European Commission: Private pensions schemes - their role in adequate and sustainable pensions

8/9/2019 European Commission: Private pensions schemes - their role in adequate and sustainable pensions

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Private pensionschemes

Their role in adequateand sustainable pensions

European Commission


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This publication is supported under the European Community programme or employment andsocial solidarity (200713) (Progress). This programme is managed by the Directorate-General

or Employment, Social A airs and Equal Opportunities o the European Commission. It wasestablished to nancially support the implementation o the objectives o the European Unionin the employment and social a airs area, as set out in the social agenda, and thereby contributeto the achievement o the Lisbon strategy goals in these elds.

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CONTENTS

Introduction

Adequate and sustainable pensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5Private pension schemes

The role o private pension schemes is growing... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

... but varied . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Securing adequacy in unded, privately managed schemes 10

Coverage and contribution levels

Pension levels: a risky business

Tackling career break risk

De ned bene t versus de ned contribution schemes . . . . . . . . . . . . . . . . . . . . . . .12

Longevity risk: the pay-out phase

Only annuities protect against longevity risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Balancing the fnancial risk

Balancing risk, security and a ordability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Protecting bene t levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

The impact o charges and costs

Setting caps on charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Better fnancial education is needed

Promoting nancial education . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Enhanced in ormation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

The impact o tax policy

Bene ts o tax incentives are uncertain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Better monitoring needed

The impact o the crisis

Conclusions


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To address the challenge o populationageing, the European Commission

and the Social Protection Committee(SPC) are working with MemberStates to support, monitor and assessthe impact o re orms to pension sys-tems on the twin goals o developingadequate pensions and ensuring thelong-term sustainability o pensionsystems. In the course o its work onachieving the commonly agreed objectives or pension provision, theSPC has examined most aspects o the policy challenges or statutory,publicly managed schemes that are -nanced on a pay-as-you-go basis. Thissquares well with the act that thebulk o income provision or todayspensioners is delivered by schemes o this type. Indeed this is the case evenin those ew countries (e.g. Denmark,Ireland, the Netherlands and the UnitedKingdom) where, rom the outset, pri-vate provision was given a signi cant,o cial role in total provision.

However, over the last decade a largenumber o Member States, as part o

re orms to strengthen the sustainabilityo pension systems, have sought to en-gage the social partners and individualcitizens more directly in pension provi-sion by enlarging the uture role or pre-

unded, privately managed schemes.

With their growing economic import-ance, the pre- unding and tax expend-iture aspects o these schemes havedrawn increasing attention rom au-thorities with responsibility or nan-cial markets and services or or publicbudgets. For the SPC, by contrast, it isprimarily relevant to take a closer look at the contribution o unded, privatelymanaged schemes to the adequacyand sustainability o pensions and inparticular to shed light on some keyissues in unded and privately man-aged schemes, which must be mas-tered i they are to per orm well asvehicles or social protection.

Introduction


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Private pension schemes Their role in adequate and sustainable pensions

In April 2008 the SPC adopted a reportwith the results o its study entitled

Privately managed unded pensionschemes and their contribution to ade-quate and sustainable pensions. Direct-ed at Member States, this report soughtto highlight some o the lessons learnedabout private, unded pensions.

Whereas the report tended to ocus onthe potential risks to ull adequacy in-herent in pre- unding, present concernsabout private pensions are much widerand tend to centre on undamental sus-tainability. The sudden reduction o thebook value o pension und assets by1535 % caused by the nancial crisis inthe last quarter o 2008 has underscoredsome o the basic vulnerabilities in pre-

unding as a nancing vehicle and ser-iously diminished public con dence inprivately managed schemes.

Restoring schemes to solvency whileavoiding the possibility that sponsors

(employers, trade unions, members)pull out or subsidies are reduced (tax

expenditure) have become key pri-orities as the very survival o schemessometimes may be threatened. Obvi-ously, economic recovery, including in

nancial markets, will determine mucho the ability to re-establish solvency.But the strengthening o mechanismsthat allow schemes to better absorbeconomic shocks by distributing thecosts among all stakeholders will alsobe called or. Likewise changes toscheme design and investment strat-egies will o ten be necessary to reducethe risk exposure o pension savers.

This little booklet seeks to highlightsome o the main issues which mustbe mastered i privately managedpre- unded schemes are to success-

ully ll the role o important con-tributors to adequate and sustainablepensions envisaged or them in manyMember States.

Adequate and sustainable pensions The adequacy o pensions relates to their ability to prevent poverty and socialexclusion in old age and to ensure a decent living standard or the retired, thatallow them to share in the economic well-being o their country and to partici-pate in public, social and cultural li e. For pensions to be socially and politicallysustainable they must be adequate and or pensions to remain adequate theymust be nancially sustainable, i.e. possible to nance without underminingthe nancing o other key aspects o sustainable societies. Adequate uturepensions require pension systems to be nanced sustainably in the ace o rapidly ageing societies. The adequacy and sustainability aspects o pensionsare thus inextricably linked.


