Tied to a promise

Peter Davy explores Spain’s struggle with retaining its generous pension system

It might well be, as Cat Stevens had it, that the first cut is the deepest, but the last is likely to prove more painful for Mariano Rajoy.

Spain’s Prime Minister came to power at the end of last year pledging not to touch pensions – a promise reiterated several times, most recently in September in a televised interview.

Just a couple of weeks later, however, speculation was mounting that the government was consid-ering dropping pensions’ inflation link and speeding up planned increases in retirement ages. They weren’t halted by the deputy prime minister’s clarification of Rajoy’s position on pensions: “[I]n his exact words, it would be ‘the last thing’ he would touch,” she explained to reporters.

The final word?
Much, of course, depends on when and if the government seeks bailout funds from the EU to help with its debt. The previous recipients of aid –Greece, Ireland and Portugal – all had to cut pensions.

The last Spanish government already passed significant reforms. Prime among the changes is the increase in the retirement age from 65 to 67, starting in January 2013. However, the increase is incremental, creeping up by only about a month a year so will not be fully in force until 2027. Similarly, the expansion in the period used to calculate pension benefits – from the last 15 years of working life to the last 25 – is to be introduced over a decade to 2023.

“The impact will be on the medium and long term rather than short term,” says the director general of the Spanish asset management and pension funds association Inverco, Angel Martínez-Aldama.

By contrast, cancelling the inflation-linked raise for this year (as the EU has long suggested) would save the government €5-6 billion immediately. Given that the government has already introduced four austerity packages in its short term in office, there are increasingly few areas to look to achieve those sorts of savings.

Moreover, even in the long term, the changes to pensions may not be enough. The University of Valencia professor in the faculty of economics Carlos Vidal-Melia points out that they only save a third of the projected increase in spending up to 2050, leaving the country to find some way of plugging the gap for the other two-thirds.

“In other words, there is no sound basis for claiming that the system’s sustainability is assured in the medium term, the long term or even the short term,” he argues.

A ‘sustainability factor’ to link pensions to life expectancy and to be reviewed in 2032 offers little clue yet as to how the costs will be contained long term, he adds.

“The 2011 reform is just a small step towards containing the growth in pension spending as a proportion of GDP.”

Keeping with debt

And in its way, that also leaves changes in the second pillar uncertain. In some ways, occupational pensions have been relatively unaffected by the crisis. The second pillar comprises two parts – pensions and collective insurance plans, with the former accounting for less than half those covered. Moreover, most schemes now are DC, limiting the changes to investment strategies.

There has been some reaction. Benefits director for Towers Watson in Spain Jaime Nieto-Marquez says there’s a division between Spanish owned companies and foreign multinationals.

“The latter have been analysing their exposure to countries pretty deeply, and a lot of them have decided over the course of the crisis to move away from the public and private debt of countries such as Spain,” he explains.

Similarly in Aon Hewitt’s Madrid office, senior associate Aitor Corral says there is some move towards looking at alternatives such as absolute return approaches, and he says the consultancy has also been working to encourage those running pension schemes to take a more active approach to manager selection.

“In countries such as the UK trustees have no problem changing managers if they perform poorly over a few quarters. In Spain, you need a couple of years of very poor performance before anyone starts thinking about it,” he explains.

It is not just inertia, however. It’s also yields. In fact, if anything, pensions have allowed their overall reliance on bonds to grow, reckons Martínez-Aldama. While exposure to equities has dropped from perhaps 30 per cent to 20 per cent on average, high yielding debt has meant staying in bonds remained attractive.

“And not only government bonds, but corporate bonds too – in Spain and the rest of the eurozone,” he says. Time will tell how wise that proves.

As good as it gets
Perhaps most crucially, however, there’s little sign yet of any increase in occupational savings.

The OECD’s Pensions Markets in Focus study published in September put Spanish pensions at 7.8 per cent of GDP, against 88.2 per cent in the UK. Only about 20 per cent of the workforce is estimated to be covered by occupational schemes.

That doesn’t look like changing at the moment.

“The government has concen-trated on the first pillar reform not on giving incentives to develop the second,” says Spanish practice Sagardoy Abogados lawyer Gisella Rocío Alvarado Caycho.

“No one is talking about it,” agrees acting director of Madrid-based think tank the Foundation of Applied Economics Research (FEDEA) Juan Ignacio Conde-Ruiz, “not the government, nor the unions, nor employers.

“We are talking about the first pillar and even the third pillar [Conde-Ruiz reckons there could be some reductions in tax breaks there], but no one is talking about the second pillar.”

Partly, that’s not surprising. The government has no money to offer incentives, and unions are more interested in protecting jobs and wages. Employers, too, have little money to spare.

“In this economic environment companies are not going to increase their contributions,” says principal at Mercer Investment Consulting in Barcelona Xavier Bellavista, but there’s another reason too, he adds.

“Look at other countries and there is a very clear relation between the replacement ratio and the importance of the second and third pillars.”

And in that respect Spain is still surprisingly generous – even after the changes.

Despite a maximum pension of about €35,000 that can cause problems for the highest paid, for most the replacement ratio is about 80 per cent – well above the OECD average; Mercer’s recent European Institutional Marketplace Overview 2012 put it even higher, with a net replacement ratio of 91.7 per cent. Either way, it does little to encourage outside savings.

“The pensions are so generous for this generation that we don’t need to have a second pillar,” says Conde-Ruiz.

There are signs that view may be changing with the discussions over pensions. ING’s recent Europe-wide study in August showed particular concern in Spain, with 73 per cent concerned about the possibility of not having enough resources to retire (the highest in Europe). Yet attitudes change slowly; still only about a quarter of the Spanish expected to retire later as a result of the crisis, against 35 per cent in the UK.

“It’s going to be a long-term change,” reckons Bellavista.

For now, it probably just means that more cuts to the first pillar are still, indeed, to come – whatever Rajoy may say.

Written by Peter Davy, a freelance journalist

    Share Story:

Recent Stories

Podcast: The benefits of private equity in pension fund portfolios
The outbreak of the Covid-19 pandemic, in which stock markets have seen increased volatility, combined with global low interest rates has led to alternative asset classes rising in popularity. Private equity is one of the top runners in this category, and for good reason.

In this podcast, Munich Private Equity Partners Managing Director, Christopher Bär, chats to European Pensions Editor, Natalie Tuck, about the benefits private equity investments can bring to pension fund portfolios and the best approach to take.

Podcast - The power of three: Using Common Contractual Funds to improve tax outcomes for investors
Large asset owners are still investing in equities in a way where they are taxed on their income. The implication is that they get a poorer return. They need to, and can, improve this, but how?

In this podcast, AMX Head of Client and Manager Development, Aaron Overy, and AMX Product Tax Specialist, Kevin Duggan, discuss with European Pensions Editor, Natalie Tuck, about three options to help ensure good withholding tax outcomes for institutional investors.

Mitigating risk
BNP Paribas Asset Management’s head of pension solutions, Julien Halfon, discusses equity hedging with Laura Blows