Simplifying The European Pension System

Simplifying the European pension system – can the EU’s ‘Open Method of Coordination’ provide a solution? Roger Koch, Senior EU Legal Analyst, AEGON Few people in the pension industry seem to have paid much attention to Europe’s ‘Open Method of Coordination’ (OMC). But the approach – based on consensus and information sharing among member states – could, and should, play a larger role in the EU pension debate. Although the OMC has not been without its critics, wider support for the system could help it evolve into a valuable tool for simplifying Europe's complex pensions systems. What is the OMC? Set up in 2000, the OMC is structured around EU member states’ ‘National Strategic Reports’ (NSRs), which are submitted every three years to the European Commission. 1 These reports provide high-level snapshots of various aspects of national social and employment policies. Under the OMC system, the member states provide information more or less according to a common format and using ‘common indicators’ for data. 2 The National Strategic Reports are integrated into Country Profiles by the European Commission Services 3 , which are compiled into a single, giant pan-European report, the latest of which was published in February this year.

OMC and the Belgian pension system: "The risk of poverty among people over the age of 65 is rising …; it remains higher than the European average and even higher than in neighbouring countries." Country Profiles, p. 10

On the basis of the Country Profiles, a Joint Report is produced, which evaluates the different national challenges and approaches. 4 The Joint Report is agreed with the Commission prior to publication. Even though the OMC provides some loose, overarching objectives, member states remain free to set their own targets and to balance competing objectives in whichever way they see fit.

The OMC’s consensual approach means that it is certainly not a suitable tool for imposing social policy coordination at European level. Rather, the OMC is intended to make Europe's diverse social protection systems easier to compare. The OMC applies to policy areas, including social and labour policy, that fall outside the EU’s mainstream decision-making mechanisms – and social and labour policy is a key area in relation to pensions.

1

These are listed at http://ec.europa.eu/employment_social/spsi/strategy_reports_en.htm

2

See http://ec.europa.eu/employment_social/spsi/common_indicators_en.htm

3

See ‘Commission Staff Working Document - Joint Report on Social Protection and Social Inclusion 2008 - Country Profiles’, SEC(2009)255, 24.02.2009. Selected comments from the Country Profiles document are included in the shaded text boxes. 4

The Joint Report as adopted 09.03.2009, is flanked by a Commission Supporting Document which together with the Country Profiles amount to some 540 sides. 1

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However, unlike financial services issues where a majority vote is sufficient, social and labour policy is subject to national veto, which makes EU-level action very difficult. No European process is complete without its own committee. For the OMC, the Social Protection Committee (SPC) has been established as a forum for exchanging views between the European Commission and EU countries about modernising and improving social protection systems. It is made up of two experts from each EU member state, plus two officials from the Commission. Not only does it contribute to the reporting process but it also produces reports in its own right. Last year, for example, it reported on challenges associated with privately managed funded pensions across the EU. 5

Where do pensions figure in the OMC system? Since 2001, member states have included information on pension policies in their National Strategic Reports. EU member states have also endorsed a set of ‘common objectives’ for their pension systems (see separate box). Although not legally binding, the set objectives at least demonstrate some commitment to the idea of greater coordination. Terms such as ‘adequacy’ and ‘sustainability’ have now found their way into almost all EU discussions on pension issues and are also entering national discourse. Even if these terms seem 'soft,' they form the beginnings of a common conceptual framework for discussing pension systems across Europe. In addition to the ‘common objectives’, the EU member states also employ a series of ‘common indicators’ in the National Strategic Reports. These common indicators’ are designed to ensure that any decisions that are made are done so on the basis of reliable (and comparable) data. Any EU-wide data needs to be relevant, comparable and comprehensive – a difficult job, both technically and politically. Not surprisingly, this area has its own committee – the so-called Indicators Sub-Group (ISG), which works closely with Eurostat, the EU’s statistical office, and with the OECD.

Why is the OMC so important? At first glance, the OMC may seem like just another EU talking shop. But, for pension policy in particular, it could have an important role to play – even if it is restricted to being part mutual-learning exercise, part enhanced selfcriticism. OMC and the Swedish pension system: "The Swedish public pension system is adequate and financially stable." Country Profiles, p. 312

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The OMC is an adult way of living with the national veto. The veto cannot, of course, simply be wished away. It has been deliberately written into the legal heart of the European Union. Consequently, meaningful progress on social policy at EU level, including pensions, can only be achieved through consensus. Even with the OMC, progress is likely to be slow.

