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Funded Pensions In Western Europe 2008

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Traditionally, the pension systems of most Western European countries were textbook examples for the dominance of public pay-as-you-go pensions. This has changed.

Traditionally, the pension systems of most Western European countries were textbook examples for the dominance of public pay-as-you-go pensions. This has changed.

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  • 1. International Pension StudiesFunded Pensionsin Western Europe 2008
  • 2. ImprintPublisher: Allianz Global Investors AG, Seidlstraße 24-24a, D-80335 Munich | http://www.allianzglobalinvestors.com | Editor: Dr. Alexander Börsch,Senior Pensions Analyst, Allianz Global Investors AG, E-mail: alexander.boersch@allianzgi.com, Phone: +49 (0) 89 1220 7472 | Contributors: Dr. Alexander Börsch,Allianz Global Investors AG; Dr. Renate Finke, Allianz Dresdner Economic Research; Dr. Martin Gasche, Allianz Dresdner Economic Research; Jordy Peek, risklab;Dr. Jürgen Stanowsky, Allianz Dresdner Economic Research | Layout: volkart:51 GmbH, Munich | Printing: repromüller, Übersee | Closing date: December 5, 2008 |This study was conducted in cooperation with Allianz Dresdner Economic Research. The OECD provided information on the second and third pillars.The entire content of this publication is protected by copyright with all rights reserved to Allianz Global Investors AG. Any copying, modifying, distributingor other use of the content for any purpose without the prior written consent of Allianz Global Investors AG is prohibited. The information contained in thispublication has been carefully verified by the time of release, however Allianz Global Investors AG does not warrant the accuracy, reliability or completenessof any information contained in this publication. Neither Allianz Global Investors AG nor its employees and deputies will take legal responsibility for anyerrors or omissions therein.This publication is intended for general information purposes only. None of the information should be interpreted as a solicitation, offer or recommendationof any kind. Certain of the statements contained herein may be statements of future expectations and involve known and unknown risks and uncertaintieswhich may cause actual results, performance or events to differ materially from those expressed or implied in such statements.2
  • 3. International Pension Studies Western Europe PrefaceT raditionally, the pension systems of most Western European countries were text-book examples for the dominance of public the financial assets of European households in international comparison and includes forecasts on the future development of finan-pay-as-you-go pensions. This has changed. cial assets. The third article addresses trendsMore and more European countries are try- in Western European pension markets anding to spread the retirement income of their pension asset projections, while the conclud-citizens across a wider base. They have intro- ing article of the first part is concerned withduced new funded occupational and private the effects of a possible application of Solven-pension schemes with the goal to diversify cy II on defined benefit pension funds. Theretirement income for future pensioners. second part analyses the pension systems in each Western European country; for the pur- Despite different starting points, almost poses of this study we defined Western Europeall Western European countries have fol- as the EU-15 plus Switzerland and Norway.lowed the trend towards funded pensions.This has taken several forms. Besides the in- The evolution of funded pensions intotroduction of new schemes, many countries a crucial element of retirement income indecided to introduce state pension reserve Western Europe has important ramificationsfunds to back public pension systems and for public policy and the financial industry.strengthen their sustainability. These funds For example, the regulation of funded pen-have grown considerably and are now crucial sions, the effectiveness of plan design, theplayers in the financial markets. The world- risk management of investments and thewide shift from defined benefit to defined quality of financial products become ques-contribution plans in occupational pension tions that will shape the financial securityprovision is also taking place in Europe, how- of many future retirees. By creating trans-ever, with a different speed and depth in the parency about the pension system designsrespective countries. in Western Europe, this study aims to con- tribute to the discussion on the future of This study is divided into two main parts. European pensions. We strongly believeThe first part is comprised of four articles, in- that transparency and comparability arecluding one on the economic impact of ageing the foundations for mutual learning andpopulations. The second article focuses on best practice sharing. Brigitte Miksa, Head of International Pensions Allianz Global Investors AG 3
  • 4. International Pension Studies Western Europe Content Imprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Western Europe – The Economic Impact of Ageing Populations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 The Financial Assets of Private Households – An International Comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Trends and Asset Development in European Pension Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Solvency II: How it Could Affect Defined Benefit Pension Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Country Profiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Austria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Belgium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Denmark . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Finland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 France . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Greece . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Ireland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Italy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Luxembourg . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 The Netherlands . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Norway . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 Portugal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Spain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 Sweden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Switzerland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 UK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1334
  • 5. Introduction
  • 6. Introduction International Pension Studies Western EuropeWestern Europe –The Economic Impactof Ageing PopulationsDemographic development Chart 1 Western European population [million]in Europe 415While Western European countries vary con- 410siderably from one another, they also havea number of commonalities. For instance, 405in most of Western Europe, the population 400is expected to stop growing within the nexttwenty years. It will not be the first time that 395European societies see a decline in their pop-ulations. The Black Death and both World 390Wars are two dramatic examples. Indeed, in 385the past, wars and pandemics led to quickly 2005 2009 2013 2017 2021 2025 2029 2033 2037 2041 2045 2049shrinking populations. Source: Eurostat In the coming decades, the decline inWestern Europe’s population will certainly be at the big picture to make rough estimates ofmore gradual. Overall population will peak in future GDP growth within a growth account-20 years. It will then start to decrease, slowly ing framework. Finally, we assess the impactat first and then increasingly faster. The age- of ageing on the Western European pensioning process of Europe’s populations will have business.a significant impact on the makeup of its so-cieties. The proportion of elderly people (i.e. Longer lives, fewer childrenpeople aged 65 and over) in the total popula-tion will increase from about 17% today to 30% Across Western Europe, the basic demograph-in 2050. In this publication, we have defined ic trends of ageing and shrinking populationsWestern Europe as the former EU-15 coun- are to blame for many political reforms thattries, plus Norway and Switzerland. have seen benefits cut – particularly pension benefits – and extended working lives. The un- The present article examines the impact derlying causes of low or falling fertility andof ageing and declining populations on GDP increasing life expectancy are well known.growth. We discuss how the shrinking labour However, the reasons and mechanisms be-force has a negative effect on growth prospects hind these factors are not as well understood.and also address the impact of ageing. First, A number of questions need to be answered,we look at the impact of population decline on among them why women do not have morethe labour market. Next, we discuss the quali- children and what can be done to increasety of labour, the role of education, and the im- fertility. Other open questions include howpact of ageing on productivity. Third, we look fast life expectancy will increase, or whetherat whether capital input can offset shrinking it will decrease due to less healthy lifestyles.labour input and shed some light on the ques-tion of how ageing affects an economy’s ability Since there are many possible answers toto innovate. Once we have done this, we look these questions, it has thus far been impos-6
  • 7. Introduction International Pension Studies Western Europesible to make any sound scientific conclu- Can ageing societies remainsions. Population development forecastsmust therefore rely on assumptions about competitive?future developments.1 For the EU-15 coun- To answer this question, the effects of ageing 1 We have used Eurostattries, fertility is expected to increase slightly on the economy and its growth prospects must figures for all countriesexcept in France and Ireland, where current be examined. The following paragraphs shed except Norway andhigh fertility levels are forecast to decrease. some light on this issue. We will identify the Switzerland. For each ofGiven the lack of scientific evidence on the relationship between demographic change these two countries, wedrivers of change in fertility in industrialised and economic growth and discuss its poten- have used the figurescountries, it is possible that actual develop- tial impact on Western Europe. and forecasts of nationalments will deviate from these assumptions. statistical offices. Demographic development affects eco- Even if fertility in France keeps rising as nomic activity in many areas. Gross domes-it has in recent years and current low levels tic product (GDP), i.e. the sum of all goodsremain constant in other countries, the im- and services produced within a given period,pact would barely be noticeable in the near is the result of an application of capital andfuture. Indeed, it will take many years for labour combined with the effects of techni-such small developments to alter the age cal progress. Clearly, labour force develop-composition of populations. After several ment has an influence on output. It shoulddecades of low fertility, the number of poten- be noted, however, that not only the numbertial mothers has significantly decreased,so that an increase in fertility will not have Chart 2 Fertility rates in Western Europe [children per woman]a noticeable impact in the short term. 2.5 A similar argument can be made about 1990life expectancy. An increase has been fore- 2 2006cast for all countries in our sample, thoughit will be higher in some than in others. Thehighest life expectancy increase for men be- 1.5tween 2006 and 2050 will presumably occurin Austria, with 7.2 years. For women, life ex- 1pectancy will increase the most in Belgium,by 6.4 years. We have assumed the lowestincrease in the Netherlands, with 3.8 years 0.5for men and 2.7 years for women. Currentnational assumptions may deviate from the 0estimates used by Eurostat. However, even Germany Italy France Spain UK The Nether- Sweden Switzer- lands landif deviating national assumptions were used,changes to the overall picture would benegligible. Chart 3: Old-age dependency ratios [65+-year-olds/15–64-year-olds] 70 The continuous ageing of societies is one 2008of the consequences of these developments, 60 2050and is reflected in the old age dependency 50ratio. It depicts the number of people aged65 and older per 100 people of working age 40(15–64 years) and demonstrates that theageing process varies in different Western 30European countries. For instance, Spain, Italyand Germany are much more affected than 20countries like the UK, France or Sweden. 10 0 Germany Italy France Spain UK The Nether- Sweden Switzer- Western lands land Europe Source: Eurostat 7
  • 8. Introduction International Pension Studies Western Europeof workers matter, but also their quality. of the 15-64 age group will differ considera-Education, i.e. the quality of human capital, bly across Europe. Germany and Italy will seeis an important determinant of productivity. the sharpest declines. Labour force potential in these two countries will shrink by 25% by Since population development and the 2050. In contrast, Ireland will see an increaseage structure of a population affect the use of 15%, the increase in Luxembourg will beand quality of production factors in a number almost 30%, and Sweden’s labour force po-of ways, the impact of demographic change on tential will grow by 3%. All other countriesoutput is difficult to determine. Some simple will have to cope with a declining potentialeconomic models describe these relation- labour force.ships. In this basic accounting exercise, GDPis the product of the number of employed A decline in the potential labour forcepersons (working population) times the does not mean that the size of the labouroutput in goods and services per employed force automatically shrinks. This is becauseperson (labour productivity): many people aged 15-64 are not active in the labour market. A substantial number of people are pursuing their education, some GDP = have retired early and others are currently at labour productivity x working population home to raise children or for other reasons. In 2007, the labour force participation rate The working population is a subset of the (i.e. people aged 15-64 who were either em-people aged 15-64 who could potentially work ployed or looking for a job) stood at 74% for(potential labour force) and do participate in men and almost 60% for women. The figuresthe labour market. for Norway and Switzerland are well above the EU-15 average. Working population = These participation rates can change for participation rate x potential labour force a number of reasons. Developments in the economic cycle are an important influence, This leaves us with: but changes in the legal environment also play a role. Since 1995, the labour force participa- tion rate in the EU-15 has increased by 3.5 GDP = labour productivity x percentage points for men and 10 percentage participation rate x potential labour force points for women. Legislation to increase Labour productivity depends on the avail-ability of capital (i.e. tools and machinery), Chart 4 Development of the working age population aged 15–64the quality of human capital and technologi- [2005=100]cal progress. All of these items are influenced 105by demographic development – some moredirectly than others. Let us begin our analysis 100with the most obvious variable, the potentiallabour force. 95 Germany ItalyDemographic impact 90 Franceon the labour market 85 Spain UK The NetherlandsHow do demographics affect the labour 80 Swedenmarket? If we assume that the potential Switzerlandlabour force comprises all people between 75 Western Europe15 and 64 years of age, we will see somechanges throughout Western Europe. 70According to current population forecasts, 2005 2009 2013 2017 2021 2025 2029 2033 2037 2041 2045 2049labour force potential will decline by 15% Source: Eurostat, national statistical officesbetween 2008 and 2050. The development8
  • 9. Introduction International Pension Studies Western EuropeChart 5 Labour force participation rates of 55–64-year-olds, 2007 [%] men 55–6490 women 55–648070605040302010 0 EU-15 Denmark Ireland Spain Italy The Netherlands Portugal Sweden Norway Belgium Germany Greece France Luxembourg Austria Finland UK Switzerland Source: Eurostatretirement ages and an improved economy policies can certainly alleviate its mosthave contributed to that development. dramatic effects.This demonstrates that a declining potentiallabour force does not automatically mean For instance, extending working life andthat fewer people are available on the labour closing loopholes that lead to early retire-market. Participation rates could increase, ment are two possible measures that couldjust as unemployment could decrease. be implemented to protect the labour mar- ket from a declining population. Another is About 13 million EU-15 citizens are current- increasing the willingness to join the work-ly unemployed, which represents the entire force by offering childcare facilities for youngcombined potential labour force of Belgium parents and/or more flexible working hours.and Greece. With unemployment rates be- Taxes play an important role, too. If taxestween 2.5% and 4%, Norway and Switzerland on a couple’s secondary income are too high,have reached almost full employment. Given the incentive to work is low, as experience inthe high participation rates in these two coun- the Netherlands has shown.tries, changes in the potential labour force willhave a more direct impact on the availability Even if the total number of workers doesof labour. In other EU-15 countries, there is still not drop by as much as some may fear, theresome room to manoeuvre. For instance, la- is no denying that the workforce is ageing.bour force participation rates for those aged In Western Europe, the current median age55 to 64 can increase substantially in most is about 40 years; it is expected to increaseEU countries. Currently, only Sweden comes by roughly 7 years by 2050, as will the medi-close to Switzerland and Norway. an age of the labour force. Until now, there has not been any empirical evidence on how If it were possible to increase labour force such a process will affect productivity.participation across EU-15 states to rates ashigh as Sweden’s, the demographic impact on The role of educationthe labour market could be cushioned con-siderably. In fact, the expected labour force As already mentioned, the quality of thedecline of 15% could be reduced by half. Even labour force plays an important role – espe-if some aspects of demographic development cially in countries with decreasing popula-cannot be changed in the short term, smart tions. In Western Europe, Germany and Italy 9
  • 10. Introduction International Pension Studies Western Europein particular must cope with pronounced pop- To assess the development of productivityulation decline. In these countries, and also in in an economy, the weight of different jobsPortugal, Greece and Spain, efforts must be in the overall workforce is important. Mentalmade in the realm of education to counter abilities, such as problem-solving skills whenthe effects of ageing and population decline. faced with new challenges, logic and theThe decline in the absolute number of po- ability to understand complex topics, seemtential workers must be countered by an in- to decrease with age. Verbal abilities andcrease in the productivity of each individual. communication skills, on the other hand, tend to improve with age, as experience plays To achieve this, national school systems are a more important role. The importance ofone of many factors that must be examined. different combinations of these abilities vary,Certainly, reducing the number of school depending on the industry. For older em-dropouts is critical. However, the education ployees, changes that are the result of rapidof the workforce as a whole must also be technological development pose a particularconsidered. Lifelong learning should not challenge with regard to productivity, as theyonly be a catch phrase, it must become an make experience acquired over decadesembedded concept in companies’ personnel irrelevant. For this reason, industries thatdepartments. Giving the increase in retire- are characterized by such change will sufferment age, workers aged 55 and over will have more from an ageing workforce than others.to spend a decade or more in employmentbefore they can access their pensions. Hence, There are very few empirical studies thateven for these experienced workers, continu- demonstrate these dynamics, and those thating education will become increasingly com- are currently available do not provide clearmon. The depreciation of human capital in answers to the critical questions. Most stud-a shrinking labour force must be prevented ies conclude that productivity declines with(Ludwig, Schelkle, 2007). age. However, it is unclear at what age the de- cline sets in and whether it is significant. ThisAge and productivity leaves us with the following results: While a decline in productivity due to ageing is pos-The development of labour productivity is sible, it appears that it will not be substantial.extremely important for an economy’s long- We must also consider the possibility that theterm growth prospects. Ageing populations deterioration of productivity can be counteredand workforces require that answers be by further education and training. There isfound to the question of how productivity ample evidence that employees can acquireis affected by ageing. In rapidly ageing coun- new skills at any age. If companies keep thistries like Germany and Italy, this question in mind, they may be able to maintain pro-is high on the agenda. The fact that certain ductivity despite ageing societies. This is par-mental abilities decrease after early adult- ticularly true in sectors where experience ishood is one of several aspects that are un- important.disputed. However, this does not mean that produc- Demography and the usetivity decreases as workers age. Experience, of capitalwhich increases with age, is also important.A good balance between mental ability and When the supply of labour declines for demo-experience leads to the best results. If we look graphic reasons, the importance of capital inat purely physical work, the picture is slightly maintaining economic performance grows.different, as productivity undoubtedly decreas- Capital must be used to substitute laboures with age. In Western Europe, however, ever and increase the productivity of the remain-fewer jobs rely exclusively on physical abili- ing jobs. In other words, investment in realties. Even in the automotive industry, it has capital will gain importance. In ageing West-not been proven that younger assembly line ern Europe, capital investment is influencedteams are more productive than their older by the need to substitute labour, which willcounterparts. While younger teams tend to become more expensive. Production will be-be faster, they also make more mistakes. come even more capital intensive. The neces- sary increases in productivity will be achieved10
  • 11. Introduction International Pension Studies Western Europeby investing more in human and physical cap- the propensity to innovate seems to in-ital – increasing capital demand even more. crease until age 40 a positive correlation between age and innovations can be found in younger populations. Chart 6 shows thatDemography and techno­ such a relationship is not contradicted bylogical progress the data, even though it does not prove it. At least an increase in the share of elderly, hereTechnological progress is an important factor the number of people aged 45 to 64, corre-for economic growth. It results in new products lates positively with the number of patents.or new, more efficient ways of producing exist-ing products. Innovations are frequently the Ageing and economic growthresult of technological progress. For WesternEuropean economies, which trade a great deal Having addressed all of these considerationswith the rest of the world (and of course with regarding future labour force development,each other), technological progress is one of productivity and technological progress, wethe pillars of growth. Western Europe can only can now have a closer look at Western Europe’ssuccessfully compete on global markets with growth prospects. The frame of reference forvery advanced products. If ageing were to in- this task is the simple growth accountingterfere with countries’ ability to innovate, their framework introduced above. GDP growthinternational competitiveness would face can be broken down into productivity growtha direct threat. Countries such as Germany, and employment growth. The latter dependswhich is a very strong exporter of highly so- on the growth of the working age populationphisticated machinery and cars, would suf- and changes in labour utilization (i.e. labourfer if it could not maintain its competitive force participation). For example, the Euro-advantage over foreign competitors. Assess- pean Commission and the European Centraling the effect of ageing on technological Bank (ECB) conducted this exercise, and theprogress is therefore critical. result of our own research is in line with their findings. It is very likely that GDP per capita It is a commonly held thought that a soci- growth will decline over the next four decades.ety’s ability to innovate suffers when it ages. However, this decline will not be dramaticThis rests on the assumption that creativity (Table 1).decreases with age. In fact, recent empiricalresearch has shown that age tends to correlatenegatively with the propensity to innovate Chart 6 Share of people aged 45–64 and number of patents(Schneider, Ragnitz, 2007). The likelihood of per 1 million inhabitants in the USa successful innovation (new product, majorprocess or product improvement) peaks at an 350 0.26average age close to 40. Afterwards, the likeli-hood begins to decrease, dropping to lower 0.24than at the age of 30 when the average age of 300 0.22personnel is over 48. Hence, there is quite a Share of people aged 45-64,long time span with fairly high innovation po- right scale [%] 0.20tential. What is more, empirical results sug- 250gest that a good balance of older and younger 0.18employees must be reached to achieve highinnovation potential. 200 0.16 Number of patents per US data on patent activity shows a rather 1 million inhabitants, 0.14 left scalepositive correlation between age and innova- 150tions. This means that even if age affects the 0.12likelihood to innovate negatively, this seemsto take effect only at higher ages – at least com- 100 0.10pared to the average age of the workforce. 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005Given the projected increase in the age of the Note: Patents are defined as Utility Patents granted to US inhabitantsworkforces in Western Europe, a strong neg- Source: US Census Bureau, US Patent and Trademark Officeative impact is unlikely to materialise. Since 11
