Two reforms are at work in France. The retirement reform law of August 2003 aims to secure the sustainability of the French retirement system by giving everyone the opportunity to build his own pension by way of specific retirement savings provisions.
This law is complemented by the draft law implementing the EU directive relating to the activities and supervision of occupational retirement provision, which is to be implemented by 22 September. This will also open occupational schemes to foreign competition.
This article will set out the main steps of the retirement reform law. It will detail the new retirement savings schemes and the main points of the law implementing the directive on IORP (institutions of retirement provision), before concluding with a look at the challenges for the future.
Law reform: the retirement reform law of August 2003 is the result of years of heated debate, set in motion in particular by the 1965 Wahl-Chaumet report on the need to reform the system of retirement provision. The system was established after the World War II at a time when savings capacity was low and the demographic outlook favoured the pay-as-you-go system. This is no longer the case today.
The 2003 reform makes it possible to control more effectively the system of retirement provision; to make adjustments to reflect changes in the overall economic situation, for example. It also encourages individuals to make their own provision
by making them better informed about their pension rights through granting them a right of access to information.
The government must report to parliament on the sustainability of the retirement system every four years starting from 2008. This will draw on the work of the Pensions Advisory Council.
The law stipulates that the relationship between the contributory period and the retirement period must remain constant. The contributory period necessary to secure the maximum pension will be extended to 41 years by 2012. Currently it is 40 years for workers in the private sector and 37.5 years for civil servants. A bonus of 3% and penalty of 5% have been introduced to encourage people to work longer. Possibilities for retirement before the age of 65 by the employer are restricted. Pensions are to be increased in line with the retail price index.
From the age of 35 and every five years thereafter, all members of mandatory pay-as-you-go systems will receive a RSI or statement of pension entitlement. From the age of 50 they will receive a so-called Global Indicative Estimate (EIG) which will inform them of the pension rights they can expect upon retirement. Implementation will be progressive from 2006 to 2010.
In addition to these measures everyone has the opportunity to build additional pension rights by joining a retirement savings plan. According to Article 107 of the law, “in addition to mandatory pay-as-you go schemes, everyone should have access as a private person or to one or several occupational retirement savings products with secure financial terms fair tax treatment”.
France has a three-pillar retirement system. Retirement savings schemes are part of the second and third pillar with the tax advantage for voluntary contributions taking into account mandatory contributions to occupational schemes.
Retirement savings: the acceptance of the role of retirement savings within the retirement system is a major landmark.
Three products will be offered; each will have tax advantages, governance rules and prudential guidelines. Within each category members will have the choice of a range of competing products.
Products: private individuals will be offered the individual retirement savings plan or Plan d’épargne retraite populaire (PERP). This is an insurance group product offering a life annuity of regular payments, and carries strict governance rules. There are no lump-sum payments.
There will also be two types of occupational scheme. An employer may set up a Plan d’épargne retraite d’entreprise (PERE) – or a collective savings plan for retirement – Plan d’épargne retraite collectif (PERCO).
The PERCO is an employment savings plan very similar to the US 401K plan offering life annuity but allowing lump sum payments on retirements. The PERE is an insurance product similar to the PERP but without GERP, being underwritten by the employer.
PERCO are managed like standard UCITS. They are dedicated employment savings vehicles whose only restriction in terms of investments is a limit of 5% of assets in unlisted or sponsor stocks. Three choices of UCITS must be offered to plan members, of which one must be a regulated SRI fund.
PERP or PERE participants will have to choose between three types of operations :
q Accrued savings converted into life annuity: the minimum level of the annuity is set upon retirement. It is at least the sum of the contributions paid during the accumulation phase net of the insurer’s loading;
q Deferred annuity: the minimum level of the annuity is set in euros at the beginning of the contract;
q Deferred annuity units: the number of units is set; they have an acquisition and a guaranteed sale price.
Each contract within each option is managed as a distinct unit. Membership must number at least 2,000; within five years the value of the assets must reach at least e10m. Transfers of individual rights are authorised during the accumulation phase except when a worker is bound to his employer’s PERE.
The options of accrued savings converted into life annuity on the one hand and the deferred annuity on the other may be managed according to one of two accounting methods. The classical method uses the book value of assets and liabilities and does not take into account capital gains or losses. The diversified method does take into account capital gains and losses and uses the market value of assets and liabilities.
