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Impact Investing

IPE special report May 2018

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Pension reform can't wait

Now is the time to tackle pension reform, European industrialist Carlo de Benedetti told those attending the ‘Defusing Europe’s pensions timebomb’ conference organised by the Friends of Europe body in Brussels last month. “Unemployment in European countries is today mostly a supply problem rather than a demand one. In the core of Europe there is a lack of workers rather than a shortage of jobs. These are the ideal conditions under which pensions reforms prolonging the active life can be carried out.”
De Benedetti was specific as to what needed to be reformed.
To create a more balanced pensions programme with a sufficiently large funded element. three steps should be taken, he said. Firstly, social partnership should be promoted, by involving workers, government and industry in the provision of retirement income. Secondly, individuals needed to be encouraged to save responsibly for retirement.
Thirdly, de Benedetti said: “Confine the role of public pensions systems mainly to redistributing resources from the lifetime poor and shift to the other social partners the responsibility for full old-age insurance provision for workers.”
More resources could be made available for those on low incomes by reducing compulsory contributions to public pensions and providing a “solid safety net”, he said. “An ageing Europe needs to retain workers in the workforce when they reach the peak of their seniority – pension programmes should no longer encourage early retirement.” He suggested retirement below age 65 should be discouraged, but favoured flexibility as to the age.
“Pension arrangements should not hamper labour mobility. Workers should be able to move freely across jobs. Hence long vesting periods should be avoided and the build-up of pension rights should be protected while the transferability of pension rights, both within a country and between countries, should be guaranteed.”
He stressed that pension fund taxation should not be an obstacle to portability of pension rights. “Global investment is the keyword to achieve flexibility of pension programmes vis à vis demographic and political crises. This is exactly where unfounded pension systems do fail.” Making a plea for global investment under prudent man rules, he reckoned this implied allowing for greater competition in private pension provision. “There should be freedom of contract between the sponsoring company and the pension fund and avoidance of any automatic cost-increasing mechanisms being imposed on pension funds, such as the automatic linking of benefits to wages and so on.”
How quickly European countries needed to act was the point put to the conference by Trevor Llanwarne, PricewaterhouseCoopers partner in London. With no reforms and with pension benefits rising in line with average earnings in the economy, pension costs in Germany and France will rise from 16% to 28% of average workers’ earnings in France and Germany and from 20% to 47% in Italy by 2050, he noted. “These are unsustainable costs, given that the total social costs, which include healthcare, unemployment and so on will make for a higher total. Action is needed.”
Llanwarne also looked at how benefits levels would need to be changed to keep costs within a prescribed level. “If costs are never to exceed 20%, a reduction of 35% in future expected benefits could be needed if started now in France.” However, he pointed out that a huge 70% reduction would be needed if the change was to be delayed to 2010, ading: “Germany is not much different from this and the figure for Italy is worse still.
“Action is needed now!”
He recommended that each country be set an upper limit on pension costs based on sustainable figures in a globally competitive economy.
“ This could be similar in principle to the Maastricht criteria and based on agreed assumptions.” He also suggested that the increasing of retirement age to a minimum of 70, perhaps by the mid-century, may be the only way to pay for increasing longevity.
The limitations of the draft directive were highlighted from another European corporate point of view: that of the Unilever pension fund in the Netherlands. Managing director Jos van Niewkerk said a directive with limitations on equity investing soon lost much of its attractiveness, as the loss of two percentge points in real returns could, depending on the fund, lead to a doubling of pensions cost. For the Unilever fund, over a 10-year period, the real returns had averaged 10.8%, with equity outperforming fixed income by an average of 8.4% a year in this period. Over 20 years the outperformance was 7%.
“In the draft directive, we see that member states have to allow 70% in equity and corporate bond investing. However, they may put a limit at the 70% level and prevent a higher allocation to equity, even when the nature of the liabilities and the financial situation of the fund would allow this.”
He welcomed the proposal for employees to become members of a pension fund across international borders in the EU. “The idea of cross border membership is a good idea but it has to be further developed into a European pension fund.” Van Niewkerk pointed out that a solution needed to be found for tax on pension contributions, returns and payments, as otherwise there would be no possibility to move ahead quickly in Europe. The proposal for a pan European pooled pension vehicle by the European Federation for Retirement Provision (EFRP) could, he said, help create institutional pension investing on a European scale. But it would depend on pension regulators accepting the idea of the single licence for the single market, he noted.
The EC was urged by the EFRP’s chairman Kees van Rees to act on its proposal for the pooled pension fund vehicle. “It goes a long way towards tackling the tax differences on pensions in cross-border traffic.” Not to tackle this issue was costing European industry a lot of money annually, he said.
“A bold step on taxation would be the implementation of the EET (Exempt-Exempt-Taxed) principle on pensions. I understand Commissioner Bolkestein has indicated his long-term support. What about the European Parliament? Member states are gradually looking at budget surpluses. It is the right time to invest some of this money in the EET principle.”
Van Rees suggested that the advent of the euro would make some inexplicable differences visible and stimulate people to ask questions about pensions issues. “By 2002, it will also become very clear that it is hard to conduct effective monetary and economic policies, while excluding some alignment of fiscal and social security policies.”
The timebomb element of the pensions debate was outlined by the European commissioner for the internal market, Frits Bolkestein.
He noted that the ratio of workers to pensioners would decline from 4:1 to less than 2:1 by 2040 and added that, if unfunded, pension liabilities in some countries would represent a debt of over 200% of GDP. Even with reforms in public pensions, he added, spending would increase by between 5% and 35% of GDP in most countries. “These figure could be come worse if there are significant increases in life expectancy,” he warned.
The primary responsibility for meeting the pensions challenges lay with member states, Bolkestein pointed out. Pension payments could turn into a vicious circle, if not reformed. Higher deficits could threaten the growth and stability pact, leading to inflationary pressures. “In turn this would result in the ECB having to set higher interest rates.” The commission’s plans for comprehensive reforms, he said, included getting member states to run public debt at a faster pace to offset increased pension spending. Employment and participation rates would also be encouraged to reduce the ratio of dependants to active workers; while greater reliance on funding for public pensions would be sought. The EC is to report in Stockholm on these issues. Bolkestein said funded pensions would play a greater role in the future and the EC proposals for pension fund supervision in the proposed directive would enhance funds’ safety and efficiency.
But pensions must be affordable and only with common prudential standards could cross-border membership be permitted, he argued .
But he appeared to reject concerns that a deal had been struck in the European Council and Parliament that would tighten prudential rules and impose certain investment strategies that would lead to lower returns. “Let me be clear. The prudent expert principle has been operated successfully for decades and it would be unwise to start telling the trustees and social partners who run pension funds in the interests of workers and pensioners, how they should do their job.”
He ended by confirming that the EC’s taxation proposals would be part of a forthcoming communication.

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