  • 12. Introduction International Pension Studies Western EuropeTable 1 Economic growth scenarios for Western Europe [average annual changes in %] Labour Change in Working age Total GDP Real GDP productivity labour force population population per capita Past: average 1 .1 0 .8 0 .4 0 .5 2 .3 1 .8 1995–2005 Base case 2011–2030 1.7 0.4 -0.3 0.1 1.8 1.7 2031–2050 1.5 0.2 -0.5 -0.2 1.2 1.4 Pessimistic assumptions 2011–2030 1 .2 0 .1 ­0 .3 0 .1 1 .0 0 .9 2031–2050 1 .1 0 .0 ­0 .5 ­0 .2 0 .6 0 .8 EU commission assumptions 2011–2030 1 .8 0 .2 ­0 .3 0 .1 1 .7 1 .6 2031–2050 1 .7 0 .1 ­0 .5 ­0 .2 1 .3 1 .5Notes: Western Europe = EU 15, labour force participation: share of employed persons of working age population Source: ECB, Eurostat, European Commission, own calculationsThe scenarios have two main results: EU policies currently aim to achieve pre-• As the table shows, growth will be affected cisely these goals, as summarised in the Lis- dramatically only under very pessimistic bon agenda. Norway and Switzerland have assumptions. In our base case scenario, similar goals with respect to growth. Indeed, which is slightly less optimistic than the policies across Western Europe are geared European Commission with regard to towards increasing labour force participa- productivity developments, but more op- tion with higher retirement ages or better timistic on labour force participation, in childcare facilities. They also aim to increase the medium term GDP per capita growth labour productivity with efforts to raise edu- will remain roughly at the level seen in the cational standards and foster research and last decade. Towards the end of the fore- development. While progress towards reach- cast period, growth will slow down as the ing these targets has not been consistent change in the working age population in all countries, we expect all of Western becomes more pronounced. Europe to make substantial progress within the next decades. Although Europe is ageing,• The table also demonstrates the impor- it will remain an economic force to reckon tance of maintaining high labour produc- with in the future. tivity. If the increase were to fall below the past average of one percent, GDP growth would be severely impeded. In fact, GDP Consequences for pensions growth above one percent would be diffi- and pension investments cult to obtain. An increase in labour force participation is another important pre- What does all of this mean for pensions? condition for economic growth to stay at First, the prospect of decent economic levels close to those reached in the past. growth rates means that there is no need12
  • 13. Introduction International Pension Studies Western Europeto fear the future. The consequences of rule out some major European countries suchageing can be dealt with. Second, public, as Italy, Spain, and Germany, among manypay-as-you-go financed pension systems others. However, as the above analysis haswill encounter difficulties as a result of the shown, an ageing society does not necessarilychanging ratio of people over 65 to the 15-64 face a bleak future.age group, which finances pensions. Thisratio, which is commonly referred to as the The move towards a pension systemold age dependency ratio, will increase from that is funded to a much higher degree than27 today to 52 in 2050. past systems can be seen as a reaction to the changing needs of an ageing society. To suc- This means that in the future, there will cessfully offset the decline in labour throughbe 52 elderly people for every 100 people of investments in physical and human capital,working age, compared with 27 today. Still, an economy needs a great deal of capital.the outlook for public pensions would be Across Western Europe, the need to adaptmuch worse if ageing automatically meant to demographic change varies significantly.economic decline. This is not the case, as in- The situations in Sweden, France and the UKcomes are expected to keep growing. Wages, differ considerably from Germany or Italy.which finance public pensions, will not be The need for reform is highest in the coun-affected that much by ageing. However, age- tries that are ageing the most quickly anding will have a large impact on the viability have not yet sufficiently reacted by adaptingof public pension systems. their pension systems and economies to the demographic conditions they will face The most common reaction to this fore- in the future.seeable development continues to be de-creasing the generosity of public pension From an investment point of view, evensystems and strengthening private pension an ageing Western Europe seems like aprovision. The latter is usually of a funded promising place to invest. The demand fortype. People save money while working and capital to finance the investments requiredreceive the proceeds of their savings after to offset the decline in labour will grow. Inretirement. While this arrangement exposes some countries, notably Germany, this proc-them to investment risk, pension asset man- ess has already begun or will start sometimeagers do their best to keep this risk manage- soon. In the end, return on investment andable. They must continuously ask themselves the associated risks determine whether orwhere the best possible investment can be not an investment is appropriate. Even ifmade. If ageing societies were doomed to higher returns can be expected in emergingslow growth, stagnation or eventual decline, economies, these also entail higher risk.the only answer would be in young and/or Among others, exchange rates and politicalfast growing economies. This concept would risks should be considered. Dr. Jürgen Stanowsky, Allianz Dresdner Economic Research 13
  • 14. Introduction International Pension Studies Western EuropeThe Financial Assets ofPrivate Households –An International ComparisonIntroduction above the level Japanese households had put aside (EUR 9.7 trillion). However, because ofOver the past decade, Europe has seen many the difference in size of the regions, an anal-pension reforms that have paved the way for ysis of the absolute values does not correctlya shift from pay-as-you-go to funded pension reflect the ratios. Taking financial assets as asystems. These reforms have led to a strength- percentage of gross domestic product (GDP),ening of the second pension pillar in most we find that wealth in Western Europe, whichcountries and highlighted the importance amounts to about 220% of GDP, is significant-of third pillar provision, as replacement ly lower than in the other two regions. In 2007,levels in the first pillar have been cut back. the United States’ monetary wealth of privateEspecially in Continental Europe and EMU households was 328% of the country’s GDP.(European Monetary Union) countries, the In Japan, it stood at 310%. In contrast, Easternintroduction of tax-favoured savings prod- Europe lagged way behind, reaching onlyucts for retirement has triggered a build-up 73% of GDP.process in this segment. The new members of the EU in Central The increasing importance of the pension and Eastern Europe (CEE) showed the mostsegment is reflected in the financial assets dynamic development among the regions inof private households. In many countries, the review. Over the past five years, they have seen 1 Former EU memberproportion of pension products has increased annual growth rates of almost 15%. Western states plus Norway andin private household portfolios in recent years. Europe recorded annual growth rates of 7.2% Switzerland, not includingTo a large extent, the differently structured on average after 2002. That year, an economic Luxembourg.portfolios in European countries can be viewed upturn laid the foundation for resuming finan- 2 Conversion at 2007as a result of differing pension systems and cial asset build-up in the household sector, rates.saving behaviours. This study generally fo-cuses on a narrow definition of retirement Chart 1 Financial assets of private households [2000=100]assets (i.e. pension funds and life insurance 260reserves), as it is difficult to earmark otherfinancial assets as destined for retirement Western Europe 230income. However, analysing the total finan- EU15cial wealth of private households is a worth- EMU 200while endeavour, as most financial products USAcan be used to top up retirement income. Japan 170 CEE 140Trends in financial assetdevelopment 110At the end of 2007, financial assets in West- 80 2000 2001 2002 2003 2004 2005 2006 2007ern Europe1 reached EUR 25.8 trillion2. Thiswas around 15% below the US level (EUR 30.8 Note: Europe excluding Luxembourg Source: Central banks, statistical offices, Eurostattrillion) and more than two and a half times14
  • 15. Introduction International Pension Studies Western Europewhich had ended abruptly with the stock Chart 2 Private households’ financial asset structure, 2007 [%]market crash at the beginning of the newmillennium. In the US, financial assets even 100 3.4 3.6 3.5 4.4 6.4increased by 9.3% p.a. after the downturn Other 10.9had torn an exceptionally large hole in house- 27.4 30.9 25.3 Insurance/ 80 34.7hold portfolios because of the high affinity pension fundsto capital market investments in the US. In 34.5 10.4 Shares/ mutual fundscontrast, Japanese households, with their low- 60 29.4 9.5 Bondsrisk and hence low-yield portfolios, recorded 26.0 2.4 40.6 Bank depositsonly a moderate increase of 2.7% per year. 40 7.9 6.1 However, the investment environment 45.8 50.5changed in 2007. Growth rates dropped to 20 8.8 29.8 31.7 Note: Europe excludinghalf the former average at the beginning of 16.3 Luxembourgthe downturn in housing markets and due to 0economic uncertainties in many countries. Western EMU CEE USA Japan EuropeThe impact of the subprime crisis on financial Source: Central banks, statistical offices, Eurostatmarkets worldwide also played a major role.In 2008, indications have thus far shown thatthe growth of household wealth will slow down ments, but this is due to the privatisationconsiderably. Assuming a stock market down- process in some Eastern European countries.turn of 30 % year-end 2008 on year-end 2007financial wealth in all major regions will even To a certain extent, bank investments indecrease. both the US and Europe have seen a revival, which is the result of a heightened desire for In the US, the crisis will have an even larger safe investments. Nevertheless, US householdimpact than in Western Europe, EMU coun- portfolios contain only 16% bank products.tries and Japan. This is because the disparate In Western Europe, the bank share is almostperformance described above stems largely twice as high as in the US; in Japan, the figurefrom differing household investment patterns is more than three times higher. In CEE coun-in the respective regions. Compared with most tries, the share of bank products is almostEuropeans and the Japanese, American house- three times as high as in the US, which canholds show a strong affinity to investments in be explained by a very low average income.stocks and mutual funds, which bears both op- Usually, the portfolio mix initially comprisesportunities and risks for performance in the less risky and liquid assets (mainly bank de-overall investment portfolio. posits) and shifts towards capital markets and more sophisticated products as income About 40% of US household portfolios is and wealth increase.invested in equity and investment assets; in1999, this share peaked at almost 50%. Direct Chart 3 Share of bank products in household financial portfolios vs.investment in corporate stocks is no longer GDP per capita, 2007 [EUR]as attractive as it was at that time. Indeed, onbalance, US households have reduced their 70%exposure to equities. In Western Europe, the 60%portion of equity and mutual fund shares Gr CEE Jap Acurrently stands at 26%, after peaking at 30% 50%in 2000. 40% Other Western Eurpean countries Nor 30% As in the US, the increase in the overall fig-ure in many European countries stems from 20%valuation changes over the course of positive US 10%stock market performance up to 2007. It isnot the result of new investment flows, as 0%households began to invest more cautiously. 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 [EUR]The household portfolio mix in CEE contains Source: Central banks, statistical offices, Eurostata surprisingly high portion of equity invest- 15
  • 16. Introduction International Pension Studies Western Europe Insurance and pension products also hampered insurance/pension asset build-up 3 In this context, the termmake up a major portion of household finan- in Greece, where only 3% of financial assets pension fund implies allcial assets. These have benefited from strong- are allocated to this segment. This figure is types of investment in fullyer occupational and private pension provi- far lower than in all other countries. funded pension schemes.sioning. In Western Europe, the share of these The investment vehiclesassets as part of household financial wealth Nevertheless, in most Western European have different featureshas increased by 6.5 percentage points over countries, growth in the insurance/pension and names in some coun-the last decade. Moreover, in most CEE coun- segment outperformed total financial asset tries. Wherever they aretries, capital funded pension arrangements growth in previous years. Again, this demon- subject to regulation bywere introduced as mandatory plans. This strates the importance of insurance and pen- the insurance supervisorygave an enormous boost to this investment sion products. Below average growth can be authorities, they are record-segment in Europe’s emerging markets. Even seen in the mature pension markets of Swit- ed for statistical purposesin the US, with its traditionally stronger capi- zerland and Denmark. It can also be observed in the “Insurances/Pensiontal funded pillar, improvements to the sys- in countries like Spain, where pension reforms Funds” category, in accord-tem are an ongoing process. If IRA (Individual have yet failed to materialise. ance with ESA ’95.Retirement Accounts) assets are also takeninto account, which are invested in other Chart 4 Gross financial assets in Europe, 2007product types such as mutual funds, bank [% of GDP, private households]accounts, insurance products or brokerageaccounts, the share of pension assets in the Switzerland 373US further increased from an already high UK 295level of 35% in 1997 to 40% ten years later. The Netherlands 280 Belgium 253 Italy 240European countries Denmark Portugal 235 223 Western Europe 218The Western European figure for financial EMU 202assets combines a variety of investment pat- Ireland 193terns and levels of wealth. The four biggest France 189 Germany 188economies combine two-thirds of total finan- Spain 182cial assets, which amounted to EUR 25.8 trillion Sweden 165in 2007. As the most populous country with Austria 152 Greece 139the highest GDP, Germany ranked second be- Finland 112hind the UK. In terms of gross financial assets Norway 103relative to GDP, Germany is in a much lower 0 25 50 75 100 125 150 175 200 225 250 275 300 325 350 375position (188%) than the UK, where 295% wasregistered in 2007. With 373%, Swiss house- Chart 5 Share of pension and insurance assets in the total financial assetsholds are the wealthiest in Europe, and are of private households, 2007 [%]also ahead of US or Japanese households. The Netherlands 58 These states are followed by the Nether- UK 55lands, Belgium and Denmark, all of which Denmark 43 Switzerland 42have stronger funded pension systems than Ireland 41countries with traditionally more extensive Sweden 40pay-as-you-go pension systems such as Ger- France 38 Norway 36many, Spain or Austria. The latter countries Western Europe 35all rank in the lower part of the listing. Pre- EMU 27sumably, the different pension systems have Germany 26 Belgium 24an impact on asset formation and can par- Finland 21tially explain the differing trends and finan- Portugal 18cial asset levels in European countries. The Austria 18 Italy 17share of insurance and pension fund assets3 Spain 14as part of total financial assets reflects the Greece 3importance of the segment in the respective 0 10 20 30 40 50 60countries. The Netherlands, the UK, Denmark Note: Europe excluding Luxembourgand Switzerland are at the very top. Very high Source: Central banks, statistical officesreplacement rates in the first pillar have16
  • 17. Introduction International Pension Studies Western Europe Very high growth rates of pension / insur- Chart 6 Insurance/pension asset growth vs. total financial asset growth,ance assets compared to total financial asset 2001–2007growth can be observed in Belgium. This hasbeen triggered by a new occupational pen- 16sion scheme (“Vandenbroucke” law), estab- 14 Insurance/pension growth CAGR [%]lished in 2004, but also life insurance products Irlsaw a strong development. Greece also saw 12 B Grhigh growth rates in pension/insurance as- N 10 I Fsets. This is likely to be the result of the gen- SP 8erally low level reached up to now, which rep- NL US S Dk UK Finresents high potential to catch up. Ireland is 6 Ger Aanother country where performance is high, 4as it belongs to a group of countries that have CHa very basic first pillar only. Low replacement 2 Jrates must be topped up with occupational 0and private pension provisioning. The extreme- 0 4 6 8 10 12 14 16ly dynamic growth of the overall Irish economy, Financial asset growth CAGR [%]which has shown the highest average growth Source: Allianz Dresdner Economic Researchrates in Western Europe in the last decade, hasgiven households the financial leeway theyneed to save for retirement. The different behaviours and influences from differing regulatory, statutory and fiscal Other reasons for the varying development arrangements have led to strongly varyingof total financial wealth include the general trends. Depending on investment preferenc-propensity to save and differences in invest- es, the stock market boom in the late 1990sment behaviour itself. As already shown for had a number of impacts on portfolios. Inthe different regions of the world, risk aversion most European countries, financial assetslevels differ tremendously. Greek households grew rapidly between 1996 and 2000. Thishold the biggest share of bank products. This was related directly and indirectly to stockrisk aversion may be due to a lower level of market gains in particular, which affectedincome and economic development. As one both the valuation of existing stockholdingsof the wealthier countries, portfolios in Aus- and attracted massive new inflows of funds.tria are geared heavily towards security, withalmost 50% invested in bank deposits and The boom gripped the Finns, Swedes andanother 9% in debt securities. Spain and Greeks in particular, generating strong growthGermany are also among the countries that between 1996 and 2000 – and losses in theinvest conservatively compared to other subsequent downturn. Still, together withEuropean countries. Spain and Norway, these countries experi- enced the highest asset gains. At the end of Savings ratio Savings ratios are often used as an indicator of savings behaviour . This can be misleading for cross­ country comparisons, as contributions to pension schemes are not counted as savings . In contrast, the accumulated savings of pension assets do count as financial assets . The savings ratio is usually calculated as the difference between income and consumption . Contributions to pension schemes and investments in other financial assets, such as bank deposits, are treated differently . While the former is recorded in national accounts as a household expense that reduces saving potential, the latter is viewed as saving . However, since contributions to pension schemes increase financial wealth, countries with large funded pension systems often show low savings ratios, but high finan­ cial wealth (as share of GDP) . This puts the very low savings ratio of UK households compared with the higher ratio in Germany, for instance, into a more realistic perspective . See also: Eurostat, Savings rates in Europe, Statistics in Focus, 33/2002. 17
  • 18. Introduction International Pension Studies Western Europe2007, their wealth was about one and a half lead to higher asset valuations in the medi-times higher than at the beginning of 1997. um and long term. In turn, this will provide aIn contrast, during this period Belgium and partial substitute for saving. This correlationGermany registered respective increases of may be one of many reasons for the decreas-only 50% and 60%. By 2005, all countries that ing savings ratios that were observed in mosthad suffered absolute losses of wealth passed European countries until the beginning of thetheir previous wealth peaks. And as a result new millennium. For the projection period,of favourable capital market developments, we have assumed a share performance of 7%they further increased their financial assets p.a. from 2009 onwards.until 2007. In 2008, the financial crisis that resulted from the subprime crisis in the UnitedFinancial asset projection States has put a burden on stock markets.through 2020 The high 2007 year-end figures are unlikely to be reached by the end of 2008. Our fore-Moving forward, we expect the acquisition casts were undertaken in the third quarterof financial assets to progress dynamically. of 2008 and we have assumed that stockIn many European countries, the develop- markets lose 30% in 2008. These perform-ment of monetary wealth will be driven by ance figures also influence the assets underefforts to provide for retirement. This will not management of investment funds.only be the case in countries with alreadystrong funded pension systems (such as the Investments will flow into a wide variety ofUK, the Netherlands and Switzerland), but product categories. A precise product-specificalso in states where reforms to public pay- forecast or econometric estimate is virtuallyas-you-go systems will lead to lower pension impossible for a longer period, as preferenceslevels. Particularly in these countries (such as for particular investment vehicles may dependGermany, Italy and Austria), people are grad- on factors that are difficult to predict, such asually learning to accept the need for supple- legal or tax circumstances and interest ratementary private provision and are building developments. For this reason, our assump-up capital accordingly. Although this process tion on asset allocation is based on long-termwill develop differently across European coun- historical structural shifts. These are driventries and depends on awareness and the by rising incomes and personal wealth, whichprogress of reform, sales of products for old- lead investors to higher performing, riskierage provisioning are likely to be very suc- products. Although stock market volatilitycessful in the coming years. during this decade has reinstated the security aspect, the basic change in investment be- Moreover, the need for personal pension haviour with increasing income is likely toprovision will encourage broader sections of remain stable.the population to save beyond state-incentiv-ised pension schemes. In most countries, our In light of these patterns, countries withprojection therefore assumes a slightly high- higher portions of direct or indirect exposureer savings rate than in the past. However, the to equity markets (through mutual or pensionratios will barely get back to the levels of the funds), such as the UK, Sweden, Finland, Ire- 4 This growth rate differsearly 1990s. Additional retirement saving will land or Spain, will see higher growth in house- slightly from that in thelikely replace other precautionary savings hold financial assets than countries with a following article on pen-efforts and the increasing number of elderly more conservative investment approach or sion assets. This is due topeople will reduce their personal savings smaller funded pension systems. On average, some classification dif-efforts as they retire. we expect the financial wealth of Western ferences in the financial European households to increase by 4.4% p.a. flow statistics of national The increase in wealth is driven not only accounts and the specificby savings, but also by asset valuations, as Total financial assets will therefore increase pension statistics we usedthe development of financial assets has dem- by 75% until 2020, reaching almost EUR 45.3 for the market analysis.onstrated in past decades. Stock market per- trillion. The strongest growth will be registered One major difference isformance also represents an important part in the area of insurance and pensions (5.4%)4. that non-life insuranceof the increase in monetary wealth. Rising By 2020, the importance of these products in products are included ininvestment in equities and equity funds will household portfolios will gain 3.5 percentage the financial accounts.18
  • 19. Introduction International Pension Studies Western Europepoints. Above average growth will also be ob- Chart 7 The financial asset structure of private households, 2007–2020served in the shares and mutual fund segment(4.6%). This will extend their portfolio share 100 3 3by roughly one percentage point. The main 3.4 3.6 Otherlosers in this process will be bank products. 27.4 32 Insurance/ 80 34.7 39 pension funds In Continental Europe, particularly in coun- Shares/tries that belong to the monetary union, growth mutual funds 60rates in the insurance and pension segment 29.4 Bonds 26.0 31are slightly higher (5.6%) due to emerging pen- 27 Bank depositssion saving programs. With its above-average 40 7.9 6.1growth rate, the UK market is not included. 5 7In EMU countries, financial assets will grow 20 31.7by only 4.3%, amounting to EUR 30.9 trillion 29.8 26 27 Note: Europe excludingin 2020 from EUR 17.8 trillion in 2007. Luxembourg 0 2007 2020 2007 2020 Prospects for the long-term development Western Europe EMUof financial assets are quite good, as growth Source: Central banks, statistical offices, Eurostat, Allianz Dresdner Economic Researchrates are expected to be higher than GDPgrowth. However, it should be noted that thefinancial turbulence of 2007/08 is yet again At the same time, introducing fully-fundedputting individual investors and long-term pensions in industrialised nations has be-savers in capital market products to the test. come more pressing than ever. Explanatory notes Financial assets The household sector’s financial assets are calculated in the financial flow statistics provid- ed by central banks or national statistical offices. The aggregate financial account shows by whom, on what scale and in which form financial resources have been made available in an economy. The system is aligned to the “European System of Accounts” (ESA), which was made binding in the European Union in 1999. Its aim is to provide a consistent set of criteria with which all economic sectors and activities can be defined. Insurances and pension products comprise one product group in the financial accounts. In this category, investment vehicles are recorded that are subject to regulation by insurance supervisory authorities, in accordance with ESA ’95. These include all types of investment in fully-funded pension schemes and insurance products. Prepayments of insurance premi- ums and reserves for outstanding claims are also included in this segment. The values are technical reserves. Insurance reserves and pension fund assets are not separated for all countries. This means that non-life, life and pension assets are shown in an aggregate fig- ure in the analysis of financial assets. This figure differs slightly from the definition in the “retirement asset” part of the study (see next article). Projections While accruals in financial assets can be traced back to valuation changes and flows, flows come from savings and contributions from other sources. As far as saving is concerned, assumptions must be made on the development of disposable income and savings rates. For disposable income, an increase in line with nominal GDP growth has been assumed. The growth forecasts for real GDP and inflation in the individual countries up to 2020 are based on Allianz Group Economic Research projections. The data on savings rates up to 2009 are sourced from OECD statistics; constant or slightly increasing savings rates have been assumed for the respective countries. 19