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Pension systems vary extensivelyacross Member States and there are

signi icant di erences not only intheir structure but also in the termin-ology used. In broad terms, however,individuals can draw retirement in-come rom:

statutory social security schemes;(1)

occupational pension schemes(2)that are linked to the employmentcontract and mostly based on col-lective agreement;

individual pension savings con-(3)tracts with nancial service pro -viders, linked to voluntary, individualdecisions.

In this brochure, the term private pen-sion schemes includes all pre- undedschemes that are privately managed. Itincorporates both:

all statutory (mandatory) ully->unded schemes such as second

tiers o statutory schemes, where

social security contributions arediverted into individual accounts,which are privately managed;

supplementary (voluntary) und->ed schemes all occupationalpensions including book reserveschemes as well as individual sav-ings dedicated to a pension pur-pose, notably pension savingslinked to annuities, but excludingother long-term savings products.

In other words, it does not cover re-serve unds accumulated within the

pay-as-you-go public schemes or indi-vidual long-term savings which do nothave speci c pension purposes.

The role o private pensionschemes is growing...

In most Member States, a dominantproportion o total pension provisionis organised within the general gov-ernment sector, with a noticeable im-pact on public nances. Until the early1990s private schemes only played asigni cant role in the pension systemso Denmark, Ireland, the Netherlands,Sweden and the UK, where the initiallimiting o pay-as-you-go public pro-vision to basic, fat-rate pensions oreverybody had spurred the growth o private provision, whether in the ormo collective occupational pensionsor individual pension insurance con-tracts. Yet, in the last decade o pen-sion re orms in response to populationageing many more countries have

expanded the role o existing privateschemes or introduced new elementso pre- unded, privately managedpensions into their pension systems. This has typically happened in ordereither to improve the overall adequacyo pension provision by adding privatecomponents to the scope o publicprovision or to compensate or reduc-tions in the uture replacement rates o public schemes resulting rom re orms.Other reasons cited by Member States

Private pension schemes


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which have a signi cant proportiono or are moving to greater reliance

on private unding in their systemsinclude wishes to diversi y provision,boost choice, improve transparencyand oster greater individual respon-sibility. Traditionally, private pensionprovision has been discretionary andvoluntary or optional in line with itscharacter o remuneration (occupa-tional schemes) or individual purchaseand saving. Yet as private provision hasbeen given greater o cial roles in pro-vision, public regulation has increasedand gradually reduced these origin-al characteristics which made themparticularly questionable as vehicleso social protection since they o tenresulted in ragmented coverage andunequal and insecure bene ts.

Indeed when a number o Member Sta-tes (Estonia, Latvia, Lithuania, Hungary,Poland, Romania, Slovakia and Sweden)recently reshaped their statutoryschemes by introducing a mandatory

component o unded, privately man-aged pension schemes to complement

the traditional statutory un unded tier,they created an entirely new mix o pub-lic regulation and private managementin European pensions, even though inmost o these cases the transition is notyet complete and some important policydecisions remain to be taken.

... but varied

The current role o private pensionschemes di ers widely across MemberStates, not only regarding their contribu-tion to the total income o retired peoplebut also in terms o levels o coverage o active members, maturity o schemesand size o accumulated unds.

As shown in the table below, MemberStates broadly all into our categor-ies when it comes to how and theextent to which they use private pen-sion schemes.

Voluntary coverage rates by deciles o income

Source: OECD Coverage o unded pension plans [DAF/AS/WD/PEN(2007)].

0

20

40

60

80

100

United KingdomIrelandGermany

10987654321

(%)


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The current overall contribution o pri-vate pension schemes to the income o retired people varies greatly across theEU. Indeed a lack o agreed measures,combined with contrasting systemsand the possibility o double counting(when coverage rom various sourcesis added) means that at present thereare no readily comparable internation-

al data sets in this eld. It is there oredi cult to accurately determine cover-age and contribution levels.

In the vast majority o Member States,pay-as-you-go statutory publiclymanaged pension schemes providethe dominant proportion o pen-sioners incomes. As private schemesprovide complements o incometo pensioners, their importance to

a certain extent refects the scaleo the public pay-as-you-go provi-sion. But where they are not simplymandated actors such as the mag-nitude o tax expenditure and othersubventions and the character o theindustrial relations system (crucial orthe spread o occupational schemes)also infuence their prevalence in ma-

jor ways.

As many pre- unded schemes haveonly been introduced in the last dec-ade and they take 30 to 40 years (i.e.the length o a work career) to ma-ture, it is hardly surprising that in mostMember States, the contribution o pri-vate pension schemes to the incomeso present pensioners remains ratherlimited. Even in those countries where

Use o private pension schemes across the EU

Member States all in to our categories, i e those that Examplesuse little private unding and do not intend to change this even thoughthere has been some marginal increase in private scheme coverage.

Spain, France,Luxembourg, Malta

have always based part o their pension promises on private, undedschemes but where the role o such schemes has increased and is stillevolving. While pay-as-you-go schemes provide e ective protection againstpensioner poverty, they will not necessarily secure ull pension adequacy inthe sense o replacement income, there ore they are combined with private,

unded schemes.

