“A Comparison of Pension Reform in the EU – 27: What Lessons Can Be Learned?”

The Cicero Foundation

Paris, 10-11 May 2007

Mika Vidlund

Structure of the presentation

The need for pension reform – changing demographics

Pension reforms applied in the EU countries

How drastically do reforms affect the future pensions?

Concluding remarks

The change in old-age dependency ratio (65+/15-64) in the EU countries

15

20

25

30

35

40

45

50

55

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

EU15

EU25

EU10

Source: Eurostat 2005

The change in old-age dependency ratio (65+/15-64) and the situation in 2050

EU-25 averageSource: Eurostat

FRBE

UKLV

EE

DKSE

LU

NL

LTFI

MT

HU

DE

IT

BGEL PT

ATRO

CYIE

SI CZ

PL

ES

SK

30

35

40

45

50

55

60

65

70

30 50 70 90 110 130 150 170 190 210

Percentual change of elderly dependency ratio 2004-2050, %

Eld

erly

dep

ende

ncy

ratio

205

0, %

Public pension expenditure as a share of GDP between 2004 and 2050

4

5

6

7

8

9

10

11

12

13

14

2004 2010 2015 2020 2025 2030 2035 2040 2045 2050

% o

f G

DP

EU15

EU10

Source:EPC/AWG-calculations 2006

Public pension expenditure in the EU-25 countries in 2004 and in 2050, % of GDP

SKLT

LV

MT

CZ

HU

SI

CYPT

DK

BE

AT

FR

FIDE

LU

SE IENL

ES

EL

IT

UKPL

EE

2

4

6

8

10

12

14

16

18

20

22

24

-6 -4 -2 0 2 4 6 8 10 12 14

change by 2050, %-points

pen

sion

exp

endi

ture

205

0, %

of

gdp

Source: EPC/AWG-calculations 2006

EU-25 average

Risk category Country

Low-riskDK, EE, LV, LT, AT, PL, SK, FI, SE

Medium-risk BE, DE, ES, FR, IE, IT, LU, MT, NL, UK

High-risk CZ, EL, CY, HU, PT, SI

Long-term (up to 2050) sustainability of public finances in the EU Long-term (up to 2050) sustainability of public finances in the EU

Source: European Commission 2006

Financial sustainability of public pension systems according to synthesis reports (2006 and 2003)

“ No major challenges”

SE, UK EE, LV

“Moderate challenges”

FI, DK, DE, IT, FR, IRL , NL, AT LT, SK

”Important pressures”BE PL, MT

”Significant challenges” ES, PT, EL, LUCZ,CY, HU, SL

”well prepared”

SE, UK

”manageable”

FI, DK, BE, IRL, NL, LU, PT

”further reforms needed”

IT, DE

”…indeed needed”

EL, ES, FR, AT

Joint Report 2003

Joint Report 2006

II: Pension reforms applied in the EU-27 countries

Not an easy task: reform of the pension systems

Path-dependency

- Institutional factors, structure of the pension system itself, is a decisive precondition to the way reforms are enacted- Pension systems are like elephants: large, grey, very popular but difficult to move (Hinrichs 2000)

- ”Frozen welfare landscape” (Esping-Andersen 1996)

Continental/Corporatist welfare states most resistant to change- Earnings-related, generous benefits- Contributions are paid out of one’s own purse- Social partners have a decisive role – highly fragmented pension system - e.g. in France, Germany, Italy union consent has been decisive for previous

successful reforms

Some general trends among the variation of pension reforms

Tightening the link between contributions and benefits- Most visible in Italy and Sweden, likewise in Poland and Latvia- Countries with DB scheme: no more ”best years” or ”last years” principles

Implementation of individual pension accounts - Widely adopted especially in EU12 countries

Establishment of various sustainability factors or demographic factors

Changes in pension indexation rules- Cost of living index instead of wage index or increased weight of the inflation component in a mixed indexing formula or lower adjustment by incorporating parametric component in the formula (as ”sustainability factors” in Sweden and Germany)

Measures aiming at raising the effective retirement age- abolition of early retirement pathways, raising the retirement age or making it flexible

Prefunding of pensions

Value of pension assets in the EU countries in 2004, per cent of GDP

0

20

40

60

80

100

120

140

NL DK SE UK FI IE CY LU SK BE PT ES FR PL DE AT HU CZ IT EE SI LV LT

%

II pillar

I pillar

Source: AWG (2006); EFRP 2005; OECD 2005

In the EU-15 countries the majority of pension reforms can be labelled parametric. However…

Parametric reforms can be a crucial precursor for a more far-reaching paradigmatic reform as they change the liabilities under the old system and may thus pave the way for smoother transition to a new system and benefit structure (Holzmann et al., 2005; Hinrichs & Kangas, 2003)

A new kind of interplay between public and private pension systems can be found in some countries when studying the issue more deeply.