  • 20. Introduction International Pension Studies Western Europe Particularly with regard to allocation, assumptions are difficult to make, as preferences for special types of investment depend on interest rate trends or legal or tax conditions, for instance. Inflow allocation to the various financial instruments has therefore been based on the average behaviour of the past 10 years. Allowance has further been made for the likelihood of additional funds being channelled into private retirement provision in any one country, insofar as there are newly introduced private pension plans that are incentivised by the government.Dr. Renate Finke,Allianz Dresdner Economic Research20
  • 21. Introduction International Pension Studies Western EuropeTrends and AssetDevelopment in EuropeanPension MarketsReforming public pensions Nevertheless, almost all countries have trimmed their public pension systems toWestern Europe’s pension systems have varying degrees and increased the retirementchanged continuously and considerably. age to strengthen the sustainability of theirFor the most part, reforms of the last decade public pension systems. Countries like Swe-were triggered by the insight that ageing den, Austria and Italy have established a veryWestern European populations would place strong link between contributions and bene-an unbearable burden on the public pension fits in the public pillar. They have introduced asystems in place in the medium and long term. notional defined contribution system in whichThis is because the ratio between contributing contributions are recorded in notional indi-employees and retirees will worsen, in some vidual accounts and benefits depend on thecountries dramatically. The degree of change accumulated sum and cohort life expectancy.and the depth of reform have differed acrossEurope. This is hardly surprising, as the pen- Despite these reforms, Western Europe’ssion policies of Western European countries public pensions are still very generous inhave been based on very different foundations. a worldwide comparison. Some European countries show exceptionally high replace- Western Europe’s public pension policies ment rates, which are defined as the ratio ofare largely based on two different systems. post- to pre-retirement income. In Italy andBismarckian systems comprise public pen- Portugal, the net replacement rate for aver-sions that provide earnings-related benefits age earners is around 90% of pre-retirementand aim at maintaining income in retirement. income. In Luxembourg, Spain and Greece,In contrast, Beveridgean systems mainly aim it is 100% or more. This dominating publicto prevent poverty, often through flat-rate pillar will have a strong impact on publicsystems. Austria, Belgium, France, Germany, finances in the future, which will influenceItaly and Spain belong to the former group, the need for pension system reform.while Ireland, the Netherlands and the UKare examples of the latter. Mixed models can The Allianz Dresdner Reform Pressure Gaugebe found in the Scandinavian countries and summarises the effects at work, compares andSwitzerland. Since Bismarckian systems are illustrates the sustainability of pension systemsassociated with higher public pension expe- and the need to reform. It includes the likelyditures, they have also faced a much greater effects of reforms already initiated. In so doing,need for reform. Another factor that has de- it assesses the future sustainability of pensiontermined the urgency of reform has been a systems and shows that reform pressure iswidely differing demographic outlook from highest in Greece. Generally, countries withcountry to country. While Spain, Italy, Por- very high replacement rates and underdevel-tugal, Greece and Germany must cope with oped funded systems are under the higheststrongly ageing societies, populations in reform pressure, as they will face dramaticSwitzerland, the Netherlands, the UK, Ireland increases in public pension expenditure in theand Scandinavia are not ageing quite as future. Portugal, Spain and Luxembourg facedramatically. this very situation. For Sweden, the UK, Den- mark and the Netherlands, the Pressure Gauge 21
  • 22. Introduction International Pension Studies Western Europe Chart 1 Reform Pressure Gauge The Allianz Pension Reform Pressure Gauge measures the pressure on govern­ Greece ments to introduce pension reforms . The lowest score indicates the least pressure to Portugal reform . This pressure can arise due to an Spain expected dramatic demographic change Luxembourg and/or an underdeveloped or unsustainable Belgium pension system . The Reform Pressure Gauge Italy consists of many different individual indica­ tors that illustrate the need for reforms . France The current and future old age dependency Austria ratio, the size of government debt, replace­ Norway ment ratios, pension expenditure or retire­ Germany ment age are such indicators . The existence Finland of a public pension reserve fund to support Ireland the finances of the public pension system is also included . This reduces reform pressure, Switzerland but only if the fund invests in a broad range The Netherlands of assets . The Reform Pressure Gauge also Denmark encompasses indicators that capture reform Sweden progress . Evidence of reform progress is, for United Kingdom example, an increasing retirement age, the reduction of a formerly high replacement ratio 0 2 4 6 8 or the strengthening of the funded system . Scale from 1–10: 1 low reform pressure, 10 high reform pressure Source: Allianz Dresdner Economic Researchindicates fairly low reform pressure because Introducing new fundedof the large share of funded old age provision. pension schemes Introduced reforms have not only aimed Throughout Europe, new pension schemesto roll back benefits from the public pillar. have been introduced in the second and thirdThey have also encouraged the private and pillars. The immediate motivation was gener-occupational provision of retirement sav- ally to compensate for the decreasing benefitsings. They have done this either by providing of public pensions by increasing the fundedgreater incentives, or by introducing new share of pension provision. However, thepension schemes in the occupational and long-term goal is to achieve a more balancedprivate pillars. The establishment of pension structure of retirement income betweenreserve funds has been another innovative the public and funded pillars. Diversifyingfacet of the move towards funded pensions. retirement income and makes it possible toGovernments have established these funds accomplish the three functions of pensionto finance a portion of public system liabili- systems: redistribution, savings and insur-ties in the future and therefore contribute to ance (World Bank, 1994).the sustainability of the public pension pillar.In the realm of European occupational pen- Funded pensions in an ageing societysions, we are witnessing a shift from defined have the additional advantage of being re-benefit to defined contribution plans. How- sistant to demographic change, as they areever, the scope and depth of this shift vary not as dependent on fertility and longevitystrongly across Europe. There are also multi- developments as unfunded systems are.ple differences between the various emerging Rather, benefits are based on accumulateddefined contribution plans in each country. savings. Funded pensions also promise bet- ter rates of return, enhanced capital market development and reduced fiscal liabilities for governments, who are responsible for deficits in unfunded systems. There is no definitive22
  • 23. Introduction International Pension Studies Western Europeanswer as to whether funded systems in- on top of social security contributions, whichcrease overall savings. They may crowd out are managed by the Portuguese pension re-voluntary savings, or may also be accumu- serve fund and held in individual accounts.lated in addition to other savings. Generally, Western Europe’s new pension Funded pensions are not only important plans are designed in very different ways.in the second and third pillars; some coun- Mandatory second pillar plans were recentlytries in Europe have at least partially funded introduced in Norway and Austria and arefirst pillars. In Finland, the earnings-related being discussed in Ireland. However, mostportion of public pensions is partly funded, plans operate on a voluntary basis. Some oc-and contributions are handled by private com- cupational schemes, like Belgium’s, attemptpanies. In Denmark, contributions to the to encourage occupational pension provisionearnings-related pension scheme flow into on a sectoral basis. Others, such as France’sa defined contribution scheme. This scheme PERCO, target single employers.is managed by an independent agency, whichinvests the money in financial markets. Nev- Several of the new plans have been veryertheless, the recently introduced pension successful. Between 2004 and 2007, assets inschemes in Europe are found mainly in the the French PERCO plans grew from EUR 77second and third pension pillars, with the ex- million to EUR 1.4 billion. During the sameception of schemes in Sweden and Portugal. period, the number of participants in Ger- many’s Riester pension increased from 4.2 The Swedish premium pension is a very million to 10.7 million. In Austria, the Prämien­innovative approach. A share of mandatory begünstigte Zukunftsvorsorge was able tosocial insurance contributions is used for attract almost one million members withinthe Premium Pension, and participants can three years. The popularity of the new planschoose between numerous investment funds. is evidence of Western Europeans’ growingThe recently introduced scheme in Portugal willingness to save individually for old-ageforesees voluntary additional contributions provision, even in countries with traditional-Table 1 New funded pension schemes in Western Europe Country Scheme Pillar Year of introduction Austria Mitarbeiterversorgungskasse Second 2003 Betriebliche Kollektivversicherung Second 2005 Prämienbegünstigte Zukunftsvorsorge Third 2003 Belgium Sectoral Funds Second 2004 France PERCO Second 2003 PERP Third 2003 Germany Pensionsfonds Second 2001 Riester pensions Third 2001 Greece Occupational Insurance Funds Second 2002 Ireland Personal Retirement Savings Accounts Third 2003 Norway Mandatory Occupational Pensions Second 2006 Portugal Public Capitalization Scheme First 2008 Sweden Premium Pension First 2000 UK Stakeholder Plans Second/Third 2001 Personal Accounts Second Planned for 2012 23
  • 24. Introduction International Pension Studies Western Europely dominating public systems. Most of the Chart 2 Pension reserve funds in Europe 2007 [EUR bn]new schemes introduced in Western Europeoperate on a defined contribution basis, re-inforcing a trend that we will discuss herein. 275 268 250 225Establishing public pension 200reserve funds 175 150When they introduced new plans in the sec- 125ond and third pillars to remove the burden 100from the public system by achieving a more 95.3 75balanced pension provision structure, many 50countries also introduced a measure directly 45.7 34.5 25targeted at achieving more sustainable pub- 23 21.2 8 6.6 13.1lic pensions. The basic idea is to partially fund 0 Norway Sweden Spain France The Nether- Ireland Belgium Portugal Luxem-the public pension pillar through pension re- lands bourgserve funds. Ageing in a pay-as-you-go system Source: OECD, national statisticsimplies that there will be fewer employees,but more retirees. Thus, either contributionsmust rise if benefits are to stay at the same GDP in the reserve fund each year. In France,level or benefits must decrease if contribu- the reserve fund is financed by privatisationtions are to stay at the same level. To cushion revenues, surpluses from certain social fundsthe impact of ageing on the public system and and taxes. In other countries, such as Spain,prevent contributions from skyrocketing, gov- assets stem from contribution surpluses inernments use the funds to set money aside the social security system. The Portuguesenow to partially pay out benefits in the future. fund is financed with social security surplus- es, a fraction of employees’ social securityDesign and operation contributions and unclaimed tax refunds.Pension reserve funds have become increas-ingly popular in Western Europe, especially Investment policies between these fundssince 2000. Nine of the seventeen countries differ greatly. In principle, the Dutch AOWinvestigated here have introduced a pension Spaarfonds has assets of EUR 23 billion.reserve fund. In some cases, the newly estab- However, the fund exists only in the Dutchlished funds are successors of previously government’s books, and no real assets areexisting funds, as is the case in Norway. How- accumulated. The Belgian Ageing Fund, forever, in most cases the funds were created example, is only allowed to invest in Belgianfrom scratch. The common aim of these funds government bonds that have been specifi-is to support the public system and contribute cally issued for that purpose. Its Norwegian,to its financing when age-related pressures Irish and French counterparts are on thebecome a serious threat. For this reason, the other side of the spectrum; they pursue verytime at which funds can begin being with- sophisticated investment strategies with adrawn is generally predefined. In Spain, for focus on diversification. The target allocationexample, reserve fund assets can be used of the Irish reserve fund, which is not allowedonce the public system has been in deficit to invest in Irish government securities, is afor three years. In Ireland, the funds can be good example. It foresees that two-thirds ofused from 2025 onwards, and from 2020 in assets are invested in equities, 13% in bondsFrance. and the rest in private equity, real estate, in- frastructure, currencies and commodities. Reserve funds can be financed in a number Also in terms of geographical diversification,of ways. The Norwegian Government Pension the fund follows the principles of modernFund, which is the biggest fund in Europe, is portfolio theory and spreads its investmentsfinanced by Norwegian oil and gas revenues. around the world. The Norwegian reserveThe aim is to ensure that future generations fund is not allowed to invest in Norway. Likewill also benefit from these limited resources. its French counterpart, its equity share isIn Ireland, the government has to invest 1% of around 60%.24
  • 25. Introduction International Pension Studies Western EuropePension reserve funds and socially responsible The (uneven) shift frominvestingThe pension reserve funds drive and defined benefit to definedstrengthen the trend towards socially re- contributionsponsible investing (SRI). The French andNorwegian funds are especially active in this The shift from defined benefit to definedarea. Norwegian reserve fund regulations contribution plans is a worldwide phenome-subject the fund to ethical guidelines estab- non that has been driven by a variety of fac-lished by the Ministry of Finance. An ethics tors. These include the underfunding prob-council serves as an advisory body that rec- lems that defined benefit plans face and theommends the types of investment that should increased volatility of pension expenses forbe excluded. The fund’s assets are managed firms that have resulted from new account-by Norway’s central bank, which pursues a ing standards. Volatile financial markets andpolicy of active ownership. This policy aims the increasing complexity of defined benefitto safeguard the fund’s financial interests plans due to new regulations, which hasand calibrate its investments based on extra- resulted in higher administrative expensesfinancial criteria, which include social issues (Clark, Monk 2006; Broadbent, Palumbo,such as child labour and children’s rights as Woodman 2006), have also played a role.well as climate issues. Consequently, employers have come to pre- fer defined contribution plans, as their finan- The French Fonds de réserve des retraites cial payments can be calculated, and invest-also pursues a policy of active ownership. ment and longevity risks can be transferredThe fund’s managers must exercise their to employees.voting rights in line with the fund’s guide-lines. The principles of SRI investing are also As labour mobility has grown, also con-included in the portfolio. The fund has allot- siderable parts of the workforce have discov-ted several specialised SRI mandates and ered the advantages of defined contributionencourages the managers of its other equity plans, which do not penalise job changesmandates, particularly of European equities, and are portable.1 While employees assume 1 In the UK, it is estimatedto make extra-financial indicators part of the investment and longevity risk in (pure) de- that a worker who switch-selection process and share data with each fined contribution plans, they avoid the risks es jobs six times over theother. The specialised mandates do not ex- that are associated with defined benefit plans, course of his/her careerclude specific companies, but rather apply such as wage path, job tenure or default risks experiences portabilitya “best-in-class” approach. (Oxera 2007). losses in defined benefit schemes of 25-30% of The Fonds de réserve des retraites intends While there is a clear trend towards de- the full service pensionto go one step further. In 2006, a process was fined contribution in Europe and elsewhere, (compared with a personinitiated that aims to assess the entire port- defined benefit plans continue to play a role. who has the same salary,folio on the basis of extra-financial criteria. Indeed, for two reasons, the degree of the but a full career with theIn 2008, the fund established a responsible shift is sometimes over-interpreted. First, be- same employer). Seeinvestment strategy based on five objectives, cause of the much longer history of defined Blake 2003.among them further efforts to include SRI benefit plans, the stock of assets in these planscriteria in portfolio management, active is still considerable. In fact, in most Europe-exercise of shareholder rights and improve- an countries, it dominates. Watson Wyattment of prevention of extra-financial risks. estimates that in the 11 largest pension mar-It is an important development that state re- kets, defined benefit assets still account forserve funds adopt SRI principles, as doing so 57% of occupational assets (Watson Wyattmay have a considerable impact on financial 2008). Second, the trend towards definedmarkets and the demand for asset manage- contribution plans is uneven. While it veryment services. Due to their size, state reserve pronounced in some regions, including Aus-funds enable SRI investing to reach a critical tralia, the US, Italy, Spain, Eastern Europemass. This will help perpetuate the approach and parts of Asia, countries such as Japan,and make it part of more mainstream invest- Germany, France and Korea have not seenment management. the trend develop as quickly. This is because industrial structures influence the choice of pension plans and the likelihood of a trans- 25
  • 26. Introduction International Pension Studies Western Europe Classifying defined benefit and defined contribution plans In their pure form, defined benefit and defined contribution plans are easy to classify and distinguish. In traditional defined benefit plans plan members accrue pension promises based on a formula linked to wages, length of employment or other factors. The employer is obliged to provide these benefits, which normally come in the form of a life annuity. In this sense, benefits are fixed. In defined contribution plans, contributions are fixed and the retirement savings depend on the paid-in capital and its return. In many countries, the capital needs not to be converted into a life annuity, but can be at least partly with- drawn as a lump sum. Classification becomes harder, when hybrid plans, which combine features of defined benefit and defined contribution plans, are considered. Cash balance plans, in which benefits depend on a notional individual account with a specified rate of return, are an example and are mostly classified as defined benefit plans. Especially challenging is the question how to classify plans in which contributions are fixed, but regulation foresees a minimum interest guarantee. This applies to some plans, for example, in Germany and Switzerland. The OECD considers all plans in which the sponsor guarantees a rate of re- turn as defined benefit plans, while other sources (like Watson Wyatt 2008) classify them as defined contribution plans. In this study we follow the OECD approach.formation. Defined benefit plans tend to be insurance product hybrids on the market,concentrated in unionised, well-established among them variable annuities and out-and large firms with a high share of long- come-oriented products. The latter aim toservice workers (Munnell 2006). In high-tech achieve a specific target replacement rate orand service sectors, and for smaller firms, DC outcomes by adjusting the contribution rateplans are more suitable. periodically, taking into account projected and actual investment return. Defined con- In Europe, there is a wide variety of de- tribution plans do not necessarily place allfined contribution plans. In the purest form, investment risk on the employees, as variousplan members choose their preferred saving design and product features allow for riskinstrument. The resulting capital, defined re-allocation. While it is highly likely that theas the contribution plus interest and minus shift towards defined contribution schemescosts, serves as a pension. However, there are will continue in Europe, it is not yet clearmany design options, some of which are de- which form will dominate.termined by regulations. In Germany, for in-stance, paid in contributions must be guar-anteed, making pure defined contribution Remaining and futureplans impossible. Swiss defined contribution challengesplans are subject to a minimum interestrate. In the Netherlands, defined contribu- Most countries in Western Europe are on thetion plans are collective, meaning that risks way to creating better balanced pension sys-are balanced. In contrast, Italy’s open pen- tems with a stronger role for funded pensions.sion fund is closer to the individual defined This can be seen as a response to the missingcontribution model as are the PERCO plans sustainability of former public pension sys-in France. tems, which has been aggravated by the future ageing of European societies. In this sense, In defined contribution plans, the invest- the implemented reforms were necessary toment risk that employees are exposed to cope with demographic developments andcan be limited through appropriate product funded pensions will disburden the publicchoice. There are various investment and systems in the future.26
  • 27. Introduction International Pension Studies Western Europe Obviously, the main trends in European The growing importance of defined contri- 2 The effective total pen-pensions markets – the greater role of funded bution plans may also have also beneficial sion and insurance assetspensions for retirement income security cou- side effects for labour mobility within Europe met the asset forecast inpled with the ongoing shift towards defined and the emergence of Pan-European pension our 2004 projection: By applying previous growthcontribution plans in occupational pensions – plans. Due to regulatory differences, especial- rates and making adjust-involve new challenges for citizens, regulators ly in social and labour law as well as taxation, ments for exchange rateand product providers. Occupational defined Pan-European pension plans have thus far fluctuation and countrycontribution plans imply greater individual faced too many obstacles and have been un- selection (ex Greece), assetsresponsibility, at least when plans allow indi- able to develop. Pension pooling has become should have amounted tovidual choice. With the level of public pen- an option; while real cross-border plans have EUR 8.58 trillion in 2007. Itsions declining, also private pension plans, often been discussed, none have been imple- should be noted that thewhere individual choice is widespread, are mented until now. total number concealslikely to constitute a greater share of retire- diverging developments.ment income. Hence, efficient retirement in- Within the framework of a single plan, The biggest difference was in Sweden, where we over-vesting and planning becomes a crucial factor managing liabilities in several countries has estimated the trend. Wefor retirement income. This applies to the ac- been far too complicated. Implementing cross- also overestimated marketcumulation phase, where regulation should border plans of the defined contribution type development in Germanynot interfere with an efficient asset allocation; is still a challenge because of different invest- and Italy. In Germany, thisthis can for example happen with quantitative ment regulations and taxation. Still, defined may have to do with theinvestment limits, as argued by finance theory. benefit plans face much greater difficulties; reduction of tax incentives hence defined contribution plans may eventu- for life insurance contracts Rising individual responsibility will bring ally lead to a door being opened for Pan-Euro- in 2005. In Italy, pensiona topic to the forefront that has been largely pean plans. This, in turn, would support la- reform decisions were bour mobility in Europe. Also within countries, introduced slowly, whichneglected in Western Europe, namely the left people feeling inse-regulatory and product design of the pay-out defined contribution plans can support labour cure. This may have affect-phase. Traditionally, the dominance of de- mobility as their lower complexity avoids the ed decisions on TFR flows,fined benefit plans implied that the pay-out portability problems of defined benefit plans. which we overestimated.phase did not require special attention as The opposite direction waslife long annuities were the norm. However, Retirement asset projections observed in the UK, wherewith the advent of defined contribution in we underestimated pen-Europe, the pay out phase needs reconsider- In 2007, Western Europe’s overall retirement sion growth. Strong equityation. There is evidence that enforced and market (including pension fund and life in- market performance, highcomplete annuitisation of funded pensions, surance assets) reached a volume of EUR 8.6 pension fund exposure to equity investments and thewhich is the norm in occupational pension trillion2. This amounted to roughly one-third overall very positive eco-systems in Western Europe, may actually of overall household portfolios. Countries nomic development inresult in a suboptimal level of retirement such as Switzerland, the Netherlands and the previous years boost-income. the UK, in which state schemes provide only ed assets under manage- a basic pension that must be increased by ment to a greater extent Currently, annuitised pay out solutions are supplementary pensions, are considerably than expected.clearly favoured by regulation and taxation; Pie charthowever, in a lifecycle perspective already Chart 3 Country share of retirement assets in Europe, 2007 [%]existing lifelong income streams from publicpensions and other sources need to be includ-ed in retirement planning. Thus, partial an- Northern 7.6 5 Rest (Austria,nuitisation or annuitisation at high ages may Europe Belgium,be sufficient to prevent old-age poverty, but Southern Ireland) Europe 8.4opens up higher return potential and wouldincrease the flexibility and liquidity of reti- 5.6 Switzerlandrees, allowing them to cope with unexpected 35.9 UKexpenses and leave bequests. Up to now, the 10.7 The Nether-main task of pension reforms has been to in- lands 14.3 Francecrease coverage of funded pensions. After thisaim has been largely achieved in many coun- 12.5 Germanytries, the next challenge will be to achieve ef-ficient solutions in this market by fine-tuning Source: Central banks, national statistical offices, OECDregulation and design. 27