Denmark,Ireland, theNetherlands,Sweden (*),the United Kingdom

recently have reshaped their statutory systems to include a tier o mandatory

unded, private pension schemes and nanced these by shi ting parts o theoverall pension contribution away rom the pay-as-you-go scheme. In mosto these countries signi cant parts o the uture adequacy o pensions is setto be based on these schemes which are expected to contribute to povertyavoidance as well as adequate income replacement.

Bulgaria, Estonia,

Latvia, Lithuania,Hungary, Poland,Romania, Slovakia,Sweden (*)

have earnings-related pay-as-you-go social insurance pension schemes butare now shi ting parts o their adequacy promise to an expansion o existingor newly created pre- unded, private pension schemes.

Belgium, Germany,Italy, Austria

(*) Sweden falls within two categories.


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Contribution o private pension schemes varies across the EU

such schemes are most developed theypresently contribute at most a third o

the total income o retired people. Thisis because they only cover a limitedpart o todays pensioners and because

most schemes are only still maturing. The map below demonstrates that

their role is modest or almost negligi-ble but will grow in a number o coun-tries as a result o recent re orms.


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When governments assign a con-siderable role in pension provision

to pre- unded, privately managedschemes they need to take accounto the key social protection vulner-abilities in scheme design. These in-clude aspects such as coverage andcontribution levels, the manage-ment o the multiple risks associated

with the accumulation and pay-outphases, the impact o charges and

the need or in ormation, inancialeducation and monitoring o schemeper ormance. These are all issueswhich need to be tackled to makeprivate schemes into ully depend-able contributors to the adequacy o the overall pension package.

Securing adequacy in unded,privately managed schemes

Coverage and contribution levels The overall contribution o private pen-sion schemes to the income o retiredpeople refects the level o contribu-tions, the coverage o such schemes,their maturity (i.e. the proportion o pensioners with a ull career coveredby the scheme) and their weight in thepension system.

Coverage and contribution levels o private schemes should refect their in-tended role in the overall pension sys-tem. I they are meant to be or become

an essential component o retirementincome or the whole population, cov-erage and contribution levels need tobe high. I they are a top-up to otheruniversal retirement provision to en-sure similar replacement rates or all,then coverage may only need to betargeted at certain segments o thepopulation. I coverage is optional orsponsors and voluntary or members,young and low-paid workers are leastlikely to be covered and most likely tohave breaks in contributions.


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The adequacy o pension bene ts incontributory pre- unded schemesis subject to a number o uncertain-ties and risks. Those covered mayexperience a break in their pension

contribution records as a result o work career interruptions due to socialevents such as unemployment, sick-

ness, maternity or caring duties (socialrisk). They may outlive their capital(longevity risk), infation may erode

uture pensions (infation risk) andreturns may become unexpec tedly

low or turn negative ( nancial risk).Furthermore, the combined e ect o these risks is greater than the sum.

Estimated contributions o statutory unded, occupationaland voluntary pension schemes to pensioners income in 2006 and 2046(% o theoretical replacement rates)

Source: 2008 SPC study Privately managed unded pension provision and their contribution to adequate andsustainable pensions, table 7

Pension levels: a risky business

0

10

20

30

40

50

60

CYITBEHUDEUK SELTIESK PLLVDK NL

2006

2046


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De ned bene t versus de ned contribution schemes The risks or bene ciaries in a unded, privately managed pension scheme di -

er markedly depending on whether it is designed as a de ned bene t (DB)or a de ned contribution (DC) scheme. In a DB pension scheme the nancialand longevity risks are borne by the scheme sponsor. Bene ts to members aretyp ically based on a ormula linked to members wages and length o employ-ment. By contrast, bene ts to members in DC schemes are solely a unctiono the amount contributed by the member and the sponsor and any returnon that investment. Thus in DC schemes it is members that have to bear the

nancial and longevity risks.

DB designs were typically used in older occupational schemes to emulate the

bene t ormula in civil servants schemes. But the number o such schemes hasbeen alling or years. Nearly all schemes established in the last 20 years areo the DC design. This goes or occupational as well as or statutory schemes. Thus where Member States have shi ted part o their social security pensionprovision into privately managed unds with mandatory participation theyhave all used the DC design.

Tackling career break risk

Most pension schemes were tradition-ally designed or men working long

ull-time careers as amily breadwin-ners. Womens pension needs weremet through their husbands contri-butions or, a ter his death, throughwidows pensions complementedwith child allowances. This approachis still refected in the basic principleso many pension schemes, althoughMember States are progressivelyadapting their systems in accordancewith existing Community law andin the light o higher labour market

participation o women and aspira-tions to greater gender equality.

In schemes where bene ts are closelyrelated to contributions, career breakswith interruptions or substantial low-ering o pension contributions raiseconcern about the uture adequacyo pensions. Groups that tend to havemore career breaks due to amily du-ties, unemployment or sickness willbe particularly a ected. Women, thelow-skilled and the low-paid may be atspecial risk.


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Career breaks generally have strongere ects on pension bene ts in DC than

in DB schemes. This is because the cal-culation o bene ts in the latter are notnecessarily as closely related to thecontribution record o the bene ciaryas in a DC scheme.