Tax advantage: one of the main features of the law is a widely available personal tax allowance. Mandatory contributions to pay-as-you-go schemes are deductible from gross income. Voluntary contributions to PERP or to PERE or to civil servant funded retirement schemes may be deducted from personal occupational income with a limit of 80% of the social security ceiling (SCC) of e30,192. Deductions of mandatory contributions to occupational funded schemes such as PERE and the employer contribution to PERCO must be taken into account. Those deductions are limited to 8% of gross income within the same ceiling. Larger allowances are offered to the self employed and to farmers.
Benefits from PERP and PERE are taxed as income. Lump-sum payments from PERCO are tax free, while annuities from PERCO are subject to a reduced income tax given that the employee contribution enjoys no tax advantage. Contributions to PERCO are subject to a 11% social levy, although this does not apply to PERP or PERE schemes.
Contributions to DC schemes are deductible from company income while book reserves of DB schemes are not.
Employer contributions to PERE schemes will be exempt from contributions to social security on up to 5% of income and not exceeding eight times the SCC. Earlier DC schemes will enjoy the same allowance. Book reserves for defined benefit schemes are subject to a levy of between 6% and 12% to be paid to the FSV, a solidarity retirement fund. Other contributions to DB schemes will be exempt from contributions to social security until June 2008 provided they have been closed to new members by that time.
Assets of PERP, PERE and PERCO schemes are not subject to wealth tax provided that contributions have been paid regularly for at least 15 years or started by the end of this year.
Governance rules: The PERP is offered to individuals by a retirement savings association, known as a GERP, which may act on behalf of one or several PERP schemes. One function of the GERP is to set up an open group contract with an insurance company. Another function is to set up a supervision committee to represent the members’ interests. At least half of the membership of the supervision committee is elected by the plan members and at least half must not have had any connection with the insurance company for at least two years. Reporting by the insurer is monthly and is in accordance with the committee’s instructions. For the PERE the supervisory committee is set up by the employer who underwrites the contract and plays much the same role.
The PERCO is offered to the market in accordance with the labour code which states that it must have a supervisory council consisting of representatives from employees and employers, like the supervisory board of a UCITS.
Competitive market: Given the expected fall in the replacement ratio offered by pay-as-you-go schemes and the broad fiscal advantage of employee savings schemes it is expected that, within the next five years, the membership of PERP, PERE or PERCO schemes will account for one third of all working people in France. It is estimated that one third of the financial savings rate of 7.9% will go to funded retirement schemes. With annual total disposable income at around e1,100bn, annual contributions should be in the order of e3.4bn, with an average annual contribution of e485 per member. In the first year contributions should reach about e700m.
The main players will be banks with branches, especially banking and insurance groups and provident mutual institutions. The main
promoters will be existing retirement schemes and institutions
for retirement provision, trade unions through provident institutions, as well as corporations through their HR departments and insurance brokers.
The main competitive differentiators will be investment performance, communication and reporting.
The stakes: savings for retirement will face three challenges:
q The replacement ratio: retirement savings have to compensate for the expected drop in the replacement ratio provided by compulsory
state schemes from 75% in 2000
to 52% in 2020. In November 2003 the compulsory AGIRC and ARRCO schemes agreed to increase contributions from next year by 0.6% of salary for the basic state scheme and by 0.28 % of salary for AGIRC and ARRCO schemes.
Thanks to a fall in unemployment, the expected deficit of e25bn
should be covered through a reallocation of resources from the
unemployment agency, UNEDIC. By that time the Fonds de Réserve pour les Retraites (FRR), which should have at least e153bn in investments, will also make a contribution.
q Communication: this will be key. People must be aware of what
they must contribute in order to have a pension that will be adequate in relation to their income as an employee. The investment horizon must be taken into account.
Our association AFPEN is offering participants a retirement savings plan certification in accordance with a process which has been published in the official journal.
It is also proposing a ‘retirement savings plan mediation service’
to deal quickly, expertly and
flexibly with any possible litigation between participants and other stakeholders such as the insurance company, the investment manager or the scheme’s supervisory board.
q Investments: French retirement schemes are managed as separate, dedicated entities. This makes it possible for performance to be calculated and thus makes the system transparent.
Participants must understand the relationship between risk and return. Risk taking and quality of investment management will be key to the success of the August 2003 law. One should not forget that an increase of 1% in the rate of return on contributions paid annually from age 30 to 65 will increase retirement capital by 25%.
Due to their segregation within dedicated units, PERP and PERE contracts cannot be compared with traditional life insurance contracts; they do not offer a guaranteed return; each scheme retains its own investment returns; management expenses are subject to prior agreement and are checked by an independent actuary; retirement savings plans offer a lifetime pension promise while life insurance schemes undertake a capital obligation that may be converted into a lifetime pension.
Vincent Vandrier is general secretary of AFPEN, the French pension fund association, based in Paris