  • 28. Introduction International Pension Studies Western Europeabove this average. The UK has the largest Chart 4 Retirement assets per capita versus net replacement rate*, 2007pension market by far, accounting forabout 35.9% of all pension assets in Western [EUR]Europe. 70,000 CH 60,000 In per capita terms, British households NLrank behind the Swiss and the Dutch. With 50,000 UKEUR 63,800 retirement assets per capita, Dk 40,000Swiss households are well ahead of the IreDutch, who also have a large stock of capital US 30,000invested in retirement assets as a result of Fin S Nor 20,000 EUtheir mandatory occupational pension sys- B F Gertem. These countries even rank ahead of the 10,000 I EsUS. With almost EUR 40,000 3 in retirement A Gr Por 0assets per capita, American households have 30 40 50 60 70 80 90 100 110 12080% more assets saved for their retirement Replacement rate (Net pension of average earner in relation to life time average earnings)than their Western European counterparts Source: Central banks, national statistical offices, OECD(EUR 21,600 on average). Most countries witha traditionally strong first pillar rank belowthe European average. Southern European In terms of assets, even the most devel- 3 Including Individual Re-countries in particular have a low stock of oped funded pension systems cannot com- tirement Accounts (IRA), Source: ICI – Investmentfunded retirement provision. pete with the public system. According to an Company Institute OECD model, future pensioners in the West- Research, 2008. The size of funded pensions in European ern EU have implicit claims on state pension 4 Here, only the first pillarcountries is shaped by public pensions. The systems ranging between EUR 89,000 in Por- is taken into account be- cause it is contrasted toamount of extra capital that must be saved to tugal and almost EUR 300,000 in Austria and the funded part. However,maintain the same standard of living after re- Sweden (OECD 2007). For the Netherlands with a quasi-mandatorytirement depends on the anticipated level of and Denmark, the OECD reported very high second pillar in the Nether-pension benefits. The close correlation between values (EUR 470,000 and EUR 435,000), but lands, actual retirementthe generosity of the state pension system and these include the (quasi-) mandatory ele- income is higher and ena- bles an adequate standardthe share of funded pensions is clearly illus- ments of private pensions. However, steps of living. The same holdstrated by chart 4. In countries where state pen- introduced in European countries to over- for Denmark, as is shownsion systems have high replacement rates, haul PAYG pension regimes are lowering the in the chart.such as Greece or Spain, people set aside less implicit value of pension wealth in the state 5 For example, the in- crease of the retirementfor old age. In contrast, people in countries pension insurance system5. Incentives for age in Germany has notwith pension systems that replace a lower pro- private savings aim to compensate for this yet been included in theportion of income, such as the Netherlands4 change. OECD model.or the UK, tend to accumulate more. 6 See preceding articleChart 5 Development of retirement assets until 2020 15% Gr The size of the bubbles reflects the estimated asset volume in 2020 12%CAGR 2007–2020 9% Por Fin SP S N B 6% I F A Dk Ger UK Ire NL 3% CH 0% 0 500 1,000 1,500 2,000 2,500 3,000 3,500 Asset increase 2007–2020 [EUR bn] Source: Allianz Dresdner Economic Research, Allianz Global Investors28
  • 29. Introduction International Pension Studies Western Europe Pension investment and pension insurance assets In our methodological approach, we divide the retirement market into two segments: pen- sion investment and pension insurance assets. Pension investment assets consist mainly of assets of pension funds. We have used the OECD database on autonomous pension funds, but also included, where available, all other (non-insurance type) occupational pension funds not included in this database. We have also included book reserves, making data classification comparable to our 2005 Western European Pension Study. However, pension investment assets do not include the whole retirement market as many pension plans are provided under insured arrangements. Particularly through group insurance, many smaller companies organise their occupational pensions in cooperation with life insurance companies. What is more, the main part of third pillar arrangements is set up as insurance contracts. Thus, we have included the assets under management of European life insurance companies in our calculations as pension insurance assets. We expect overall retirement assets Chart 6 Development of pension investment assets until 2020to grow strongly within the next decade.With 5.3% annual growth, they will increase 15%faster than overall financial assets, which Gr The size of the bubbles reflects the estimated asset volume in 2020we have forecast to increase by an average 12%of 4.4% annually6. Retirement assets willamount to EUR 16.9 trillion by 2020. The F I CAGR 2007–2020laggards on the funded pension front – 9% S SPGreece and Spain – are expected to grow A B Ireby 14% and 7.7%, respectively. Dk 6% UK Fin N Por Ger NL Mature markets like Switzerland (2.8%) CH 3%are showing the slowest growth. This is likelydue to a longstanding tradition of occupation- 0%al pensions, which implies that more mem- 0 500 1,000 1,500 2,000bers are near retirement or are already retired. Asset increase 2007–2020 [EUR bn]As a result, outflows play a bigger role thanin countries where funded pension schemes Source: Allianz Dresdner Economic Research, Allianz Global Investorswere more recently introduced. Hence, the Chart 7 Development of pension insurance assets until 2020development of assets under managementis driven far more strongly by returns on ex- 15% The size of the bubbles reflects theisting assets than by net contributions. For Gr estimated asset volume in 2020the same reasons, these developments can 12%also be expected in the Netherlands and theUK. However, the UK will end up with a higher CAGR 2007–2020annual growth rate due to the introduction 9% Por Fof personal accounts with auto-enrolment SP Nfrom 2012 onwards. In most of the other coun- 6% Fin S A Itries, the flow of funds into occupational or Ire Dk B Ger UKindividual pension schemes is more impor- NL 3%tant for the development of retirement asset CHvolumes. 0% 0 500 1,000 1,500 2,000 Today, most of the markets have a high Asset increase 2007–2020 [EUR bn]level of pension insurance assets. However, Source: Allianz Dresdner Economic Research, Allianz Global Investorsthis will change gradually, as we expect 29
  • 30. Introduction International Pension Studies Western Europe Retirement market – definition and sources The difficulty to define the retirement market is that most assets held by individuals are not usually earmarked for any particular purpose. For instance, money set aside for a new car is often indistinguishable from retirement savings. For this reason, we focus on pen- sion investment and pension insurance assets, leaving out assets in savings deposits, mutual funds or other vehicles that may also contribute to retirement income. For some European countries, pension insurance and pension investment assets are shown in the financial accounts of private households, which belong to the broader system of national accounting. We therefore based our approach on the financial accounts and correspond- ing flow statistics, which illustrate the annual change apart from valuation changes. This information was necessary, particularly for those countries without detailed data on con- 7 Details on the financial tributions. We also added secondary statistics from insurance associations, particularly asset projections can be the European Insurance and Reinsurance Companies Federation (CEA), pension fund found in the preceding associations and supervisory bodies.7 article.pension investment assets to develop faster dominated in the past. This means that indi-than life insurance assets. For pension in- vidual responsibility for old-age provision isvestment assets, we expect an increase of on the rise. This may have several beneficial5.5% p.a., more than doubling during the pro- side effects, such as more interest in financialjection period and reaching EUR 6.7 trillion matters, better financial education and morein 2020, from EUR 3.3 trillion in 2007. The in- highly developed capital markets. Currentsurance portion, in turn, will rise by 5.2%, trends – such as the introduction of new fund-amounting to EUR 10.2 trillion in 2020 from ed pension schemes, the increasing assets ofEUR 5.3 trillion today. pension reserve funds and SRI investing, as well as the shift from defined benefit to defined Funded pensions are becoming in- contribution schemes – have the potential to creasingly important for the future significantly change the European pension andretirement income of Europe’s citizens. For capital market environment. Funded pensionsmany countries, this development entails a and their design will therefore remain a top eco-new approach to pensions, as public pensions nomic and political priority in the years to come. Dr. Alexander Börsch, Allianz Global Investors AG Dr. Renate Finke, Allianz Dresdner Economic Research30
  • 31. Introduction International Pension Studies Western EuropeSolvency II:How it Could Affect DefinedBenefit Pension FundsIntroduction Solvency II requirements will be more comprehensive than in the past. While EUThe insurance industry in the European Union solvency requirements currently concen-(EU) is facing a major regulatory change in trate mainly on insurance risks, Solvency IIthe near future as a new solvency regime will will take account of asset risks, liability risksbe introduced. Solvency II is currently being and their interactions. The exact calibrationdrafted and is expected to come into force of the solvency capital requirement has notin 2012. The aim is the advancement and EU- yet been defined. Solvency II is being testedwide harmonisation of solvency requirements by way of quantitative impact studies (QIS),for insurance companies towards risk-based which are simulations performed by insur-regulation, thereby enabling better risk man- ers on a voluntary basis. These simulationsagement of insurers. The basic idea behind demonstrate the impact of the proposed newSolvency II is to consider all relevant risks in requirements on their financial resources.the solvency requirements. QIS 4 is the current status. Solvency II is meant to regulate insurance Solvency II and pension fundscompanies, however, there are discussionsto extend it to pension funds. In this context, To explore the effects of a possible extensionthe possible consequences of such an appli- of Solvency II on defined benefit pensioncation are of critical importance to pension funds, Allianz Global Investors, risklab andfunds. The main question is to what extent the Institute of Finance and Actuarial Sci-Solvency II would impact on investment poli- ences conducted a study on these issues ascy and plan design of pension funds, especial- part of a joint research project with thely of defined benefit funds. OECD on risk-based regulations (Peek, Reuss, Scheuenstuhl 2008). Generally, the aim of a solvency regimeis to ensure the financial soundness of finan- One of the study’s key findings was that thecial companies. The solvency regime needs funding level for a typical final pay plan wouldto ensure that these companies can survive decrease from 100% under IAS accountingdifficult times to protect the claims of policy- to 64% under Solvency II. This is mainly dueholders and maintain the stability of the fi- to the higher valuation of pension liabilitiesnancial system. Solvency requirements define under Solvency II and the inclusion of a sol-the minimum amount of capital deemed vency capital requirement to cover unfore-necessary to cover the risks to which these seen risks (further details below). For pensionundertakings are exposed. As a result, solven- funds with career average plans, the resultscy requirements can have a significant impact were similar.on an undertaking’s business situation andits ability to fulfil its financial obligations. Clearly, this funding level reduction would require an adjustment strategy on the part of pension funds to restore the solvency level to the required 100%. Several actions are con- ceivable: 31
  • 32. Introduction International Pension Studies Western Europe• The introduction of the Solvency II rules for Benefit cuts work in a similar way; when pension funds could lead to shifts in the pension funds are underfunded, benefit investment strategies of pension funds. payments to policyholders are reduced. A pension fund would need to hold a signif- These risk-sharing mechanisms would icant amount of capital to be able to invest improve the funding level under Solvency in growth assets such as (private) equity II compared with pension funds that do or alternative investments. Pension funds not have these characteristics. The impor- that are in an underfunding situation would tant point, however, is that pension fund need to scale down investments in these in- policyholders actually take on the addi- vestment classes and shift to fixed income tional risks that the pension fund reduced investments. Another way to reduce the in order to improve the funding level. In solvency capital requirement (and thus a way, these risk-sharing mechanisms re- improve the solvency level) is to match duce pension payments to policyholders. the interest rate sensitivity of assets with the interest rate sensitivity of pension lia- • Additional contributions to finance the bilities. Since the duration of pension fund pension fund deficit under Solvency II liabilities are typically higher than asset would be another way to improve the level duration, pension funds would have to in- of solvency. These contributions could vest more in higher maturity fixed income be significant, depending on the pension investments. fund and pension plan characteristics.• Rethinking the pension promises that Solvency II framework pension funds make to policyholders may be another consequence of the introduc- The Solvency II framework requires market- tion of Solvency II. The study showed that consistent valuation of assets and pension pension funds with risk-sharing charac- liabilities (technical provisions). What is more, teristics improve their solvency level under the solvency capital requirement (SCR) must Solvency II. The conditional indexation be calculated. This is depicted in figure 1. of benefit payments and benefit cuts are examples of risk-sharing mechanisms. Pension funds typically invest in fixed Pension funds with conditional indexation income and equity with a small portion of of benefit payments index the benefit pay- assets invested in alternatives such as prop- ments to policyholders with inflation only erty, commodities and hedge funds. For these if the funding level of the pension fund is asset classes, a market-consistent valuation sufficient. In underfunding situations, the is generally straightforward. This is because pension fund does not index the benefit pay- market values are either available (mark-to- ments, or does so only in part. This shifts market) or can be derived (mark-to-model). part of the investment risk to policyholders. Under most accounting rules (IAS e.g.), pen-Figure 1 Solvency II framework overview Excess Capital Solvency Capital Requirement (SCR) Available Capital Risk Margin Market Value of Assets Technical Provisions Best Estimate of Liabilities32
  • 33. Introduction International Pension Studies Western Europesion fund investments are also valued at rates used under Solvency II, which leadsmarket value, which leads to a valuation to a higher valuation of the best estimatesimilar to Solvency II. of liabilities compared to pension liabilities under IAS 19. Technical provisions, however, are valuateddifferently. Under Solvency II, technical pro- The difference between IAS 19 and Solvencyvisions must be valued “at the amount for II in the valuation of pension liabilities willwhich they could be transferred, or settled, depend on the difference in the discount ratebetween knowledgeable willing parties in an and on the duration of pension liabilities. Forarm’s length transaction” (European Com- pension funds with mainly active policyhold-mission 2008). The technical provisions of ers (high duration of pension liabilities), thea pension fund are expected future pension increase in pension liabilities under Solvencypayments, which do not have a readily avail- II will be larger than for pension funds with aable market value. In such instances, Solven- majority of retired plan members (lower du-cy II requires that the technical provisions ration of pension liabilities).are split into a best estimate and a risk mar-gin (European Commission 2008). In addition to the best estimate of liabili- ties, Solvency II requires the calculation of The best estimate is defined as “the prob- a risk margin. The risk margin ensures thatability-weighted average of future cash flows, the value of a company’s technical provisionstaking account of the time value of money, is equivalent to the amount that a willingusing the relevant risk-free interest rate term party would be expected to require to takestructure” (European Commission 2008). over the obligation. In order to take over pen-Pension funds would need to discount the sion liabilities, an undertaking must put upexpected future pension payments with the capital. The undertaking requires compen-risk free rates (swap rates), which is clearly sation for the cost of capital (currently setdifferent from accounting rules. For instance, at 6%) that it will incur in the future whenIAS 19 prescribes that the discount rate be paying off pension liabilities. The risk mar-based on high quality corporate bonds, gin is the discounted value of the future costwhich is usually interpreted as the yield on of capital. Calculating a risk margin is not re-corporate bonds with an AA credit rating. quired under IAS accounting. The technicalThis discount rate is higher than the swap provisions will therefore be significantlyFigure 2 Solvency Capital Requirement (orange lined boxes are relevant risks for pension funds) SCR BSCR SCR operational SCR non life SCR market SCR health SCR default SCR life Currency Disability Property Longevity Interest Rate Expense Equity Spread Concentration 33
  • 34. Introduction International Pension Studies Western Europehigher under Solvency II due to the lower dis- (European Commission 2008). Pensioncount rate and the inclusion of a risk margin. funds that are significantly invested in these asset classes will face high solvency Solvency II requires the calculation of the capital requirements under Solvency II.Solvency Capital Requirement (SCR), whichis the level of capital that enables an under- • Interest rate risk can be significant for taking to absorb significant unforeseen losses. a pension fund if the interest sensitivityIt also provides policyholders with reasonable of assets is different from the interest sen-assurance that payments will be made as they sitivity of technical provisions. Both thefall due. The SCR reflects the amount of cap- assets and the technical provisions of aital required to meet all obligations over a pension fund can be interest-rate sensi-specified period of time (1 year) to a defined tive. Fixed income investments changeconfidence level (99.5%). This aims to limit in value when interest rates change. Thethe risk that available capital deteriorates to same holds true for technical provisions,an unacceptable level at any time during the as the expected future pension paymentsspecified period of time. are discounted with interest rates. To de- termine the risk charge for interest rates, In the SCR calculation, all significant the net impact of changes in assets andquantifiable risks are taken into account. technical provisions has to be taken intoCapital requirements are first calculated account, which is what Solvency II requires.separately for each individual type of risk, The duration of the technical provisionsassuming a worst-case change in the under- of pension funds typically lies in the rangelying risk factor. For most risk factors, the of 10 to 15 years for a mixed plan memberworst-case changes are based on actual portfolio. For portfolios that contain main-observations in the financial markets. For ly young workers, the duration is evenexample, equity risk arises from the level of longer. Interest rate sensitivity for suchvolatility of market prices for equities. The technical provisions is high, requiring astress factor for equity risk was calibrated similar sensitivity on the asset portfolio toon the MSCI Developed Markets index (total avoid a high risk charge for interest rates.return) from 1970 until 2005 (European This can be difficult to achieve with cashCommission 2008). instruments if part of the asset portfolio is invested in non-interest rate sensitive The capital requirements for the different investments and if the funding level isrisk factors are then aggregated using pre- clearly below 100%.defined correlation matrices (the variance-covariance approach). This results in a lower • Longevity risk is typically an important solvency capital requirement than the sum risk factor for pension funds. Longevityof the risk charges for each individual risk risk is the risk of life expectancy amongfactor. policyholders increasing to a level higher than that which a company or fund origi- The main risk categories that are relevant nally anticipated. If the life expectancyfor pension funds are market risks, life-un- of their policyholders increases, pensionderwriting risks and operational risks (see funds must increase the valuation of thefigure 2). The pension fund’s asset and liabil- technical provisions.ity structure will eventually determine whichrisk factors have the biggest impact on the Solvency II requires the market-consistentsolvency capital requirement. However, some valuation of assets and technical provisions.major impacts should be recognised: The main differences between IAS account- ing rules and Solvency II will be on the liabili-• For equities that are listed in European ty side of the balance sheet. The technical Economic Area (EEA) or OECD countries, provisions of pension funds would increase the risk charge amounts to 32% of the under Solvency II due to the lower interest investment’s market value. For other in- rates used for discounting the expected fu- vestments, such as equity listed only in ture pension payments, and the inclusion emerging markets, non-listed equity or of a risk margin. After making adjustments hedge funds, the risk charge is even 45% for the higher technical provisions under34
  • 35. Introduction International Pension Studies Western EuropeSolvency II, the pension fund would need tohave enough available capital left to coverthe solvency capital requirement.ConclusionThe introduction of Solvency II for pensionfunds would lead to a significant reductionin funding levels compared with IAS account-ing. Our research shows that pension schemesthat are currently 100% funded under IAS 19will be only 65% funded under Solvency II.Meeting this funding gap could impose an un-acceptable burden on many scheme spon-sors. Sponsors would have to consider a rangeof options, including increased contributions,a change towards more defensive asset allo-cations and a move to a risk-sharing structurewith policyholders.Jordy Peek,risklab 35
  • 36. International Pension Studies Western Europe36
  • 37. Country Profiles
  • 38. Country Profiles Austria International Pension Studies Western Europe Austria Finding a New Retirement Income MixPension system designIn recent years, the Austrian pension system Demographics and macroeconomicshas undergone a transformation. The tradi- Population 8.2 milliontionally dominating first pillar has beenchanged into a notional defined contribution Old-age dependency ratio* 2005: 25 2050: 53system with higher actuarial fairness. In therealm of occupational pensions, the sever- GDP [EUR] 273 billionance pay system has been reformed and is GDP per capita [EUR] 33,300now more formal and funded. In the marketfor voluntary occupational pensions, multi- GDP growth, 2002–2007 [av. in % p.a.] 2.4employer funds dominate and there has been Unemployment rate [%] 4.4a major shift towards defined contributionplans. Furthermore, a new insurance-typevehicle has been established in the form of Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsoccupational collective insurance. Introduced Source: Allianz Dresdner Economic Researchin 2003, tax-favoured third pillar plans havebeen a major success. Participants can choosebetween insurance and investment products. duced a uniform pension law for all gainfully employed people. Prior to this, there were Demographic change in Austria is much various schemes for different occupationalin line with developments across Europe. groups. The reform was the first effort toAustria’s old-age dependency ratio will reach create a uniform system with the same con-a value of 53 in 2050, slightly above the EU-25 tribution rates and benefit entitlements.average of 52. We expect the overall pensionmarket, which currently amounts to EUR 75.3 It also introduced a notional defined con-billion, to increase at a CAGR of 6.3% until tribution system with individual accounts2020. in the public pillar. The system is still pay-as- you-go financed and does not accumulate capital, but all paid-in contributions are re-Public pensions corded and credited with a pre-determinedAustria’s public pension pillar is generous, interest rate, so that a notional capital results.with a net replacement rate of 80% for an This notional capital determines pensionaverage earner. The public pillar has under- benefits. For people older than 50 in 2005, thegone substantial reforms since 2000, with the new system does not apply. For those young-main goal of increasing actuarial fairness er than 50, a mixed system is in place, and itand the system’s sustainability. A number fully applies only to those who did not haveof reforms were passed in 2000 and 2003, any pension entitlements before January 2005.including early retirement discounts, a high- As a result, transitional periods are long.er retirement age, an increase in the assess-ment period to 40 years from 15 years, and areduced accrual rate. The 2004 reform intro-38
