| Hurdles facing European pension system far from being insuperable |
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| 22/08/2004 | |
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The pension problem could get worse, but there is no reason why it should. While politics and demographics stand in the way of healthier pensions in Europe, the implementation of the IAS 19 accounting standard and the introduction of innovative solutions could signal an embellishment of the European pension picture for the coming years. Data released by Lane, Clark & Peacock (LCP), the actuary services company, showed that the aggregate deficit of Europe's largest blue-chip companies was over €116 billion at December 31st 2003. Emphasising that comparisons between European companies are often impossible due to the variety of national GAAPs, LCP found that the largest average deficit per company is in Germany at €4,287 million, followed by Spain and the UK. But due to the specifics of its pension system, concerns are not necessarily to be primarily directed at Germany. "Despite German companies having the largest average deficit, this is not necessarily a cause for concern. Historically German pension arrangements have been unfunded but are protected by a nationwide arrangement in the case of company insolvency, similar to the proposed Pension protection Fund in the UK", write the authors of the LCP study. Average deficits of companies in the Dow Jones STOXX 50 blue-chip index on 1st January 2004  Source: LCP In one of its staff reports, the International Monetary Fund points out that remarkable progress has been made in Germany with the adoption of the Agenda 2010, which pushes a reform of the German social security system, and in France, where a pension reform has been put into slow motion, among other things by introducing a new form of supplementary private pension and by setting up a reserve fund for the first pillar of the pension system. However, the IMF's enthusiasm is severely constricted by the strong political opposition to pension reform it forecasts in Western European countries, in which the Pay-As-You-Go (PAYG) pension system, where the active workforce pays for the benefits of the retirees, is deeply anchored. Further to that, what the IMF calls the "ultimate stress test" for the European welfare state, a rapidly ageing population, is only one business cycle away. "The direct effect of aging will be to shrink employable labor resources and boost the number of beneficiaries", warns the IMF. Partly clouded sky But political opposition and a workforce that grows older is only part of the story. New developments, among which the adoption of the IAS 19 accounting standards should contribute to the improvement of the situation. "It would be a bridge too far to say that IAS19 will lead to a wholesale move towards defined contributions in Europe, but it will inevitably have an effect on the way companies consider their pension obligations and plan design", says Eric Steedman, a partner at Watson Wyatt, adding that the introduction of the FRS17 in the UK has been cited as one of the drivers moving companies from defined benefits schemes towards defined contributions plans. The Organisation for Economic Cooperation and Development (OECD), whose members have released a list of "core principles of occupational pension regulation", along which they believe pension reform should take place, is also far from being hopeless with regard to pension prospects in Europe - to the extent that far reaching solutions are implemented. "If no steps are taken to increase labour market participation in Europe, the dramatic reduction in the workforce will make the state pensions funded by PAYG unaffordable", reports the OECD. But the switch to defined contribution schemes, which shifts the responsibility on employees, may not always be the proper solution since employees may not be equipped to face related risks, the international organisation says. Among the recommendations listed by the OECD, it is suggested that companies create separate legal entities for their pension funds in order to shield the retirement benefits of their employees from the financial consequences of a bankruptcy, and that investors should be made aware of any funding shortfall, which will become reality on January 1st 2005, when listed companies start using the IAS 19 accounting standard. A pinch of private In its last report, the European Banking Federation (FEB), the lobby group of European bankers, also joined the debate for public pension reform, suggesting that a full shift to capital funding of pension schemes, is not warranted. The FEP explains that while a full shift would require current workers to both bear the burden of the current retirees and their own pension, "a partial shift to capital funding could help to cover against future reductions in PAYG contributions, while not imposing too heavy a charge on the current workforce". The FEB believes that the encouragement of supplementary savings through private means is an attractive way to reduce the strain on the public purse, as shown by the popularity of the mixed private/public model exemplified by the Netherlands, Ireland, and the UK – whose private pension schemes have not been spared by widening pension gaps either for the time being. But we are still a far cry from a fully private pension system, according to the FEB. "Governments will never shed the burden of funding pensions entirely, and it seems that public pension schemes will continue to be the main source of post-retirement income in most member states", it says in its report. Julien Laplante |
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