Pension reform advances with new rules and proposals by the Portuguese government
- Portuguese pension funds’ regulatory framework is under review in relation to the transposition of the IORP II directive
- New rules on pension drawdowns have brought more flexibility to defined benefit scheme members
- Demographic trends and complexity put pressure on public pension system and further reforms are needed
The introduction of new rules affecting pension funds and proposals for further changes by the Portuguese government are expected to have a significant impact on the future shape and functioning of the country’s pensions industry.
In July, the government submitted a law proposal to parliament, the Assembleia da República, to transpose the EU’s IORP II directive into national law, and to review the current regulatory framework for the setting up and operations of pension funds and activities of pension funds and pension fund managers.
As a result of the transposition of the directive, the new law sets the ground for more robust governance mechanisms for pension fund managers, the establishment of risk self-assessment – similar to the self-assessments under the EU’s Solvency II directive – more rigorous information requirements, as well as measures of relating to the reporting and public disclosure of information, supervision, and cross-border transfers, among others. The proposals are still subject to parliamentary approval, which is expected to happen by the end of the year.
Earlier this year, details about new rules affecting pension drawdowns were revealed. The changes were introduced by decree law passed in 2017 affecting Portugal’s insurance companies, pension funds and pension fund managers.
The new framework brings more flexibility to the sector by allowing defined contribution (DC) schemes to pay pensions to members directly. The decision was welcomed by the sector but uncertainty about the specifics of how the system would work led to much speculation.
At the end of 2018, following a consultation period, the insurance and pension funds supervisory authority, the Autoridade de Supervisão de Seguros e Fundos de Pensões (ASF) released details on new forms of pension payments.
Previously, an employee reaching retirement age could receive up to one third of the accumulated pension pot in cash, and the remainder had to be used to buy an annuity from the insurance market. Under the new structure, members will be given three choices.
The first would be to receive the pension through a pension fund, being the sponsor company responsible for the payment of extra contributions if required. This option is only available to those already covered by a pension fund contract.
The second possibility would be to receive the pension through a pension fund until the accumulated amount is depleted, provided the member sends a written agreement to the pension fund manager.
The third option would be to purchase an annuity from an insurance company. This will also be the default option if members fail to make their own choice within 60 days from retirement date.
The new regime will have implications for sponsor companies as all existing pension contracts will need to be amended to incorporate the different pension drawdown alternatives.
Sponsors are also expected to ensure that employees reaching retirement receive adequate advice to choose a route that takes into account their risk profile and financial situation. Similarly, effective communication to active employees will be needed to make sure investment decisions are made with a longer-term horizon, beyond retirement.
The recent regulatory changes have been seen as a step towards creating a stronger private-funded pensions sector which is currently underdeveloped.
According to an OECD report published in the spring, occupational pension plan coverage in Portugal is low compared with other OECD countries. At the end of 2017, there were just over 160,000 members of pension funds, representing only 2.5% of the working-age population.
Communication and education
The new rules allowing for members of DC schemes to decide how they want to receive their pension on retirement have increased the need to improve communication between company sponsors, pension fund providers and members.
Several market participants including consultants have highlighted the importance of establishing effective communication channels with members to improve understanding about the choices they face, the evolution of their pension accounts, and the investment choices available to them.
A lack of financial knowledge remains a barrier to effective retirement planning. Over recent years, the ASF has developed an initiative to promote education on insurance, pensions and risk. However, and according to the OECD, more can be done to specifically target education related to retirement income.
Although companies and pension fund providers have made progress on how they share information with members, much of the communication efforts have been directed to members approaching retirement age. That is instead of targeting younger scheme members and educating them about the different investment options available
to them – especially now that investment horizons will expand beyond retirement age for those deciding against the purchase of an insurance annuity.
Even though the changes in regulation have brought more flexibility to DC members, the temptation to opt for an initial pension that is too high is still there. Stronger education and communication channels could prevent scheme members from risking running out of money too early into retirement.
The mix of coverage between defined benefit (DB) and DC plans has been changing since 2007; the number of active DB members has declined while active DC membership has risen. The coverage rate of personal pension plans is higher than for occupational pension plans, but is still lower than most other OECD countries with voluntary pension systems.
Today, the vast majority of the Portuguese population relies on state pensions for retirement income. However, demographic trends and budgetary pressure are threatening the long-term viability of existing arrangements.
The decline in Portugal’s working-age population looks set to be among the steepest in the OECD countries, with the number of 20-64-year-olds expected to fall 30% by 2050, compared with an average drop of 5% in the OECD membership.
The complexity of the first-pillar system remains a source of concern. In short, the public pensions system consists of an old-age safety net, a pay-as-you-go DB scheme and a voluntary funded scheme. The safety net includes an old-age social pension, the Complemento Extraordinário de Solidariedade (CES), and a top-up, the Complemento Solidário para Idosos (CSI). The DB scheme has two main components – the general social security scheme, and a plan for civil servants. The latter has been closed to new entrants since 2006, and new civil servants now contribute to the general scheme.
“The new framework brings more flexibility to the sector by allowing defined contribution schemes to pay pensions to members directly”
Although safety-net provisions have been effective in reducing old-age poverty, access to those provisions is complicated by administrative complexities. The OECD has called for the simplification of non-contributory benefits to avoid the multiplication of instruments with similar objectives, recommending the merger of the CES and the CSI.
The gradual integration of the civil-servants scheme into the general scheme mentioned earlier is one of the many reforms introduced over the past decades by successive governments.
Other important changes include increasing the period to calculate the reference wage, aligning the retirement age between women and men and linking it to life expectancy, and the introduction of a sustainability factor to adjust pension benefits over time.
Regarding the latter, the OECD highlights that, currently, the sustainability factor only generates large penalties in case of early retirement. Although these measures are needed to encourage people to work longer, it should be used to adjust pension benefits across the board as an ultimate instrument to ensure financial sustainability.