  • 39. Country Profiles Austria International Pension Studies Western Europe Under the new system, a 45/65/80 formulaapplies. It foresees that after 45 years of contri- First pillar designbutions and retirement at age 65, the old-agepension will amount to 80% of average lifetime Contribution rate [% of gross salary] Employer: 12.55earnings. The reforms could be considered Employee: 10.25successful in fiscal terms, as the projected pub- Replacement rate [% of last income] Gross: 64lic pension expenditure has decreased sub- Net: 80stantially. According to the Austrian Central Legal retirement age 65 menBank, prior to the reforms pension expendi- 60 women (65 by 2033)ture was expected to amount to 17% of GDP in Public pension expenditure [% of GDP] 2005: 13.42050. Following the reforms, 12.2% is expected 2050: 12.2(OeNB 2006). Contributions must be paid upto an assessment limit of EUR 3,132, while Source: OECD, EU 2006the maximum monthly pension is EUR 2,480.Benefits are adjusted in line with inflation. cial institutions. They offer defined contribu- tion type funds. The law stipulates that staffOccupational pensions provision funds must guarantee the paid-inThere are two types of occupational pension capital; further voluntary guarantees are pos-arrangements in Austria. One is a severance sible. Assets under management amountedpay system and the other is voluntary pension to EUR 1.6 billion in 2007. 2.4 million membersprovision. participated, representing approximately two- thirds of Austria’s employees.Mandatory severance payTraditionally, employees in Austria have re-ceived severance pay when they retired or the MVK statistics, 2007employment relationship was terminated. AuM [EUR bn] 1.6This was commonly referred to as the Abfer­tigung, which was normally financed inter- Members 2.4 millionnally. In 2002, a new severance pay system Taxation EEEwas introduced (Abfertigung neu). Now, theemployer contribution is invested in a Mit­ Source: Betriebliche Vorsorgekassenarbeiterversorgungskasse (MVK, staff provisionfund). This system is mandatory and appliesto all employees who began working in 2003 Voluntary occupational pensionsor later. It can also be extended to existing em- Until 1990, voluntary occupational pensionsployees, provided that both sides agree. As of were almost exclusively organised in the form2008, the self-employed are also included in of company book reserves. That year, thisthe system. The contribution amounts to 1.53% changed with the introduction of pensionof an employee’s salary; employees themselves funds called Pensionskassen. Besides these,cannot make contributions. Benefits can be companies can still use book reserves forpaid out as a lump sum or as an annuity when occupational pensions or support funds, butemployees reach the official retirement age. they rarely do.The mandatory contribution is not taxed.However, if employers make any additional Institutional framework and governancecontributions, they are subject to taxes. Cap- Pensionskassen are either single or multi-ital income is tax-free, as are benefits that are employer joint-stock companies. Assets andtaken out as an annuity. If employees opt for liabilities must be kept separate from thosea lump sum, a 6% income tax applies. of the pension fund company. Pensionskassen are subject to specific supervision, which dif- MVKs are independent entities that are fers from that which applies to banks and in-selected through an employer/work council surance companies. What is more, they mustagreement. If none is chosen, the Association have at least 2,000 members no later than twoof Social Security Institutions allocates the years after their establishment. The generalcontributions. There are nine MVKs on the assembly, the board of directors and the su-market, which are operated mainly by finan- pervisory board make up the governance 39
  • 40. Country Profiles Austria International Pension Studies Western Europestructure. An advisory committee may be Pensionskassen asset allocation, 2006 [%]required by the pension fund statutes. Thegeneral assembly elects the shareholder andbeneficiary representatives to the supervisory Cash and 2 Real estateboard. deposits 4 Other 6 Plan types can be defined benefit ordefined contribution and are financed byemployer contributions. Employees may Equities 36make additional contributions on a volun-tary basis, provided that they do not exceed 52 Fixed incomethe sum of annual employer contributions.In 2005, the average annual contribution permember amounted to EUR 1,290. Up to a cer-tain limit, benefits are paid by the pensionfund itself, usually in the form of annuities. Source: OECDRegulation, asset allocation and taxation employee contributions, 25% are taxed, whilePensionskassen must achieve a certain mini- the rest is tax-exempt. Employer-financedmum rate of return. However, since 2005 they benefits are fully taxed.have been allowed to opt out of the minimumrate with consequences for quantitative invest- Trendsment restrictions. Most pension funds have There are currently 540,000 people partici-opted out. The minimum rate of return applies pating in the Pensionskassen system, repre-to five-year averages, and pension funds that senting around 20% of economically activechoose to be subject to the minimum rate people. There are 13 company pension fundsmust build up reserves to reach it. In 2007, on the market as well as 6 multi-employerthe minimum rate stood at 1.03%. If Pensions­ funds. The latter account for around 80% ofkassen opt out, they may have a higher share the market, and the biggest three make upof equities in their portfolios. The main invest- two-thirds of the segment. While Austriament limits for Austrian pension funds in used to be a defined benefit market withgeneral include the following: book reserves, this has changed since the• 70% of assets for equities, bonds and cor- introduction of the Pensionskassen. New plans porate bonds (50% for Pensionskassen with tend to be of the defined contribution type, minimum return guarantees) as are plans for new employees. According• 20% for real estate investments to the OECD, 75% of pension fund assets are• 30% for foreign assets in defined contribution plans, and the rest• 5% for single issuers/issue and for self- is in defined benefit schemes (OECD 2006). investment, 10% for issuers/issues of one Current discussion on occupational pensions group focuses on whether mandatory staff provi-• 10% for derivates sion funds should be opened to voluntary employer and employee contributions, and There are no limits for loans and bank whether they should be developed further indeposits. The current asset allocation of a mandatory pension pillar. The implemen-Pensionskassen leans towards bonds, coupled tation of these ideas could create a majorwith a significant share of equities. competitor for the Pensionskassen. Pension fund contribution taxation isa complex matter. Employer and employee Pensionskassen statistics, 2007contributions are subject to different taxation AuM [EUR bn] 13.1rules and are therefore held separately.Employer contributions of up to 19% of the Members 540,000employee’s salary are tax-deductible. Employ- Taxation EETee contributions are tax-deductible as specialexpenses. Investment income is tax-exempt. Source: WKO PensionskassenIn the case of benefit payments financed by40
  • 41. Country Profiles Austria International Pension Studies Western EuropePrivate retirement savings PZV statistics, 2006In 2003, Austria introduced new tax- AuM [EUR bn] 1.8advantaged pension products in the form ofprämienbegünstigte Zukunftsvorsorge (state- Members 987,000sponsored pension provision, PZV). The state Taxation TEE (annuities)tops up contributions with a premium ofcurrently 9.5% of contributions. The maxi- Source: FMA Finanzmarktaufsicht 2007, OECDmum subsidised annual participant contri-bution amounts to EUR 2,165. only accessible to members who already Any taxpayer under the age of 62 can par- have a PZV. Contributions of up to EUR 1,000ticipate in the scheme. Contributions must are topped up with a bonus. Payout can onlybe made for at least 10 years, during which begin when participants receive a statetime they cannot be accessed. If the money is pension in the form of an annuity.withdrawn before retirement, tax advantagesare lost. Contracts, particularly insurance con-tracts, often have durations of 20, 30 and 45 Life insuranceyears or more. More than half of the contracts Companies can also conclude insurancehave durations of 30 years or more. Contribu- contracts for their employees as occupation-tions are paid from taxed income, investment al pension provision. Direct insurance is oneincome is tax-exempt. If benefits are paid out available option that existed before the Pen­as annuities upon retirement, they are also sionskassen system was introduced in 1990.tax-exempt. Payouts are taxed when they are However, only annual premiums of up towithdrawn before retirement age. EUR 300 are tax-deductible. The Betriebliche Kollektivversicherung (occupational collective Participants can choose between life insurance), a second option of insured pen-insurance products (traditional, index or sions, was introduced in 2004.unit-linked) and investment funds. Thereare about 20 providers on the market, and The goal was to put insurance solutionsinsurance products dominate. In 2006, there on a level playing field with pension funds.were 885,000 insurance contracts on the The new vehicle enjoys the same tax treat-market; 102,000 contracts were investment ment as Pensionskassen. However, differentfund-based. Providers must guarantee the investment regulations apply. The collectivepaid-in capital. insurance is subject to stricter investment regulations. The equity limit is 40%, and it There are investment limits for PZV. For has to offer a guaranteed interest rate of 2.25%instance, at least 40% of assets must be in- per year, in line with general life insurancevested in equities. These equity investments regulations. Due to the guaranteed mini-can only be made in certain, so-called “under- mum return, investment strategy has to becapitalised” markets, among them the Vienna considerably more conservative comparedstock exchange. Other markets in which PZV to Pensionskassen. The initial take-up of theproviders are allowed to invest include 10 new vehicle has been slow. In the medium-Eastern European stock exchanges, Portu- term, however, the collective insurance couldgal and Cyprus. However, the share of non- contribute to a higher penetration of occupa-Austrian equities of total assets amounted to tional pensions in Austria, as the main target0.8% in 2006 (FMA 2007). It could therefore be groups are initially small- and medium-sizedargued that the PZV not only served to create companies. In contrast, Pensionskassen area retirement vehicle, but also to develop Aus- concentrated among bigger companies.trian capital markets. With regard to the life insurance market Besides the PZV, there is an additional in general, Austria shows below-average den-third pillar pension plan, which is referred sity and penetration rates compared to theto as the prämienbegünstigte Pensionszusatz­ European average. While life premiums perversicherung (state-sponsored additional inhabitant stood at EUR 880 in 2007, thepension insurance). Initiated in 2004, it is EU-15 average amounted to EUR 1,716. Life 41
  • 42. Country Profiles Austria International Pension Studies Western Europepremiums as a share of GDP amountedto 2.6% the same year, compared to 5.9% for Savings and financial markets, 2007the EU-15 (Swiss Re 2008). The Austrian lifeinsurance market is driven by individual Household savings ratio [%] 10.6contracts, which accounted for 96.6% of total Household assets [% of GDP] 152premiums in 2005 (CEA 2007). Average per capita financial wealth [EUR] 50,700Savings and financial markets Assets of institutional investors [% of GDP] 96From 2001 to 2007, Austria’s household sav- Source: OECD, World Federation of Exchanges, Austrian National Bankings ratio increased from 7.5% to 10.6%, makingit one of the highest in the EU. Householdassets stood at EUR 415 billion; in terms of Household asset allocation, 2007 [%]GDP share, personal wealth in Austria is quitemodest compared with the rest of Europe. Incountries such as Switzerland, the UK and the QuotedNetherlands, household assets range between shares 9 4 Other280% and 373% of GDP. In Austria, the figure Debtstands at 152%. The generosity of the public securities 9pension system is one of the main reasons for 48 Currencythis discrepancy, as it lowers the need for pri- and deposits Investment 12vate pension savings. funds Nevertheless, up to 2007, the assets of in- 18 Life andstitutional investors increased considerably, pension fundsand stock market capitalisation experiencedan upswing. Institutional investor assets Source: Austrian National Bankamounted to 96% of GDP. While countrieslike Switzerland have much higher values,Austria is ahead of a number of states thatalso have strong public pension pillars, in- Future Market Trendscluding France, Germany and Italy. The asset Household assetsvolume of institutional investors is particu- In the near future, financial market turbu-larly noteworthy with regard to growth. In lence will have an impact on asset forma-2002, it stood at 70% of GDP, meaning that it tion. However, Austrian portfolios will not begrew 26 percentage points in just four years. affected as much as those in countries withInvestment funds make up the bulk of assets. a higher exposure to stock market invest-What is more, they account for 54.9% of GDP ments. Given the solid savings rate, the assetand have been the fastest growing category, allocation preference over the last few yearsfollowed by insurance corporations (36.7%) and an assumed equity market performanceand pension funds (4.7%). of 7% a year (from 2009 onwards; -30% in 2008), we expect total financial assets to reach EUR The structure of household financial port- 766 billion in 2020. This translates to an an-folios again reflects the dominance of public nual growth rate of 4.8% from the 2007 levelpensions. Only 18% of financial assets are of EUR 415 billion.invested in insurance and pension products.Austrian households are risk-averse; almost The share of pension/insurance products50% of their portfolios are invested in bank of total financial assets is expected to risedeposits. In recent years, shares and mutual from 18% in 2007 to 22% in 2020, which is stillfunds gained importance; their portion of significantly below the forecast Europeanfinancial assets increased to 21% in 2007 average of 39%. There are two opposite effectsfrom 12% in 2000. New flows in 2007 were at work in the pension market. The advance-geared towards safe investments: 60% of in- ment of occupational and private pensionsflows were directed into banking products. is giving the pension and insurance market further impetus. At the same time, ageing Austrian households will cash in maturing42
  • 43. Country Profiles Austria International Pension Studies Western Europecontracts. Their proportion was already high Austria: Financial household assets [EUR bn]in 2006 and 2007 as a result of the introduc-tion of single premium, 10-year contracts 800in the late 1990s. This influence will last for Other assets 700some time yet, hampering insurance asset 166 Insurance/build-up. 600 pension funds Shares/mutual funds 500Pension investment assets1 192 BondsPension assets include the assets of Pensions­ 400 Bank deposits 75kassen, which amounted to EUR 13.1 billion 300in 2007. Pensionskassen benefit from trends 88 53towards defined contribution and funding 200 36 24 32defined benefit pension liabilities. The other 317 100 201main scheme is the MVK, which is still very 137 151small but expanding rapidly. Its volume in- 0creased three and a half times between 2004 1996 2000 2007 2020eand 2007, reaching EUR 1.6 billion. This new Source: Bank of Austria, Allianz Dresdner Economic Researchseverance pay system, which became man-datory for new employees in 2003 and forthe self-employed in 2008, will keep inflows Austria: Pension market development [EUR bn]high and support asset accumulation withhigh growth rates in this emerging segment. 180Together with the other second pillar instru- 160 Life insurance assetsments, we expect assets under management Investment assets 140to reach 40 billion by 2020, which corre-sponds to annual growth of 7.9%. 120 100 126Pension insurance assets 80Insurance products play a dominant role inthe Austrian market. Life insurance assets 60stood at EUR 60.5 billion in 2007. With the 40 60.5introduction of the PZV in 2003, Austria has 20 40a new tax-favoured vehicle for old age provi- 14.8sioning, with inflows mostly directed into 0insurance products. 90% of PZV plans are in- 2007 2020e Source: National statistics, Allianz Dresdner Economic Researchsurance based, and these plans will continueto be one of the main drivers of growth. Atthe same time, the traditional life insurance Austria has laid the foundations for 1 Pension investmentmarket is maturing. In an environment in funded pensions to play a greater role. assets include the assetswhich first-pillar replacement rates remain In fact, over the past few years, Austria has of autonomous pensionhigh, Austrians will not save additional money reformed more elements of its pension system funds and otherfor retirement. We therefore expect some sub- than almost any other country in Western (non-insurance type)stitution processes, which will likely have a Europe. For instance, it has transformed its occupational pensionnegative impact on insurance asset build-up. public pillar into a notional defined contrib- funds, while the assetsAnnual growth may reach 5.8%, with insur- ution system, reformed the severance pay of life insurance com-ance assets rising to EUR 126 billion by 2020. system, and introduced a new occupational panies are referred to as vehicle as well as a new third pillar scheme. pension insurance assets. We expect the total Austrian pension/ The latter has turned out to be a great success,insurance market to grow at a compound while the new occupational vehicle has had aannual rate of 6.3% until 2020, reaching slow start. Austria has also experienced a shiftEUR 166 billion. towards defined contribution plans, which now dominate in occupational pension provision. Clearly, the shift from a very dominant first pillar to a more balanced pension system is underway. 43
  • 44. Country Profiles Belgium International Pension Studies Western Europe Belgium Encouraging Sectoral Pension PlansPension system designOver the past year, the main political aim Demographics and macroeconomicsof Belgium’s pension policy has been to pro- Population 10.5 millionmote occupational pensions. Sectoral planshave been particularly encouraged, mainly Old-age dependency ratio* 2005: 26 2050: 48through a new legal framework. The earn-ings-related public pillar is complemented GDP [EUR] 317 billionby a pension reserve fund. Tax-favoured third GDP per capita [EUR] 30,300pillar pensions offer insurance and invest-ment products. GDP growth, 2002–2007 [av. in % p.a.] 2.1 Unemployment rate [%] 7.5 Demographic change in Belgium willbe slightly less severe than the Europeanaverage. The old age dependency ratio will Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsreach 48 in 2050, while the corresponding Source: Allianz Dresdner Economic Researchvalue for the EU-25 will be 52. Our projectionsforesee that the overall pension market,which is currently worth EUR 188 billion, allowance of EUR 525. The gross replacementwill grow at a CAGR of 6.2% until 2020. rate for an average earner is 41%, while in net terms it amounts to 63%. In the future, public spending on pensions will be a significantPublic pensions burden on Belgian public finances. PublicShape of the public pillar pension expenditure is expected to rise by 5.1Belgium’s public pension system covers all percentage points to 15.5% of GDP by 2050.employed persons, with separate schemes For the EU-25, it is expected to increase 12.8%for the self-employed and public servants. over the same period.Employees contribute 7.5% of earnings andemployers pay 8.86%. The legal retirement The Ageing/Silver Fundage for men currently stands at 65 years and In 2001, the Belgian government decidedwill be the same for women from 2009 on- to set up a pension reserve fund called thewards. Early retirement is possible from the Ageing or Silver Fund. The goal of the fund isage of 60, provided that 35 years of contribu- to cushion expenditure increases in publictions have been made. To receive full bene- pensions in the period between 2010 andfits, employees must contribute for 45 years. 2030, on condition that government debtThere is no ceiling for contributions. Full is less than 60% of GDP by 2015. The fund isbenefits are equivalent to 60% of average life- financed by budget surpluses, social securitytime earnings up to a maximum of about surpluses and non-fiscal revenues (OxeraEUR 43,300. In Belgium, the minimum pen- 2007). In 2007, 0.3% of GDP was earmarkedsion amounts to EUR 10,190 for a single per- for the fund, increasing by 0.2% percentageson with a full career record. In addition to points each year to reach 1.3% in 2012. Fromthis, pensioners receive an annual holiday 2013 onwards, a Royal Decree will deter-44
  • 45. Country Profiles Belgium International Pension Studies Western Europemine payments into the fund, depending onthe surplus situation. In 2007, assets of the First pillar designAgeing Fund amounted to EUR 13.1 billion.The fund is only allowed to invest in Belgian Contribution rate [% of gross salary] Employer: 8.86government bonds that are specifically Employee: 7.5issued for purchase by the Ageing Fund. Replacement rate [% of last income] Gross: 41 Net: 63Occupational pensions Legal retirement age 65 (from 2009 onwards also for women)Institutional framework and governance Public pension expenditure [% of GDP] 2005: 10.4There are three kinds of occupational pen- 2050: 15.5sions available in Belgium: Company, sec-toral and individual plans. Sectoral plans, Source: OECD, EU 2006for which the Vandenbroucke law of 2004 setthe legal framework, are based on collectiveagreements. Employers can only exit secto- Occupational pension funds’ asset allocation, 2006 [%]ral plans if the agreement allows opting out,and if they establish an equivalent plan.In individual plans, the employer promises 1 Other 3 Real estatepension benefits to individual employees as Fixed 2 Cash anda supplement to collective pension plans. income 6 depositsHowever, establishing different individual Equities 9plans for workers of the same category isprohibited. Company and sectoral plans canbecome “social pension plans”, which wereintroduced 2004, if they contain a “solidarity 79 Mutual fundsclause”. This clause, which carries tax ad-vantages, has several preconditions. Amongthem are waivers during times of a member’sinactivity, indexation and limits to adminis- Source: OECDtrative costs. Occupational plans can be implemented The Vandenbroucke law of 2004 introducedthrough pension funds, group insurance pol- a new framework for pension legislation andicies or collective pension savings accounts. attempted to strengthen occupational pen-They can be of the defined benefit or the sions. It also introduced a minimum returndefined contribution variety. Pension funds requirement for defined contribution (or cashthemselves can operate as foundations or balance) schemes. Regulations now requiremutual insurance associations. Pension employers to guarantee a minimum returnfunds must have a board of directors and a of 3.25% on employer contributions and 3.75%management board. Since 2007, a new type of on employee contributions. These figures dopension funds has been available that will be not apply to yearly returns, but are long-termdiscussed further below. Employers generally requirements. This means that they must bepay most of the contribution rate. Benefits met upon retirement. Hence, it refers to cu-can be paid as an annuity or as a lump sum. mulative and not annual returns.Regulation, asset allocation and taxation Almost 80% of pension fund assets areInvestment regulations in Belgium are liberal; invested into mutual funds, the popularitythe prudent person rule applies, with some of which can be explained by tax advantages.quantitative asset restrictions. These include Investments in mutual funds allow pension10% limits for non-listed equities and for bonds funds to avoid tax on realised capital gains.issued by non-OECD countries or companies. A better distinction of the asset classes intoIn addition, there are limits for non-European which these mutual funds invest is notinvestment funds, self-investments and single available. However, as an indication generalissuers and issues. investments in mutual funds can be used, which display an allocation of 23% in bills 45
