Europe's governments face the music
Written by Paul Burgin
July / August 2010
Politicians can no longer ignore the problem of Europe's ageing population. Budget deficits need to be reduced, meaning cuts to public and private pensions.
The European Commission esti-mated last year that European state pension funding costs will rise an additional 2.4% of GDP by 2060. Richard Warne, head of global pensions strategy at Aviva Investors, believes all EU states face similar challenges – more retirees, fewer workers and too much dependence on state systems. He says: “These are common themes but there are marked differences in the approaches adopted by each government.” The easiest step is to raise retire-ment ages. This caused riots and strikes in France and Greece, but has been generally accepted elsewhere.
Reducing dependency on state schemes through auto-enrolment or compulsion is the alternative. Few governments have the funds
to make pensions more attractive.
“I wish I could say they were using tax to encourage people to contribute,” laments Warne.
The Baltic States suffered early in the financial crisis. In Estonia, pension contributions slumped when the government was forced to cut state payments to mandatory second pillar schemes.
Mandatory funded pensions were introduced in 2002 and now cover 90% of workers. Employees must place 2% of their gross salary into the schemes. The state normally redirects twice as much from the individual’s social taxes into their personal pension pots.
But in the crisis, the government withdrew the mandatory pension deal, suspending its contributions until 2011. They resume next year at half their previous rate. The government promises additional contributions between 2014 and 2017 to make up for suspended payments. That is unlikely to prove adequate as worker contributions have collapsed too.
Ireland also had to act early after its property bubble burst and many banks had to be rescued. The government was forced to take extraordinary measures in a Budget in March to cut the country’s deficit.
A new national pensions frame-work promises an early increase in the retirement age, then stepped increases to 68 by 2028. Michael Martins, partner at Mercer Ireland, says: “The 2014 increase is quite sudden and took a lot of people by surprise. In terms of legislation, that is a fast lead time.”
Martins says most employers have not yet decided how they will handle the change. Some may opt to let staff retire at the current age and cope with just private pension income before the State scheme kicks in.
A new public sector funded scheme and an auto-enrolment fund for the private sector are also on the table. Martins says: “There was union resistance to the imme-diate proposals, so the government deferred many pension decisions whilst seeking agreement on wages.”
The new auto-enrolment scheme should be up and running by 2014. Initial plans are that employees will stump up the most with a 4% contribution taken from their salaries. Employers will contribute a further 2% and the Government another 2%.
Senior partners at Towers Watson are watching developments else-where in the EU. Progress in Holland has not been for a lack of trying, thinks Falco Valkenberg, Towers Watson’s Dutch scheme expert. After two years of disagreement, the employers and unions that control the important second pillar system recently delivered a new framework.
He says: “It is great we finally have agreement between the employers and unions. But the problem is we do not have a government at the moment, so no laws can be passed to bring the measures into force.”
The proposed measures will increase the retirement age to increase to 66 in 2020. A new system to evaluate life expectancy every five years is likely. Mandatory contributions will probably be frozen at current rates as employers fear an additional ‘jobs tax’.
In Italy, most work has concen-trated on public pensions. A big increase in public sector retirement ages from 60 to 65 is mooted next year, says Andrea Scaffidi in Towers Watsons’ Rome office. State pension contribution formulae were revised for all public and private sector employees in 1995.
Immediate action on private pensions seems unlikely, thinks Scaffidi. Contribution ceilings and capital gains tax rates were altered just three years ago.
In Spain, Towers Watson’s Jaime Nieto-Márquez, says reform has been a long time coming. In 1995, parliamentary deputies from all parties agreed the Pacto de Toledo (the Toledo Pact), which promised to look at the state scheme and recommend changes.
Nothing much has happened since then, although a report is due in the autumn. Current opinion is that the retirement age will rise along with minimum contribution periods from the current 15 years.
Yet Nieto-Márquez argues that the bigger issue of private provision is still being ignored. He says: “The second and third pillar has not developed at all.”
Retirement income replacement rates are around 80%, making the Spanish state pension one of the most generous in Europe. In contrast, Spain’s level of private provision measured against GDP is one of the worst.
Nieto-Márquez says some big firms have pension schemes, but many are inadequate. Most small and medium sized firms simply do not bother.
Last month, the government announced plans to consult with employers and unions about setting up personal LT savings accounts. Legislation may allow workers to access their accumulated ‘fondo de capitalización’ savings if they are dismissed, move geographically to find work, invest in training and at retirement.
Given that the new fondo de capitalización scheme is set for implementation early 2012, all concerned will have to work fast to beat the deadline. Convincing the public to save may take far longer, warns Nieto-Márquez.
There are no such problems in Germany. Workers are very aware that they must provide for them-selves, says Dr. Thomas Jasper, head of consulting at Towers Watson Germany. Employers increasingly see pensions as a valuable tool to attract and retain staff.
DAX-quoted companies are not obliged to contribute, but carried on regardless during the financial crisis. Jasper says: “Even hard hit auto-motive companies like BMW under-took substantial funding in 2009."
Current discussion centres on insolvency protection and the rates paid to the Pensions-Sicherungs-Verein (PSV) fund that pays out if occupational schemes fail. Rates quadrupled last year as the PSV faced 700 scheme insolvencies, including that of retail giant Arcandor.
In Britain, the new coalition government has stressed the need to cut state spending. It is reviewing the need for auto-enrolment and the role of National Employment Savings Trust scheme. NEST was introduced by the previous government for launch in 2012.
Tom McPhail, head of pensions research at adviser Hargreaves Lansdown, thinks it is unlikely the scheme will be cancelled. He says: “I would still wager NEST will happen. There is still a huge portion of society that the pensions industry is not willing to deal with.”
Cancelling the programme could save the government £600m. But, warns McPhail, there is a huge political risk in cancelling auto-enrolment only to find it is needed even more urgently in a few years' time.