Thus DC schemes provide higher bene-ts or those that have longer working

careers and smoother wages over theirworking li e. Those who nd them-selves unemployed or long periodso their working lives or have brokenwork records or other reasons will beless well o in retirement. In MemberStates where unded pensions are ex-pected to play a signi cantly higherrole in the uture, this could result in agreater incidence o pensioner povertyamong vulnerable groups with poorerwork and income records.

Depending on the exact role supple-mentary pensions are playing in anyparticular Member States pension sys-tem, it may be important to pay con-tributions at a certain level or credit

career breaks (in particular, unemploy-ment, sickness/disability, maternityand parental breaks) to ensure the ad-equacy o nal pension income. Somecountries have introduced solidarity

elements into their statutory undedschemes. Others have also done so in

occupational schemes, or example bycompensating or certain periods out-side active employment (e.g. with thestate paying contributions during pe-riods o childcare or unemployment). The costs o such rules may, however,be quite signi cant and also a ectwork incentives.

In Member States which rely moreheavily on private provision, the link with minimum or means-tested uni-versal income in retirement needs tobe care ully designed. The provisiono a means-tested retirement incomemay discourage saving or some, sinceadditional income rom savings couldlead to a reduction in their entitlement

or means-tested bene ts. The UK, orexample, has sought to tackle this is-sue using savings credit, a decreasingsupplementary bene t which rewardssavings by those who are eligible ormeans-tested bene ts. Yet, tapering o assistance in this way is more expen-sive due to increased coverage. While

encouraging take-up, the UK is there-ore also re orming pension credit aspart o its wider pension re orm pack-age to ensure that it remains appropri-ately targeted and cost-e ective.


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The organisation o the pay-out phasein private schemes impacts on the

adequacy o bene ts. Scheme de-sign should o er su cient protectionagainst infation and survivor risks and

or longevity.

There are three broad groups o pay-out products.

Annuities> are most commonlyused as pay-out products in man-datory or semi-mandatory DC pen-sion schemes. They provide period-ical payments to bene ciaries withinsurance against biometric riskssuch as longevity and there is thepossibility o survivors protectionin the event o death, based on theuse o li e expectancy tables.

Lump sums> provide a single pay-ment to bene ciaries, leaving it tothem to ensure that this providesa su cient pool o income during

retirement. In a signi cant propor-tion o countries, citizens may opt

to take the whole or substantialproportion o retirement savingsas lump sums.

Phased withdrawals> provideperi odic payments, but withoutany insurance against the longev-ity risk, progressively diminishingthe capital available.

Member States vary greatly as towhether scheme members can choosebetween annuities, phased withdraw-als and lump-sum payments. In mostcountries where private, undedschemes are mandatory, annuities arecompulsory (e.g. Estonia and Roma-nia). There are also requirements totake up an annuity in some occupa-tional pensions (e.g. the Netherlands),but elsewhere pension savings canbe taken as lump sums under certainconditions (e.g. the UK).

Longevity risk: the pay-out phase


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Only annuities protect againstlongevity risk

Annuities guarantee an income or li eregardless o its eventual length and,as such, are the most secure meanso providing an income in retirement. They are common in many countries(and or some, they constitute the onlyoption available), but where voluntarythey are not as prevalent as might behoped. This is because people canbe somewhat short-sighted regard-ing their nancial uture; in particularthey tend to underestimate their li eexpectancy and o ten opt or phasedwithdrawals as this enables themto bequeath any remaining money.With annuities, the remaining streamo payments can only be inherited

during a guaranteed period (i thatoption is chosen) and so can seem to

be less attractive. As bene ts romprivate schemes o ten complementli e-time bene ts rom public schemespeople may be tempted to take in theirprivate pensions as lump sums in orderto raise their short-term consumption.While this at times may make sense theenvisaged contribution to pension ad-equacy rom private schemes will here-a ter be missing rom their pensionpackage. Although phased withdraw-als or lump sums can sometimes beconverted into annuities, this is rarelyundertaken without compulsion. Sincethe risk that the bene ciary will outlivethe money available is growing withrising longevity only annuities are ullysuited to ensure adequacy.


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Rates o returns i.e. the ratio o mon-ey gained or lost on an investment rel-

ative to the amount o money invested tend to fuctuate signi cantly overtime, posing signi cant risks or pen-sion adequacy. I rates o return arelower, pension savers need to stay inthe labour market or more years tocontribute longer and ensure the samelevel o bene ts. Thus, to provide peo-ple with adequate in ormation on theirexpected pension level on retirement,to take decisions regarding urtherlabour market participation, assump-tions about projected long-term rateso return need to be made with a rea-sonable level o accuracy. In this con-text, well- unctioning nancial super-visory bodies and e ective nancialregulatory rameworks are essential.

Future bene ts depend both on net re-turns during the accumulation phase

and on the actuarial calculations thatdetermine bene ts in the pay-outphase. Both o these phases are equal-ly important and thus require care uldesign and supervision.

