Sustainability and Adequacy of Pensions in EU countries: Synthesis from a Cross-national Perspective
3. Pension Reforms and their Aggregate Impact: Evolution of the Benefit Ratio
The changes in the benefit ratio measure the likely development of the relative value of the average pension (total public pension spending divided by number of pensioners) relative to the likely evolution of the average wage (approximated by the GDP per hours worked). All other things constant, a decline in the benefit ratio over time points to a fall in the generosity of public pensions, relative to wages. The projected reduction in the benefit ratio can also be seen to be a sign of improving public finances. However, it can also lead to an increase in the poverty rate of older people in the future, and this will require greater expense in the form of social assistance from the government. Moreover, the fall in the benefit ratio may occur because the pension system has moved partly towards private schemes, and thus public revenues and expenditures from public pension schemes will be lower in the future. Such observations should be kept in mind when interpreting the results for the changes in the benefit ratio presented below.
The results presented here are derived from the recently completed assessment of ageing related public expenditures by the European Commission. Figure 5 shows that the projected benefit ratio will be declining in the majority of EU countries, over the period 2007-2060 (Economic Policy Committee, 2009a, pp. 111).
Figure 5: Changes in the Benefit ratio % (average public pensions/average economy-wide wage) across EU27, for the period 2007-2046
Source: The 2009 Ageing Report, pp. 11 – Nale EU27 – unweighted average.
There are important variations across EU states. The main findings with respect to the development of the benefit ratio can be summarised as follows:
• The decline in the benefit ratio is quite strong for Poland (-54%), Sweden (-39%), Austria (-30%), Slovakia (-27%) and France (-25%). With the exception of Slovakia, the decline in public pension generosity will not be offset by other mandatory private pension schemes because the fall in the benefit ratio will still be more than 20%. Thus, in the absence of any counteracting policy changes to improve adequacy, future retirees in Poland, Sweden, Austria and France run the risk of being more often poor than is the case now.
• The magnitude of the decline in the benefit ratio is quite strong for Estonia and Latvia, and these countries were identified with a high at-risk-of-poverty rate for the elderly during 2008. In both countries, the expected decline will be partially offset by the new private pensions, although a decline of about 18% is still expected in Estonia. Thus, Estonia is expected to be facing a high risk of continuing to be a high poverty risk country for its older population in the future.
• Portugal could be identified as the country where the poverty risk for the elderly population is expected to be higher in the future, because of its falling benefit ratio. In Italy, on the other hand, the benefit ratio remains among the highest in 2060, despite the fall observed during the period 2007-2060.
• Greece is in a league of its own, as it remains the country with by far the highest benefit ratio, despite a fall during the period in question. However, these results do not show the possible impact of the most recent reforms in the public pension system in Greece, which involve cuts in pension payments and raising of the retirement age for both men and women. Spain and Cyprus are also countries that will continue to have a high benefit ratio in the future.
4. Impact of Reforms: Reshaping of Future Pension Systems
This section provides results showing how the structure of pension systems has changed as a result of pension reforms during the last 10-15 years. The results shown in Figure 6 are reported in terms of net replacement rates: that is, the value of the pension in retirement, after taxes, compared with the level of earnings when working, after taxes and contributions.
For each country, the first bar shows the position of low earners: workers earning 50% of the economy-wide average each year of their entire working life. The middle bar shows the net replacement rates for average earners and the third bar for above average earners (workers earning 150% of the average). By comparing the impact of reforms across these three earnings groups, we can provide an indication of changes in redistributive aspects of pension systems, arising from the reforms that have taken place during the past 10-15 years. These impact-of-pension-reforms results are derived from the simulations of pension income entitlements for future retirees, undertaken by OECD in 2009.
Depending on the effect of the pension reforms on the retirement income of workers at different earnings levels, countries can be divided into three groups: countries with reforms that protected low earners, countries with reforms that strengthened the link between contributions and pension benefits, and countries with reforms that resulted in across-the-board scaling down of pension benefits.
Figure 6: Impact of pension reforms on net replacement rates by earnings level, estimates for stylised full career workers who entered the labour market in 2006
Source: OECD (2009), pag. 80.
Results for the UK and Belgium are presented first and they stand for the group of countries where pension reforms have protected low earners. In these two countries, pension reforms are likely to leave the pension entitlements of average and above-average earners unchanged, but they will increase the benefits for low earners (by nearly 23% for the United Kingdom, and 6% for Belgium). Similar results are observed for the Czech Republic, although the differences across workers with different earnings are less noteworthy. In France and Finland, the reforms will result in a decrease in pension entitlements across the board, but the decrease in the benefits for low earners is less than that for workers with average and above-average levels of earnings. Germany offers the unique prospect of observing a rise in the pension entitlements for low earners to be accompanied by a decline for workers who have average and above-average earnings.
Poland and Slovakia represent the second group of countries. Results for these countries show that pension reforms are likely to strengthen the link between pensions in retirement and earnings when working. Such reforms are justified on the grounds that the reformed system will be fairer than a redistributive system and that it would reduce work disincentive distortions in the labour market. However, these reforms have also raised concerns regarding the adequacy of pension benefits for future retirees. In Poland, there is a strong decline in the pension entitlement of those who are low earners: -22%. In contrast, the pension entitlement is expected to fall only slightly for average earners and there will be a rise for high earners (+8%). The reform impact in Slovakia is along the same lines as observed for Poland, but the decline in the pension entitlements for low earners is smaller (-13%) and the rise observed for high earners is considerably higher (+22.7%).
The third group of countries falls into the category in which reforms will result in a similar impact on benefits for low, average and above-average earners. These two countries are likely to experience across-the-board cuts in pension benefits. Portugal is set to observe the highest decline in net replacement rates, followed by Italy. Despite these across-the-board cuts, these countries will continue to offer an impressively high net replacement rate (around 70%).
All in all, no single trend exists across EU countries, but more information of this sort is required for other EU countries, especially for the CEE countries. The pension income adequacy concerns will be arising for Poland and Slovakia as well as for Portugal and Italy. In contrast, the pension systems have become more redistributive than before in Belgium and the UK (and also in Germany and Ireland), and these countries could be seen to be addressing issues of elderly poverty. Poland and Slovakia (and also Germany) have been able to enhance a linkage between contributions and pension payments. Other trends observed are that Hungary had been moving in the other direction from neighbouring Poland and Slovakia i.e. a higher replacement rate and they will continue to rise in the future (thus, raising further concerns regarding the sustainability in Hungary).
Tags: contributins vs benefits, EU dependency ratio, fiscal crisis, future pension systems, pension reforms, pensions sustainability in EU, unemployment rate