Spain: Age old problem
Plans are being implemented to cope with the country’s rapidly ageing population
• Demographic and economic pressures have resulted in a record deficit for the social security system
• Protests by pensioners have forced the government to increase state pensions by 1.6% in 2018 and 2019
• A return to inflation-based revaluation of pensions could mean the end of IRP and the 2013 pension reforms
• Auto-enrolment suggested as an option for promoting the country’s underdeveloped complementary pensions sector
Spain is getting older at a faster pace than other European countries, putting extra pressure on an already over-stretched pay-as-you-go state social security system. According to UN projections, Spain will have the second highest old-age dependency ratio in the OECD in 2050, just after Japan.
The state system has continued to pay generous pensions, with replacement rates for full-career workers of about 80%. The average retirement pension is just over €1,000 per month, higher than the minimum wage of just under €860 per month.
The country’s first-pillar pensions system has undergone several reforms in recent years, aimed at counteracting the impact of demographic trends and taking into account the country’s economic woes – Spain’s social security system has been running a deficit for the last seven years, hitting a record €18.8bn shortfall in 2017.
Reforms introduced in 2011 included a gradual increase in the statutory retirement age, and an extension of the reference period used to calculate pension payments. Crucially, in 2013 a new mechanism for the annual revaluation of pensions was established, replacing the former system that linked annual pension increases to the rate of change of the consumer price index (CPI).
The pensions revaluation index, or indice de revalorización de las pensiones (IRP), has been a focal point of debate this year, and is the reason why thousands of pensioners took to the streets demanding fairer pensions.
The IRP takes into account social security revenue and expenditure to calculate annual rises in pensions. Since it came into force four years ago, the IRP has been at its lowest possible level of 0.25%, but a recent rise in inflation meant that 2018 was the first year that saw pensioners with less money in their pockets – and marching in large numbers.
“According to the OECD, the implementation of pension reform will be key to ensure long-term fiscal sustainability”
The politically-charged mobilisations forced the conservative government of Mariano Rajoy to make concessions to have its annual national budget approved by parliament, with the support of the Basque Nationalist Party (PNV).
These included increasing pensions in line with the CPI in 2018 and 2019, to the rate of 1.6% per year, and delaying the introduction of the Factor de Sostenibilidad, a feature which links the level of state pensions to life expectancy.
The sustainability factor, which will see pension payments reduced over time, was due to come into force in January 2019 and there are now plans to delay it until 2023.
In yet another political twist, Rajoy’s government was ousted in June after a no-confidence vote triggered by corruption scandals. However, the new socialist government of Pedro Sánchez has said it will honour previously agreed pension increases, and arrangements have been made to process backdated payments to reflect the rise.
While both the IRP and the sustainability factor were originally introduced to control and reduce pensions costs, the new concessions will do just the opposite.
According to a report by a pensions observatory led by Willis Towers Watson and the University of Extremadura, the consequence of increasing pensions above the IRP will result in an extra cost of just over €2bn in 2018, which will be higher in 2019 due to the cumulative effect of the revaluation. This additional expenditure carries an actuarial present value (APV) of nearly €40bn, representing 34% of the total expenditure in pensions in 2017.
Although pensioners and the country’s powerful trade unions have welcomed the rise in pensions, the short-term and political nature of these decisions set alarm bells ringing across the country.
Firstly, there is the question of how these increases will be funded, with the new government proposing new taxation initiatives, such as a special tax for the banking sector specifically dedicated to fund pensions, and the ‘Google tax’, which targets digital and technology companies.
Secondly, those working on finding solutions for the long-term sustainability of the system see these temporary measures as dangerous steps that could compromise future pensions payments, and the economy as a whole.
The Spanish economy has been growing at over 3% per year over the past three years, after years of recession. It is projected to continue growing at a robust, although more moderate, rate in 2018 and 2019.
Despite the benign economic outlook, unemployment remains high, at over 15%, and salaries low, resulting in a shortfall of contributions into the social security system. According to the OECD, the implementation of pension reform will be key to ensure long-term fiscal sustainability.
Against this backdrop, discussions about the need to promote complementary pensions continue to be limited. Data from the investment and pension fund association Inverco showed that about 8m people had a complementary pension plan at the end of June, of which only 2m were members of an occupational pension scheme – Spain’s working population is 23m.
Assets accumulated in the complementary pensions system represent about 10% of Spain’s GDP, roughly the same amount needed by the state system to pay pensions every year.
Earlier this year, the previous government announced measures aimed at promoting individual pensions savings, including the possibility of taking money out of pensions pots after 10 years, and lowering the commissions savers pay to pensions management companies from 1.5% to 1.25%.
Calls have also been made for the government to consider the introduction of a semi-compulsory auto-enrolment pension system, similar to the UK’s NEST, although this has not been discussed in depth.
The Pacto de Toledo commission, which has guided pension reforms since it was created in 1995, is now revisiting the implications of returning to an inflation-based formula to calculate future pension rises. There is disagreement across the different parties regarding when and how these should apply – some support the idea of maintaining the IRP formula when the economy is strong, and increasing the rate in line with CPI during crisis periods.
Regardless what is agreed, a more permanent return to an inflation-linked approach to calculate pension increases could mean the end of IPR and the 2013 reforms.
Dipping into the reserves
The Spanish social security reserve fund, Fondo de Reserva de la Seguridad Social (FRSS), was created in 2000 as one of the recommendations by the 1995 Pacto de Toledo.
Its aim was to invest any surpluses of the social security system to finance future state pensions shortfalls. At its peak in 2011, the fund reached €66.8bn but at the end of 2017 there was just €8bn left.
High unemployment and the consequent reduction in social security contributions drove the previous government to tap into the fund on many occasions to pay for pensions – over €20bn was taken out in 2016, and €7bn in 2017. In addition, the social security system had to borrow €10bn from the Spanish treasury to cover the two extra payments that pensioners receive each year, one in July and one in December.
The new government, which criticised the previous executive for emptying the ‘pensions piggy bank’, would not want to see the fund totally depleted under its watch.
However, the new social security minister has been quoted saying she would tap into it if needed. For the time being, the government has authorised a further loan from the treasury to cover short-term pension payments.