Sustainability and Adequacy of Pensions in EU countries: Synthesis from a Cross-national Perspective

5. Impact of Reforms: Changes in the Theoretical Replacement Rate

Another indicator pertinent to the analysis of the adequacy of pension incomes of future retirees is the change in the ‘Theoretical replacement rate’ (TRR). The TRR indicator is calculated by the Indicators Sub-Group of the Social Protection Committee of the European Commission, and it is the change in the TRR that is adopted to highlight the impact of pension reforms.
In the first instance, the TRR is calculated for a male worker entering into the labour market around 2006, staying in employment for a full career (40 contribution years), earning average wage, retiring at 65 and accumulating pension rights under the new pension scheme. The pension entitlement for this hypothetical worker is divided by the projected average wage in the immediate previous time period to calculate the theoretical replacement rate. This ratio is then compared with the replacement rate for someone who would have accumulated pension rights under the current pension policies. The change will then approximate how reformed pension reforms will affect future pension entitlements. The calculations cover pension entitlements from public pensions and mandatory private schemes as well as private schemes that are expected to play a significant role in the pension incomes of future retirees.
Figure 7 displays the change in the TRR from the current situation to the prospective situation in 2046. There are wide variations across EU states. The TRR (net) is projected to decline in twelve countries, and the most notable fall is observed for the Czech Republic (-21 p.p.), Portugal (-20 p.p.), and Poland (-19 p.p.). Closely behind them are Sweden (-13), Spain and Latvia (-12) and Ireland and Finland (-11). This decline in the TRR is a reflection of reforms that have taken place in these countries over the recent past and which have lowered future benefits in most instances. An increase in the TRR is expected for eight EU states, the most notable of them being Romania (+52 p.p.). Other significant increases are observed for Bulgaria (+15) and Cyprus (+14) and for these countries the TRR was relatively low in 2006.

Figure 7: Changes in the theoretical replacement rate (net), for the period 2006-2046, for a stylised full career male worker on average wages retiring at 65

Source: Updates of Current and Prospective Theoretical Pension Replacement Rates 2006-2046 (Annex – Country fiches) – Dec. 8th 2009.

6. Conclusions: Policy Challenges going Forward

Fiscal policy challenges…. first stating the obvious: budgetary consolidation is required in many EU countries. Not so obvious is the question “when” and “how”? “when”: consensus towards austerity as soon as possible while not putting economic recovery at risk…. “how”: it’s not just about reducing deficit and debt, but also about adjusting budgetary structures and not missing out on welfare goals. Important to realise: what risks are faced with regard to reducing employment growth in the future (and thus increasing the burden for future pension spending?). Important to have a good understanding of what compromises are being made on the social front!
Labour market policies challenges….? Stating the obvious: Improved (re-integration of groups with typically low employment (particularly women, older workers, disabled persons); a longer and less disruptive working career promotes both sustainability and adequacy. Not so obvious are the ways to encourage extending working life as an opportunity instead of a constraint!
Not so obvious is to determine how to compensate mothers for childcare responsibilities but without affecting incentives for them to return to work. How to improve financial education and change behaviours towards greater work and savings towards retirement? What policies to be aimed at improving employers’ attitude towards hiring and retaining older workers? What improvement in the health and safety environment of work places are absolutely essential?
Pension policy challenges…? Stating the obvious: avoiding early retirement pathways, and raising pension eligibility age in accordance with development of life expectancy! And, do not lose sight of adequacy considerations! Not so obvious is to know whether a move towards private funded second pillar still remains the right course? Or, are parametric adjustments to the PAYG system sufficient? What regulations are required, at the national and the European level? What simpler, more direct, policies to address poverty in “old age•: is raising social minimum pension levels to the poverty line level the way forward? What balance should there be between incentives to work and save and at the same time provision of the social safety net.
… In view of the evidence available, countries must make a fresh assessment of the social objectives aimed at in their pension policy and re-examine how recent policy reforms compromise the pension income adequacy of future retirees…!

Economic Policy Committee (2009a): The 2009 Ageing Report: Economic and Budgetary Projections for the EU-27 Member States (2008-2060), Joint Report prepared by the European Commission (DG ECFIN) and the Economic Policy Committee (AWG), European Economy 2/2009.
Economic Policy Committee (2009b): “Sustainability Report 2009”, European Economy 9/2009.
Social Policy Committee (2009): Updates of Current and Prospective Theoretical Pension Replacement Rates 2006-2046, available at:
Eurostat (2010): “Provision of Deficit and Debt data for 2009 – first notification”, EUROSTAT News Release: Euro Indicators, 55/2010 – 22 April 2010, Luxembourg.
OECD (2009): Pensions at a Glance 2009: Retirement-Income Systems in OECD Countries, Paris.
Zaidi, Asghar (2010a): Poverty Risks for Older People in EU Countries — An Update, Policy Brief Series, the European Centre Vienna, January 2010.
Zaidi, Asghar (2010b): “Fiscal and Pension Sustainability: Present and Future Issues in EU Countries”, Policy Brief Series, the European Centre Vienna, February 2010.
Zaidi, Asghar and Malgorzata Rejniak (2010): “Fiscal Policy and Sustainability in View of Crisis and Population Ageing in Central and Eastern European Countries”, Policy Brief Series, the European Centre Vienna, August 2010.

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