Message to ECOFIN Council on 7 March 2002

DRAFT

European Financial Services Round Table

Message to ECOFIN Council

The European pensions crisis – what is to be done?

Message to ECOFIN Council on 7 March 2002

European pensions crisis – what is to be done?

Introduction

Most Europeans remain totally unaware of the danger that unsustainable state pension systems pose to their futures. If Member States and the EU fail to act rapidly and prioritise change, millions of Europeans will face inadequate resources in old age, compromising Europe’s proudly and painstakingly achieved social models.

As a result of the ageing of Europe’s population – increased life expectancy and falling birth rates - public pension expenditure is on course to rise by as much as 30% in the next 40 years unless prompt action is taken. An alternative to a 30% increase in costs is a reduction in benefits of a similar amount. The potential impact on individuals would be of enormous concern. The issues must be faced today and appropriate changes put in place.

Time is running out for Europe’s state pensions systems. On current trends, the combination of increased life expectancy, falling birth rates and early retirement will have devastating effects. European Union Member States can expect their pensioner-to-worker ratios to fall from current levels of 1 pensioner for every 2.6 workers today to 1 pensioner for every 1.4 workers. This reflects a change from 61 million people aged over 64 and 159 million workers today to 105 million older people and 150 million workers by 2040 (Eurostat projections). Public pension expenditure is on course to rise by as much as 30% in the next 40 years unless prompt action is taken. An alternative to a 30% increase in costs is a reduction in benefits of a similar amount. But such a scenario may need to be considered in the absence of radical reform. The potential impact on individuals would be devastating. The issues must be faced today and appropriate changes put in place. Most ordinary Europeans remain blissfully unaware of the danger to their futures. If Member States and the EU fail to act rapidly and prioritise change, millions of Europeans will face inadequate resources in old age, compromising Europe’s proudly and painstakingly achieved social models.

The challenge of ageing populations and the need forof pensions reform has featured at several European Councils in recent years. In particular the Barcelona Council of 2002 issued a call for reform to be accelerated to ensure that pension systems are both financially sustainable and meet their social objectives. The forthcoming Brussels Council on economic issues will further debate co-ordinated pension reform in the EU.

Such resolutions are warmly welcomed. The European Union has no mandate to reform national pensions systems and the responsibility falls squarely to national governments, who must approach the common task with new methods of co-ordination.

The EU however should guarantee access to markets and the EFR supports the aims of the draft prudential supervision Pensions Directive, along the lines of the Prudent Person Principle approach to investment, as a first tentative step towards a single market in pensions.

The European Financial Services Round Table is closely following the debate. It vigorously supports the call for reform and is keen to contribute to solutions to the impending crisis. Last year the EFR published a report, ‘One Europe, One Pension’ ( which highlighted the fact that most state sponsored schemes will not be able to deliver benefits to tomorrow’s pensioners at the same rate as for current pensioners without unsustainable increases in costs.

We see private funded pensions standing alongside a reformed state pension system as the way forward. We fully support the three pillar model of pension provision – state, occupational pensions and personal or individual pensions. We need a new balance, which reflects the needs of each member state and its citizens. Within the second and third pillars themselves there is also a need for balance and flexibility in benefit design and for new choices for individuals and their employers. Above all we need to see a transfer to a more capital based system, certainly for private pensions but the issues for public systems must also be debated. This transfer will be gradual but must begin at once. Failure to reform means that future generations of workers will face unacceptable levels of taxes which will put at risk the inter-generational solidarity which underpins the current unfunded PAYG systems.

The following analysis prepared by EFR may provide useful input to the developing debate.

The extent of the crisis

Economic Policy CommitteePC figures for the growth in public pension expenditures, without further reform, are stark.

Public pension expenditures (including most public replacement revenues) to people aged 55 or over, before taxes, as a percentage of GDP

2000 / 2020 / 2040
Austria / 14,5 / 16,0 / 18,3
Belgium / 10,0 / 11,4 / 13,7
Denmark / 10,5 / 13,8 / 14,0
Finland / 11,3 / 12,9 / 16,0
France / 12,1 / 15,0 / 15,8
Germany / 11,8 / 12,6 / 16,6
Greece / 12,6 / 15,4 / 23,8
Ireland / 4,6 / 6,7 / 8,3
Italy / 13,8 / 14,8 / 15,7
Luxembourg / 7,4 / 8,2 / 9,5
Netherlands / 7,9 / 11,1 / 14,1
Portugal / 9,8 / 13,1 / 13,8
Spain / 9,4 / 9,9 / 16,0
Sweden / 9,0 / 10,7 / 11,4
UK / 5,5 / 4,9 / 5,0
EU / 10,4 / 11,5 / 13,6

Table 3.5 Budgetary challenges posed by ageing populations: EPC/ECFIN/655/01

Such additional costs, paid for by the contributions of those at work, cannot be assumed by the system and are thus unsustainable. There is no doubt It is clear that reform is necessary.

