Keeping the first pillar in pole position

“At a pensions conference in Vienna in 2001 a delegate from the European Commission said that we were doing almost everything wrong with our pensions system but that apparently it seems to be working, and that that was why we were so reluctant to change it,” recalls Nadine Du Bois, political adviser to Déi Gréng, Luxembourg’s Green party.

Indeed, Luxembourg is different. While its neighbours have grappled with the reform of state pension systems that are threatened by the twin hazards of budgetary constraints and demographic changes, the grand duchy has retained a PAYG-dominated pensions system that occupies some 95% of the pensions arena. The legal retirement age is 65 but the average age at which people retire is 58.

“The statistical life expectancy in this country now exceeds 80,” says Frank Engel, secretary-general of the parliamentary group of the Christian Social People’s Party (CSV), the party that has led all governments since World War I but for two brief interruptions and the party of prime minister Jean-Claude Juncker. “Increasingly people enter the labour market in their late 20s and so they are supported for almost 30 years, work for 30 years and then are provided for for a further 20-30 years.”

But although health and social security minister Mars Di Bartolomeo intends to initiate tripartite discussions between the government and the social partners later this year to discuss the future of the pensions sector there is no suggestion of urgency.

The pension insurance scheme is financed by 24% of gross wages through contributions of 8% (to a ceiling of five times the minimum wage) from employees, employers and the government. The contributions are paid into a statutory reserve fund which is managed by a tripartite combination of trade union and employer representatives chaired by a representative of the state.

The social security inspectorate general (IGSS) is charged with ensuring that the reserve fund always exceeds the total annual expenditure by 1.5 times and to this end reassesses the minimum contribution rate every seven years. According to Di Bartolomeo, presenting the IGSS’ technical assessment on the evolution of the pension scheme for 2006-2012, the financial reserve was €6.6bn, or 3.12 times the annual expenditure on benefits, at the end of 2005, up from 2.9 times at the end of 2000.

In the previous seven-year period, covering 1999 to 2005, pension reserve income rose by 5.1% and expenditure by 4.4%.

So can Luxembourg afford to buck the reform trend? As its much-buffeted fortifications attest, the grand duchy has found itself in the front line of many of Europe’s conflicts over the centuries. “Now we are aware that we are at the eye of the hurricane,” says Jacques-Yves Henckes, a member of parliament for the Action Committee for Democracy & Pensions Justice (ADR).

“Our state pensions are very generous, especially those paid to civil servants,” says Mario Hirsch, editor in chief of independent weekly newspaper d’Lëtzebuerger Land. “But pensions are based on solid ground, at least that’s what politicians are telling us, although this can be questioned depending on how far ahead you look. There has been no real debate on this.”

In fact various studies and reports over recent years have indicated that the current situation is only sustainable as long as the economy continues to grow at a higher than EU average rate and as long as this continues to suck in ‘transfrontaliers’, the 120,000 cross-border workers who commute in from neighbouring France, Belgium and Germany. This makes the system doubly vulnerable as a downturn in the economy would dry up the jobs and thereby the inflow of commuters.

But even then the system is only sustainable for a defined period, after which it will hit what in Luxembourg is known as ‘the wall’. The only problem is that the definitions and the times differ from report to report.

“Five years ago the ILO was invited to make a report on our pensions and they gave us different scenarios,” says Niki Bettendorf of the opposition Democratic Party (DP), vice-president of parliament and vice-president of the parliamentary social security committee. “If our economic growth was only 2% a year our reserve would only last for 12-13 years but with 4% growth it would last for 30 years and we normally realise growth of 4%. So the wall will be somewhere but the growth of the economy is pushing it further away.”

“Currently we have two and a half active people per pensioner but we will have a cash drain scenario when payments will exceed contributions in less than 20 years under a somewhat optimistic scenario that foresees economic growth of 3% and increasing labour productivity throughout that period,” says Pierre Bley, secretary general of employers’ grouping, the Union of Luxembourg Enterprises (UEL). “Central bank calculations indicate that the cost of maintaining a social security system where people live an increasing number of years after retirement will give deficit in the pension system of 160% of GDP by 2085. Currently, the deficit is around 1.9% of GDP.”

According to IGSS estimates, a scenario based on a real economic growth rate of 3% would see the statutory reserve exhausted by 2041 unless the contribution rate was raised by 2034. A 2.2% growth rate would see the reserve exhausted in 2034 unless contributions were lifted by 2027.

So in light of such forecasts one would expect that pension reform would be pushing its way to the top of the political agenda, right? Well, no.