While legislators in most o the Mem-ber States have introduced measuresto mitigate investment risks, ew havebrought in a direct mechanism o guarantees against investment risksin the accumulation phase. Regardingguarantees in the pay-out phase, thereare increasing calls or nancial serviceproviders to have reinsurance to covertheir liabilities i they should ail.

Balancing the nancial risk


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Balancing risk, securityand afordability

Measures to protect against nan-cial risk have costs. Tight regulationsaimed at short-term nancial stabil-ity can become counterproductive i large and rapid increases in the levelso contributions are required to restore

nancial reserves a ter an economicdownturn. Particularly since this mayincrease the cost o labour and reducespending during a nancial crisis, aswas the case at the start o the last dec-ade in the Netherlands.

Achieving an appropriate balancebetween the short-term security o pension schemes and the overall long-term robustness o the pension systemremains a challenging task or poli-cymakers and regulators. In the lastdecades, regulations have been loos-ened in many Member States to allowpension unds to seek greater returnsby investing a larger share o unds inmore risky assets. Losses in the presentcrisis have raised calls or tighter regu-

lation o pension und investments.

Minimum returns can be used to pro-tect savings against investment risks,but such guarantees imply costs. Thesemay be both direct payment o an

insurance premium in the case o acapital guarantee and indirect

through lower overall returns becausethe provider opts or a conservativeinvestment strategy aimed merely atmeeting the target set by the mini-mum return.

Protecting bene t levels

Bene t levels may also obtain impor-tant protection against investment risk by altering individual port olio struc-tures when people are approachingretirement. It is thus advised to developa li ecycle approach towards invest-ments: with such a strategy, youngercitizens choose riskier products witha higher chance o earning more overones li e; in contrast, people close to re-tirement select xed interest productsto avoid the risk o large drops in assetvalues be ore turning pension savingsinto annuities.

As prices o annuities will vary, theexact month in which assets are an-

nuitised may signi cantly a ect thesum o bene ts received. It is there-ore important that regulators allowor some fexibility in the time rame

within which assets have to be turnedinto annuities.


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Administrative charges levied by pen-sion unds can represent signi cant

costs and as such signi cantly reducepension levels. This may be particularlyserious or low-income earners, whomay have di culty accruing adequatebene t levels. For private, unded pen-sion schemes, administrative costs area key variable to consider. Di erencesin costs add up to huge di erences inpension bene ts in the long run: orinstance a yearly charge o 1 % o as-sets will, over 40 years, consume asmuch as 20 % o total contributions ( 1). Thus governments have a clear role inkeeping costs low and acilitating ac-cumulations o adequate levels o u-ture pension bene ts. The challenge ishow to regulate the ee structure so asto maintain a proper incentive design

or und participants as well as or undmanagers. Policies used by MemberStates vary rom so t to strict regula-tion o charges.

(1) I a person saves 100 currency units per year or40 years, that would make 4 000 currency unitsby the end o his or her career ( or simpli cation,infation and the real rate o return equal zero). I administrative charges amount to 1 % o assetsper year, the accumulated charges a ter 40 yearsamount to about 720 currency units. This meansthat the level o charges as a percentage o totalcontributions made would amount to around 18 %.

Setting caps on charges

In a context o low transparency, cus-tomer choice and in ormation disclos-ure is unlikely to deliver low costs byitsel . Speci c regulation, in particularthrough caps on charges, is there orelikely to be needed. Thus, some Mem-ber States have set cost caps on man-agement ees, or in terms o the syn-thetic cost indicators, or instance in theUK. In other countries, limits are put onthe cost structure. In Italy, or example,the duplication o management ees isnot allowed: this discourages pensionscheme asset managers rom invest-ing in mutual unds managed by other

und management companies.

There are, however, also downsides tocost caps. For example, they may haveambiguous in ormation content: whilethey may prevent products with exces-sive costs being o ered in the market,they may also limit competition by sig-nalling as acceptable a particular levelo cost that is not necessarily optimal.

The impact o charges and costs


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With the introduction o unded, private-ly managed schemes, pension systems

have become ar more complex. Peoplemay be asked to choose between vari-ous pension scheme providers and theyare presented with options concerningthe investment o their contributions. Forincentives in scheme design to work and

or pension markets to unction, peopleincreasingly need to make in ormeddecisions about pension products, theirsavings and about the length o theirworking li e and the timing o their re-tirement. As scheme members are askedto take more responsibility or their pen-sion they need to better understand -nancial issues in order to make in ormedchoices. Indeed, those who are less -nancially literate are less likely to bene t

rom more complex nancial arrange-ments and there ore less likely to save orretirement. Without nancial education,those who are con ronted with a widechoice or complexity will tend towardsinactivity. This underlines the necessityto use automatic enrolment and de aultoptions or workers who may not be mo-tivated to make in ormed choices.

Promoting nancial education

Education di ers rom in ormation asthe ormer combines the latter withskill building and motivation to changebehaviour. Both have been ound to besuccess ul: or example, an awarenesscampaign was undertaken in Irelandto promote understanding o how thepension system worked. The action saw

a simultaneous increase in take-up o personal retirement accounts, particu-

larly among its target age bracket o 2535 year-olds. As such, awareness incombination with nancial literacy maynot only improve the situation o thespeci c customer, but also boost the

nancial services market by making itmore competitive.