The pensions gap

The EFR has attempted to calculate the pensions gap which will emerge if governments maintain expenditures at 2000 levels as a percentage of GDP, but individuals retiring in future aspire to a state pension of the same percentage of earnings as thoese retiring in 2000. We estimate the additional ANNUAL savings to close the pensions gap which will building up over the next 40 years as follows:-

bn Euro / bn Euro
Austria / 11,65 / Italy / 55,33
Belgium / 10,53 / Luxembourg / 0,00No data
Denmark / 9,84 / Netherlands / 22,88
Finland / 3,11 / Portugal / 6,29
France / 137,46 / Spain / 26,38
Germany / 109,69 / Sweden / 12,61
Greece / 6,03 / UK / 38,49
Ireland / 6,10 / Total / 456,39

Of course, not all of this saving is new; Ssome of the gap maycan be filled by the redirection of existing savings but this will still leave a big hole. S However the message is clear, people must have more savings must increase if if their aspirations for income in retirement are to be fulfilled.

Approaches to reform

Of course, the answer to the looming crisis for state pensions will take many forms. ThSe sustainability of state pensions systems depends on an appropriate balance between contributors and beneficiaries. Systems developed when there were relatively fewer pensioners, with more modest benefits, and growing workforce numbers. That balance is changing. Governments cannot ignore the realities of longer life expectancies and falling birth rates. Action must be taken to achieve a new and sustainable balance.

Whilst governments can attempt to change the balance by, for example,, reducing benefits, or by raising retirement ages or, by encouraging promoting increased participation in the labour force, such approaches – which are to be encouraged - are onlylikely to be partial solutions in reducing public expenditure. Governments can hardly fully solve the pension gap issue in this way. They will surely have to reduce benefits, thus reducing pensioners’ welfare and creating the need for private funded pensions. Individuals must be encouraged to make more provision for their own retirement. Action is required to make this alternative a practical and attractive reality for tomorrow’s pensioners.

The nature of retirement is changing. Increasingly people will not move from full time work to full time retirement overnight; instead they will reduce working over a number of years, with the same employer or with a new employer. Pensions must reflect this. A wide range of products can be provided to meet the diverse needs of people in terms of risk structures, financial guarantees, biometric risk including life long annuities, and differing risk horizons.

A standard for single market pensions

Last year we proposed a standard that ensures the best possible combination of

• Security – a fund will be properly managed and sums contributed will be safeguarded.

• Efficiency – the cost-effectiveness of the operations of the provider.
• Flexibility – the ability of the pension plan to adapt to the changing employment, residency and other life circumstances of the pension holder.

• Transparency – full, frank and easily understood disclosure of the terms and provisions of a pension scheme or plan.

• Information provision – timely, accurate and user-friendly statement of the projected pension income at retirement: consistent from member state to member state.

• Portability – the ability to transfer a pension or annuity at a ‘fair’ transfer value.

• Mobility – the ability to change jobs, country of employment or country of residence or retirement without penalty; the ability of employers to obtain EU-wide pension schemes.
• User-friendliness – pension matters will be presented in a fashion that enables individuals and employers to easily understand where they stand and make decisions accordingly.

These guiding principles apply within and across member states. We recommend them as a blueprint for the encouragement of funded pension provision.

There is increasing recognition that private funded pension provision has a key role in ensuring that tomorrows’ pensioners will not lose out.

We see private funded pensions standing alongside a reformed state pension system as the way forward. We fully support the three pillar model of pension provision – state, occupational pensions and personal or individual pensions. We need a new balance, which reflects the needs of each member state and its citizens. Within the second and third pillars themselves there is also a need for balance and flexibility in benefit design and for new choices for individuals and their employers. Above all we need to see a transfer to a more capital based system. This transfer will be gradual but it must begin immediately. The alternatives are untenable. Failure to reform will mean that future generations of workers will be faced with unacceptable levels of taxes which will put at risk the inter-generational solidarity which underpins the current PAYG systems.

The European Union has no mandate to reform national pensions systems and the responsibility falls squarely to national governments. They must act and act quickly. The EU can create access to the market and the EFR supports the aims of the draft prudential supervision Pensions Directive, along the lines of the Prudent Person Principle approach to investment, as a first tentative step towards a single market in pensions.

A single market for private pensions is needed

EFR encourages the Council of Ministers to go further and create a genuine open and transparent Single Market for private pensions in which costs, prices and charges will come down and quality will go up. Only competition, not regulation, can achieve that. . In particular EFR urges Member States to agree on the same taxation principles for private pensions (the “EET” model) with the removingal of tax tax discrimination from non-domestic providers. This is a prerequisite for Pportability of pensions which must become a reality. We must also avoid national restrictions on product features.

A study carried out for the EFR last year (The Benefits of a Working European Retail Market for Financial Services, highlighted the consumer benefits to consumers in terms offrom increased product choice and lower prices infor a single market. : benefits which will help create a favourable environment for the increased savings which are needed. In our report ‘One Europe, One Pension’ we estimated that reductions in fund management costs combined with the effects of greater competition generally might increase the pensions from a given level of contribution by 10% or more for a given level of savings.