“I wrote an article in an attempt to launch a debate 10 years ago,” says Hirsch. “It was based on a Credit Suisse First Boston study of European pension liabilities which found that Luxembourg had the highest pension pledges, which at that time were projected to be in the region of 270% of our GDP.” There was no debate. And the ILO findings? “It came out with some pretty preoccupying warnings based on the demographic evolution, but hardly anybody took any notice,” Hirsch says.

“As long as we have a legal provision that says the pensions system must at all times have a reserve that guarantees the continued payment of pensions for 18 months, while it is known that at present our legal reserve stands at about three years and as long as we continue to create about 5,000 new jobs a year, jobs which largely are no longer taken by Luxembourg residents but anyway mean 5,000 new contributors to the system annually, it is simply not possible to convince people we might have a problem,” says Engel. “We know that eventually we will have a problem but one that will not hit us for some decades and that is a time horizon that in political terms is quasi-geological.”

But if, as former British prime minister Harold Wilson once observed, a week is a long time in politics, a few decades is not very long in pensions.

Engel agrees. “There is one politician who for the past 10 years has being saying that he is aware that there is a problem and he is Jean-Claude Juncker,” he says. But although Junker has been prime minister since 1995 and is also finance minister, and is a popular and charismatic figure with an appeal that transcends party affiliations he has not been able to take public opinion with him on this issue.

“We have a different problem,” says Engel. “Our state religion is social dialogue, and as long as long as you have six-digit trade union membership and trade unions that simply refuse to believe that we have a problem, and as long as there is simply nobody from any other party who would dare to say there is, there is simply no problem.”

But there have already been some changes. Luxembourg has two state pension systems, one for private sector workers and another for the public sector, covering civil servants, municipal employees and state-owned companies. Until 1998 public sector workers did not make contributions and their pensions corresponded to five-sixths of their last salary.

Outrage at what was seen by many as an inequitable situation led to the creation of the ADR. “The party waged a campaign over three elections demanding the alignment of pensions treatment,” says Hirsch. “We started because we discovered that the state pensions paid to private sector employees were about half of those paid to former public sector employees,” says Henckes. “The maximum state pension for private sector retirees, for entrepreneurs and businessmen, was €2,500 while the minimum pension for unskilled public sector workers, the guy opening
and closing the door, was also€2,500. And we had a lot of what we considered very poor pensioners, getting the equivalent of €250 a month. So we demanded equal rights and we got it, at least for the new entrants to the public sector, from 1 January 1999.”

That reform was not without its drama. “More than 40,000 people in the public sector and associated enterprises demonstrated against the changes,” recalls Engel. “That’s 10% of the total population. The last time something like that happened was in 1942 at the time of a general strike during the German wartime occupation.”

And the reform triggered a change in the makeup of the governing coalition after the 1999 general election, although the CSV remained the dominant player. “The Democrats returned to power because they defended the rights of civil servants,” says Hirsch.

They replaced the Luxembourg Socialist Workers’ Party (LSA). “We were in government at that time and the reform that we supported is considered one of the reasons we lost office at the following general election,” says Di Bartolomeo. “Supporting a reform that took away one part of the pensions for working people was not very good for our party stance.”

But the roles switched again at the 2004 election with the socialists returning to office and the Democrats to opposition. “They couldn’t deliver what they promised, namely defending civil servants against all kinds of jealousies, so they were punished at the next election,” says Hirsch. And that was despite being in an administration that increased pensions payments.

“A committee was formed to propose ways to align the public and private sector systems and set out the consequences of the assumptions,” says Eric Paques, manager, tax, at PricewaterhouseCoopers. “Their recommendation was very clear: that the benefits of the civil servants had to be diminished. But despite the advice the alignment as achieved by increasing the pension benefits of the private sector system.”

“The 2001 pension reform was generated by a round table debate on pensions between the government and the social partners and they put new burdens corresponding to a 10% increase in annual expenditure on the pensions regime,” says Di Bartolomeo. “Such generous actions will no longer be possible. On the contrary, in the autumn I will begin a concerted action with the social partners to identify the weaknesses and the strengths of our system and then define the fields where we have to act.”

The previous government also decided to adopt a more adventurous policy for the statutory reserve. “In 2002 we decided that this money should be run by a group of specialists who know exactly how it should be invested,” says Bettendorf. And the process is continuing. “We have constructed a legal framework to give more possibilities in the placement of the funds,” says Di Bartolomeo. “We have built the cahier de charges and created autonomous boards charged with making the best use of the money in the market within investment guidelines. The procedures will be implemented in the coming months.”