SPC, ‘Privately managed funded pension provision and their contribution to adequate and sustainable pensions’, 2008.

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THE SMC’S VIEW ON ‘PRIVATE PENSION PROVIDERS’ 6 In 2008, the OMC’s Social Protection Committee published a paper on privately-managed funded pension provision, raising a number of important issues (summarised below). These points may be indicative of EU action in the future: •

There are substantial information gaps and a lack of harmonised measures and comparable data. As it is hard, statistically, to identify and to assign pension arrangements to particular individuals, a problem of ‘double counting’ arises when assessing coverage levels, leading to biased information.

•

There is great variation in coverage and contribution levels between Member States and schemes: depending on their role within the overall system, low coverage in supplementary pensions (together with breaks in contributions) can become a cause of concern for future adequacy, in particular for the most vulnerable groups (women, young, lower educated, lowly-paid).

•

Tax incentives are not likely to be effective in increasing savings levels in voluntary schemes for the whole population.

•

The trend from DB to DC provision seems to be accompanied by lower levels of contributions, which can bring into question the future level of pension benefits.

•

Increasing shift of risks (employment, longevity and financial risks) from the pension provider (employer or State) to the individual: there is a need for better financial education, and the impact of career breaks on adequacy need careful consideration. But for literacy to deliver, it needs to be matched by appropriately reliable information.

•

Given the trend to DC, there is a need for the careful design of the pay-out phase, if adequacy is to be properly addressed. Longevity risk is still an issue for DC schemes – even if responsibility for addressing this shifts from, for example, employers to employees. The SPC also notes that DC also does not generally deal with survivorship issues.

•

In the view of the SPC, the low transparency of charge levels mean that voluntary choice and information disclosure alone are unlikely to deliver low costs. Regulation in order to cap charges is likely to be needed.

The OMC is a good tool for mapping out national diversity across Europe's 27 pensions systems. From an EU perspective, it makes it easier to identify the limits of realistic action, where one and the same rule may have 27 different effects. Could the OMC eventually become the basis for greater coordination? Or even a single EU-wide pension policy? In a typical piece of ‘Eurofudge,’ the ‘finalité’ of OMC – its ultimate purpose – has been left open.

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This summarizes main points of the SPC’s, ‘Privately managed funded pension provision and their contribution to adequate and sustainable pensions’, 2008.

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EUROPE’S COMMON OBJECTIVES ON PENSIONS EU members have agreed three basic common objectives on pensions 7 : Adequacy: This is directly related to the social objective of a pension – to ensure that retirees have sufficient benefits to meet their requirements. It is not just about replacement levels at the time of retirement but also about how the value of benefits relative to prices and wages is maintained over time. Sustainability: This refers to the long-term economic viability of any given pension system. Modernity: This is a catch-all that takes in everything from trends in the work/life balance to labour force mobility and discrimination. The three objectives are interconnected. To a large degree, the security offered by a pension system depends on the capacity of an economy to deliver the promised benefits, while any failure to take account of shifts, for example, in the labour force or work /life patterns could result ultimately in funding shortfalls or the creation of disadvantaged minority groups.

Is the OMC the way to ‘cognitive’ or ‘policy’ convergence? The OMC is providing the EU with a common basis for understanding and comparing national pension systems – a process known, in academic circles, as ‘cognitive convergence.’ However, more ambitiously, the OMC could be seen as a first step by member states to moving in the same policy direction – not so much ‘cognitive convergence’ as ‘policy convergence.’ This distinction may seem insignificant – but it’s potentially a political hot potato. It’s easy to imagine, for example, how a discussion based on common objectives and common indicators could turn into a naming and shaming exercise, with those countries at the bottom of the league table under moral pressure to improve their performance, particularly as the results of the process are public and the Commission provides its own evaluation.

OMC and the French pension system: "According to long-term forecasts, if the labour market does not become more accessible for older people, France will face the double challenge of adequacy (a drop in the theoretical net rates of replacement) and financial viability (a rise in expenditure in relation to GDP)." Country Profiles, p. 120

That said, even the more modest of the two ambitions – ‘cognitive convergence’ – pursued with the right amount of scientific rigour, could bring considerable benefits, not least by contributing towards the emergence of a common language on pensions which could enable policymakers to compare different national systems. This is something CEIOPS, the association of European pension supervisors, has considered, albeit from a different starting point. 8 A common language would go a long way towards making sense of the EU’s patchwork of pension rules, without necessarily seeking to impose a single, harmonised pension system across Europe.

