by Konstantina Briola, Member of the Social Issues Research Team

Introduction

In recent years, the need for drastic reform of the pension system has become a top priority for many European Union countries. Ιn this context, demographic ageing is a phenomenon that has a direct negative impact on pension spending. In the face of this need to properly manage pension funds, efforts are being made by all countries to overcome this obstacle.

Demographic Ageing

Population ageing is a global phenomenon. All European countries are expected to see changes in population structure over time in the coming decades, simply at different speeds and to different degrees per country. Its effects on the structure and age of society are dramatic. In this context, the European Union (EU) is estimated to lose 10% of its population between 2000 and 2050 (European Environment Agency, 2016).

In addition, such a phenomenon has implications for both social, political and economic life. The phenomenon of demographic ageing will lead larger portions of younger populations to meet the retirement needs of older age groups (Bonoli & Shinkawa, 2005). At the same time, it is causing a number of changes in pension policy.

Political institutions play a central role in the structure of the pension system. For example, countries whose institutions wield greater power are more likely to adopt unilateral reforms, in which governments need a broad consensus on the policies they will pursue (Bonoli & Shinkawa, 2005). However, these policies are at the discretion of each country on how to shape them. The political conjuncture of the government may be partly decisive, yet it does not so much influence macroeconomic decisions concerning the future of the pension system (Bonoli & Shinkawa, 2005). 

By 2040, the population over 65 is expected to exceed 25% of the total population in all countries (United Nations, 2019). The key pressure is to ensure long-term economic viability. Due to this, a series of reforms have been adopted, which have resulted in a reduction in the size of the state for pension benefits. In the next section, the main types of pension plans applied to manage the pension problem will be analyzed. 

Types of pension plans

A pension is essentially a form of investment, designed to provide an income to retirees. There are a variety of pension arrangements, from the state pension system offering little financial support, to private pension schemes that give individuals the freedom to set up a larger pension fund. Below are the most common types of retirement plans. 

Α) Fully Funded Pension

In a Fully Funded Pension, the company is the one that finances the retirement plan without being deducted from the employee’s paycheck, or having to make periodic deposits (OECD, 2019). The money in the account is not managed by the employee himself/herself. Instead, there is a fund manager who manages the account and, together with the scientific team, they judge the most appropriate way in which the money can be invested, always according to the requirements of the pension fund (Guillén  & Mosqueda, 2013). In addition, employees being able to choose the time they are going to work, their payment will be adjusted accordingly. Therefore, they receive a guaranteed payment depending on the length of time they have worked for the company (Guillén  & Mosqueda, 2013). 

The fund itself has enough money to invest responsibly so that the return on investment and the fund’s assets can pay off all the benefits of the plan in the future. Funded pensions depend on ongoing new contributions to continue the payment of retirement benefits for all eligible employees. 

B) Pay as you Go (PAYG) 

In the Pay as you Go (PAYG) system, the arrangements are financed directly by government funds, although reserves that are the legal property of the employer (government) can be created (Ponds, Severinson & Yermo, 2011). Contributions to PAYG pension schemes are often referred to as taxes (Willmore, 2004). However, unlike other taxes, these levies are similar to buying bonds. At the same time, these contributions take the form of a promise or otherwise a tacit debt from the government (Willmore, 2004). Two important differences need to be mentioned at this point. On the one hand, pension contributions are mandatory, while the purchase of bonds by the government is optional. On the other hand, pension rights can not be transferred, while bonds can be commercialized.

All pension schemes (PAYG or pre-financed, public or private, mandatory or optional) transfer current employee output to current retirees. The government promises that individuals, by contributing to the public PAYG scheme through future taxes (mandatory contributions), will be provided with services in their old age. At the same time, by contributing to the pre-financed pension system, future production can gain value. Financial assets (bonds and capital) are accumulated, which are later sold to younger employees. If the supply of financial assets in the market is high, due to the large number of retirees who want to sell, and at the same time the demand for them is low, their price may decrease, reducing the market value of the pension fund (Willmore, 2004). 