However, Di Bartolomeo sees no need to offer further encouragement of the few private funded schemes created after legislation on the regulation of supplementary occupational schemes was passed in 1999 and which exist on the margins of the pension system.

“We want strong publicly supported pensions, so for us complementary pensions are really complementary,” he says. “We believe we have to organise a pensions regime that not only assures a minimum but on the basis of solidarity assures people a rather high state pension.”

“The idea behind the law for occupational based pension systems was not really to help people get an occupational pension from their company but to show to the world that Luxembourg is an attractive place in which to domicile pension funds,” says Joe Spier of the Luxembourg Christian Trade Union Confederation (LCGB). “The approach was very specific and that was the main preoccupation and may be one of the explanations why this type of pension has not developed.”

For Anne-Christine Lussie, a director at Fortis private banking and chairman of the Luxembourg Pension Fund Association to which seven of the 15 local pension funds established since 1999 belong, the administrative burdens imposed on company funds and pension fund managers are a major disincentive. “The disclosure and reporting requirements are prohibitive,” she says. “In addition, there are the tax rules: Luxembourg adopted the tax-exempted-exempted philosophy instead of exempted-exempted-tax.”

And then there is the question of tax incentives to boost the takeup of occupational schemes “The tax incentives are not very attractive, unlike in other countries,” says Paques.

“A distinction should be made between the contributions paid within the framework of an occupational pension plan, for which the deductibility ceiling is fixed at €1,200 a year, and contributions paid to a so-called ‘prévoyance vieillesse’ scheme that is opened to all taxpayers and which may attract tax deductibility of up to €1,500 a year until the contributor is aged 45 which then increases gradually to €3,200 over the age of 55,” says Lussie. “But the underwriting of a prévoyance vieillesse contract is totally independent from any occupational retirement plan and I think the tax deductible item is quite high.”

Di Bartolomeo appears unimpressed. “If there are very good state pensions I don’t have to explain for whom extra pensions are interesting and for whom not. If I am earning the minimum wage I have no interest in investing in supplementary pensions because I haven’t the means to invest. And if you increase the tax advantages you are going to give an incentive to people that already have a very serious pension. And so the first goal would not be boosting their pension but to allow them save some tax when investing money.” So what will his new round table explore? “We have to make a statement on the actual problems, problems coming in the short term and problems coming the day after tomorrow,” he says. “We expect the pensions regime to be rather stable for the next 15-20 years but then problems will increase rapidly. My timetable foresees discussions in 2006 and 2007 on the challenges and the specific answers to them, and then the presentation of medium-term and long-term proposals.” For Bley, part of the solution lies in boosting the supplementary system. “A young person joining the labour force now needs to make complementary provision and we are asking the government to give incentives for people to enter the second and third pillars,” he says.

“In this country the trade unions and to a certain extent the government are opposed to the second pillar because they feel that if it were to grow it would engender a certain disinterest in the first pillar, where their interests are organised. But while psychologically this might be correct reasoning, it does not take into account the demographic threat to the first pillar. We need the second pillar. We have been pushing for this since the late 1990s but unfortunately the government still has not got the message that relief can come from the second pillar.”

“At the previous round table the trade union confederations adopted a common platform noting that while pensions had been funded by a percentage of salary, the economic situation has changed,” says Spier. “We suggested that companies with a substantial amount of money but not employing many people and that made money not only by people working but in another way, could provide an alternative source of financing through a tax on computers or on their generated revenues. Our ideas were not taken up then but they are still a demand from our side. I think that this would help us to finance pensions more easily in the future.”

But although views vary about just what the question might be, let alone the answer, unease is growing that the current mainstay of the system, the cross-border commuters who contribute to the system, might in the longer term undermine it.

“One of the challenges is that the young cross-border workers today will be pensioners tomorrow,” says Di Bartolomeo.

“The taxpayer’s one third contributions to the pension system costs €1bn out of a state budget of €7.5bn,” says Engel. “The question is where do the funds go? As long as you pay Luxembourg residents it’s OK because they will spend the money here. But we are going to come to a situation where we will have to pay tens of thousands of people who will spend their pensions elsewhere because they don’t reside here. And that is going to contribute to an accelerating worsening of the pensions situation.”

However, no calculations seem to have been made of the balancing the feared pensions outflow against the advantages brought by the commuters - that Luxembourg does not pay for their education or post-retirement medical costs, that they will only a partial pension not having spent all their working lives in Luxembourg and that their presence contributes to the economy’s growth. “Yes, we get them quite cheaply,” Spier concedes. “But we are very aware that in the future we might export a lot of assets when the commuters retire to Belgium, France and Germany.”

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