  • 46. Country Profiles Belgium International Pension Studies Western Europeand bonds, 47% in equities, 21% in cash and The law also introduced the prudent per-deposits and 9% in other asset classes. son principle for pension fund investments. At the same time, pension fund taxation was In terms of taxation, employer contribu- reformed, abolishing a 0.17% tax on pensiontions for old-age provision are tax-deductible fund assets. OFPs in general are subject tounder certain conditions. Employee contri- a special income tax regime, which has beenbutions are taxed at 4.4%, but they receive a applied to UCITS-type funds. The goal of thesetax credit on their contributions. Investment reforms was to offer multinationals flexibilityincome is tax-exempt. Pension benefits are as a means of promoting Belgium’s attractive-taxed as income, but retirees receive a tax ness as a location of European cross-bordercredit. Lump sum payments are subject to a pension funds.flat-rate tax.Trends Private retirement savingsAs of 2007, there were 20 sectoral funds with Belgium’s third pension pillar is open toa total of 633,000 members. Six of these funds every citizen between 18 and 64 years of age.are autonomous pensions funds, which also Members can choose between pension in-manage company plans, with 392,000 mem- surance provided by insurance companiesbers; the majority is managed by insurance and pension savings funds that are offeredcompanies. The large majority of sectoral by banks and asset management compa-funds are defined contribution plans with nies. Insurance vehicles must offer a mini-contribution rates that vary between 0.6% mum return of 3.75% per year. Savings funds,and 4.2% of wages. Seventeen of the sectoral which are specific open-ended investmentschemes are exclusively funded by employer funds, are not subject to this regulation.contributions. Larger companies generally Contributions to these pension schemes areset up self-administered funds. (partially) tax deductible, up to a maximum contribution of EUR 810. Contracts have a minimum duration of 10 years and contribu- Occupational pension fund statistics, 2007 tions must be made in at least 5 of these 10 years. Benefits are available from age 60; pre- AuM [EUR bn] 15.6 mature withdrawal results in a substantial Members 392,000 penalty payment. Under certain conditions, there are also tax deductions for individual Taxation EET life insurance with guaranteed returns. Source: OECD Life insurance The implementation of the European Belgium has a very developed life insuranceUnion Directive on Institutions for Occupa- market. Compared with the rest of Westerntional Retirement Provision (IORP) brought Europe, the average premium per inhabitantregulatory change for Belgian pension funds. was considerably higher in 2007, amountingIn 2006, Belgium implemented the directive by to EUR 2,171 (EU-15 average: EUR 1,716). Inadopting a new legal framework for pension Belgium, life premiums amount to 5.9% offunds called “Organisations for Financing GDP, also higher than the EU-15 average ofPensions” (OFP), which defines the structureand the workings of pension funds. The OPFstructure must be adapted by existing funds Savings and financial markets, 2007by 2012. The structure will enable pensionfunds to operate across borders, but will be Household savings ratio [%] 10.4subject solely to the Belgian legislative frame- Household assets [% of GDP] 253work. Sponsoring companies and plan mem-bers do not have to be located in Belgium. Average per capita financial wealth [EUR] 80,000 Assets of institutional investors [% of GDP] 108 Source: OECD, EFAMA, National Bank of Belgium46
  • 47. Country Profiles Belgium International Pension Studies Western Europe6.1% (Swiss Re 2008). The market is driven by Household asset allocation, 2007 [%]individual life insurance, which accountedfor 84% of total life premiums in 2005. A quar-ter of these premiums flows into unit-linked Debtcontracts (CEA 2007). securities 9 29 Currency and depositsSavings and financial markets Investment 15 fundsBelgium has a high savings rate. With 10.4%of disposable income, the level is similar tothose of Spain, Germany and Switzerland. Life and 23.5However, the savings rate has been decreas- pension funds 23.5 Quoted sharesing steadily since 2001 when Belgium had,at 15%, by far the highest savings rate in Eu-rope. At the end of 2007, household financial Source: National Bank of Belgiumassets stood at EUR 838 billion. Measured interms of GDP, this amounts to 253%. Whilecountries with a very mature second pension Belgium: Financial household assets [EUR bn]pillar such as the UK, the Netherlands andSwitzerland have respective values of 292%, 1,600280% and 373% of GDP, many European coun- Other assets 1,400tries are behind. In Western Europe, the aver- Insurance/age value is 219%. Institutional investors in 1,200 441 pension fundsBelgium managed assets worth 108% of GDP, Shares/mutual funds 1,000which is approximately half the Dutch value, Bondsbut three times the value of Spanish institu- 800 Bank deposits 203 576tional investors. The dominating group of 104 600institutional investors are insurance com- 57 335 263panies, the assets of which account for 67% 400 156of GDP, followed by investment funds with 349 200assets of 37% of GDP. Pension funds account 251 158 172for only 4% of GDP. 0 1996 2000 2007 2020e In 2007, the share of stocks and mutual Source: National Bank of Belgium, Allianz Dresdner Economic Researchfunds in Belgian household portfolios(38.5%) was one of the highest in WesternEurope. Over the last decade, mutual funds ance of 7% a year from 2009 onwards, we ex- 1 Pension investmenthave shown strong growth. The insurance pect the total financial assets of private house- assets include the assetsand pension segments have grown the most holds to increase by about 4.4% a year to over of autonomous pensionstrongly. Their share rose from 11% ten years EUR 1.47 trillion by 2020, from EUR 838 bil- funds and otherago to 23.5% in 2007. However, this is still lion in 2007. This will also be the result of (non-insurance type)significantly lower than the Western Europe- Belgium’s relatively high savings and asset occupational pensionan average of 35%. This branch could profit allocation preferences over the last few years. funds, while the assetsmost from pension reform, increasing its The share of pension/insurance products of life insurance com-portion of the market at the expense of pen- of total financial assets is expected to rise panies are referred to assion funds. from 24% in 2007 to 30% in 2020, which is still pension insurance assets. significantly below the forecast European average of 39%.Future market trendsHousehold assets Pension investment and insurance assets1Since the second half of 2007, Belgian house- The political aim of increasing occupation-holds have increasingly invested in safer as- al pension coverage to 70% of employees issets as a reaction to the subprime crisis. This taking longer than expected. At present, 2.3pattern may last for some time and slow down million employees participate in occupation-the build-up process of household financial al pensions including group life insurancewealth. Assuming an equity market perform- schemes (around 55%), meaning that there 47
  • 48. Country Profiles Belgium International Pension Studies Western Europeis still growth potential in the second pillar. Belgium: Pension market development [EUR bn]Since the majority of plans are set up as groupinsurance, pension fund assets lag way 450behind insurance assets. At present, pen- 400 Life insurance assetssion investment assets amount to EUR 15.6 Investment assets 350billion. In 2007, life insurance assets stoodat EUR 172.6 billion. 300 250 Since the financial burden on public pen- 374 200sion expenditure is still high compared withother European countries, further reforms 150are likely to lower the public pension level. 100 172.6Consequently, additional saving for old age 50will become increasingly important. Howev- 15.6 35er, the process is still ongoing. There has been 0a substitution effect between second and 2007 2020e Source: Allianz Dresdner Economic Researchthird pillar plans, as industry-wide pensionschemes introduced in 2004 are limiting theattractiveness of third pillar schemes. Like many countries in Western Europe, Belgium has been trying to Although there is high potential in encourage occupational pension provision,Belgium’s relatively small overall pension particularly in the form of sectoral schemes.market, we expect the overall market to grow Certainly, these schemes need time to develop.only by 6.2% p.a. until 2020. Since the pen- However, initial acceptance of the schemes hassion investment asset volume in particular been encouraging, even if coverage aims haveis still low, we expect a slightly higher growth not yet been achieved. While establishing arate of 6.4% p.a. until 2020. Assets will reach pension reserve fund in Belgium can certainlyEUR 35 billion by then. The insurance seg- increase the sustainability of the public system,ment will display a slightly lower rate of 6.1%, the restriction to invest only in Belgian govern-which will increase insurance reserves to ment bonds significantly limits its advantages.EUR 374 billion by 2020. Given the exceptional burdens of ageing on Belgian public finances, it is likely that the reform process will continue.48
  • 49. Country Profiles Denmark International Pension Studies Western Europe Denmark Banking on Funded PensionsPension system designDenmark operates a pension system that is Demographics and macroeconomicsunique in Europe. The first pillar consists of Population 5.4 milliona tax-financed and residence-based scheme.An earnings-related scheme that is fully fund- Old-age dependency ratio* 2005: 23 2050: 40ed and of the defined contribution type is alsopart of the first pillar. It is managed by an GDP [EUR] 227 billionindependent agency. Voluntary occupational GDP per capita [EUR] 41,800pensions cover the majority of the workforce,while third pillar plans are available in sever- GDP growth, 2002–2007 [av. in % p.a.] 1.9al variants. Unemployment rate [%] 3.8 The Danish occupational pension marketis one of the few pure defined contribution Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsmarkets in Europe, with pension funds mostly Source: Allianz Dresdner Economic Researchset up in the form of multi-employer funds.The demographic outlook in Denmark is lesssevere than in most other EU countries. The and the Special Pension. The Special PensionDanish old-age dependency ratio is expected was previously financed by a 1% contributionto reach 40 in 2050, while the EU average will from employees and the self-employed. How-be 52. Total current pension assets amountto ever, it was suspended by law from 2004 toEUR 220 billion; our projections foresee that 2008, and its future is uncertain. The ATP isthe market will show a CAGR of 5.4% until 2020. employment-related and funded. The contri- bution rate is a fixed amount of about 1% of the average wage. It is split between employ-Public pensions ers, who pay two-thirds of contributions, andShape of the public pillar employees, who contribute the remainingDenmark operates a universal basic pension third. It currently amounts to EUR 393 (DKKscheme that is completely financed through 2,927) per year, but is set to increase in 2009.taxation without specific contributions. The ATP is a defined contribution schemeThe scheme is residence-based, and full ben- and pays out lifelong pensions, which are de-efits presuppose 40 years of residence. There pendent on the contribution record. Membersare also means tested supplements to this neither have individual accounts nor thebasic pension. The full benefit amounts to possibility to choose an investment strategy.EUR 16,460 (DKK 122,748) a year including In 2007, the ATP had 4.5 million members.supplements, while the basic amount isEUR 7,834 (DKK 58,416). Public pension expenditure in Denmark is projected to increase from 9.5% of GDP today In addition to the basic pension scheme, to 12.8% in 2050, which will match the EU-25there are two mandatory components; a sup- average. The gross replacement rate of the firstplementary earnings-related scheme (ATP) pillar currently stands at 45%. If occupational 49
  • 50. Country Profiles Denmark International Pension Studies Western Europepensions are included, the overall gross re-placement rate is 49%. This results in a net First pillar designreplacement rate of 71%. Projections until2050 foresee that the importance of the first Contribution rate Tax-financedpillar will decline, but the contribution of (basic scheme)occupational pensions will rise considerably. EUR 393 for ATP FundAs a result, the overall replacement rate will Replacement rate [% of last income] Gross: 45 (including ATP)increase (EU 2006). Net: 71 (including ATP and occupationalThe ATP Fund pensions)Contributions to the funded ATP scheme Legal retirement age 65are managed by the ATP Fund. The fund isan independent agency; the government, Public pension expenditure [% of GDP] 2005: 9.5employer associations and trade unions 2050: 12.8nominate the members of its supervisoryboard. Most assets are managed in-house. Source: EU 2006The fund is subject to several investmentrestrictions. For example, no more than 20%may be invested in unlisted holdings, and ATP beta portfolio asset allocation, 2007 [%]no more than 10% in countries that are notmembers of the EU or the OECD, or whichhave special loan agreements with the IMF. 4 Credit10% limits also apply to investments in the Commodities 6US and the UK. Up to 70% of assets can beinvested in equities (Oxera 2007). 15 Inflation The ATP Fund’s asset allocation aims topreserve pensions’ long-term purchasingpower. Hence, the goal is to achieve absolute 44 Interestreturns and risk diversification. The portfolio Equities 31is divided into the beta portfolio, accountingfor 98% of the total portfolio, and the alphaportfolio, which aims at stable returns inde- Source: ATP 2008pendent of financial markets’ long-termdevelopment. Asset allocation is orientedtowards five risk classes, namely equities Occupational pensions(listed and private), interest (governmentand mortgage bonds), credit (low-rate gov- Institutional framework and governanceernment and corporate bonds), inflation Occupational pensions in Denmark are volun-(index-linked bonds, real estate and infra- tary. However, the overwhelming majority ofstructure) and commodities (oil equities, employees is covered by some form of occu-commodity-indexed bonds). pational pension provision. There are several types of pension provision available. Schemes There is a longer-term target portfolio, can be operated either as multi-employer/which foresees that assets in the risk classes professional funds based on collective bar-of inflation, commodities and credit will gain gaining or as company schemes and schemesimportance, while interest and equities will operated by life and pension insurance com-decrease. panies and banks. Closed pension funds are established as foundations. Pension funds must have a board of directors and a general assembly. The board of directors is obliged to act in the best interest of pension fund members; it determines the investment poli- cy and is responsible for fund administration. Half of the directors of company pension funds must be nominated by the members.50
  • 51. Country Profiles Denmark International Pension Studies Western EuropeEmployers and employees generally make Occupational pension funds’ asset allocation, 2006 [%]contributions of two-thirds and one-third,respectively. 2 Real estateRegulation, asset allocation and taxation Other 5Danish pension funds operate in a relatively 12 Mutual fundsliberal environment, but are still subjectto some quantitative asset restrictions.The most important are as follows:• A maximum of 70% may be invested in equities Equities 30 51 Bonds• No more than 10% may be invested in hedge and private equity funds There are several limits for investments Source: OECDof single issuers depending on the assets inquestion, but no restrictions for real estateinvestment, bank deposits and general in- regard to alternative assets. Socially respon-vestments in OECD countries. 51% of assets sible investing also ranks high on the invest-are allocated to bonds, slightly less than a ment agenda. In 2007, Denmark lost a trialthird to equities and 12% to mutual funds. at the European Court of Justice. As a result, tax exemption on contributions must also Taxation in Denmark is of the ETT type. be granted to contracts with foreign pensionContributions are tax-deductible for employ- providers.ers and employees, while investment incomeand benefits are taxed. Private retirement savingsTrends There are three possibilities for individualThe Danish market is strongly dominated by pension savings in Denmark. Contributionsdefined contribution schemes. According to can be put into a saving plan that investsthe OECD, 97% of assets in occupational plans in unit-linked products, special deposits orare in defined contribution schemes (OECD bank accounts and pays out a lump sum at2006). Insurance companies dominate the retirement; alternatively a saving plan withcorporate pension market. While there are withdrawals over a fixed period of time or a658,000 people enrolled in occupational pen- life annuity can be chosen. The tax-deductiblesion funds, the number of members in occu- amount for individual pensions is DKK 43,100pational life insurance is approximately double (EUR 5,780), subject to certain preconditions.as high. The overall coverage stands at 73%. Lump sum payments are taxed at 40%, whileWhile multi-employer schemes are also im- annuities are taxed at the income tax rate.portant, company pension funds do not play In Denmark, there is a clear tendency towardsa significant role. There are around 40 single unit-linked products for individual pensions.employer funds, the majority of which are very Banks dominate the third pillar market, butsmall, and most are not open to new members. cannot offer annuities. Insurance companies and pension funds are also active in the mar- There is a growing trend towards diversifi- ket. It is estimated that individual plans havecation among pension funds, especially with around one million members. Occupational pension fund statistics, 2007 Life insurance Denmark is among the most developed life AuM [EUR bn] 68 insurance markets in Europe. While the Members 658,000 average life insurance density, premiums per inhabitant, in the EU-15 amounted Taxation ETT to EUR 1,716 in 2007, in Denmark it stood at EUR 2,470. Life premiums as a share of Source: OECD GDP amounted to 5.9% (Swiss Re 2008).The 51
  • 52. Country Profiles Denmark International Pension Studies Western EuropeDanish life insurance market is dominatedby the group business due to the strong in- Savings and financial markets, 2007volvement of life insurance companies in theoccupational pension market. 87% of group Household savings ratio [%] 4premiums stem from group contracts. The Household assets [% of GDP]* 235overall share of unit-linked contracts stoodat 13% in 2005 (CEA 2007). Assets of institutional investors* [% of GDP] 177 * 2007, data from 2006 or latest available yearSavings and financial markets Source: OECD, Statistical Office of DenmarkIn recent years, Denmark’s gross householdsavings rate has decreased to around 4%. Household asset allocation, 2007 [%]At the end of 2007, Danish household assetsamounted to EUR 535 billion1. This repre-sented 235% of GDP, which was above the 1 OtherWestern European average. With this figure, Debt securities 5Denmark is one of the leading Europeannations in this respect, along with other Currency 21countries that have strong funded old age and depositsprovisioning systems, such as Switzerland,the UK and the Netherlands. The importance 43 Life andof funded pensions is reflected in the assets Quoted shares/ pension funds mutual funds 30of institutional investors. Insurance compa-nies hold assets of 71% of GDP, pension fundassets amount to 50% and investment fundsmake up 56%. Source: Statistical Office of Denmark The lion’s share of household assetallocation in Danish portfolios is invested attitude towards individual pension savings, 1 Calculated on the basisin the insurance/ pension segment (43%), there is no foreseeable extra impulse for this of the 2007 year-endwhich is substantially above the Western market besides wage rises or increases in exchange rate.European average of 35%. The other major contribution rates (which we have not taken 2 Pension investmentinvestment is held in equity and mutual into consideration). We therefore expect pen- assets include the assetsfund shares (30%). sion investment assets to rise by 6.3% p.a., of autonomous pension rising to EUR 152 billion in 2020. funds and other (non-insurance type)Future market trends Pension insurance assets occupational pensionHousehold assets Denmark’s life insurance market is more funds, while the assetsConsidering Denmark’s low savings and re- sizeable than the pension fund market, as of life insurance com-cent asset allocation patterns, and assuming many arrangements are on an insurance panies are referred to asan equity market performance of 7% a year contract basis. In 2007, total life technical pension insurance assets.(from 2009 onwards), we expect the total reserves stood at EUR 152 billion. Industry-financial assets of private households to rise wide pension funds, which will increase inby 4.4% p.a., amounting to EUR 939 billion by importance, drive the market. Since insur-2020 from EUR 535 billion in 2007. ance assets are invested more traditionally, performance may lag behind pension fundPension investment assets2 asset growth. Furthermore, given a maturingIn 2007, Danish pension fund assets stood market, growth will likely be slower than inat around EUR 68 billion, excluding ATP as- the pension fund market. We expect assetssets. Contribution flows were quite volatile to reach EUR 285 billion by the end of 2020in 2007 because of an unstable economic (CAGR 5.0%).environment. In the future, benefit paymentswill increase due to an ageing population, The retirement market as a whole willwhich will eat up a portion of new contribu- therefore reach assets of EUR 437 billion intion inflows. In light of the broad coverage 2020, with an average annual growth rateof occupational pensions and a reserved of 5.4%.52
  • 53. Country Profiles Denmark International Pension Studies Western Europe The Danish pension system is mainly Denmark: Financial household assets [EUR bn] based on funded pension provisionthrough the earnings-related portion of 1,000the public pillar. With their high coverage,voluntary occupational pensions also play an 900important role. Defined contribution schemes 800 Other assetsdominate the occupational market, and the 454 Insurance/ 700 pension fundsfunded public tier is also of the defined con-tribution type. Clearly, Denmark has followed 600 Shares/mutual fundsthe two main pension market trends in Western Bonds 500Europe: funding and the shift towards defined 231 Bank deposits 400contribution schemes. Coupled with relatively 248favourable demographic development, this 300 148demography-resistant pension system set-up 200 158 102has ensured the system’s sustainability. 72 100 39 190 113 57 68 0 1996 2000 2007 2020e Source: OECD Denmark: Pension market development [EUR bn] 450 Life insurance assets 400 Investment assets 350 300 285 250 200 150 151.7 100 152 50 68.3 0 2007 2020e Source: Allianz Dresdner Economic Research 53
  • 54. Country Profiles Finland International Pension Studies Western Europe Finland Partly Funding Public PensionsPension system designThe Finnish pension system is centred Demographics and macroeconomicson the first pillar. It consists of a residence- Population 5.3 millionbased portion, which is integrated with anearnings-related portion. The remarkable Old-age dependency ratio* 2005: 25 2050: 47feature of the earnings-related portion isthat it is partly funded and managed by GDP [EUR] 179 billionprivate companies. Due to the dominance GDP per capita [EUR] 34,000of this scheme, the voluntary occupationalpillar is underdeveloped whereas third pillar GDP growth, 2002–2007 [av. in % p.a.] 3.2savings are more popular. Unemployment rate [%] 6.9 While demographic change in Finlandwill have a significant impact, it will be not Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsas sweeping as in the EU as a whole. The old- Source: Allianz Dresdner Economic Researchage dependency ratio will rise to 47 in 2050,while the EU-25 average will be 52. The totalpension market currently stands at EUR 129 Mandatory earnings-related pensionsbillion. According to our forecast, it will grow Finland’s earnings-related pensions areat a CAGR of 6.2% until 2020. unique in several respects. First, they are not of the pure pay-as-you-go type, as they are partly funded. Second, the system is decen-Public pensions tralised and administered by private com-The national pension panies. Contributions are handled eitherThe Finnish public pension system compris- by pension insurance companies, companyes two components. The first is the residence- or industry funds. The Finnish Centre forbased national pension. It provides minimum Pensions acts as a coordinating body. Theincome to retirees with little or no earnings- system was established in the early 1960srelated pensions. It is linked to earnings- and covers all employees in the private andrelated pensions in that it decreases when public sectors. The main plan is based onthe earnings-related part increases. If a per- the TyEL act, which covers all private sectorson has an earnings-based pension above employees. There are other schemes fora certain limit, they do not have access to certain occupational groups, including thethe national pension. Until the mid-1990s, self-employed and seamen. As the result ofthe national pension was paid regardless of a 2005 reform, retirement age was madeother pension benefits. A full national pen- flexible; it is now between 63 and 68 years.sion is paid after 40 years of residence. In 2007, The reform also abolished the replacementthe full amount for a single person was EUR target of 60%, changed accrual rates and the525 a month. It is financed by employer and benefit formula to take a person’s entire work-government contributions. ing life into account rather than the last 10 years of employment only.54
  • 55. Country Profiles Finland International Pension Studies Western Europe Contribution rates for employees differdepending on their age. Employees under 53 First pillar designcontribute 4.3%, while older employees pay5.4%. The average employer contribution to Contribution rate [% of gross salary] Employer: 21.6pension insurance stands at 21.6% of earn- Employee:ings (pension providers may give bonuses or 4.3 (for people under 53) 5.4 (for people over 53)rebates). There is no income ceiling. The grossreplacement rate of public pensions is 57% Replacement rate [% of last income] Gross: 57of pre-retirement income. In net terms, it is Net: 6363%. Public pension expenditure is projected Legal retirement age Between 63 and 68to increase from 10.7% in 2004 to 13.7% in2050, while the EU-25 average is projected to Public pension expenditure [% of GDP] 2005: 10.7be 12.8% at this point in time. 2050: 13.7Institutional framework and governance Source: EU 2006Employers can decide which provider andvehicle they wish to use. Pension insurancecompanies are by far the most popular pro- Asset allocation earnings-related pensions, 2007 [%]viders. They need a concession from thegovernment to provide mandatory pensioninsurance. The supervisory board and theboard of directors of pension insurance com- Real estate 10.9panies must include an equal number of em- 49.3 Fixed incomeployer and employee representatives, which securitiesare selected by the respective associations.Their total number must be at least half theoverall number of members on the super-visory board and board of directors. Equities 39.8Regulation, asset allocation and taxationFinnish mandatory pension funds are sub-ject to quantitative limits. These include: Source: Finnish Centre for Pensions• No more than 50% listed equities• A maximum of 40% real estate investments• No more than 5% in hedge funds pension funds and 3% through industryNo more than 10% of assets can be invested funds. In 2007, overall assets in the systemin OECD countries other than EEA (European amounted to roughly EUR 112 billion.Economic Area) countries. Pension insurance accounted for EUR 74.4 billion. There is also a buffer fund for state Almost 40% of assets in the earnings-related employee pensions. In 2005, the fund hadscheme (in the private sector) are invested assets of EUR 8.2 billion. The fund is an inde-in equities, two-thirds of which are invested pendent state agency; members of the boardin foreign equities. Fixed income securities are nominated by the Ministry of Finance.account for 49.3% of assets and real estatemakes up 10.8%. Of total assets invested, theshare invested in Finland amounts to 33%. Occupational pensions38% is invested in the rest of the Eurozone Voluntary occupational insurance plays aand 29% in other countries. minor role in Finland. The statutory schemes account for 95% of pension expenditure, whileTrends group pension provision has a share of 3.6%There are 30 company pension funds, 8 in- (Finnish Centre for Pensions 2007). Arounddustry funds and 7 pension insurance com- 8% of employees are covered by voluntary sup-panies on the market. The market is strongly plementary schemes. The mandatory systemdominated by the latter. 85% of insured per- structure, particularly the earnings-relatedsons have policies with pension insurance scheme, explains this underdevelopment.companies; 12% are insured through company Since there is no ceiling for pension contri- 55
