Defined contribution pension plans have, until recently, been a footnote in the story of Greek pensions. This is set to change, however, in the wake of legislation introduced last year as a part of a reform of the country’s pension system.
The reform represents Greece’s first uncertain steps towards the adoption of the three pillar model advocated by the World Bank. Currently, the Greek system of pension protection is overshadowed by the first pillar, a publicly financed pay-as-you go (PAYG) system of primary pensions. In 2001 this accounted for 84% of the country’s pensions bill and 10.6% of the gross domestic product (GDP).
Primary pensions are supported by auxiliary pensions which sit somewhere between first and second pillar pensions. They are financed by public bodies, enjoy a state guarantee and are paid simultaneously with primary pensions. In 2001 they accounted for 14.5% of the total pensions bill and for 1.8% of GDP.
Second pillar pensions – that is, privately financed occupational pensions – hardly figure at all, covering no more than 5% of the working population. They are confined to larger companies with an international presence. Group pensions plans for these companies are typically provided by insurers in the form of deposit administration funds (DAFs). These can be either DB or DC type plans. Employees’ and employers’ contributions are deductible from income, while capital gains and interest are tax-exempt. Employers’ contributions to life assurance policies are tax deductible up to a limit of 5% of annual wages. The benefits paid under such policies are tax-exempt. Currently, there are estimated to be some 35,000 group plans in operation.
DAFs tend to be targeted at management, since there is a cap on the pensionable salary of employees who entered the pension system before 1993. As a result, the replacement rate provided by a social security pension is relatively low for senior managers.
Third pillar pensions – individual pension plans – are also used to top up retirement benefits. Individual pension plans are provided by insurance companies and are subject to legislation governing life insurance. Benefits are usually paid as a lump sum rather than as an annuity.
The development of a third pillar has been slow, largely because of the lack of fiscal incentives, although the tax-free limit was raised from E400 to E1,000 last year. The development of a second pillar has been restrained by the fact that, until recently, funded occupational schemes were forbidden by law. Article 43 of the 1990 Pensions Law states that collective labour agreements cannot include provisions which might lead to the creation of occupational funds or accounts which provide pensions or separation payments financed by employers.
However, the economic argument for a system of complementary, privately funded pensions to take the strain off the state-funded system is compelling. The UK Government Actuary’s Department report, commissioned by the Greek government, predicted that the deficit of the pension system would rise from 4.8 % of GDP in 2002 to 9.1 % in 2025 and 16.8 % in 2050 from in the absence of reform. This has been endorsed by a study of the Centre for Strategic and International Studies and Citigroup Asset Management Greece, which estimates that public pension spending will reach 19 % of GDP by 2050.
The government has now for-
mally recognised the importance of
encouraging the develoment of second pillar pre-funded occupational pensions, although it is careful to emphasise the continuing predominance of state-funded primary pensions. The Report on Pensions Strategy, published jointly by the Ministry of Economy and Finance and the Ministry of Labour and Social Security in September, states: “We must formulate structures that are going to reflect the competitive potential of our economy, and these are the occupational pension funds. The occupational funds are the future and they have the potential to add a new kind of support for the workers of future generations.”
The first step is to create the framework for such funds. Until last year, there were no legal or regulatory controls for DC arrangements in Greece. This is partly because they are treated as insurance contracts, and fall under insurance supervision and partly because the regulatory authorities classify DAFs as DB schemes, in spite of the fact that more than 50% are DC type plans.
However, the new Pension Law, known as Law 3029, provides an institutional and supervisory framework for independent, self-financed, funded occupational pensions. This framework, the government says, compares favourably with those already existing or currently under discussion in other EU countries. “The ultimate objective of these provisions is to release the growth potential of the social insurance system – by enabling linking of pension savings with the finance of productive investment and other infrastructures.”
The government’s strategy document sketches out the way this will work: “Under the new Law 3029 occupational funds will henceforth be available as a means for financing departures from the norm or special needs of sectors of the labour force. Law 3029 envisages that workers and employers will have the right to regulate pension issues through the introduction of voluntary pension funds, as well as collective labour agreements. It will also facilitate the operation of international pension funds and other organisations who wish to invest in Greece.”
Occupational pensions in the new structure can be either DB or DC. However, they are more likely to be DC, says George Kendouris, partner at pension consultants Hewitt Bacon & Woodrow in Athens. “Some of the unions are thinking seriously about such schemes and they have started the process by appointing an actuary. Most of the new plans will be DC, especially the union plans where it will be impossible to be DB.”
Kendouris says the key to its success will be the ability of an employer to contract out of the auxiliary pensions system. The government initially proposed contracting-out in the first draft of Law 3029 in July 2002. “There was an option for the employer that wanted to opt out from the auxiliary social security plan to establish its own scheme to cover also the state pensions,” says Kendouris.
However, the proposal ran into strong opposition from the unions. The government sidestepped and decided to establish the supervisory framework as a first step with the possibility of introducing contracting out as a second step.
“My impression is that we will have contracting out in the near future,” says Kendouris. “This will not ensure that anything happens but at least there will be the option. There will be some employers who will think seriously of moving from the existing auxiliary sector to the new schemes.”
Kendouris says there are still a number of unanswered questions, mainly in the area of taxation. There is no indication of whether or how investments or investment gains in pension funds will be taxed. There is also doubt about the taxation of retirement benefits. “A new pension scheme can deliver either a lump sum or a pension. But we do not know yet how they will be treated for tax purposes? It is proposed for the time being that lump sum benefits will be tax free but a pension will be taxed as income, which is crazy. If only the lump sum option is tax free then every fund will deliver lump sums at the end.”
These issues will be resolved by the newly-established National Actuarial Authority (NAA) which plans to introduce detailed regulations this month June. But progress is likely to be slow. It is estimated that the reform measures – including the setting up of the NAA itself – will require at least eight presidential decrees and 16 ministerial decisions to acquire the form of detailed regulations. An additional brake on progress is the prospect of elections next year. Bearing in mind the strong public reaction to pension reform proposals in 2000 and 2002, the government is unlikely to want to push ahead too fast with change.
This is prudent. The Greeks remain more sceptical than most other Europeans about the private sector’s role in pensions provision. A Eurobarometer public opinion poll conducted in October 2001 of people in the 15 countries of the European Union found that 86% of Greek respondents, compared with 70% for the EU generally believed that compulsory state or public pensions would be their main source of income after retirement. And only 2.6%, compared with 9.8% throughout the EU, believe that a private pension scheme, through an employer would be their main source of retirement benefit.
DC occupational pension plans will eventually have an important complementary role in Greece’s pensions system. But it may take some time.