EUROPEAN PAPERS ON THE NEW WELFARE

Pension Reforms in EU Member States: progress and Challenges

5. Secure Private Pensions Provision

Many Member States place greater emphasis on the contribution private funded provision can make in ensuring adequate retirement incomes, emphasising the positive role of diversification of risk between public and private schemes for individuals. Ageing populations, notably the retiring of the baby-boom generation, means that the financial sustainability of pay-as-you-go systems requires close attention as the dependency ratio changes substantially. However, funded systems will also be affected by population ageing.
Several countries see a role for the private pension provision as part of the total pension provision. This has traditionally been the case in some Member States (like DK, NL and UK). Moreover, the importance of private pension provision has essentially been increased by the introduction of a funded tier of statutory schemes in a number of Member States like in SE, PL, HU, EE, LV, LT, and SK. Furthermore, a great number of countries have increased provisions for occupational or private schemes that complement public pensions (DE, IT, AT).

Table 1: Coverage and contribution to income of retired people of private pension provision
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However, while the expected contribution of privately managed pension schemes is projected to increase in the coming decades, in all but a few Member States, the public pay-as-you-go pension schemes are expected to remain the principal source of income for pensioners. This will allow Member States to maintain a degree of redistribution and solidarity that is necessary to provide fair incomes to all older people and to mitigate risks associated with private provision. Moreover, the trend towards a broader use of privately managed pension provision does not allow public policy to retreat from the area. A well functioning private pension market requires transparency and a competitive market for financial intermediaries. Monitoring and regulating private pension provision is becoming an important and complex task for public policy.
As far as private pensions are based on a wider use of voluntary private pensions, they are generally used more frequently by higher income groups. This could exacerbate the impact of reductions in the level of individual replacement rates in statutory pension systems especially for older pensioners. Hence there is whole set of measures in Member States to encourage private pension savings for all income groups. One obvious option is to go through employers and social partner agreements — occupational pensions. One other option is fiscal incentives — but costs to public budgets can be substantial and concerns have been articulated on distributional impacts. This also explains the debate in some Member States about making private savings mandatory, in particular if a major part of the pension provision should be based on private saving (as is the case in many new Member States) -some countries have done so notably in the North of Europe and in Eastern Europe. Recently, IT and the UK have moved for a so called Opt Out solution. Compulsory and opt out schemes have specific characteristics which distinguish them from traditional private funded systems in terms of freedom and choice on the one hand and risks and security on the other. If private pensions are to provide retirement incomes for people with lower incomes it is essential that Member States invest in good governance structures for them. Some Member States provide relatively favourable incentives for low-income people (DE, CZ) to participate in privately managed pension provision, but this may not be sufficient. The contribution of private pensions will benefit people who are actually covered and thus a significant share of pensioners will rely only on the contribution provided by statutory schemes.7
It is important that Member States monitor whether the actual development of private pension provision matches needs, by assessing levels of coverage and benefits and their distribution by age and socio-economic status. Moreover, privately managed schemes, as well as reserve funds of pay-as-you-go schemes have to operate at a sufficiently high level of security and efficiency. Rules on acceptable investment risks and prudent assumptions about future returns are important safeguards if their implementation is well enforced and monitored, while efficiency also means ensuring that administrative charges are kept low.
Finally, the translation of individual accounts into safe and secure annuities will become more and more important, in particular for the regimes recently introduced that will begin to provide first, partial benefits in a few years and often before the end of the decade (like in PL, EE, HU, LV, LT or SK).

Figure 6: Expected evolution of private pension provision (2005)
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6. Conclusion

The NSRs highlight the interlinkages between the three broad objectives of pensions adequacy, sustainability and modernisation and the synergies and trade-offs between them. For reform strategies to be succesful, all three elements must be present and considered together. Adequacy and sustainability of pensions cannot be achieved separately: they are mutually reinforcing in a virtuous or vicious circle.

Figure 7: Projected evolutions of theoretical replacement rates (TRR) and pension expenditures for public pension schemes
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Source: ISG and AWG projections (public pension schemes include the funded tier of statutory schemes).

The evolution of theoretical replacement rates is linked to the evolution of pension expenditure. Member States with more positive developments of theoretical replacement rates appear to face more significant challenges as regards their future pension expenditures (Graph 8 for public statutory pensions) and are generally relatively less advanced in the process of pension reform (it should be noted that reforms up to 2004 are taken into account and that some Member States have introduced significant reforms since then).
If society does not develop an integrated approach linking adequacy and sustainabilty the risks are substantial. Unsustainable promises for future pensions jeopardise the possibility of adequate incomes in retirement. Inadequate accrual of pensions and delivery of low levels of income (or reducing pension provision previously promised) would create unforeseen pressures for the sustainability of public finances, as an increasing demand for ad-hoc revaluations of pensions and possible unexpected demands for other (even means-tested) social benefits can result in higher public expenditure. These situations could lead to sharp conflicts concerning the credibility of the pension system.
Increasing transparency in pension systems is important for both individuals (who need information and clarity in order to make long-term decisions) and governments (which need to develop monitoring tools for the long-term management of pension systems). A particularly interesting new feature of recent pension reforms is the introduction of automatic or semi-automatic mechanisms that contribute to a periodic monitoring of various sources of uncertainties – in particular demographic trends – and promote the likelihood of proportionate and timely reforms.

7 See Joint report on Social Protection and Social Inclusion, 2007, supporting documents, section 3.3 for a presentation of issues linked to representativeness.

References

Bontout, O. and Fischer, G. (2007): “Trends in European Pension Reforms”, Updated for the 9th Annual Joint Conference of the Retirement Research Consortium “Challenges and Solutions for Retirement Security” August 9-10, Washington, DC.

European Commission: Employment in Europe Reports (in particular 2003, 2006 and 2007 forthcoming), ec.europa.eu/employment_social/employment_analysis/employ_en.htm

European Commission: Synthesis Report on adequate and sustainable pensions (2003 and 2006), ec.europa.eu/employment_social/social_protection/docs/2006/rapport_pensions_final_en.pdf.

Joint Reports on Social Protection and Social Inclusion (2005, 2006 and 2007) and their supporting documents, ec.europa.eu/employment_social/social_inclusion/jrep_en.htm.

Joint Employment Reports (notably 2007).

Social Protection Committee (SPC).
ec.europa.eu/employment_social/social_protection/pensions_en.htm.

SPC Special Study on Promoting longer working lives (2004).

SPC Special Study on Privately Managed pension provision (2005).

ISG Report on theoretical replacement rates (2006).

SPC Special Study on Minimum income Provision for older people (2006).

SPC Special Study on Flexibility in retirement provision (2007, forthcoming).


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