An example from Germany

Germany:

- the pension reform in 2001 with the introduction of a voluntary pension saving scheme (so-called Riester pension) has been described as a path-breaking law which will over time substantially alter the institutional logic of the pension system (Hinrichs 2002, 2004 and 2005; Lamping & Rüb, 2004; Schmähl, 2004; Börsch-Supan & Wilke, 2006)

- movement towards a new kind of public-private mix has further been strengthened by 2004 reforms with introduction of a sustainability factor slowing the pensions adjustment as well as establishment of target values for the contribution rate

An example from France

France- According to Palier (2000), governments in France have long preferred

to increase social contributions than to cut benefits.

- Parametric changes. However, with the reform of 2003 a link between the level of pension and average life expectancy was established. Lengthening the period required for a full pension in pace with average life expectancy and especially the use of price indexation in both basic and supplementary systems decrease significantly the future pension level.

Market based approach in UK and Ireland

UK:- Opting out system. The attractiveness to opt out was raised by parametric reforms in 1986- stakeholder pensions 2001- SERPS was replaced by S2P in 2002 (MIG, Pension Credit) - Plans for moving the S2P towards a flat-rate scheme- New scheme of personal accounts in the near future?

Ireland: - Flat-rate statutory pension system - PRSA were introduced in 2002- The government has raised the basic pension significantly

Twofold pension strategy: the target is to shift pension provision to the private schemes while guaranteeing adequate incomes for the poorest pensioners

Path-breaking reforms in Sweden and Italy

Italy established NDC reform in 1995 and Sweden in 1999

In Sweden fully funded individual pension accounts

Italy is also launching individual pension accounts through the new TFR system starting from 2008

Changeover to the new system in Italy will be much slower and changes in life expectancy will not be taken into account annually but only after discussions once every 10 years

Multipillar reforms in the new EU countries

Several new Member States play an important role as “testing ground” for the ’second pillar’ pension reform

Also ”newcomers” have adopted mandatory individual pension accounts (2nd pillar) - Romania in 2006; contributions to the private savings accounts to begin in 2008- In Bulgaria a new system consisting of 2nd pillar individual accounts was implemented in January 2002

Individual pension account component much larger in the new EU countries than in Sweden

III: How drastically do reforms affect the future pensions?

Theoretical gross pension replacement rates in the EU-15 countries in 2005 and projected for 2050, %

0

20

40

60

80

10020

05

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

UK IE FI SE DK DE FR BE LU NL AT IT PT ES EL

% o

f ave

rage

ear

ning

s

Public pensions Occupational pension (II-pillar)

Theoretical gross pension replacement rates in the EU-10 countries in 2005 and projected for 2050, %

0

20

40

60

80

100

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

2005

2050

CZ EE CY LV LT HU MT PL SI SK

% o

f ave

rage

ear

ning

s

Public pensions Occupational pension (II-pillar)

What lessons can be learned?

There is no single roadmap, no “one size fits all,” what comes to pension reform.

Institutions do matter – continuity in pension policy is a visible phenomenon when countries develop their pension systems

However not even traditional Bismarckian countries have stayed intact – substantial changes come as a result of incremental steps

In many countries the income composition of the retiree will change – towards multipillar approach, shift of reliance to ”new players”

Defined-contribution savings accounts are high on the pension reform agenda. However, a range of variation in the role of the state, individual’s freedom of choice, the provision of minimum pensions, overall coverage, regulation, investment rules and benefit guarantees

Pension reform policy is a ”never-ending story”

EU can afford to grow old

According to EPC/AWG report 2006:

- There are grounds for being optimistic that the EU can afford to grow old. Reforms work and many EU countries have made real progress in recent years

- Ageing pushes up spending in the coming decades. However, other factors such as increase in the employment rate, tightened eligibility rates and declining relative benefit level will offset part of the demographic pressure.

- In the EU15, these factors are projected to curtail some 70% of the pressure caused by demographic developments alone, and in the EU10 they would offset almost all the demographic pressure.