Reforming Pensions in Europe: Evolution of Pension Financing and Sources of Retirement Income

05/03/2004

Reforming Pensions in Europe: Evolution of Pension Financing and Sources of Retirement Income

Edited by Gerard Hughes The Economic and Social Research Institute Jim Stewart Trinity College Dublin

During the 1990s Governments in many EU and Central and Eastern European countries reformed their pension systems. The reforms were in two parts (1) changes to the public pay-as-you-go pension systems to contain costs in the face of ageing populations and (2) replacement of parts of the public systems by privately managed pension plans. The contributors to this book examine how these changes are likely to affect retirement incomes in Europe and who is likely to gain or lose from them. Although the implementation of the reforms is specific to each country the book indicates that the outcomes are likely to be similar in relation to the following issues:

Gainers and Losers.
In the EU as a whole the average income of pensioners relative to the average income of employees and the proportion of retirement income provided by the public pension systems are expected to fall. The biggest losers from the reforms are likely to be women, the low paid, and part-time employees. The voluntary nature of private pension provision, the increasing withdrawal of employers from defined benefit schemes and the rising cost of privately funded pensions are all likely to lead to greater income inequality in the future and increasing poverty among the elderly.

Security and Incomes in Retirement.
The introduction of private pension plans in the reforms in Hungary and Poland were supposed to provide greater security and higher retirement incomes than would have been possible by relying on the public pension systems alone. However, analysis of their reforms shows that the pension replacement rate in Poland is likely to fall and that in both countries there is now greater uncertainty about what the level of income is likely to be during retirement. The outcome of the reforms in Italy and Germany suggests that if the pay-as-you-go pension system is weakened beyond a certain point reductions in social insurance contributions could threaten the security of their public pension systems.

Tax Benefits for Pensions.
As part of their reforms France, Germany, Hungary, Italy, Poland, Portugal, Spain, and Sweden all use tax reliefs to encourage the development of private pension plans. Yet none of these countries publish estimates of the cost of these tax concessions. The experience of countries which have used the tax system to subsidise the growth of private pension plans (Australia, Canada, Ireland, the UK and the US) shows that the average cost of their tax benefits for private pensions relative to GDP has doubled in the last twenty years. It also shows that in Ireland, the UK and the US tax reliefs for private pensions cost more than means-tested pensions for the poorest old people and that tax reliefs for private pensions are inequitable as most of the benefits accrue to taxpayers at the top of the income distribution and very little to those at the bottom.

Sources of Retirement Income.
Despite the large subsidies which government provides for the private pensions industry in Ireland analysis of the sources of income of households headed by a person aged 65 and over shows that the largest single source of income in retirement is provided by the public pay-as-you-go pension system. The public system provides about half of the retirement income of these households while the private plans provide about a quarter. The failure of private pension plans to cover the majority of the working population or to provide the major part of income during retirement raises important issues in relation to the cost and effectiveness of the subsidies for private pension plans.

Gender Effects.
Women generally have more discontinuous work histories than men as they largely bear the burden of caring for the young and the old. Reforms which strengthen the link between contributions while in work and pension benefits during retirement combine with women’s longer life expectancies to leave them the main losers of pension reforms in Europe. Analysis of the reform in Germany indicates that if gender discrimination in market based pension products is to be avoided it will be necessary for the state to legislate in favour of unisex pensions.

Intergenerational Equity.
Reforms of pay-as-you-go pension systems were often justified by their ability to make each cohort bear the cost of the increase in its life expectancy. This actuarially based concept of equity ignores the unequal social and economic outcomes experienced by different cohorts over the course of their life cycle. It is argued that these inequalities can only be addressed by public pay-as-you-go pension systems which involve redistribution between generations. Pay-as-you-go systems have the potential for a transparent, democratic decision-making process and assessment of pension choices which contrasts with market based pension systems where the collective fate of different cohorts is subject to random swings in financial markets.

Pension Coverage and Earnings-Related Pensions.
Most EU countries provide earnings-related pensions for all of those at work through their compulsory pay-as-you-go public pension systems. Some countries which rely on the private sector to provide earnings-related pensions (Ireland and the UK) have achieved coverage for only about half of the labour force. Other countries provide earnings-related pensions and achieve high coverage rates through contractual agreements between employers and trade unions (Sweden and the Netherlands). In Australia and Switzerland high coverage rates have been achieved through government mandated private pension coverage. Contractual or mandatory approaches have been adopted in countries where there is mistrust of the power of government or a philosophical bias in favour of private sector provision of pensions.

Contributors to this book demonstrate the complexity of pension provision, and highlight the dangers of focusing on one particular model of reform. They emphasise that whichever model of reform is adopted it should be recognised that encouraging pensions through the tax system or mandating compulsory provision by employers does not serve a social purpose unless the resulting pensions provide a significant amount of retirement income.