Top 1000: Spain - Serious about reform
Spain is serious about reducing its 7.1% budget deficit, at least judging by the pace at which Mariano Rajoy’s centre-right government is pushing reforms through parliament. After an overhaul of the labour market in 2012, the Spanish parliament passed a new pension regulation earlier this year that promises to bring sizeable savings. An equally ambitious proposal for tax reform is currently being discussed.
The pension reform of 2014 follows another set of significant changes approved in 2011, when the retirement age was raised from 65 to 67 to ensure the sustainability of public pensions. The government has now introduced further measures aimed at ensuring sustainability as well as reducing the state deficit by cutting pensions.
Key to the new regulation is how state pensions are increased. Revaluations were guaranteed in line with an index of consumer prices. From this year, pensions will be increased using a complex formula that takes into account the income of the social security fund, the number of pensioners, the average pension and the structural deficit in the pension system. A minimum annual increase of 0.25% is guaranteed.
Increases in inflation will not be taken into account in pension increases unless the state pension fund is in surplus. The law also establishes that even if that condition is met, state pensions will be increased by a maximum of 0.5% above CPI. From January this year, the ceiling for state pensions is set at €2,554.49 per month.
The reform has also introduced a ‘sustainability factor’, which will be applied from 2019 to the calculation of state pensions. This will link pensions to life expectancy and will be revised each year.
Regulation in summary
• A new pension reform will gradually cut benefits to keep the budget deficit in control.
• Pensions will be increased according to a complex formula, with a guaranteed annual increase of 0.25% and a maximum of 0.50% over CPI.
• A sustainability factor links pension payments to average life expectancy and may be revised every five years.
• A proposed tax reform is not expected to have significant consequences for the development of the second-pillar system.
Nevertheless, these measures do not guarantee that the government will not tap into the social security reserve fund, set up in 2000 to fund pension shortfalls. The fund shrunk from €67bn to €60bn in 2011 after several drawdowns by the current administration. Rosa di Capua, partner at Mercer, believes the government will have to use the fund again as the fiscal situation will not allow it to fully cover pension expenses.
Some are also worried that the pension reform may significantly reduce pensioners’ purchasing power over the long term. Mariano Jiménez Lasheras, senior consultant with the actuarial consultancy CPPS, notes that the two major reforms have focused on cost containment, with an aggregate net effect of reducing new pensions by 25%. This will help ensure sustainability in the future, he says.
Lasheras adds that it would have been difficult to increase contributions from the employers, employees or the state given the poor labour market situation and the high public deficit.
He comments: “While the reforms contribute to the sustainability of the system in the long term, the expected decrease in the amount of pensions raises the issue of sufficiency – that is, in the future will pensioners be able to rely on sufficient and adequate pensions that allow them to maintain standards of living as prior to retirement?”
The issue is particularly relevant considering the limited size of the second and third pillar systems in Spain.
A framework for complementary pensions was created 25 years ago, but as of today the second-pillar system represents just 7% of GDP. The second-pillar system mainly provides benefits to employees of large companies in the financial, energy, telecommunications, food and chemical sectors.
Contributions by employers and employees are voluntary, and there are few incentives to contribute, unless companies are willing to offer benefit packages to attract employees.
After momentous growth in the early 2000s, the system has stalled in terms of growth contributions, employees and the number of funds, partly due to weak economic conditions.
At the end of 2013 there were around 1,400 pension plans with €34bn assets belonging to more than 2m workers, or 10% of the working population. Funds are mainly of the DC type or other hybrid structure, with 14% of sponsors running pure DB schemes.
Part of the reason why so many Spain people do not have a complimentary pension plan lies in the structure of the country’s economy, where SMEs account for more than 80% of workers.
However, the government is yet to take any concrete steps towards boosting the second pillar. One initiative is to provide those aged 50 and over with a clear estimate of their pension income, including state pension and complimentary pension if they possess one, in order to raise awareness of the need of complementary pension savings.
Commentators fear that the measures proposed in new tax regime will not help rectify the lack of private pension savings. Indeed, some parts of the reform could have an adverse effect on pension investment. Mercer’s Di Capua is pessimistic, noting that the current rules on lump-sum payments are likely to be restricted, and that companies have little incentive to start new plans as tax deductions that favour the creation of supplementary pension funds will not be introduced.