This month’s Off The Record considers the issue of solidarity. Many pension schemes in Europe rely on current contributions to pay for the benefit of pensioners now in the expectation that the succeeding generation will help them in their turn.
A joint report by the EC and the European Council on adequate and sustainable pensions a year ago made ‘promoting solidarity’ a key objective, after preventing social exclusion and enabling people to maintain living standards.
On the other hand, there is a strongly-held view that inter-generational solidarity involves moral risk or hazard. If we know that others are going to pay for the consequences of our improvident behaviour we will be more likely to indulge in such behaviour. In a pensions context, this means that we might take retirement earlier than necessary, fail to accumulate adequate savings, and neglect to provide for our own pension.
Some of the pension fund managers and administrators who res-ponded to our questions felt it was important to define from the outset what is and what is not meant by solidarity. In particular, a manager at a pension fund in Belgium, a country which has recently introduced the idea of ‘social pensions’ with additional solidarity benefits, warns that the debate about solidarity should not be confused with the debate funded and pay-as-you-go pension plans: “The solidarity issue is totally different from the repartition versus capitalisation debate. Indeed it is a common misunderstanding to describe repartition as solidary and capitalisation as selfish.
“A capitalisation scheme can be more truly solidary than a repartition,” he suggests. “For example, the ‘youth’ provided by young members of a capitalised scheme will increase the total duration of the fund, which will enable it to invest more in equities. This in turn should benefit the older members of the scheme, who would have a much smaller duration of their own. The younger members, however, will loser some average duration and the benefits that go with it.
“The older members on the other hand will provide economies of scale, because of their higher pension reserves, which will benefit the younger ones through lower investment costs. So the solidarity works in both directions.
“In contrast, a repartition scheme can hardly be called solidary if the younger member must contribute more than necessary to provide back service to the older members, since there is no ‘revenue sharing’ in the other direction.”
With these caveats in mind, we can consider the results of the survey. The responses was perhaps predictable, with support for solidarity from managers in countries which value the concept, and opposition from managers that place less value on it. However, there were some surprises, notably in the view of the future of defined benefit (DB) schemes and the part solidarity plays in them.
Three in five of the managers (59%) think the concept of inter-generational solidarity, in the context of European pensions, has outlived its usefulness. One UK manager says bluntly: “It never made any sense.”
However, there is strong, even passionate support, for solidarity from others. The manager of a pension plan in France, a country which has endorsed the repartition system of complementary pensions, says: “Solidarity is not a systematic redistribution in favour of the most vulnerable people but a system that binds everyone to prepare a minimum pension, on a compulsory individual basis or a collective basis, so that everyone benefits from income in connection with their needs when they are retired. That means that you cannot only rely on a free individual choice.”
One of the objections to the solidarity is that it encourages people to make no provision for themselves. This received a strong endorsement with almost two thirds (65%) of pension fund managers agreeing with the proposition that a pensions system based on solidarity may encourage improvident behaviour such as failing to accumulate adequate savings.
However, three in four managers (73%) believe there is strong public support in Europe for solidarity elements in pensions systems. An administrator in a Danish fund points out that this broad support has been diluted by a strong strain of neo-liberalism. “In a macro-economic perspective, there is not doubt that solidarity means better pensions, better savings and better financial tools. However, the very liberal winds blowing over the general debate have been able to promote the individual approach to pensions in an almost astonishing manner.”
A number of managers point out that support for solidarity is strong at the national level – in France Germany, Belgium and Italy, particularly – but not at the EU level.
Promoting solidarity was one of the 11 common objectives of the Laeken European Council two years ago. However, opinion is divided on whether the EU should promote solidarity in pensions systems, with slightly more against (53%) than for (47%). The manager of an Austrian pension fund comments: “I am contributing to solidarity with my taxes already.”
At the national level, one option is for government to create ‘solidarity funds’ to prop up unviable solidarity pension funds. Again a small majority (56%) feel that is not the business of governments.
A slight majority of managers (55%) think that inter-generational solidarity is not currently catered for in a typical DB scheme, although the manager of an Austrian pension fund suggests that solidarity might be served by “a kind of paternalistic behaviour by the sponsoring company”.
So if even if the concept of inter-generational solidarity is abandoned, DB plans should survive. One in two managers (50%) think DB schemes could survive the abandonment of solidarity, although some warn that their form will have to change. “The normal DB system would not survive, but the guarantee system in DC plans has characteristics of the DB system,” says one pension fund manager.
We also asked about concepts of fairness in pension systems. A large majority (78%) feel that people get a fair deal in a typical DB scheme, although one UK manager points out that people can lose out if executive pensions are cross-subsidised or otherwise underfunded and over-rewarded. Another UK mananger remarks that “long stayers and high flyers get a fair deal, short stayers and slow promoters do not”.
Most managers (69%) think that, switching from final earnings to average earnings would result in greater distributive justice in a DB scheme. A similar percentage (69%) agree that greater reliance on private pensions provision will increase inequality, since private pensions reflect earnings more closely and are more accessible to people on higher incomes.
However, this is not seen as necessarily retrograde. One Swedish pension fund manager observes: “It is not the role of a pension plan to iron out the inequalities of society,” while the manager of a Swiss pension fund comments: “I wouldn’t judge this ‘inequality’ as a disadvantage.”
A substantial majority of managers (83%) feel that capitalised pensions systems are fairer and more resistant to political pressure and abuse than inter-generational solidarity pensions systems. However, one manager of a corporate scheme based in France observes that capitalised pensions cannot be considered fairer if they are the only option available. “I believe there should be state/ mandatory intergenerational or DB schemes topped by DC schemes available either individually or through company sponsored schemes.”
Supporters of solidarity point out that “capitalised pension are dependent on market changes and solidarity pensions need not always be directly administered by governments – social partners for example.”
Finally, what role will individually funded pension play in the future? Will the young expect to fund their own pensions rather than rely on concepts of solidarity?
This is the view of most managers (72%). One manager speaks for many when she says: “They know that the PAYG system will not cover their needs upon retirement because of the lower number of people contributing and lower commitments about earnings replacement levels .”
Yet the manager of a Swedish pension fund disagrees: “As always, the young will have other problems.” So solidarity may still be needed.