Notwithstanding further reforms, most EU member states have improved the efficiency and financial affordability of their first-pillar pension systems. However, at the same time, the adequacy of pension income needs to be preserved so that a decent level of income after retirement is ensured
The slimming down of public pensions has sadly not been matched by reforms enhancing complementary retirement savings. It has been proven that member states with well-developed multi-pillar pension systems have lower poverty rates.
Moreover, quantitative easing (QE) policies and pro-cyclical rule-based regulations lead to inferior long-term returns. This attenuates pension income and further affects the trust and reliability of pensions as replacement income.
Income replacement rates from public pension schemes are projected to decrease on average within the EU by about 10 percentage points (see the EU’s Pension Adequacy Report). Future adequacy of pension income will also depend on the ability to have longer careers and on whether older workers have sufficient health, skills and opportunities to postpone retirement and earn full pension rights at a time when life expectancy at age 65 is expected to increase by about five years by 2060.
Labour income as a share of national income is also declining, so pension income should be integrated within housing and health-access policies in the EU member states.
Occupational – and other complementary – retirement savings will have to play a greater role in securing the future adequacy of pensions; the EU and the member states will have to find ways to improve access, awareness, depth and trust in complementary pension schemes.
While there is wide access to pensions, depth of coverage is highly uneven and awareness is still low. Comfort levels have been hurt by the financial crises as well as by reduced expectations caused by low interest rates and economic growth.
Moreover, pension funding is challenging not just because of the economic situation but also due to central banks, policy makers and regulators. Safe-haven assets no longer exist and the volatility of EU government bonds is at levels not seen for such long periods since the Second World War. The QE policies of central banks have led to zero-yielding bonds, which have lost their status as defensive assets and which may even prove to be risky assets when inflation re-emerges.
Regulators are punishing investment in ‘real’ assets by rule-based regulation demanding full funding at all times, while imposing huge, uncalibrated capital buffers on life insurers for these assets.
Regulators should differentiate risks; risk is not homogeneous for all institutions since they have a different capacity to absorb it. The one-size-fits-all approach that regulators apply is a systemic risk in itself. Pension funds and life insurers have the capacity to absorb certain risks since they have long-term liabilities. That capacity will further increase since people will retire later and live longer. Pension funds are natural investors in long-term securities and can take advantage of risk and liquidity premia to enhance future returns and pension income.
Occupational pensions should offset the declining trend in decent pension income from stste pensions. The problem is that most EU citizens either do not have access to workplace pensions or do not know what they can expect from their occupational pension. We have to acknowledge that systems are heterogeneous across the EU but also even within member states. There is no reference framework, but pension systems should be evaluated from the perspective of pension adequacy.
Designing or redesigning pension regimes starts with the purpose: what is the desired level of pension income? What are the expectations? Which adequacy level is appropriate for social security and which to level-up with occupational pensions? What is the appropriate comfort level for private pension savings?
Each of these adequacy levels, or indicators, may have its own rationale, protection levels, risk and risk-sharing characteristics, Prudential framework, funding methodology, tax incentives, and so on. Within this framework, member states should apply a ‘bottom-up’ approach to their own pension regimes with a mapping exercise or gap analysis. They should then align their future pension system design or redesign to the different adequacy levels of an EU recommended framework.
The EU should recommend such a framework, according to which pension adequacy can be measured to different dimensions starting with the poverty ceiling – a risk-of-poverty indicator at age 65 – up to a ‘nice to have’ level.
An informal high-level committee at EU-level should start to explore this possibility. Alternatively, the Commission could consider a communication or a Green Paper without invading member states’ prerogatives on pension policy and design.
If complementary retirement savings are to play a greater role in securing adequate retirement incomes across Europe, the EU should have a consistent overall policy enhancing the reach and depth of workplace pensions coverage. While policy measures in the 2012 White Paper on pensions have received considerable attention, progress in enhancing complementary retirement savings has been limited.
Many citizens will receive lower state pensions in future because of state pension reforms, so auto-enrolment systems should be promoted, particularly for lower earners. The reference framework could help to define the gap analysis and the level to which these gaps can be filled by complementary pensions, taking into account future pension reforms.
Where EIOPA is considering an additional regime for pan-European personal pensions (PEPPs) on top of what may already exist in member states, the first consideration – given the heterogeneous and fragmented design of pensions in the EU – should be an assessment study of need and purpose. This cannot be done without first creating a reference framework for adequacy levels worked out by the Commission’s directorate-general for employment. This would make it clear for all member states if and for whom the PEPP is needed, and to which adequacy level it may respond.
Such a reference framework is vital to provide EU citizens with greater insight into their total retirement income and to allow well-informed decisions, in particular when individuals must make decisions themselves, as in a personal pension product. Citizens are asked to take responsibility for themselves but without appropriate knowledge of all vested and future pension rights in different existing pensions regimes. Given the general low degree of pension readiness of citizens, and without pension ‘benchmarks’ or a reference framework, they cannot take informed decisions to fill the gaps in personal pension planning.
Finally, all current EU pension initiatives – including the IORP II Directive, capital markets union, European tracking service (TTYPE), the code of good practice, and financial market regulation – should be more streamlined. Given the clear need to provide adequate retirement income for all citizens, each should be assessed, evaluated and measured in terms of its coherence and contribution towards enhancing coverage and depth of workplace pensions and the trust placed in them.