shrinking while the number of beneficiaries is increasing. Hence, if people retire at the same age, they will benefit from a pension for a longer period. This will need to be financed by future active populations or benefits would necessarily be lower. Funded systems may be safe in terms of contribution base, but the increase in life expectancy also implies some imbalance: if contributions are not increased and/or people do retire later, benefits would be lower. In the absence of reform, defined benefit (DB) systems would be unable to maintain their promises, while defined contribution (DC) systems would result in benefit levels well below what was foreseen when people paid in. In general, potential effects of ageing and a shift in the balance between active population and retired people on rates of returns and productivity affect both systems as well. Rates of returns affect future benefits in funded systems, while productivity affects contribution levels in unfunded systems.
2. The Open Method of Coordination in the Field of Pensions in the Context of the Lisbon Strategy
Pension reforms require long-term strategies. The process of reform itself is lengthy as pensions reforms are usually built on broad consensus as they are a fundamental part of our social protection systems and of social cohesion. Furthermore, States dedicate significant amounts of public expenditure to old age provision, which in light of demographic trends is set to grow significantly. Therefore reforms of pension systems should be seen both in the context of ensuring adequate and sustainable retirement provision, and in the context of sustainable public finances as a whole and sustainable growth across the EU.
The Laeken European Council of December 2001 recognised that there could be significant benefits by enhancing dialogue and co-operation on issues related to the reform of pension systems. It endorsed common objectives of adequacy, financial sustainability, adaptability, and a working method based on the open method of co-ordination (hereafter OMC).
The basic structure of this coordination process is as follows: Member States and the European Commission have agreed to work within the open method of coordination on social inclusion and social protection. The open method of coordination works through the common setting of objectives by the European Commission and the Council of Ministers, the reporting by the Member States on the basis of these objectives, and the Commission synthesising the findings in a report which is subsequently endorsed by the Council. Then, at the EU level, overall progress, challenges and arising areas of future concern are reported on, as are the type of action to be taken.
Common objectives for pensions
The common objectives of the OMC in the field of pensions are to provide adequate and sustainable pensions by ensuring: (g) adequate retirement incomes for all and access to pensions which allow people to maintain, to a reasonable degree, their living standard after retirement, in the spirit of solidarity and fairness between and within generations; (h) the financial sustainability of public and private pension schemes, bearing in mind pressures on public finances and the ageing of populations, and in the context of the three-pronged strategy for tackling the budgetary implications of ageing, notably by: supporting longer working lives and active ageing; by balancing contributions and benefits in an appropriate and socially fair manner; and by promoting the affordability and the security of funded and private schemes; (i) that pension systems are transparent, well adapted to the needs and aspirations of women and men and the requirements of modern societies, demographic ageing and structural change; that people receive the information they need to plan their retirement and that reforms are conducted on the basis of the broadest possible consensus.
There is agreement that the key objectives of pension reforms, adequacy, financial sustainability and adaptation of systems go together: pension systems should provide adequate retirement incomes in a financially sustainable way while adapting to societal and economic change. Member States presented a first round of National Strategy Reports in 2002 and a second in 2005. These have been synthesised in 2006 by the Commission in the Joint Report on Social Protection and Social Inclusion, endorsed by the European Council and by the Commission Services Paper, ‘Synthesis Report on Adequate and Sustainable Pensions’ and its annexes (country summaries and horizontal analysis).
The Synthesis Report noted that Member States had made substantial reforms in recent years, partly to address key sustainability issues presented by ageing populations, but also to ensure that reforms provided adequate pensions for all citizens. The report also confirmed that the reform of pension systems cannot be conducted within a vacuum and must be considered alongside labour market reforms and overall public spending plans.
The Synthesis Report identified a number of key issues requiring careful monitoring:
• A key challenge is to promote more and longer working (in particular the mobilisation of previously less active members within paid work, such as women and older workers).
• There is a need to promote adjustment of systems for the management of changes in life expectancy and the introduction of a life-cycle approach in their design.
• Pension systems should modernise and take better account of the changing and more flexible nature of careers (reflecting the role of carers, periods of training and education and job mobility).
• There is a need to ensure future adequate minimum pension provisions, which will probably gain in importance notably as regards indexation rules and possible disincentives to work or save.
• A fifth key issue is the financial sustainability of public pensions systems and monitoring of the effect on government budgets (including the impact private pension systems may have on public finances).
• The evolution and development of occupational and private funded pensions was also emphasised reflecting Member States’ efforts to reform existing structures, or develop funded provisions for the first time.
• It is important to enhance transparency and to promote better education and understanding of pension issues among the public.
• Regular review and adjustment mechanisms are important innovations not only for adapting systems over time but also to promote a better understanding of the need for reform in the face of demographic challenges.
In 2006 and 2007 the OMC concentrated on deepening knowledge and policy exchange on issues highlighted by the Synthesis report. The following sections summarises work on incentives for working longer, minimum income for pensioners and private pension provision.
Pension Reforms in EU Member States: progress and Challenges: The findings and conclusions expressed are solely those of the author and do not represent the views of the European Commission.
Ruth Paserman: European Commission, Directorate General for Employment, Social Affairs and Equal Opportunities
Tags: EU pension reforms, minimum income, private provisions, the Lisbon Strategy, Working incentives