Two studies on Member State initiativesto provide nancial education have

ound that in ormation is providedby a range o sources rom nancialsupervisory authorities, adult literacyagencies, debt advice clinics, socialworkers, nancial industry ederations,micro nance organisations, consumerrepresentatives, education authorities,individual nancial rms and housingauthorities ( 2). Above all, though, na-tional authorities were identi ed as themain drivers o such initiatives.

The European Commissions recentcommunication outlining the basicprinciples or the provision o high-quality nancial education schemes

shows its support or such actions (3

).It has also established the Dolcetawebsite o ering consumer educationon each national market in Commu-nity languages.

(2) Observatoire du Crdit et de lEndettement etal., FES (2007), Better access to nancial servicesand nancial education, Report o the survey on

nancial education, April 2007, and Evers and Jung

(2007), Survey on nancial literacy schemes in theEU-27, November 2007.

(3) http://ec.europa.eu/internal_market/ inservices-retail/docs/capability/communication_en.pd

Better nancial education is needed


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20

The impact o tax policy

Enhanced in ormation

While guidance and regulation di ersgreatly between countries, there arecertain discernible trends not least to-wards greater simplicity. In particular, theneed to use simpler language to avoidcon using citizens has been highlighted(in Ireland and Spain, or example).

In ormation should be tailored ac-cording to peoples needs and theircircumstances. General guidance isnot appropriate or all individualsand, in attempting to o er clear andsimple in ormation, there is a danger

that it may be made so generic that itbecomes meaningless. This has led to

calls or personalised advice althoughthis may be expensive and di cult toimplement.

Any sort o in ormation, particularlypersonalised, also raises the issue o liability. Whoever supplies the in or-mation may also be seen as liable orits quality and use. As such, supplierscan be reluctant to provide any orm o in ormation that might be construedas advice beyond the generic through

ear o being held responsible or anyun oreseen results.

The ultimate goal o tax relie to unded,privately managed pension schemesis to reward private saving in order toensure a higher standard o living inretirement, both by encouraging moreprivate saving and by contributing tothe nal sum. The e ciency and cost o

these tools clearly depend on whetheradditional savings are made. There aremany di ering actors that can infu-ence peoples pension saving such asadvice rom nancial advisers and en-couragement rom employers.

Within this ramework, a number o Member States consider that tax relie plays an important role as an incentive

or individuals to join and participate inpension schemes. Providing such tax re-lie can be expensive. The Organisation

or Economic Cooper ation and Develop-

ment (OECD) projections suggest that,while demographic changes will meanan increase in revenues rom taxation o pension income rom unded schemes,the costs o tax relie will continue tooutweigh revenues collected ( 4).

(4) Pablo Antolin, Alain de Serres and Christine dela Maisonneuve (2004), Long-term budgetaryimplications o tax- avoured retirement plans,Economics Department Working Papers No 393,OECD.


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Bene ts o tax incentivesare uncertain

Furthermore, there is a lack o clear evi-dence or the e cacy o using tax relie to encourage citizens to invest more inpensions. For instance, it is not clearthat tax subventions actually createadditional savings rather than simplydiverting existing savings. I savingsare merely diverted, tax relie will beboth expensive and ine cient as it re-wards savings that would have takenplace without it.

Another issue regarding tax relie iswho bene ts both in terms o great-er incentives and greater savings.Evidence rom the US 401(k) pensionplans shows that middle and lowerearners are more likely to respondto saving incentives with saving cre-ation, and higher earners with savingdisplacement ( 5). However, while thismight suggest that tax relie is bettertargeted at those with lower to mid-dle incomes, evidence rom the USA,UK and Canada also suggests that

the take-up is higher among higherearners (in terms o participation and

(5) Sheena S. Iyengar, Wei Jiang and Gur Huberman,How much choice is too much?: Contributions to401(k) retirement plans.

contribution levels) ( 6). The design o certain tax relie systems seems thus

to avour higher earners, while thecomplicated nature o tax relie canresult in con usion. What is more, it iso ten only those on higher incomeswho have access to independent

nancial advice to take ull advantageo tax relie .

In some Member States, there areadd itional advantages or individualpension savings through direct statesupport (e.g. Germany and Austria).Matching contributions or signi cantpension contribution subsidies allowthe targeting o lower earners whoneed to save more, and would o -

er much better value or money orsmaller savers. It is also much easier tounderstand and so would better targetthose without nancial advice.

Given the lack o clear evidence regard-ing the scal incentives o tax relie and the substantial costs to publicbudgets, there is scope or MemberStates to look at tax relie options,

particularly regarding the e ects onadequacy and sustainability.

(6) Pablo Antolin, Alain de Serres and Christine dela Maisonneuve (2004), Long-term budgetaryimplications o tax- avoured retirement plans,Economics Department Working Papers No 393,OECD, June.