  • 56. Country Profiles Finland International Pension Studies Western Europebutions and benefits in the public pillar, the Plan participants can choose betweenneed for additional provision is limited. fixed-term policies or annuities, and be- tween traditional life and unit-linked insur- Employers can arrange supplementary ance. Traditional policies dominate overall,pension provision through group insurance three-quarters of existing savings are in thisor individual pension insurance. Plans can be type of insurance. Unit-linked insurancedefined contribution or defined benefit. De- accounts for the bulk of new business, withfined benefit plans dominate due to their long- almost 90% in 2006 (Finnish Centre for Pen-er history, but in recent years new contracts sions, 2007). Participant contributions ofhave mainly been of the defined contribution up to EUR 5,000 are tax deductible, whiletype. Supplementary pension provision can employers taking out contracts for their em-be arranged with a company pension fund, ployees can deduct up to EUR 8,500. In thean industry fund, a life insurance company, latter case, the tax limit for additional em-or can be set up as book reserves. Pension in- ployee contributions is EUR 2,500. Pensionsurance with life insurance companies is the benefits are taxed at the capital gains taxmost popular option. In recent years, several rate of 28%.company pension funds have been dissolvedto transfer money to life insurance compa-nies. Of the 210,000 employees covered, 71% Third pillar statistics, 2005participate in life insurance schemes. AuM [EUR bn] 7.6 Employees can pay up to half of annual Members 550,000contributions. Employer pension contribu- Taxation EETtions are fully tax-deductible, and employeecontributions are tax-deductible up to 5% of Source: Finnish Centre for Pensions 2007salaries or EUR 5,000 a year. Taxation is of theEET type. Life insurance Occupational pension fund statistics, 2006 The Finnish life insurance market is among the most developed in Western Europe. Life AuM [EUR bn] 8.7 density, defined as premiums per inhabitant, Members 210,000 amounted to EUR 2,258 in 2007. This was sig- nificantly higher than the EU-15 average of Taxation EET EUR 1,716. Life premiums accounted for 6.6% of GDP, considerably higher than the 5.9% Source: Finnish Pension Alliance Tela Western European average the same year (Swiss Re 2008).Private retirement savingsPersonal pension insurance in Finland is Savings and financial marketsmore popular than voluntary occupational In recent years, household savings ratespensions. Around 550,000 people participat- in Finland have been the lowest in Westerned in 2005. Individuals hold two-thirds of Europe. They have been negative since 2005policies, and one-third is taken out by em- and currently stand at -3.6%. The main rea-ployers (Finnish Centre for Pensions 2007). sons behind this are rising wages and theThird pillar pension provision is especially economic growth rates of recent years, whichpopular with the self-employed, but is not have resulted in a high propensity to consume.very widespread for wage earners. According The volume of household assets is also smallto survey research, participants pay approxi- compared to that of European countries,mately EUR 100 a month into their policies. which amount to 112% of GDP. Only Norway has a lower volume. The same can be said of institutional investors’ assets. Insurance companies manage assets of 28% of GDP, while autonomous pension funds (only vol- untary plans) come to 3.2%.56
  • 57. Country Profiles Finland International Pension Studies Western Europe In 2007, the financial assets of privatehouseholds amounted to EUR 200 billion. Savings and financial markets, 2007Throughout the 1990s, Finns increased theirstock and mutual fund holdings steadily at the Household savings ratio [%] -3.6expense of bank deposits. In 1999, they held a Household assets [% of GDP] 112very high portion of shares in their portfolios(46%). This made Finnish households vulner- Average per capita financial wealth [EUR] 38,000able to the equity market slide in the early Assets of institutional investors* [% of GDP] 31.2years of the new millennium. Their wealthmore or less stagnated between 2000 and * Insurance companies and pension funds without investment funds2002, but increased considerably in the years Source: OECD, Statistical Office of Finlandthat followed, as the Finns still have a highaffinity to the stock market. 43% of their finan-cial assets are invested in equities and mutu- Household asset allocation, 2007 [%]al funds – the highest percentage in Europe.The insurance/pension segment is relativelyunimportant in Finnish household portfolios. Debt 2 Other securities 2With 21%, Finland is among the countries withthe lowest portion in Western Europe. Perhaps Investment 9 34 Quoted sharesthis can be explained by the strong manda- fundstory earnings-related pension system1, whichis hampering the build-up of private voluntary Insurance and 21old age provisioning. pension funds 32Future market trends Currency and depositsHousehold assetsAs a result of the subprime crisis, Finnish Source: Statistical Office of Finlandinvestors have rediscovered their preferencefor less risky assets. However, the high expo-sure to stock market investments could put segment to increase by 6.1% p.a., assuming a 1 The pension assetspressure on household portfolios and wealth 7% return on investment from 2009 onwards which are reported in thisformation. In our projection, we included a (-30% in 2008). context are much higherstock market decline of 30% from year-end than the figures from the2007 to year-end 2008. Assuming an annual The voluntary occupational segment is flow of funds statistics,growth rate of 7% thereafter, we expect the very small. It amounts to EUR 8.7 billion and which shows households’total financial assets of private households coverage is very low. Since there is no ceiling financial assets. This mayto increase by a CAGR of 4.8% until 2020, in- for contributions and benefits in Finland’s be explained by differentcreasing to EUR 366 billion from EUR 200 mandatory system, there are limited incen- classifications of schemesbillion in 2007. tives for additional old age provisioning. (whether already attribut- For the projection period, we expect a higher ed to the individual or not).Pension investment and insurance assets 2 growth rate in this small market than the The further projection isIn 2007, the mandatory pension market, mandatory system. We expect the Finnish based on the wider defini-which includes private and public funded voluntary occupational pension market to tion of pension and insur-pension arrangements, reached EUR 112 bil- increase by 7.3% a year. The total market, ance assets, as they canlion. Life insurance played a much bigger consisting of the mandatory, occupational be externally managed.role than pension funds and comprised 85% and private segments, will amount to 2 Pension investmentof the market. Given the mandatory character EUR 281 billion (CAGR 6.2%), from EUR 129 assets include the assetsof the system, growth can only be achieved billion in 2007. Since we expect insurance of autonomous pensionthrough wage increases and workforce assets to continue to account for more than funds and othergrowth. The workforce will continue to grow 85% of total pension assets under manage- (non-insurance type)until the beginning of the next decade and ment by 2020, insurance assets will stand occupational pensiondecrease thereafter. From then on, contribu- at EUR 239 billion. funds, while the assetstions will no longer be higher than benefit of life insurance com-payments, making asset performance the panies are referred to asonly driving force. We expect the mandatory pension insurance assets. 57
  • 58. Country Profiles Finland International Pension Studies Western Europe The Finnish pension system and Finland: Financial household assets [EUR bn] market have a rather unusual designcompared with other European countries. 400The earnings-related portion of the first pillar Other assetsis partly funded and managed by private 350 Insurance/companies, which makes it a unique model 93 pension funds 300in Western Europe. Finland is also the only Shares/mutual fundscountry in which the third pillar is more popu- 250 Bondslar than the second. Despite these differences, 200 149 Bank depositsthe set-up of Finland’s pension system aims 42to diversify the sources of retirement income, 150which is in line with general Western European 26 86 100trends. 58 10 50 22 109 63 39 44 0 1996 2000 2007 2020e Source: Statistical Office of Finland, Allianz Dresdner Economic Research Finland: Pension market development [EUR bn] 300 Life insurance assets 250 Investment assets 200 239 150 100 110 50 42 19 0 2007 2020e Source: Allianz Dresdner Economic Research58
  • 59. Country Profiles France International Pension Studies Western Europe France On the Path to a Multi-Pillar SystemPension system designTraditionally, pensions in France have been Demographics and macroeconomicsstate-centred, with a dominating role for Population 60.7 millionpublic pension provision. Through severalreforms, particularly 2003’s Fillon law, the Old-age dependency ratio* 2005: 25 2050: 48system seems to be slowly changing towardsa greater role for funded occupational and GDP [EUR] 1,892 billionprivate pensions. The public pension pillar is GDP per capita [EUR] 31,200still generous, and is complemented by twooccupational systems for different categories GDP growth, 2002–2007 [av. in % p.a.] 1.8of employees. These also work on a pay-as- Unemployment rate [%] 8.3you-go basis and are mandatory. In 2001,the French government introduced a publicpension reserve fund to support the public Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldssystem’s finances after 2020. Source: Allianz Dresdner Economic Research In the realm of voluntary occupationalpensions, several plans are available. Themost important are two saving plans: the Public pensionsPEE, which is oriented towards the short Shape of the public pillarterm, and the PERCO, which was introduced France’s public pillar comprises a variety ofin 2003 with the Fillon law and is specifically schemes. The main scheme applies to privatefor retirement purposes. Private, third pillar sector employees and covers around 70%pensions have seen an upswing as a result of of the workforce. There are special schemesthe introduction of PERP plans in 2003. Life for public sector workers, which representinsurance is a very popular instrument for around 20% of employees, and for liberalvoluntary savings, but also features promi- professions and artisans, which account fornently in occupational pensions, where de- the remaining 10% of the labour force. All offined benefit and defined contribution group these systems work on a pay-as-you-go basis.insurance plans are well established. Pension benefits depend on the duration Demographic change in France will be of professional life, income level and a multi-slightly less severe as in other EU countries. plier. There are both maximum and mini-The French old-age dependency ratio will mum pensions. In general, the French publicdeteriorate to 48 in 2050, compared with an pillar provides generous provision for theEU-25 ratio of 52. According to our projec- elderly. In net terms, public pension paymentstion, the French pension market, currently replace 80% of pre-retirement earnings foramounting to EUR 1.2 trillion, will grow at a an average worker with a 40-year career.CAGR of 6.1% until 2020. However, the replacement ratio is projected to decline substantially, to 66% in 2030 and 63% in 2050 (EU 2006). 59
  • 60. Country Profiles France International Pension Studies Western Europe In recent years, reforms have focused onensuring the sustainability of public sector First pillar designpensions. To this end, required years of serv-ice for a full pension were extended and will Contribution rate [% of gross salary] Employer: 8.3continue to increase until 2012 (to 41 years). Employee: 6.65What is more, incentives for later retirement Replacement rate [% of last income] Gross: 66have been strengthened, and differences Net: 80between pension schemes in the public and Legal retirement age 65private sectors have been reduced in someregards. However, full or substantial harmo- Public pension expenditure [% of GDP] 2005: 12.8nisation of the schemes has been met with 2050: 14.8considerable political resistance. Source: OECD, EUPublic pension reserve fundIn 2001, the French government establishedthe FRR (Fonds de réserve des retraites), a FRR asset allocation, 2007 [%]pension reserve fund that aims to cushionthe impact of demographic change on publicpensions. By the end of 2007, the fund had 0,8 Alternativesaccumulated EUR 34.5 billion and is expect- Cash 1.2ed to grow to EUR 150 billion by 2020. Fromthen on, the capital will be used to finance Bonds 33.5public pension payments. The fund is financedthrough privatisation revenues, surplusesof certain social funds and a portion of therevenues from the 2% social tax on capital 64.5 Equitiesreturns. The FRR is an administrative agencyof the French state, which is run by an execu-tive board and controlled by a supervisoryboard comprising representatives of the Source: FRRNational Assembly, ministries, trade unions,employers and experts. The Ministries of socialsecurity and of the economy share respon-sibility for the FRR, the assets of which are Occupational pensionssolely managed by external asset managers While France’s occupational pensions com-that are selected by the executive board. prise a variety of schemes, a distinction can be drawn between mandatory pay-as-you-go The FRR’s strategic asset allocation was schemes and voluntary funded pensions,initially defined in 2003 and reformed in which often take the form of saving plans.2006. The list of admissible instruments wasbroadened to include alternative assets, such Mandatory schemesas private equity, commodities and infra- ARRCO (Association des régimes de retraitesstructure. At the same time, the target asset complémentaires) and AGIRC (Associationallocation for equities was increased from générale des institutions de retraites des cadres)55% to 60% and the share of European equi- are statutory complementary schemes forties was decreased. Also bond investments blue (ARRCO) and white collar workerswere decreased, while the target asset alloca- (ARIGC). Both operate on a pay-as-you-gotion for alternative assets increased from 0% basis and are based on collective agreements.to 10%. AGIRC was set up in 1947, and ARRCO was founded in 1962. Contributions to these The FRR aims to incorporate environmen- schemes are converted into pension points,tal, social and governance (ESG) criteria into which determine the amount of future pen-its investment decisions. Several equity man- sion payments. The value of each pensiondates are managed according to ESG criteria, point is determined each year by the nationaland the fund initiated a process to assess its associations AGIRC and ARRCO, and is cur-entire portfolio based on ESG criteria. rently set in line with prices. The legal retire-60
  • 61. Country Profiles France International Pension Studies Western Europement age is 65; full benefits are payable from PERCO plans can be set up at the companyage 60 if a member qualifies for a full pen- or industry level; firms that do so must havesion under the public scheme. Both schemes a PEE in place. Collective agreements deter-are part of the state’s social security system. mine the coverage of each PERCO scheme,ARRCO has approximately 18 million active meaning that the PERCO is introduced aftermembers and 10 million beneficiaries, while negotiations with union representatives.AGIRC has 3.6 million active members and The scheme must be offered to all employ-2.1 million beneficiaries. ees, who can join voluntarily. There are also PERCO schemes for multiple companiesVoluntary schemes (PERCOI).Clearly, the scope of public pensions andmandatory occupational plans means that Employees can make contributions ofthe importance of voluntary occupational up to 25% of their gross annual salary. Em-plans is limited. Nevertheless, a variety of ployers can match contributions up to EURplans exist, several of which have been intro- 5,149 per year (or three times the employeeduced in the last decade. Some of these are contribution). Benefits are paid out as annu-of the insurance type and will be discussed ities or a lump sum. Employer contributionsin one of the following paragraphs. There are up to EUR 4,600 are not considered part ofalso book reserve systems and severance pay the employee’s income for tax purposes. Em-systems in place. PESI and PERE plans, which ployers themselves are not taxed on contri-were established in 2005 and 2003, respec- butions up to EUR 2,300, but pay an 8.2% taxtively, are geared towards smaller companies, for contributions between EUR 2,300 andwhich can participate on an industry or geo- EUR 4,600. Voluntary contributions made bygraphical basis. employees are subject to normal taxation. Investment income is exempt from income The two most important plans are the and social taxes. Retirement benefits are tax-PEE (Plan d’épargne entreprise) and the exempt as well. Contributions can also origi-PERCO (Plan d’épargne retraite collectif). Both nate from corporate profit sharing schemesare saving plans, the main difference being that are paid to the employee, or from assetthat the PEE is a short-term saving plan and transfer from PEE plans.therefore not a retirement vehicle in the strictsense. The PERCO, on the other hand, is ex- PERCO plans are managed by externalplicitly designed for retirement purposes. financial institutions and are of the definedAssets in a PEE must be held for at least five contribution type. Providers must offer atyears, after which they can be withdrawn, least three investment options with differentbut can also be paid into a pension plan. The profiles from which employees can choose;company must at least bear the administra- a default option is normally also provided.tive costs, but can also contribute to the plan. Contrary to PEE plans, investment in the com-Employees can invest up to 25% of their net pany’s own shares is not possible. Fund pro-income into mutual funds or shares. PEE is viders and administrators are selected by thewell established; if it were classified as a pen- company and union representatives. Due tosion product, it would amount to almost 50% their short history, assets in PERCO plans haveof the overall pension market, including col- thus far been modest, but the scheme’s growthlective insurance (Oxera 2008). Companies has skyrocketed in recent years. Between 2004have the option of setting up a joint PEE, in and 2007, assets grew from EUR 77 million towhich case it is called a PEI (Plan d’épargne EUR 1.4 billion. The plans are offered to aroundinterentreprise), which is mostly used bysmall- and medium-sized enterprises. Perco statistics, 2007 The m ain difference between the PEE and AuM [EUR bn] 1.4the PERCO is that PERCO capital is availableupon retirement only. Premature withdrawal Members 334,000is only possible in rare circumstances, such Participating firms 56,000as long-term unemployment. The PERCO wasintroduced by the Fillon law in 2003 with the Source: Association Française de la Gestion Financièreaim of creating a dedicated retirement vehicle. 61
  • 62. Country Profiles France International Pension Studies Western Europe1 million employees, a third of whom have contributions are shared between employersjoined so far. and employees. The defined benefit plans are financed by the employer only; employee con- tributions are not possible. Both types of planPrivate retirement savings enjoy tax advantages and benefits are paid outThe 2003 pension system reform not only as annuities in both cases. Defined benefitestablished PERCO plans, but also an indi- plans tend to be set up for senior manage-vidual pension plan in the third pillar, the ment. However, the bulk of new plans is setPERP (Plan d’épargne retraite populaire). Par- up in the defined contribution form, andticipation is voluntary and independent of defined contribution or PERCO plans are in-the employment relationship. PERPs are life creasingly replacing defined benefit schemes.insurance contracts and can be invested indifferent forms, including unit-linked prod- Life insurance is a very popular instru-ucts. Contributions to PERP plans are flexible: ment for financial investments in France.regular and one-off contributions are usually The penetration rate, defined as life premiumpermitted. They are deductible from taxable to GDP, amounted to 7.2% in 2007. This isincome (up to 10% of income or eight times substantially higher than the EU-15 average,the social security ceiling). Benefits are locked which stood at 5.9%. Life density, premiumsuntil the participant reaches retirement age per capita, amounted to EUR 2,248; the corre-and are paid out as annuities. If a primary sponding value for the EU-15 was EUR 1,716residence is purchased, benefits can also be (Swiss Re 2008). 92% of life premiumspaid out as a lump sum. Within just three stemmed from individual contracts in 2005.years, the PERP plans attracted almost 2 mil- This highlights the prominence of life insur-lion participants. ance for individual savings. The share of unit- linked contracts stood at 21% in 2005 (CEA 2007). PERP statistics, end of 2006 AuM [EUR bn] 2.4 Savings and financial markets Members [m] 1.9 At 12%, the household savings ratio in France is among the highest in Europe. Only Belgium, Taxation EET Germany and Spain save to a similar extent. As a percentage of GDP, France’s household Source: Drees 2008 assets are more than 100 percentage points lower than figures for the Netherlands, Swit- There are also special pension plans for zerland and the UK. However, this is mainlythe self-employed called Madelin plans. due to the pension system in place and typi-These plans covered 940,000 persons in 2006 cal of public pillar-centred systems in Europe.and assets under management amounted to The higher the funded part of the pensionEUR 13 billion (Drees 2008). Another saving system, the higher the financial assets, whilevehicle, which could be seen as pension- contributions are not included in the house-related in the broader sense, is the PEA (Plan hold saving rate.d’épargne en actions). It is a tax-favouredsaving plan in stocks; access to capital is re- This is the also the main reason why thestricted for five years, and full tax advantages average financial wealth of French house-apply for an eight-year period. The PEA is used holds is slightly below the Western Europeanmostly by wealthy individuals. average. Countries with funded pension sys- tems, such as Switzerland, Denmark, and the UK have higher levels of wealth. BetweenLife insurance 2000 and 2007, financial assets in FranceThere are two main types of group life insur- grew at a CAGR of 7.2% and reached EUR 3.57ance in France, namely Article 83 and Article trillion. As a result of the growing institution-39. The former is defined contribution life alisation of savings, institutional investorsinsurance, while the latter is of the defined play an important role on French financialbenefit type. The defined contribution plans markets. They hold assets amounting to 93%can be financed by the employer alone, or of GDP if only assets of insurance companies62
  • 63. Country Profiles France International Pension Studies Western Europe(91.6%) and pension funds (1.1%) are con-sidered. Data for investment funds are not Savings and financial markets, 2007available for France. Assets of insurancecompanies have grown considerably since Household savings ratio [%] 122000, when they amounted to 70% of GDP. Household assets [% of GDP] 189 Over the last eight years, household asset Average per capita financial wealth [EUR] 58,800allocation in France has been subject to in- Assets of institutional investors* [% of GDP] 93cremental, but steady change. Around one-third of household financial assets are cur- * Only insurance companies and pension funds, data for investment funds not availablerently invested in less risky assets (currency Source: OECD, Bank of Franceand deposits, bonds); more than a quarterare invested in shares and mutual funds;and the lion’s share is invested in insurance Household asset allocation, 2007 [%]and pension assets. Apart from a minor in-crease during the equity market boom of thelate 1990s, the portion of shares and mutual Investment 2 Fixed incomefunds has not changed much over the past funds 9 (Thereof 4 Otherten years. The portion of currency and de- 4 equitiy savingposits in total financial assets has decreased plans (PEA))by ten percentage points since 1997. Clearly, 38 Life insurancethe insurance and pension markets benefit- reserves Shares and 18ed from this development, particularly the other equitylife insurance segment. Its share of total fi-nancial assets increased by ten percentage 29 Currencypoints during the same period. Interestingly, and depositsinvestment funds via life insurance policiessaw the biggest upswing within the invest- Source: Bank of Francement fund category. They account for slight-ly more than half of investment fund assets,which indicates a growing demand for Retirement saving will pick up on a broader 1 Pension investmenthybrid products. scale only if French households begin to assets include the assets realize the impact that pension reforms are of autonomous pension having on their benefits. funds and otherFuture market trends (non-insurance type)Household assets Pension insurance assets occupational pensionAssuming an equity market performance French household portfolios contain a rela- funds, while the assetsof 7% a year (from 2009 onwards) and in tively high portion of insurance products. of life insurance com-light of France’s high savings rate and asset These are used primarily as a general savings panies are referred to asallocation preferences over the last years, we instrument and it is difficult to distinguish pension insurance assets.expect the total financial assets of private between old age provisioning and other types 2 This volume is reportedhouseholds to increase by about 4.7% a year of savings. The share of insurance in wealth by the OECD in its “Pensionto over EUR 6.5 trillion by 2020, from EUR 3.6 formation is very high, which is partly due market in Focus“; most oftrillion in 2007. to favourable tax rules (incl. inheritance tax these assets come from rules and capital gains tax). We do not expect defined benefit pensionPension investment assets 1 French households to change this behaviour funds. The figure does notPension investment assets stood at EUR 21 substantially. Only the unit-linked contracts, include the company sav-billion in 20072. Since this segment is still in which have boomed due to positive stock ing schemes (PEE), as theyits infancy, we expect pension investment market performance in recent years, may are not earmarked as pen-assets to grow more strongly than insurance suffer from volatile equity markets in 2008. sion savings plans. Thisassets, by a CAGR of almost 10%, reaching With the high savings rate, we expect life in- procedure differs from ourEUR 71 billion by 2020. However, we do not surance assets to increase from an already previous pension study.expect growth to be stronger than in other high level of EUR 1.2 trillion in 2007 to EUR For this reason, Frenchmarkets with emerging funded occupational 2.57 trillion in 2020. This translates into a pension assets in thesepensions, as people are still building on the compound annual growth rate of 6.0%. two studies cannot bestrong first and mandatory second pillars. compared directly. 63