C) Book Reserved

In the Book Reserved pension plan, the employer enters amounts in his balance sheet as reserves or provisions for the payment of future pension benefits (Davies, 2013). However, the employer has the option to cancel the insurance in the face of the risk of bankruptcy.

This program takes the form of an internal fictitious funding. In essence, the company creates a reserve in users’ accounts, where it will reflect their future obligations. Thus, the assets being within the company provide certain advantages: on the one hand the various funds can be maintained, and on the other hand a better return can be achieved by making internal investments (MacNicol, 2004). The only downside for employees is that they remain uninsured. In this case, security can be improved by introducing reinsurance. However, the cost to the employer will increase greatly.

Pension funds in Europe: The PensionsEurope

The use of the financial institution PensionsEurope has been proposed as a solution to the pension problem. PensionsEurope, founded in 1981, represents national associations of pension funds and similar institutions for pensions in the workplace (PensionsEurope, 2017). PensionsEurope members are large institutional investors representing the market side of the financial markets. 

PensionsEurope has multiple purposes. One of its roles is to provide a regulatory framework for pension institutions that finance pensions in the workplace, or that allow them to provide adequate and affordable pensions. In addition, it promotes pension institutions as institutional investors to stabilize the economy. Finally, it promotes a balanced multi-pillar pension model at European level, so that each Member State can place its pension scheme according to its political preferences.

Furthermore, it has a central role to play in reporting on pensions and the labor market. One of its main roles is to cooperate with the institutions of the European Union (the European Council, the European Commission, the European Parliament, the Council, the European Court of Justice, the ECB, the European Court of Auditors, the Economic and Social Committee, and the Committee of the Regions) to achieve the best possible results.

PensionsEurope has a total of 24 members: Australia, Belgium, Bulgaria, Croatia, Estonia, Finland, France, Germany, Hungary, Spain, Italy, Luxembourg, the Netherlands, Norway, Portugal, Romania, Iceland, Sweden, Switzerland and the United Kingdom. The members cover different types of pensions for over 110 million people. Through its members, they represent more than 4 trillion assets managed for future pension payments.

Conclusions 

Many European countries, aiming at the sustainability of the pension system, are introducing a series of reforms within themselves. These reforms concern measures related to the harmonization of pension benefits and contributions, the extension of the contribution period, etc.

Insurance reform is one of the most complex issues of both the Greek and European reality. What can be observed as a whole is that due to demographic ageing the percentage of pensions in the GDP of European countries is increasing. Pension reform is a valuable effort to clarify some of the most important issues undergoing the reform process. The countries that have joined the European Union (e.g. Bulgaria, Hungary, Poland, Estonia and Latvia) have already introduced significant reforms in their system, in about the same direction. However, even more countries are preparing for these pension reforms that will benefit them greatly.

References

[1] Bonoli G & Shinkawa T. (2005). Ageing and Pension Reform Around the World: Evidence from Eleven Countries. Northampton, MA, USA. Available here 

[2] Davies R. (2013). Occupational Pensions: Second Pillar provision in the EU policy context. Library of the European Parliament. Available here 

[3] European Environment Agency. (2016). Population trends 1950 – 2100: globally and within Europe. Europa. Available here 

[4] Guillén J.B. & Mosqueda R. (2013). Pay as you Go System versus Fully Funded Pension in Peru. Ecos de Economía Universidad, EAFIT Nº 36 – Año 17. Available here 

[5] MacNicol R. (2004). Pensions: Finance, Risk and Accounting. Reproduced from the Encyclopedia of Actuarial Science. John Wiley & Sons, Ltd. Available here  

[6] OECD. (2019). Financial incentives for funded private  pension plans. OECD Country Profiles. OECD. Available here 

[7] PensionsEurope. (2017). PensionsEurope Pension Fund Statistics 2017. Available here 

[8] Ponds E.,  Severinson C &  Yermo J. (2011). Funding in Public Sector Pension Plans: International Evidence.  OECD Working Papers on Finance, Insurance and Private Pensions, No. 8. Available here

[9] United Nations. (2019). World Population Ageing. UN, New York. Available here 

[10] Willmore L. (2004). Population Ageing and Pay-as-you-go pensions. Oxford Institute of Ageing, Issue 1. Available here