Turning the corner

Spain is healing. After exiting the EU’s €41 billion bank bailout programme at the end of last year, positive economic news has continued in the first half of 2014, with January to March delivering the third consecutive quarter of growth (0.4 per cent).

In May, Standard & Poor’s Ratings Services raised the long-term sovereign ratings of Spain debt.

As the International Monetary Fund said in a report the same month: “Spain has turned the corner.”

It has also continued on the road to reform its pension system. 2011 saw the retirement age hiked to 67, the reference period for calculating pension benefits increased from 15 to 25 years, an increase in the number of years contribution required for a full pension, and restrictions on early retirement.

This year has seen implementation of the next steps begin: controlling the cost of payments to the country’s existing nine million pensioners.

From January, pension payments’ automatic indexing to inflation was dropped. It is replaced by a minimum rise of 0.25 per cent a year, with bigger increases dependent on the state pension fund being in surplus, and a maximum increase allowed of CPI plus 25 basis points. A new ‘sustainability factor’, limiting payments to take account of rising life expectancy, was brought forward by eight years to 2019.

According to Towers Watson in Spain the cumulative impact of the measures, based on a number of theoretical examples, could be between a 10 to 15 per cent reduction in pension payments a year. For Spanish consultancy Novaster pension consultant Jon Aldecoa, however, the significance of the reform is more profound.

“The changes are historic, despite the fact they are very gradual and technical to reduce the political costs.” In effect, he says, and as others have noted, the first pillar has moved from a DB to a DC scheme – with future increases dependent on the health of the first pillar, and not necessarily keeping up with inflation.

“There is no longer a clear warranty,” says Aldecoa.

Mañana

It is, though, early days – and particularly for those hoping to see the development of the private sector pensions market, long-believed to have been stunted due to the generosity of the first pillar, which before reform provided an average 83 per cent of workers’ employed salaries, according to Inverco, the Spanish investment and pension fund association.

In March Inverco’s figures showed second pillar pensions had assets of €33.3 billion, and covered about two million members (less than 10 per cent) of the Spanish workforce. Even the third pillar, used by the wealthy to supplement the €35,000 per year maximum third pillar pension is bigger, with €59.5 billion in 7.7 million third pillar schemes. Pension assets in the UK, for comparison, amount to £2 trillion.

“The second pillar is underdeveloped,” says Inverco director general Angel Martinez-Aldama. “Neither employers nor workers are demanding second pillar schemes due to the generosity of the first pillar.”

It will take time for this to change.

First, the impact of the first pillar changes will remain modest for the time being. The sustainability factor is only to be introduced in 2019, and the changes to retirement age and benefit are being brought in over a transitional period that continues until 2027.

“The full impact will be significant but only when the legislation is fully applicable,” says Aon Hewitt in Madrid benefits director Angeles Almena.

At the moment, it is doubtful that workers even know about the changes, according to Deloitte in Barcelona pension manager Jaume Jardon.

“Pensioners are aware of the changes because they have been directly affected. However, the impact of the changes has not yet been embraced by current workers,” he says.

Moreover, even the pensioners are unlikely to have been too worried by what they’ve seen so far from the new indexation rules.

In the first year, the new rules have actually led to an increase of 0.25 per cent in pension payments in line with the new minimum, where the old indexing regime would have left them unchanged, since inflation in 2013 was about zero.

More to come

Added to this, despite repeated promises, the pensions industry is still waiting to see government plans for the second pillar. Reform was meant to be imminent last summer, but there has still been nothing.

Some remain hopeful. Jardon, for instance, says he expects proposals in the coming months – perhaps plans to ease implementation of pension plans for mid-size companies. Longer term, Spain may even look to the UK for inspiration.

“The idea that some sort of auto-enrolment might be the ultimate solution is gaining ground,” he says.

However, he admits that at the moment businesses are unlikely to stomach any extra costs and employees would be likely to see compulsory contributions as a tax increase. Others, meanwhile, are less convinced any concrete changes will emerge before elections in 18 months.

Martinez-Aldama says: “Unfortunately we are not very optimistic we’ll see any real reform of the second pillar – at least for this government.”

In fact, the one change outside the first pillar that has been seen undermines the government’s professed commitment to developing retirement savings. At the end of last year, it scrapped the exemption for pension contributions in calculating social security payments.

“For all the talk about promoting the second pillar the only real action – at least so far – is in the opposite direction,” says Mercer in Barcelona principal Xavier Bellavista.

However, there is perhaps one move that might start to prompt the population to think more deeply about saving for its future: government proposals, expected to be finalised shortly, that will see all workers over 50 sent an annual statement of the projected retirement for both the first pillar, and from any second and third pillar schemes they have – similar to Sweden’s orange envelopes.

That could help the current reforms start to hit home, says Bellavista. “Even though people today are not affected by the reforms, they will see the expected pension.”

Almena is also hopeful. “When this new communication system is in force we expect employees will be more concerned about the pensions they will receive from the first and second pillar, and that will affect the savings employees invest in pensions,” she says.

Time to talk

Whether this will be enough to invigorate the second and third pillars is questionable, particularly given the fragile state of the economy. Unemployment was still 26 per cent in the first quarter and the economy has seen the Spanish population’s savings rate halve in the last five years, Martinez-Aldama notes. Taxes, both direct and indirect, have increased dramatically.

Nevertheless, it’s a start, and it could sow the seeds for something better in future. According to Towers Watson in Spain benefits director, Jaime Nieto-Marquez, companies should embrace the opportunities for communication.

Sooner or later, he warns, employees will realise that their pension income is not going to meet their expectations and they will push for higher company contributions.

“We don’t know whether that will happen in three years, five years or 10 years, but it is going to happen,” he says. Encouraging workers to make their own contributions now, will mean those demands are more affordable in future.

“The more they make their own contributions now, the less workers are going to request in future to meet the level of income they think they need,” says Nieto-Marquez. “That’s what we’re trying to say – encourage saving now to save costs in the future.”

Peter Davy is a freelance journalist

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