7

These have undergone a number of evolutions, their current form (items (g) to (i) inclusive) was agreed in 2006.

8

In the context of solvency and security mechanisms for occupational pension funds, see CEIOPS ‘Survey on fully funded, technical provisions and security mechanisms in the European occupational pension sector‘, 31.03.2008, page 7 and also its ‘Key issues on solvency for the European occupational pension sector‘ 30.05.2008, page 9.

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Is OMC working? Unsurprisingly, the OMC process is not to everyone’s taste. Some academics have found it both Kafkaesque and an ‘innocuous exercise in euro-verbosity.’ 9 Others argue that its very strength is its consensual approach: that it helps find a way forward where traditional policy-making mechanisms fail. 10 Both views are probably right. For those who like their policy-making to be quick and OMC and the Slovenian pension system: decisive, the OMC process appears laborious and "Without policy changes, overall government ineffective. But the process does at least provide an debt, currently contained at 29.1% of GDP, alternative and the possibility of dialogue. The recent would rise to about 287.2% of GDP by 2050." emergence of the Lamfalussy fast-track system in financial Country Profiles, p. 274 services shows that there is sometimes a ‘smart’ way to reinvent basic EU processes that avoids the need to change the EU Treaty (as the ongoing Lisbon Treaty saga proves, changing the Treaty is an unthinkably painful and protracted process). The OMC may be such a ‘smart’ reinvention. However, even its supporters agree that more needs to be done to tighten up the OMC process. In pensions, for example, work is certainly needed to firm up and extend the ‘common indicators’. In its 2008 report, the SPC said there were substantial information gaps, and, even at a national level, data may still be fragmentary. 11

Where does the debate go from here? So far, cross-border pension issues have not featured on the OMC’s radar. Discussion has been limited, more or less, to national systems and national policies. There has been, for example, no full-blown debate on how greater integration could help create a better, more efficient pension system in the EU. There are two possible explanations for this reticence: either the issues are simply too sensitive politically, or else efforts are being focused, for the time being at least, on building an adequate knowledge base, rather than on potential policymaking. OMC and the German pension system: "[T]he German pension system is a financially stable system that provides a high replacement ratio. It is rather successful in fighting old-age poverty …" Country Profiles, p. 59

9

At present, there is no indication that those involved in the OMC system see it as part of wider efforts to create a more modern pension system for Europe. Having said that, next year – 2010 – things could change. The European Commission has already said it wants to look more closely at pensions – including solvency rules for IORPs. 12

See Alisina and Perotti, ‘The European Union: a politically incorrect view’, 2004, page 9.

10

See Jonathan Zeitlin The Open Method of Coordination and reform of national social and employment policies: influences, mechanisms, effects, in Heidenreich and Zeitlin (eds) ‘Changing European Employment and Welfare Regimes: The Influence of the Open Method of Coordination on National Reforms’ Routledge/EUI Studies in the Political Economy of Welfare, London: Routledge, 2009.

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‘Not only is existing information itself insufficient in many member states, but it is also often incomparable between member states’: Social Protection Committee, ‘Privately Managed Funded Pension Provision and their Contribution to Adequate and Sustainable Pensions’, page 54. 12

European Commission: ‘Report from the Commission – On some key aspects concerning Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision (IORP directive)’, COM (2009) 203, 30.04.2009. Source: please click here.

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2010 was always supposed to be a moment for reflection, the year in which Europe was to deliver on the ambitious goals of the ‘Lisbon Strategy’ – for the continent to ‘become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth, with more and better jobs and greater social cohesion’. 13 There’s no doubt pensions are a key part of those ambitions. Whatever happens now, the traditional policy-by-policy approach to pension issues in Europe is obsolete. Regardless of its limitations, the OMC process could provide a way of building consensus – a way, ultimately, of reforming Europe’s diverse pension systems. For that to work, however, the OMC process, with its committees, reports and sub-groups, will need to become more effective as a tool for evidence-based policy-making. It will also need to become simpler to understand. Only then will it gain the visibility and influence in the European pensions debate that it really deserves.

13

Set by the European Council of 23 and 24 March 2000.

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