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There is a growing trend to shi t therisk away rom the state towards pri-

vate institutions and individuals. Sucha strategy may look nancially soundbut, i adequacy problems arise, theresponsibility or guaranteeing it mayagain all on the state. As such, thedevelopment o unded pensions andtheir potential e ects on adequacyneeds to be monitored and more com-parable in ormation is required romMember States.

Indeed, with the growing importanceo private pensions, major improve-ments o the tools to monitor them arecalled or. In some Member States dataare broken down by di erent criteriabut in others data gathering and databreakdown is ar more limited par-ticularly those where private schemeshave recently been introduced. Ex-tensive in ormation is required to un-derstand the ull impact o a greaterreliance on private pension saving particularly to gauge uture incomes inretirement and identi y those groupswho are not saving and so may experi-

ence lower incomes in retirement.

Currently the relative impacts o di erent policies in Member States

cannot accurately be compared. Their relative merits there ore re-main somewhat obscured. Countrieswould bene it rom more extensiveand comparable in ormation to bet-ter understand the impacts o theirpolicies and to better evaluate themonce implemented.

Further e orts are needed to enhancethe ramework o unded pensions (inparticular statutory ones). There is aclear need to enhance the monitoringo the development o unded pen-sions and their potential e ects onadequacy. Tools need to be developedto monitor uture advances as well asto better assess the current situation;in particular, cross-country compara-bility and reliability o national dataneed to be ensured ( or example, solv-ing the issue o coverage and doublecounting o individuals participatingin private pension schemes). Inde-pendent sources o data are in devel-opment, however, in particular rom

Eurostat and the OECD (see box).

Better monitoring needed


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Sources o harmonised data remain in development

Source Data availableEurostat European systemo integrated social protectionstatistics (ESSPROS)

Pension expenditure is broken down on the basis o types o bene ts paid out, contributions depending on the type o contribution (employer, government, employees).http://epp.eurostat.ec.europa.eu/portal/page/portal/living_conditions_and_social_protection/introduction/social_protection

Eurostat Structuralbusiness statistics (SBS)

Occupational schemes (with the exception o Spain andPortugal where the statistical data include both occupationalschemes and individual schemes) broken down by variableson the number o members, pension und demographic andvariables on accounting, internationalisation and employment.http://epp.eurostat.ec.europa.eu/portal/page/portal/european_business/data/database

Eurostat EU statistics onincome and living conditions(SILC)

Breakdowns o disposable income (including all types o pension and survivor bene ts) and variables on individualprivate pensions.http://epp.eurostat.ec.europa.eu/portal/page/portal/living_conditions_and_social_protection/introduction/income_social_inclusion_living_conditions

OECD Global pension

statistics (GPS)

For unded pension schemes, including unded and book

reserved pension schemes, as well as pension insurancecontracts that are workplace-based or accessed directly in retailmarkets (personal pension schemes). Mandatory and voluntaryarrangements are included. Data include schemes wherebene ts are paid by a private sector entity (classi ed as privatepension schemes by the OECD) as well as those paid by a publicsector entity.www.oecd.org/da /pensions/gps

OECD EU 2007 Survey It provides elements on the distribution o membership bystatus (active, de erred members and retirees) and by earningsbrackets (e.g. less than average wage, rom average wage to twoaverage wages, more than two average wages), age bracketsand gender or some Member States.http://www.oecd.org/document/8/0,3343,en_2649_34111_38958856_1_1_1_1,00.html#contents


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Pension unds real return on investment in selected OECD countries

(1) JanJun 2009 investment rate o return is an OECD estimate.

(2) Estimate including IRAs.(3) Data re er to APRA-regulated entities with more than our members and at least AU$50m in total assets.

Return on assets is net earnings a ter tax divided by the average assets or the period.(4) Data re er to mandatory pension unds. Nominal return data or voluntary pension unds are 4.63 % (-10.67 % or 2008).(5) JanDec 2008 investment rate o return is an OECD estimate.(6) Data re er to the period JanuaryMarch 2009.(7) Data re er to JanuaryAugust 2009.(8) Data relates to a selection consisting o the largest private and municipal pension unds, accounting or about

80 % o aggregate total assets.(9) Data re er to the second pillar pension unds. Nominal return data or third pillar pension unds are -0.16 % (-1.93 % or

2008).(10) Data re er to contractual pension unds. Nominal return data or open pension unds are 3.0 % (-14.0 % or 2008).(11) Estimated data. The net return or investors equals 0.34 % or 2008, a ter extra unding by the und managers. Source: OECD Global Pension Statistics and OECD estimates.

At the time o the adoption o the report(April 2008) on which this booklet is

based the increased importance o pre-unded schemes in the overall pension

package envisaged by Member States

can be illustrated in the gure below. Itdepicts the trajectories in coverage and

share o pensioner income which pre-unded schemes were expected to take

in various Member States until 2050.

