Top 1000: Portugal - Towards sustainability
Portugal had a tough 2013, facing negative GDP growth of -1.6% and a political crisis that undermined the government’s efforts to meet the conditions of its €78bn IMF-EU bailout. Eventually, the crisis was resolved when the centre-right Social Democratic Party (PSD) struck a deal to keep a coalition government going, avoiding a further bailout. However, in July 2014 the stock market was hit when worries about the financial strength of a major Portuguese bank, Banco Espírito Santo, spread among investors. The bank was finally split in August following a €4.9bn capital injection.
The government still managed to take steps to address its pension problem, which is an integral part of its fiscal adjustment programme, by introducing a series of significant changes in February. The government chose two main ways to reduce the burden of pensions on the state and to encourage pension savings: cutting state pensions and raising the retirement age.
At the end of 2013 the Portuguese government had approved the budget law (law 66–B/2012) that introduced the extraordinary solidarity contributions (CES) law, which essentially consists of cuts to state pensions aimed primarily at reducing public expenditure.
Initially, the CES applied to pensions above €1,350 and cuts ranged from 3.5% to 50% of pension income, with the higher rate applied to pensions above €7,545.96. Earlier this year, the government amended the CES, further penalising state pension benefits. The cut is now applied to pensions above €1,000 and pensions above €7,126.74 are halved.
It was feared that the CES would negatively affect second-pillar pensions, as the state demanded that it was applied to private pension pots as well. “The Portuguese authorities interpreted that pensions paid by private pension funds were also within the scope of these cuts, demanding that pension fund providers withhold the corresponding amounts and deliver it to the state,” says José Veiga Sarmento, chairman of Portugal’s investment and pension funds’ association APFIPP. “The measure is damaging the reputation and credibility of pension plans as efficient vehicles for saving for retirement, preventing the creation of new pension plans and even leading to the closure of some of the existing ones. This happens because the economic crisis that affects Portuguese companies does not favour spending on occupational pensions and also because these plans, due to the cuts, are not valued by employees.”
Regulation in summary
• The Portuguese government has introduced measures to ease the burden of state pensions, aiming to save €388m.
• The normal retirement age has been raised from 65 to 66 years of age and it could be raised further.
• The ‘sustainability factor’ used in pension calculations, which links pensions to average life expectancy at 65, has been changed to make pensions more affordable in the long term.
• Additionally, state pensions will be cut from 2015 through a ‘sustainability contribution’.
• Total pension assets grew by 4.7% in 2013, topping €15bn. This was mainly due to asset appreciation; net inflows accounted for 18% of growth.
More recently, the government announced that, from next year, the CES will be replaced by another measure for the reduction of state pensions – the sustainability contribution (CS) – and that cuts to private pension plans will be scrapped. The CS will mean smaller reductions, with cuts initially ranging between 2% and 43.5%, and in the medium term the maximum reduction rate will be 3.5%.
Another legislative measure (83-A/2013) changed the social security regime, introducing the possibility of adjusting the normal retirement age in line with the evolution of life expectancy indices. Lawmakers have increased the normal retirement age by one year, from 65 to at least 66 years of age or 43 years of contributions. But the new law essentially means that the standard retirement age may be subject to changes.
This is because the law amended the ‘sustainability factor’ element of the formula used to calculate pensions. The sustainability factor linked average life expectancy at 65 in 2006 to the same figure in the year before retirement.
The new law foresees that the reference year may be changed in response to increased life expectancy or other contingent factors that make pensions unsustainable. At the moment, the reference year has been changed to 2000.
Early retirement had been suspended until 2014, and it is now possible to retire earlier. However, because the new sustainability factor was applied to pension calculations, under the new rules, early retirees will receive a lower pension from 2015.
These changes are expected to save the government around €388m, helping reduce the deficit to 4% of gross domestic product during 2014. But there are worries that the methods chosen will not bring sustainable savings.
Still, it is hoped that the new rules will encourage private pension savings.
“These changes are aimed only at public pensions but they can also impact pension funds,” says Veiga Sarmento. “Firstly, because the access to benefits from private pension funds is conditional on reaching the normal age of retirement, and this is going to be dynamic in the future.
“Secondly, as there is the possibility of early retirement but with the application of the sustainability factor, the value of the first-pillar pension can be reduced significantly. This constitutes an incentive to promote savings for retirement through occupational and individual pension plans.”
Veiga Sarmento adds that people who want to retire early need to save for retirement to maintain the same level of income, or at least to ensure that the reduction of income is not significant.
It may take some time before the second-pillar system grows to a significant size, however the growth rate of pension funds for 2013 was a healthy 4.7%, according to APFIPP.
The country’s pension funds added almost €680m, bringing their total assets to more than €15bn. This was, however, mainly due to positive returns, as the difference between inflows and outflows accounted for just 18% of the increase.