Chronic political instability has turned attention away from pension reform while features of previous legislation have been undone

Key points

  • April’s general election resulted in a hung parliament, meaning Spain could be heading for its fourth general election in as many years
  • Political instability has put pension reforms on hold and key features of previous legislations have been suspended or delayed
  • Public pensions benefits are expected to shrink over the next two decades and complementary pensions remain underdeveloped
  • Measures to guarantee the long-term sustainability of the country’s pension system and intergenerational equity are urgently needed

At the time of writing, Spain’s Socialist caretaker president, Pedro Sánchez, had failed to gain enough support from parliament to form a government. He will have to wait until late September for his next and final attempt to secure sufficient backing, or otherwise call another general election for November – the fourth in as many years.

Against this backdrop, it is not surprising that few meaningful steps towards reforming the country’s pensions system have been taken. On the contrary, recent decisions affecting the first-pillar pay-as-you-go system have taken a step backwards. They have undone some of the key changes introduced by previous reforms. Those were aimed at counteracting the impact of demographic trends and the country’s challenging economic situation following the financial crisis.

Spain is ageing rapidly and its demographic challenges have the potential to significantly increase the burden of age-related expenditure such as health services, long-term care and pensions. 

According to the Organisation for Economic Co-operation and Development (OECD), ageing pressures will continue to increase the cost of pensions as a share of GDP, which is expected to peak in 2045. Additionally, the old-age dependency ratio is expected to double between 2015 and 2050, making it the second-highest projected dependency ratio in the OECD, after Japan.

Pension reforms of 2011 and 2013 introduced significant measures to ensure the long-term sustainability of the system. The 2011 reform introduced a gradual increase in the statutory retirement age, and an extension of the reference period used for calculating pension payments. 

In 2013 the índice de revalorización de las pensiones (IRP, pensions revaluation index), was established, taking into account social security revenue and expenditure to calculate annual pension increases. It was a move away from the previous formula that linked pension rises to the rate of the consumer price index (CPI). 

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Another key aspect of the 2013 reform was the introduction of a sustainability factor, linking the level of state pensions to life expectancy.

Under the recent economic environment, the application of the IRP would have led to a quasi-freezing of pensions, growing at a rate of only 0.25% a year which, even in years with moderate inflation, would mean a loss of purchasing power for pensioners. This was the case in 2018, and it prompted thousands of pensioners to demonstrate across Spain’s main cities, forcing the government to suspend the application of the IRP and increase pensions in line with the CIP again, at a rate of 1.6% a year in 2018 and 2019. The introduction of the sustainability factor, which was due to come into force in January, was also postponed until 2023. 

With the two key pillars of the 2011 and 2013 reforms now on hold, the debate has moved to whether these suspensions are only temporary or a step towards a permanent derogation. At present, the general consensus among the main political parties seems to be to repeal the IRP for good and return to the indexation of pensions to the CPI. 

Pacto de Toledo needs a new lease of life

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.

In July, and during the speech before his failed investiture vote, Spain’s acting president Sánchez said the next political term should “light up a new Pacto de Toledo” to safeguard the public pension system and guarantee the sustainability and public nature of pensions.

He talked about his commitment to “consolidate” the indexation of pensions to the CPI and abolish the IRP system adopted by his predecessor, Mariano Rajoy. Importantly, he also outlined his intention to end the deficit in the social security system in five years, through new taxation and financing formulas and a fairer distribution of pension benefits.

The Pacto de Toledo parliamentary cross-party commission was created in 1995 with the aim to guide pension reform and guarantee the sustainability of the social security system for future generations. Its work has been instrumental in promoting cross-party debate and driving pension reform. But Spain’s new political landscape, with a highly fragmented parliament, has affected the commission’s ability to find consensus.

In February, after two years of negotiations, the commission failed to reach an agreement on further reforms. It remains to be seen if next government, whether led by Sánchez or not, can inject a new lease of life into the Pacto de Toledo.

Data for 2017 shows that the average pensions replacement rate in the OECD is 57.6%, of which 41.3% corresponds to the public pensions system and 16.3% to the private system. In the case of Spain, the replacement rate is 82% and is fully absorbed by the public system – the highest rate among OECD countries covered exclusively by the public system. The European Commission has warned that the evolution of the replacement rate of the Spanish public pension system in the coming years could gradually decline to about 49% by 2050.

Building stronger complementary pensions could help mitigate the risks associated with the challenges faced by the social security system and the expected gradual reduction in pension benefits. But, so far, little has been to promote the growth of the sector. 

According to data from pension and investment fund association Inverco, assets under management by occupational and individual pension funds amounted to €107bn at the end of 2018, a reduction of €4bn compared with the 2017 figures. The number of people covered by a complementary pension plan is about 7.5m.

Assets under management in the Spanish complementary pension fund system represent just 14% of GDP. In addition, the expenses associated with saving through such vehicles are among the highest among OECD members. 

Last year, as an incentive to boost participation in complementary pension plans, the government announced proposals to lower fees, and also allow the early withdrawal of funds after 10 years of contributions from tax-advantaged private pension plans. Although these measures might make the sector more attractive to savers in the short term, there are concerns that they could undermine long-term savings for retirement.

“recent decisions affecting the first-pillar pay-as-you-go system have taken a step backwards ”

Political instability and a lack of willingness to adopt long-term measures that could trigger short-term public opposition have been major obstacles to pension reform, and there is a growing sense that time is running out. The social security funding gap is growing fast, representing €18bn at the end of 2018, or 1.52% of GDP, and it is expected to be slightly higher by the end of 2019.

Following the April general elections, several organisations including the Spanish

central bank, the Independent Authority for Fiscal Responsibility (AIReF) and the Foundation for Applied Economics Studies  voiced their concerns about the urgent need for addressing the problems facing the pensions system. 

In its annual report, the Banco de España, the central bank, called for renewed efforts to try a and build “a broad consensus, without unnecessary delays” to adopt measures to guarantee the long-term sustainability of the country’s pension system and intergenerational equity.