The impact o the crisis

10

5

0

-5

-10

-15

-20

-25

-30

-35

-40

Real JanJun 09

Real JanDec 08

I r e l a n d ( 1 )

U n i t e d S t a t e s ( 2 )

H u n g a r y

( 4 )

A u s t r a l i a ( 3 )

C a n a d a ( 6 )

W e i g h t e d a v e r a g e

S i m p l e a v e r a g e

P o l a n d

N e t h e r l a n d s

B e l g i u m

U n i t e d

K i n g d o m

( 5 )

N o r w a y

( 8 )

F i n l a n d

S w i t z e r l a n d ( 7 )

P o r t u g a l

A u s t r i a

S p a i n

G e r m a n y

M e x i c o

S l o v a k

R e p u b l i c ( 9 )

I t a l y

( 1 0 )

T u r k e y

K o r e a ( 6 )

C z e c h R e p u b l i c ( 1 1 )

G r e e c e


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25


Future trajectories in coverage and share o pensioner income romunded schemes; stylised illustration

Yet with the sudden onset in the earlyautumn o 2008 o a nancial crisis o

unprecedented scope and the sub-sequent deep economic downturn,

unded pension schemes have su ereda major reduction in the book value o their assets rom which they still have torecover. As illustrated in the OECD gureabove, pension unds across Europe hadby November 2008 already experienceda negative real return on their invest-ments in the magnitude o 15 to 35 %.

The subsequent steep economicdownturn and rapidly rising unem-

ployment has made it di cult tosustain the hope ul expectations

that rapid growth would allow activewage earners to build up extra und-ed pensions or themselves at thesame time as they nanced pensions

or their parents and grandparents.Indeed a number o the more ambi-tious countries have had to revisittheir plans and temporarily shi t parto the contribution or the undedscheme back to the nancing o thepay-as-you-go scheme and thus ex-tend the time rame or the build-upo pension unds.

0

25

50

75

0 25 50 75 100

Current situationExpected situation

C o n t r

i b u t i o n t o

i n c o m e

( % )

Coverage level (% of active population)

LV

DK

EE

PL

DK

SE

NLLT

UK

AT

IE

CZ EE

SI

DEBE

PTFI

FR

IT


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Find out moreDirectorate-General or Employment,Social A airs and Equal Opportunities

http://ec.europa.eu/social/main.jsp?catId=443&langId=en

Full report rom the Social ProtectionCommittee

http://ec.europa.eu/social/main.jsp?catId=752&langId=en&moreDocuments=yes

Social Protection Committee http://ec.europa.eu/social/main.jsp?catId=758&langId=enOECD http://www.oecd.org/homeEurostat http://epp.eurostat.ec.europa.euDolceta http://www.dolceta.eu

The expansion o pre- unded privatepensions as supplement to pay-as-

you-go statutory schemes has inno-vated and potentially strengthenedthe ability o many Member Statesto deliver adequate and sustainablepensions. As scheme designs in sev-eral Member States o ten are neither

nished nor ully optimal there isgreat scope or improving the overallper ormance o pension unds as ve-hicles o social protection. Moreover,the crisis has revealed the vulnerabil-ity o unded schemes to volatility in

nancial markets and highlighted theneed or policymakers, regulators andsupervisors to promote more prudentmanagement o peoples retirementsavings. With a wide range in the lossesincurred and with even greater varietyin capacities to absorb the shock, di -

erences in pension und designs andinvestment strategies clearly matter.From the variance in impacts across the

Union important lessons can be drawnabout how unded schemes can be im-

proved and a better balance betweenrisk, security and a ordability or pen-sion savers achieved. Accordingly inseveral Member States a new agendais emerging or necessary changes to

unded designs and or speedy com-pletion o the un nished parts o thenew mandatory schemes or exam-ple, concerning more secure de aultoptions, li e-styling, charge capping,rules or annuitisation, the pay-outphase and capacity or shock absorp-tion. Ful lling this will be an importantpart o rebuilding and maintainingpublic con dence in unded, privatelymanaged pensions. The crisis has ur-thermore underlined how pension

unds as signi cant operators will haveto be included in measures to stabilise

nancial markets. In this as in the otherareas the need or better regulationmay also have a European dimension.

Conclusions


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Re orms to pension systems have been ongoing. Member States are acing the challenge o population ageing which is putting a signi cant strain on current pension systems. This bro-chure examines the growing importance o privately managed unded pension schemes. It isavailable in printed ormat in English, French and German and in electronic ormat in all otherEU o cial languages.

European Commission


Luxembourg: Publications O ce o the European Union

2010 26 pp. 14.8 21 cm

ISBN 978-92-79-14657-2doi:10.2767/93511


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How to obtain EU publicationsFree publications: via EU Bookshop (http://bookshop.europa.eu); at the European Commissions representations or delegations. You can obtain their contact

details on the Internet (http://ec.europa.eu) or by sending a ax to +352 2929-42758.

Priced publications:

via EU Bookshop (http://bookshop.europa.eu).

Priced subscriptions (e g annual series o the Ofcial Journal o the EuropeanUnion and reports o cases be ore the Court o Justice o the European Union): via one of the sales agents of the Publications O ce of the European Union

(http://publications.europa.eu/others/agents/index_en.htm).


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www 2010againstpoverty eu

K E - 3 2 -1 0 -2 1 5 -E N - C

www acebook com/socialeurope

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