The Spanish pension system needs significant adjustment to ensure its sustainability, but politics has got in the way
Regulation in summary
• Spain’s current political climate has forestalled reform efforts.
• The Social Security fund is shrinking to cover gaps in the pension system.
• The private pension industry is demanding clear information on future payouts.
• Private pension funds are growing and diversifying, albeit from a low base.
Spain has been without a government since August, after two elections failed to produce a parliamentary majority. Meanwhile, the Social Security Reserve Fund (Fondo de Reserva de la Seguridad Social) is being depleted at an alarming rate.
The government relies on the fund to close gaps in the social security system. In July alone, the labour ministry withdrew €9.7bn from the fund, after taking €11.5bn last year and €15.3bn in 2014.
The government is forced to do this because contributions going into the pay-as-you-go system are insufficient to pay pensions. This is partly an after-effect of the economic crisis from which Spain is still recovering, albeit at a good pace, and partly due to structural issues.
As in most of Europe, Spaniards are living longer, and not enough jobs are being created to cover public pensions.
The government first tapped into the reserve fund in 2012 and, so far, it has drawn on more than €55bn. As a result, the fund, after peaking at more than €66bn in 2011, is now worth €24.2bn (2.24% of Spain’s gross domestic product).
The fund was set up in the 1990s and invests in domestic government debt and high-quality European government debt (it receives no external contributions). The good news for the incoming government is that the European Commission has decided to waive a fine of up to 0.2% of GDP for breaching the European Union fiscal rules (deficits must be below 3% of GDP). This is, however, a temporary measure, as fines could be imposed later this year if Spain fails to get its affairs in order.
Amid this situation, the private pension industry is growing, but Spaniards still rely too much on the state pension. This is unsurprising given that the replacement rate of the public pension is 73.9%, according to Inverco, the Spanish association representing the interests of mutual fund and pension fund investors. This is one of the highest figures of the OECD countries. But, due to planned decreases in benefits, that figure is bound to decline.
Diego Valero, chairman at Novaster, a Spanish pensions consultancy, says the future government will have to intervene, at least in the short term, to balance the books. The public pension system is in a transition period, in which the retirement age is increasing, and the variables that determine benefits, such as years of contributions, are being increased by law according to a plan. In particular, the statutory retirement age is planned to reach 67 years in 2027.
The plan was set following pension reforms in 2011 and 2014, approved under pressure from the European Union. Valero says the next government is likely to speed up the planned rise in retirement age. This means the 67 years statutory retirement age will be effective sooner than originally planned. Lawmakers may also adjust the variables determining the payout, such as years of contribution, average life expectancy at retirement and overall inflows into the system.
Valero notes that none of the political coalitions vying for power has put private pensions on the agenda. According to him, the first priority is to launch a strong and clear information campaign to make people fully aware of their future level of income once in retirement.
Given the amount of reform in recent years, there is much confusion on the topic, but clarity on future benefits would be enough to encourage people to save in a private pension. A bill designed to launch a Spanish version of the Swedish ‘orange envelope’, a letter sent to all citizens outlining their future pension benefits, was discussed by the outgoing parliament but never passed.
“Spanish pension funds, meanwhile, are growing, despite economic headwinds and market turbulence. According to Inverco, 8.5m people are covered by a pension plan. At the end of 2015, total assets were €104.5bn, according to Inverco”
Valero says the pension industry has been quite vocal in demanding such clarity over future benefits. Other possible measures to boost private pension funds, and thus ensure the future sustainability of the system, have been debated within the industry but never translated into legislative or regulatory action. These have included tax incentives for pension funds, both from an employer and employee perspective, and reducing asset management fees, which Valero believes are too high.
Spanish pension funds, meanwhile, are growing, despite economic headwinds and market turbulence. According to Inverco, 8.5m people are covered by a pension plan. At the end of 2015, total assets were €104.5bn, according to Inverco. The figure corresponds to about 9.5% of GDP, compared with an OECD average of 84.4%. Yet, AUM increased by 4% between 2014 and 2015, and Inverco forecasts 1.9% growth for 2016, which would bring the figure to €106.5bn. The average 2015 return was 1.8%.
Spanish pension funds invest mainly in fixed income, which take up 57.4% of portfolios on aggregate. The allocation to equities is 22.6%, and the rest of the portfolios are allocated to cash (8.3%), and ‘other’ assets, including real estate (11.7%). According to Inverco’s figures, there is a clear trend towards diversification away from traditional fixed income and towards equities and alternatives.
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