But a single market will not of itself be enough to address the crisis. Political leadership is required to persuade citizens of the case for reform and the consequent need for increased private provision. The citizens of Europe should become enthusiastic advocates of reform. A European who is not encouraged to start saving for their pension in their early twenties will have to save double in their thirties and three times as much in their forties. They will not be able to afford it. Important tax incentives will be required to encourage savings. No modest compromises will do. Massive education and information campaigns have to be launched to alert young people to the new challenge. There is no time to lose. For adequate private pensions to be provided, we need an open, competitive and transparent market. Costs, price and charges will have to come down and quality go up. Only competition, not regulation, can achieve that.

We all have a role to play

A single market is not enough to solve the crisis. Political leadership is also required to persuade citizens of the need for action so that they are enthusiastic advocates of reform. Massive education and information campaigns have to be launched to alert young people to the new challenge. Important tax incentives will be required to encourage savings.

Both the Commission (in driving the Single Market) and nNational gGovernments, with responsibility for welfare and taxation policies, have crucial roles in creating pensions solutions. These should avoid further divergence of provisions systems arising from the initiatives of member states. Reform should be within a European context and not lead to isolation of member states from general trends as is the risk for Belgium with its minimum guarantee requirement. ButAnd individuals, employers and the financial services industry must be involved as well.

The challenge facing all of us is immense. All parties have key roles to play. The EFR does not underestimateunderstands the challenge of persuading people to save more. Fortunately But there are lessons fwhich can be learned from past experience. For example, the UK experience points to shows the importance of engaging employers in pension provision, especially where provision is voluntary. In the Netherlands and elsewhere the importance of fiscal incentives and the consistency of the approach is well known. AndiIn Germany and Belgium there is particular concern views have been expressed that product complexity and over burdensome regulation cancan be inhibitors to saving. In Italy and Spain, for example, it is found that individualspeople generally underestimate the consequences of increasing life expectancy as well as the need for long-term planning: people are too optimistic about future pensions.

The nature of retirement is changing. Increasingly people will not move from full time work to full time retirement in one step; instead they will reduce working and increase leisure time over a number of years, perhaps with the same employer or with a new employer. Pension arrangements and products must reflect this. Moreover pensions systems must be transparent, provide value for money, and deliver security to better informed consumers. Systems must also work to address inequalities in provision between men and women.

A standard for pensions

In our report on pensions last year we proposed a standard for Single Market pensions that ensures the best possible combination of

Security – the assurance that a fund will be properly managed and that sums contributed will be safeguarded.

Efficiency – the cost-effectiveness of the operations of the provider as they apply to the fund.

Flexibility – the ability of the pension plan to adapt to the changing employment, residency and other life circumstances of the pension holder.

Transparency – full, frank and easily understood disclosure of the terms and provisions of a pension scheme or plan.

Information provision – timely, accurate and user-friendly statement of the projected pension income at retirement: the statement should be consistent from member state to member state.

Portability – the ability of a pension holder to transfer his or her pension or annuity to another provider at a ‘fair’ transfer value.

Mobility – the ability of a pension holder to change jobs, country of employment or country of residence or retirement without penalty, and the ability of employers to obtain EU-wide pension schemes.

User-friendliness – the assurance that all pension matters will be presented in a fashion that enables individuals and employers to easily understand where they stand and make decisions accordingly.

These guiding principles apply within member states as well as across member states and we recommend them as a blueprint for the encouragement of funded pension provision.

A call to action

The EFR calls for a wide ranging debate on the future of Europe’s pension systems and is ready to play its part. We look to gGovernments to acknowledge the scale of the problems; to explain the issues to the electorate; to persuade them of the need build a consensus for reform – and then to begin the process itself. Only then can tomorrow’s pensioners have a realistic prospect of seeing their reasonable expectations fulfilled. We urge Europe’s political leaders to rise to the challenge. Europe’s citizens deserve nothing less.

European Financial Services Round Table 26 February5 March 2003

Members and Mission of the EFR

A group of leading European banks and insurers formed the European Financial Services Round Table (EFR) in 2001. The purpose of the EFR is to provide a strong industry voice on European policy issues relating to financial services. The initial objective is to support the completion of the single market in financial services. Members of the EFR believe that creating free competition on a level playing field withharmonised regulations and a single capital market will bring substantial benefits to customers including increased competition and greater innovation. These benefits will help to drive down prices and deliver a wider and better choice of financial products to customers.

Pehr G Gyllenhammar

Chairman, EFR and Chairman, Aviva plc

Dr. Rolf E. Breuer

Chairman of the SupervisorySpokesman of the Board,of Managing Directors, Deutsche Bank AG

Henri de Castries

Président du Directoire, AXA

Hans Dalborg

President and CEOChairman of the Board, Nordea AB