Change with the times

Matt Ritchie asks what impact austerity measures in Spain and Portugal will have on private pensions

Both Spain and Portugal have put in place austerity measures to bring their public finances into line in recent years, and the generous state pension arrangements have not escaped the cuts.

But what impact will the pension reforms have on provision within the countries themselves?

In Portugal's case, a major reform of the state pension system was implemented in 2007.

This saw a decrease in the benefit accruing to an individual at the end of a full career, and further changes are planned.

In the Programme for the 19th Constitutional Government, the newly-elected representatives stated steps would need to be taken to ensure the ongoing affordability of the pension system.

The government says that real growth in salaries - the basis on which the contributory charge is levied - is making it impossible to keep up with the real growth in total pension payments. This is due to the decreasing ratio of the number of workers to retirees, and the "progressive maturation of careers".

"It will be necessary to study and evaluate bringing in reforms which, while maintaining the state guarantee in the compulsory solidarity domain, introduce a savings component in old-age pensions that is based on individual responsibility, with capitalisation, in such a way as to maintain a sustained intergenerational balance."

The Portuguese Association of Investment Funds, Pension Funds and Asset Management (APFIPP) considers the government's agenda to be something of a mixed bag regarding private pension provision.

Nationalisation of the pension fund of Portugal Telecom was considered a step back. Furthermore, Portugal's banks had previously operated their own first pillar schemes but since March 2009 all new hires from the bank sector have been integrated in Portuguese social security, and since January 2011 the future service of the active population has been transferred to social security. The government has now announced it is in negotiations towards transferring these schemes' remaining liabilities as well.

APFIPP president José Veiga Sarmento said these funds represent around 75 per cent of the Portuguese pension fund market and even partially transferring them would lead to a "great reduction" in Portuguese pension funds.

Conversely, indications of a wage ceiling for contributions and the determination of the amount of the state pension would be a boost. Also, the signalled intention to introduce individual savings accounts as part of the state pension system would be expected to be beneficial.

Plans to reduce Portuguese companies' social security contribution rates - foreseen in the agreement signed between the government, the ECB, the EU and the IMF - could mean companies can spend more to provide plans for their workers.

However, Veiga Sarmento says the potential for this to bring about growth in the industry is hampered by the economic environment.

"Therefore, the near future (two to three years) will probably see occupational pension funds reduce significantly because of the announced nationalisation of the first pillar schemes sponsored by banks. After that, if the economic conditions improve and the measures announced by the government in their programme are implemented, then we will probably see a recovery of the size of Portuguese pension funds market."

Principal at Mercer Portugal Cristina Duarte expects the overall decrease in state pension provision to have the ultimate effect of increasing the role of the second and third pillars.

Indeed, Mercer is already witnessing a shift in attitudes from employers. In particular, the Portuguese divisions of multi-national companies who have traditionally not offered pensions due to the generosity of the state regime are starting to look into the issue.

"New companies I have worked with this year understand that the level of the social security pension has decreased; and will probably decrease more in future with limits on pensions. It will take some time but we are already witnessing a trend to change," Duarte says.

Of course, it is not as simple as putting a plan in place and allowing employees to join if they choose. Developing a strong private pension system will require a shift in the public's attitude to saving and retirement income.

Effective communications strategies will need to be put in place so employees know what they are getting into, and the general level of financial literacy will need to improve.

"At the end of the day you increase your social responsibility as an employer. On the employee side, your liabilities will increase and you should know what you have to do," Duarte says.

Spain
Under a plan announced earlier this year, Spain's relatively generous public pension system is to be pared back in response to the continuing financial pressures the country is under.

To reduce costs from pension provision, the country has placed new restrictions around the eligibility criteria for the state pension.
The normal retirement age will be increased, and the number of years of social security contributions necessary to receive a full benefit will also rise. To receive full benefits from age 65, 38.5 years of contributions will be required.

An early retirement provision will be in place for those who would have been able to access a full benefit at 65 prior to the changes. These citizens will be able to access a reduced state pension providing they have 33 years of contributions.

Not all changes have served to increase the age at which people can access pensions, however. Early retirement will be permitted from age 63, provided the individual has 33 years of social security contributions.

The calculation used to determine an individual's pension benefits has also been changed, with the effect of reducing the resulting figure.

While there is yet to be an indication that the reduction in benefits offered by the state will result in an increase in private provision, Mercer Spain principal Henry Karsten says it would be logical the second and third pillars will play a greater role.

For employers, the direct impact is likely to be small as the majority of employers either offer a defined contribution scheme or nothing at all.

"If it's a company with no pension plan at all, or with a defined contribution plan, they have no nervousness of any kind. For them there's no real change. Then we have this minority of cases with DB plans where each case needs to be judged on its merits," Karsten says.

Director of Towers Watson and Jaime Nieto-Marquez says the reforms do not go far enough, and further amendments are likely to be necessary in future.
"We think that making further changes to public pensions makes sense, because the system will not be sustainable as it is and the changes will still need to be reinforced in the future," Nieto-Marquez explains.

Furthermore, whilst the changes may encourage more people to save by reducing the total benefits people receive, Nieto-Marquez says that legislators could do more to compel people to provide for their own retirements, in light of increased awareness around retirement savings.

"This awareness is an opportunity for the government to establish adequate measures and platforms to encourage people to save. If you don't establish those then people will be concerned but they will not have the know how to save, on what proportion, how to control saving, and so on."

Change for the good?
The austerity measures the troubled European nations are putting in place, of which pension reforms form a large part, are not necessarily going to solve the wider problems, according to Neil Williams, chief economist, global government and inflation-linked bonds, at Hermes Fund Managers.

While much focus has been placed on the need for the countries to tackle their deficit positions, Williams argues that the reform packages implemented to date and in the pipeline have not provided the boost to growth Spain and Portugal require.

“[Pension reform] certainly does improve the situation, it does attack the problem in the longer term, but in the shorter term it simply imposes austerity depending on how you do it, and takes away the very thing that each of these high debt countries need, which is growth.”

Using a benchmark of a country’s relative unit labour costs against its current account shift as a measure of GDP to determine the competitiveness of economies, Williams says there are two main ways of shrinking the gap between the performance of Eurozone countries.

“One is for countries like Spain and Portugal to put in place things like labour and pension reform and get their fiscal positions a bit slimmed down. The other route is for Germany to reflate. Given austerity being enacted elsewhere in Europe, that, at the current time, doesn’t look like a very likely option.”

Written by Matt Ritchie

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