The Future of Pension Plans in the EU Internal Market

Old-age pension systems can be classified according to three aspects: funded versus unfunded systems (pay-as-you-go), actuarial versus non-actuarial systems, and defined benefit (DB) versus defined contribution (DC) systems.

Several European countries have (or had) public old-age pension schemes with defined benefits, financed by a pay-as-you-go (PAYGO) scheme, where old-age pensions are determined by a formula not related to actuarial principles.

However, given the existence of several structural problems, such as the decrease in employment, ageing of the population and decline in fertility rates, these systems have reached their maturity, showing certain signs of difficulties as regards sustainability and/or the capacity to meet social goals.

In this context, in order to guarantee the sustainability of the systems, some countries have introduced structural reforms in their pension system architecture adopting alternative solutions as regards the funding of the system and/or the calculation of the pension benefit value.

This article intends to compare the main pension models, trying to identify, from a conceptual perspective, the advantages and disadvantages of each one of them, in order to identify how to better address common challenges in the EU with regard to the protection of old age citizens in a sustainable manner.

Recent history has shown that with tight public finances the costs associated with a transition from a PAYGO to a diversified pension system with funded and PAYGO components can be high. A number of countries backtracked on previously decided transitions, highlighting that the political risk of policy reversals is considerable. There is an actuarial equivalence between PAYGO and funded schemes. While, when an economy is dynamically efficient, a move from PAYGO to funding can boost future pension levels, it creates both winners and losers, thus implying some form of redistribution. Hence, choosing one type of financing over the other is essentially a political decision. While the economic condition for dynamic efficiency was typically fulfilled without ambiguity in the past, the current economic context questions whether this is still the case, suggesting to revisit the trade-off between PAYGO and funded schemes. Risk diversification remains a key argument for combining PAYGO and funded elements, but the benefits of risk-diversification should be weighed against the medium-term costs generated by the transition towards a multi-pillar system.

Due to ageing, governments have put into place parametric pension reforms during the last two decades. Consequently pension systems have become extremely complicated. Whether statutory, occupational or personal all pension forms are remarkably difficult to understand in depth. Nonetheless this huge complexity people are connected to their national pension system due to the existing underlying pension concepts. Each country possesses thus a unique own national pension identity. Every national pension landscape is created by or composed of the various pension forms occurring and operating concurrently, resulting in an aggregate pension concept that is tailored to a specific national context. It is this uniqueness that makes transposition of reforms from one country to another so complicated or at least deeply problematic. Changes from PAYG to funded schemes are therefore far from self-evident to be successful.

Expanding private pension plans coverage is seen as an alternative to address the growing pension gap. Indeed, due to recent reforms, lower public pension system replacement rates are expected for future generations of retirees. However, in most countries, private provision remains voluntary and the coverage rates observed are still very low. Several factors might explain this evidence and several policy options have been suggested to increase coverage in private pension plans. Yet, the issues concerning both the decision of the occupational pension plan type, defined benefit or defined contribution, and the characteristics of the personal pension plans, are most important and complex, as the implications for attaining the expected retirement income adequacy are diverse. This paper reviews these issues and the coverage of these pension plans.

Demographic developments are unfavourable for the financing of pension schemes in most OECD countries, implying continued growth in pension expenditure in virtually all OECD countries. This chapter examines the vulnerability of pension systems, with an emphasis on financial sustainability and adequacy. Policy trade-offs and complementarities are reviewed and flanking policies, which could underpin successful pension reforms, are examined. Automatic adjustment mechanisms are highlighted, as are the roles of prudential regulation and buffer or reserve funds in the case of shocks.

Very recently, the European Institutions made progress on the Capital Markets Union (CMU). The CMU is part of the so called “Juncker-Plan” which aims to boost investment across Europe. In our contribution we focus on retirement savings and investment for growth aspects of the CMU. We find that Europeans indeed accumulate savings but do not invest and thus do not prepare for retirement. Additionally, long-term investment could foster growth in the European Union (EU). We argue that the CMU is a step in the right direction as it introduces a new pan-European Pension Scheme, reduces bank reliance of enterprises, especially SMEs, and represents a key complement to Banking Union. However, CMU focuses mainly on the demand side, although functioning capital markets need (potential) investors who a willing and open to invest in capital markets products. Transparency, a stronger regulatory framework and better financial literacy could help overcome this shortfall.

Living considerably longer than ever before is certainly a positive fact, but at the same time, this presents a number of challenges and opens up questions how to reserve for retirement. Projections show that there will be fewer and fewer people paying into the pensions systems to support an ever-increasing number of pensioners. People living longer and low birth rates in developed countries, paired with low interest rates, mean that there is pressure on any pensions system, as funds have to cater for much longer periods. For a number of years, the growing gap between what people perceive as what they will receive as retirement income and what they will actually receive—as well as the basic adequacy of retirement income—has been on the agenda of governments, policy makers and regulators. There have been a number of studies showing that in Europe, yet also in many other developed and developing countries, not just the pensions gap, but also the funding gap of pension funds, is increasing and will be hard to close.

We analyze and compare the long-run effects for a country introducing a capital-funded pension pillar in two scenarios: The case of separate capital markets, on the one hand, and the case of integrated capital markets (a capital market union), on the other hand. Our analysis is based on simulations with a large-scale overlapping-generations model. We find that, in the long run, the introduction of capital-funded pensions is more attractive in integrated capital markets than in separated capital markets, if other countries in the integrated capital market have pay-as-you-go pension systems.

With a rapidly aging population, Portugal faces some serious pension challenges including a Social Security system which is under pressure, and pension benefits gradually approaching levels that will require individuals to supplement Social Security with private savings. In addition, Portugal has a low rate of financial literacy and hence transferring the responsibility of retirement planning to the general population runs a major risk of many individuals retiring poor. While some attempts have been made to create private pension plans, they have not had the level of acceptance as has been the case in some of the Anglo-Saxon countries. This paper argues that the government of Portugal could issue a new form of Sovereign Contingent Debt Instrument (SCDI) that can address the growing retirement challenge and achieve other goals as well. SeLFIES (Standard-of-Living indexed, Forward-starting Income-only Securities) are a new type of bond that greatly simplify retirement planning to the level of basic financial literacy and can not only address retirement security, but also improve the government’s debt financing and funding for infrastructure. Finally, since Portugal is part of the EU, the demand for these new bond instruments could be Euro-wide thereby providing additional benefits to the government in reducing its overall financing cost.

The article provides a general framework for the proposal for the Pan-European Personal Pension Product (PEPP) and details some particular aspects that will be discussed in the context of its application such as “national compartments” and the problem of PEPP taxation.

The PEPP is analysed as an instrument of the Capital Markets Union (CMU). It is concluded that it represents an opportunity for the EU to obtain long-term investment liquidity but also that, in the end, it is just a small palliative measure to alleviate the structural deficiencies of the EMU that remain to be solved.

Not much is left of the Personal European Pension Product (PEPP) as intended by the European Commission in June 2017. Proposed as a core element of the Capital Markets Union (CMU), the text as agreed between the European Parliament (EP) and the EU Council has become unclear, unattractive and unsuitable. The EP should not have rushed into signing off on an inadequate measure, or the EU Commission would have done well to withdraw the text. Key elements of the proposal were watered down or replaced in response to heavy pressure from member states and certain organisations. It is a classic example of how not to create the capital markets union: protecting national idiosyncrasies and vested interests, and losing out globally at the same time.

This chapter deals with the deepening of financialization in the EU which is intended with the Capital Markets Union (CMU) and its consequences for pension regimes. It departs from a brief overview of financialization and its meaning. It focuses next on deciphering the CMU as an institutional reconfiguration aimed at removing impediments to the circulation of capital and reviving the role of financial markets in the EU. The revival of finance-friendly views and policies in the EU institutions, after the traumatizing experience of the Global Financial Crisis, is interpreted as the outcome of a political stalemate on ‘fiscal unification’ which opened the path for the advance of the idea of private risk-sharing through finance as a substitute for public risk-sharing in a Fiscal Union. The pan-European personal pension product (PEPP), which is part of the CMU, is then addressed as a plan to speed up the shift of pensions schemes in the EU from Pay As You Go (PAYG) to funded pensions. Finally, the consequences of the possible development of an EU ‘third pillar’ of funded pensions with respect to the future of member states pension systems are highlighted.

Departing from the two basic historical models of social protection, the Bismarckian or labour model and the Beveridgean or universal model, the author proceeds with analysing two contrasting alternatives for the future design of pension systems: (i) The individual insurance model; (ii) The universal tax-financed model. Although motivated by common drivers—an ageing society and technological revolution—the responses and incentives are substantially (philosophically) different. Ultimately, there is a tension between social rights and financial markets that may end up with the predominance of one over the other. In the current (liberalizing) environment and considering past and recent EU policy guidance on this matter—the timidity of the social-rights centred strategy (contained in the European Pillar of Social Rights) in contrast with the impulse given to the development of the Capital Markets Union—may after all mean the triumph of a financial market-driven approach.

Since the early days of European integration, social policies have been a particularly contentious field. This was due, to an important extent, to the combined effect of the resilience of national welfare states and the idiosyncratic nature of the integration process. It was this context that led to the development of a specific pattern of social policies at the European level, characterised by the coexistence of different methods of governance. This chapter will reflect on the European repertoire of social policies, their distinctive features and how they have evolved over time. It will end with a discussion of how Europe, de facto, influences domestic social policies, as well as the challenges facing further developments in this policy field.

This chapter analyses the intense reforms which have taken place in the European Union after the Great Recession (2014–2019) by looking at how Member States addressed the adequacy side of pensions schemes. It also assesses the discourse at EU level regarding pensions for the period 2011–2019, demonstrating an incremental but visible evolution towards a more socially oriented EU approach. Principle 15 of the European Pillar of Social Rights stresses that all workers have the right to an adequate income. Both the Member States and the EU have begun to bring adequacy back in the policy equation, but the shadow of previous austerity policies still looms large over pension reforms.

Against the background of population ageing pension debate has focussed for many years on the future increase of the so-called old-age dependency ratio, i.e. the number of older people against the number of people of working age. Incomprehensibly, this ratio is often misinterpreted as the ratio between workers and pensioners. Yet, wrongly equalizing the number of people of working age with the number of people in employment distorts the view of the most effective strategy with which countries can prepare for population ageing—which is improving the employment integration of those of working age.

Referring to a study recently carried out in Germany the authors show that improving employment integration across all ages would help to significantly contain the future increase of economic dependency ratios and, thus, significantly support pension adequacy and financial sustainability.

For majority of people, pensions are the most important income replacement benefit, when the ability to work is reduced (or no economic activity is expected anymore) due to old age. Moreover, equal access to social protection, regardless of the type and duration of employment, is one of the goals of the European Pillar of Social Rights, aiming also at adequate income in retirement. Hence, the paper focuses on old-age pensions and highlights potential national and mobility linked problems and challenges for future pension adequacy concerning persons working in non-standard forms of employment and self-employment. After the introductory part in which also the fluidity of the EU society is being explained, paper focuses on three aspects: 1) necessary changes in the pension systems due to new working arrangements, 2) appropriateness of the EU legislation on free movement and social security coordination in relation to public and supplementary (occupational) pension schemes, and 3) importance of combating fraud and error.