  • 64. Country Profiles France International Pension Studies Western Europe Overall, we expect assets under manage- France: Financial household assets [EUR bn]ment in the French retirement market tomore than double, increasing from EUR 1.2 7,000trillion in 2007 to EUR 2.6 trillion by 2020. This Other assetswill represent an annual growth rate of 6.1%. 6,000 Insurance/The share of pension/insurance products in pension funds 5,000total financial assets is expected to rise from 2,964 Shares/mutual funds38% in 2007 to roughly 46% in 2020, which is Bonds 4,000significantly above the forecast European av- Bank depositserage of 39%. This can mainly be explained 3,000 1,352by the strong life insurance segment. 1,745 2,000 752 466 955 748 1,000 456 1,467 839 1,050 728 France’s pension system is in a 0 process of major change. Previously 1996 2000 2007 2020ea showcase for the dominance of pay-as-you- Source: Banque de France, Allianz Dresdner Economic Researchgo systems, even in an occupational pensioncontext, new schemes are changing the shapeof the pension market. Since 2003, a number France: Pension market development [EUR bn]of new and funded pension plans such as thePERCO, PERP, PESI and PERE have been intro- 3,000duced. These new plans are very likely to boost Life insurance assetsfunded pensions in France. The introduction 2,500 Investment assetsof a pension reserve fund also demonstratesthe importance of funded pensions, even for 2,000French public pensions. Indeed, France hasinitiated a change in its approach to pensions. 1,500 2,570It is very much in line with European trendsand aims to diversify retirement income by 1,000introducing new pension schemes. 1,208 500 0 21 71 2007 2020e Source: Allianz Dresdner Economic Research64
  • 65. Country Profiles Germany International Pension Studies Western Europe Germany From Unfunded to Funded Occupational PensionsPension system designGermany has been one of Western Europe’s Demographics and macroeconomicsprime examples for a pension system domi- Population 82.2 millionnated by the public pillar. Under demographicpressure, reforms were initiated at the begin- Old-age dependency ratio* 2005: 30 2050: 56ning of the millennium to achieve a morebalanced structure of old-age income. The GDP [EUR] 2,424 billionfirst pillar has experienced several paramet- GDP per capita [EUR] 29,500ric reforms in recent years. Occupationalplans, which can be set up in five different GDP growth, 2002–2007 [av. in % p.a.] 1.2ways, saw an upswing in terms of coverage, Unemployment rate [%] 8.4as did third pillar pensions. While the German occupational market Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldswas long characterised by unfunded pension Source: Allianz Dresdner Economic Researchpromises, this pattern is changing and thefunding of pension promises has been strong-ly increased. Pure defined contribution plans tributing to these funded systems or the pub-are not possible under German law, but the lic pillar. Public service schemes are financedintroduction of a new vehicle in 2001 allowed directly through public budgets. Recent re-to introduce defined contribution elements, forms will increase the retirement age fromplans with capital preservation guarantees. 65 to 67 in the period between 2012 and 2029.Germany faces a severe demographic chal- The taxation regime has also been changed.lenge. The old-age dependency ratio will stand Since 2005, at least 50% of pension benefitsat 56 in 2050, four years older than the EU-25 have been taxed (with a tax-exempt amount).average. Our projections indicate that the This share will stepwise rise to 100% by 2040,overall retirement market, which currently at which point contributions will becomecounts assets of EUR 1.07 trillion, will grow fully tax-deductible. The contribution rate,at a CAGR of 4.6% until 2020. which is shared equally between employer and employee, amounts to 19.9% of salary. There is a contribution ceiling of EUR 63,600Public pensions (West Germany), and 25% of the system’s pro-The public pension pillar still dominates ceeds are funded by government subsidies.the German pension system, contributingmore than two-thirds of retirement income Public pensions are calculated usingto people over 65 years of age. The earnings- a point system. One point is credited forrelated, pay-as-you-go system is mandatory annual contributions at average earnings:for all employees. Certain professions, such higher contributions are attributed moreas lawyers or architects, are covered by spe- than one point, and lower contributions earncial, funded schemes in the first pillar, while less. Upon retirement, annual pension pointsthe self-employed can choose between con- are added up and the sum is multiplied by a 65
  • 66. Country Profiles Germany International Pension Studies Western Europe“pension point value”. This value currentlyamounts to monthly benefits of EUR 26.50 First pillar design(West Germany) for each year of average earn-ings. Each year, it is adjusted to the develop- Contribution rate [% of gross salary] Employer: 9.95ment of net wages and a sustainability factor, Employee: 9.95which considers the relations between con- Replacement rate [% of last income] Gross:43tributors and retirees. Net: 63 Legal retirement age 65 In 2004, public pension expenditure stoodat 11.4% of GDP. It is projected to increase Public pension expenditure [% of GDP] 2005: 11.4to 13.1% by 2050. The corresponding values 2050: 13.1for the EU as a whole are 10.6% and 12.8%.The replacement rate amounts to 43% in gross Source: OECD, EU 2006terms and 63% in net terms. As a result of theenacted reforms, the gross replacement ratewill decrease to 34% in 2050. However, this possible. What is more, they are subjectshould be counterbalanced by a stronger role to more liberal investment regulationsfor occupational and private pensions. If this than the other vehicles.occurs, the overall gross replacement ratewill actually increase to 48% by 2050. Direct pension promises remain by far the most popular vehicle for pension provi- sion in terms of assets (EUR 234 billion).Occupational pensions They are followed by Pensionskassen (EUREmployers can offer occupational pension 96 billion), direct insurance (EUR 47 billion),provision in five ways. support funds (EUR 37 billion) and Pensions­• Direct pension promises (Direktzusage) fonds (EUR 2 billion, all data from 2006, are made to employees and financed by source: aba). Since 2001, employees have book reserves, which are tax-deductible. had the legal right to access occupational Employers may build up pension reserves pensions, at least of the deferred compen- to fund these pension promises. sation type.• Direct insurance is a life insurance contract between the employer and an insurance Institutional framework and governance company in favour of employees. The em- Pensionskassen and Pensionsfonds are the only ployer is the policyholder, who takes out an vehicles subject to the EU’s IORP directive. individual or group life insurance policy They are separate legal entities. Employee for the employee. The employee has a di- representatives of the establishing company rect claim against the insurer. have a say in design issues, but not in the• Support funds (Unterstützungskasse) are choice of vehicle. Pensionskassen are insur- legally independent institutions; employ- ance undertakings. If they belong to a single ees do not have a legal claim to benefits. company, they are usually set up as mutual However, employers are obliged to fulfil associations. In this case, they are subject to their pension benefit promises. Support the same regulatory, supervisory and govern- funds are not subject to insurance super- ance framework as other insurance compa- vision. This means that capital, for in- nies. Large mutual associations in Germany stance for loans to the employer, is freely must be governed by a managing board, disposable. member representatives and a supervisory• Pensionskassen are separate legal entities board. sponsored by one or more companies that provide funded schemes. They are a special Regulation, asset allocation and taxation type of life insurance company. Investment regulations for the respective• Pensionsfonds were introduced in 2001 vehicles vary. There are no investment limits and are separate legal entities. They were for direct pension promises and support intended to be more return oriented than funds, as neither is a regulated entity. Direct Pensionskassen as defined contribution insurance and Pensionskassen are subject to arrangements with minimum benefit investment regulations, the most important guarantee (capital preservation) are also of which are as follows:66
  • 67. Country Profiles Germany International Pension Studies Western Europe• A maximum of 35% of assets may be Occupational pension funds’ asset allocation*, 2006 [%] invested in equities• No more than 25% of assets in real estate• No more than 50% in bonds, loans and 3 Cash bank deposits 2 Other• International investments are limited Real estate 3 to 30% of assets Moreover, insurance products such asPensionskassen have to provide a guaranteed 34 Equitiesinterest rate of currently 2.25% a year. ThePensionsfonds is subject to much more liber- 58 Fixed incomeal rules of the prudent person type. Thereare no limits to equity investments, foreigninvestments or other asset classes. Thereare limits to investments in single issuers * includes Pensionskassen and Pensionsfonds Source: OECDor issues (the same which apply to Pensions­kassen) and a 70% currency matching require-ment. Pensionfonds have to guarantee the accounting standards, especially amongpaid-in capital minus costs. larger companies. By setting up a CTA, com- panies are able to finance their pension In Germany, pension fund (Pensionskassen liabilities off the balance sheet. This allowsand Pensionsfonds) asset allocation is domi- them to place assets into a trust that is le-nated by fixed income instruments. Almost gally separate and belongs to the employer.60% of assets are invested in them, while about CTAs are not regulated, thereby allowinga third of assets is invested in equities. Other a free choice of investment strategies. Theinvestments account only for a minor share. Pensionsfonds has intensified competition for the CTA, as it also allows the funding of pen- Since 2005, Pensionskassen, Pensionsfonds sion liabilities, but has to pay lower contri-and direct insurance have been taxed in the butions to the insolvency protection system.same way. Contributions of up to 4% of the Moreover, it makes the complete outsourcingsocial security ceiling are tax-deductible, up of pension administration possible. Amongto an amount of EUR 2,544. While investment the DAX 30 companies, 70% of pension obli-income is tax-exempt, benefits are taxed. This gations are funded (Watson Wyatt 2008b). Inmeans that in Germany, occupational pen- addition, partial funding of pension schemessions operate according to the EET principle. for public servants has begun. The majority of Germany’s state governments have decid-Trends ed to create their own state pension funds.Occupational pension coverage in Germanyhas been on the rise in recent years, increas- The Pensionsfonds is the only vehicle thating from 52% of employees in 2001 to 65% in allows defined contribution-type pension2006. Certainly, improved incentives for retire- plans. Traditionally, the German occupation-ment provision as a result of the 2001 reform al pension environment has been driven byand an increased awareness of the impor- insurance and defined benefit schemes. Intance of occupational pensions have con- the framework of Pensionsfonds, both definedtributed to this rise. The recent governmentdecision to extend the social security exemp-tion of pension contributions, which was Occupational pension funds’ statistics*, 2006originally limited until 2008, will also help AuM [EUR bn] 98the funded occupational pillar in the future. Members [m] 7.3 In the occupational pension market, there Taxation EEThas been a trend towards funding unfundedpension liabilities through contractual trust * includes Pensionskassen and Pensionsfondsarrangements (CTAs) for the past few years. Source: OECDThis was triggered by the introduction of IFRS 67
  • 68. Country Profiles Germany International Pension Studies Western Europebenefit and defined contribution-type plans After a slow start, 10.8 million Riester con-are possible. However, defined contribution tracts were in force at the end of 2007. 78%plans in Germany must guarantee paid-in were insurance contracts, 18% were mutualcontributions, so that pure defined contribu- fund saving plans and the rest were banktion plans are not permitted. Some large com- deposits. Despite the dominance of insur-panies have established a Pensionsfonds and ance contracts, saving plans are growingthe segment has been growing dynamically, quickly: in 2004, their share stood at 7.5%.but on a very low level. Sector-wide occupa-tional pensions are another important partof the occupational pension environment. Third pillar (Riester pensions) statistics, 2007These resulted from collective bargaining; Members [m] 10.8the biggest schemes are found in the metaland the chemical industries. Taxation EETPrivate retirement savings Source: Ministry of FinanceThe German pension system provides twopossibilities to set money aside for old age Available since 2004, Rürup pensions arein the form of Riester and Rürup pensions. especially designed for the self-employed toAvailable since 2002, Riester pensions are substitute for public pensions, though em-open to all persons covered by the social in- ployees can also participate. The maximumsurance system. This includes employees, annual contribution limit is EUR 20,000 (EURtheir spouses, unemployed persons, self- 40,000 for a married couple). While the tax-employed persons who have chosen to be deductible portion is currently set at 66%,covered by the social insurance system and it will increase to 100% by 2025. Taxation ofother groups. The idea behind the Riester benefits follows the reforms in the public pil-pension was to compensate for the coming lar. Benefits are paid as an annuity after thedecrease in public pension benefits. age of 60; lump sum payments or early with- drawals are not allowed. Accrued pension There are three kinds of products available rights are not inheritable or portable. At thein the framework of Riester pensions: insur- end of 2007, there were around 630,000 Rürupance contracts, bank deposits and mutual contracts in force. Since 2007, banks andfund saving plans. These products must meet asset managers have also been allowed tocertain criteria and be certified by the finan- offer Rürup products. Previously, customerscial service authority. Riester products can- could choose between traditional pensionnot be withdrawn before the age of sixty. insurance and unit-linked life insurance.What is more, the provider must guaranteethe paid-in capital, and 30% of accumulatedcapital can be withdrawn as a lump sum at Life insurancethe beginning of the withdrawal period. Ben- At EUR 74.8 billion, Germany is Europe’sefits can be paid out as an annuity or in the third largest life insurance market in termsform of withdrawal plans (which run until of premiums. Nevertheless, life premiumsthe age of 82, after which pension insurance per capita and as a share of GDP amount totakes over). Riester products are subsidised about half the European average only. In 2007,in two ways, with an allowance of EUR 154 a life premiums amounted to 3.1% of GDP, whileyear and a child allowance of EUR 185. Both life premiums per capita stood at EUR 909.subsidies have been continuously increased The corresponding values for the EU-15 wereand the allowance for children born in or 5.9% and EUR 1,716 (Swiss Re 2008). The shareafter 2008 will rise to EUR 300. In addition, of premiums for individual life insurancecontributions are tax- deductible, depending contracts amounted to 86% in 2005; the reston the income level. 4% of income up to a was made up of group insurances. The samelimit of EUR 2,100 is tax-deductible. Taxation year, unit-linked contracts accounted for 11%is based on the EET principle. of premiums, while the EU-15 average stood at 25% (CEA 2007).68
  • 69. Country Profiles Germany International Pension Studies Western EuropeSavings and financial markets Savings and financial markets, 2007In Germany, the household savings rate isamong the highest in Europe. At 10.9%, it was Household savings ratio [%] 10.9second only to France in 2007. Despite this, Household assets [% of GDP] 188household assets as a share of GDP stand at188%, far behind the Western European aver- Average per capita financial wealth [EUR] 55,500age and countries such as Switzerland, the Assets of institutional investors* [% of GDP] 73Netherlands or the UK. In these countries,household assets range between 280% and * without investment funds, for which no comparable data are available373% of GDP. In absolute terms, the financial Source: OECD, Deutsche Bundesbank, EFAMAassets of German households stood at EUR4.56 trillion at the end of 2007. The modestoverall level of household assets largely re- Household asset allocation, 2007 [%]flects the dominance of the public pensionpillar. Consequently, the assets of autono-mous pension funds, including Pensionskas­ 0.3 Othersen and Pensionfonds, are also quite modest. Debt securities 7 5.7 PensionThey amount to 11% of GDP, while the assets reservesof insurance companies account for 62% of Investment funds 12 36 CurrencyGDP. However, these assets do not includeall pension assets, as the numbers do not and depositscover unfunded obligations and funding Quoted and 13through CTAs. unquoted shares 26 Life and As in most other countries, Germany’s pension fundsoverall wealth has clearly improved since2003 as a result of stock market recovery. Source: Deutsche BundesbankHowever, people did not take advantageof this boom to increase equity exposure.Instead, households withdrew from engage- 2008 will not be taxed in the future. For this 1 Pension investmentments they started in the late 1990s. The reason, we do not expect much change in assets include the assetsportion of listed equities in households’ port- the coming years. Investments with safety of autonomous pensionfolios decreased from 14% in 1999 to 8.5% in guarantees, some types of structured prod- funds and other2007. The long-term trend of the declining ucts and insurance-based products are likely (non-insurance type)importance of bank deposits was halted, as to profit from this trend. Assuming an equity occupational pensionGerman investors sought low-risk invest- market performance of 7% p.a. (from 2009 funds, while the assetsments. In addition, insurances were able to onwards and -30% in 2008) and in light of the of life insurance com-gain larger shares of household portfolios. relatively high savings rate in Germany, we ex- panies are referred to asInsurances and pension funds combined pect the total financial assets of private house- pension insurance assets.accounted for 26.4% of household assets in holds to increase by 3.8% a year to EUR 7.42007. Another 5.7% is earmarked for retire- trillion by 2020, from EUR 4.6 trillion in 2007.ment, namely as book reserves on companybalance sheets. Pension investment assets1 With EUR 1.07 trillion in assets under man- agement, Germany is the third largest retire-Future market trends ment market in Europe in absolute terms. TheHousehold assets pension reform of 2001 introduced incentivesGerman households have turned to low-risk to strengthen occupational and individualinvestments because of the stock market old age provisioning. After a slow start, thedownturn at the beginning of the new millen- measures have begun to bear fruit. As annium and new financial market uncertainties. increasing number of people become awareThe introduction of a flat rate withholding of the need for personal and occupationaltax on capital returns and gains in 2009 is un- pension provision, pension products willlikely to trigger a new equity boom, even if continue to grow strongly. As the smallercapital gains from equities purchased until part of the total market, pension investment 69
  • 70. Country Profiles Germany International Pension Studies Western Europeassets (adjusted for direct insurance) are Germany: Financial household assets [EUR bn]expected to increase by 5.1% p.a., reachingassets of EUR 684 billion in 2020 from EUR 8,000358 billion in 2007. It should be noted that Other assetsgrowth will be split into two diverging trends: 7,000 Insurance/Companies will continue to switch their pension funds 6,000 2,257unfunded pension liabilities to external Shares/mutual fundsfunding, thus reducing their book reserves. 5,000 BondsAt the same time, this money will be shifted 4,000 Bank deposits 2,161into investment vehicles, investments with 1,205insurance companies and pension plans. 3,000 866 1,144Thus, there will be shift within the pension 628 2,000 989segments. The legal entitlement to deferred 543compensation will be the decisive driving 1,000 1,621 2,054 1,180 1,235force of pension investment asset growth. 0 1996 2000 2007 2020ePension insurance assets Source: Deutsche Bundesbank, Allianz Dresdner Economic ResearchThe retirement market has traditionallybeen insurance-driven, with insurance as-sets accounting for 66% of retirement assets Germany: Pension market development [EUR bn]under management. Private life endowmentinsurance has long been the most popular 2,000product for old-age provision, but it has lost Life insurance assetsground since tax advantages were reduced. Investment assetsIn this changing environment, the already 1,500emerging trend towards the annuity business 1,235has been further strengthened. Until now,annuities have made up the bulk of new in- 1,000surance business. 716 Due to the impact of pension reforms 500and the new success of Riester savings plans, 684we expect additional inflows for old-age 358.3provision. At the same time, life insurance 0companies will face major outflows in the 2007 2020e Source: Allianz Dresdner Economic Researchcoming years as households begin to cashin maturing contracts concluded during thereunification boom of the early 1990s. This Pension reform in Germany has aimedwill hamper the build-up of insurance as- to encourage funded pensions to com-sets. We therefore expect a moderate yearly pensate for decreasing public pensions andgrowth rate of 4.3% for insurance assets up to diversify retirement income. The strongerto 2020. Technical reserves will increase to incentives for occupational and private pen-EUR 1.24 trillion at the end of the projection sions seem to be effective. Occupational pen-period, from EUR 716 billion in 2007. sion coverage has increased. What is more, after a slow start, the third pillar Riester plans Overall, we expect the German market to have gained wide acceptance and member-grow 4.6% on average up to 2020, when it will ship. Funding pension promises is an unbrokenamount to EUR 1.92 trillion. trend in the occupational market; the main question here is whether the Pensionsfonds will compete with CTAs or whether it will com- plement them. Another question is whether the Pensionsfonds can gain significant market share. In light of demographic projections for Germany, funded pensions will have to play a significant role in retirement income. This is a process that needs time, but is well underway.70
  • 71. Country Profiles Greece International Pension Studies Western Europe Greece Relying on the Public PillarPension system designGreece runs the most generous public pen- Demographics and macroeconomicssion system in Europe. In fact, pensions for Population 11.2 millionaverage earners are higher than their incomebefore retirement. For this reason, saving in Old-age dependency ratio* 2005: 28 2050: 59the occupational and private pillars is not apriority, and these are therefore underdevel- GDP [EUR] 229 billionoped. The legal foundations for occupational GDP per capita [EUR] 20,500plans were established only in 2002 and cov-erage is very limited. There are no specific tax GDP growth, 2002–2007 [av. in % p.a.] 4.3advantages for third pillar products. Unemployment rate [%] 8.3 Greece is among the European countries Data from 2007 or latest available yearthat are highly affected by demographic * Ratio of over 65-year-olds to 15–64-year-oldschange. Its old-age dependency ratio will Source: Allianz Dresdner Economic Researchworsen from 28 to 59 in 2050, while the EU-25average will stand at 52. Our projections fore-see that the overall Greek retirement market, Employees contribute 6.67 % of theirwhich currently amounts to EUR 7.8 billion, wages, while employers pay 13.33 %, andwill grow at a CAGR of 13.9% until 2020. the government contributes 10 %. The public pillar covers employees and certain groups of self-employed people. While there is noPublic pensions minimum limit for contributions, there isGreece operates a public pension system with a maximum limit for an annual income ofa gross replacement rate of 105 % and a net EUR 68,300. The minimum pension is EURreplacement rate of 115% (for a 40-year career 428 and the maximum pension amountswith average earnings). The structure of to EUR 3,200. A means-tested scheme targetsthe first pillar is complex, as there are main low-income elderly people. The official retire-schemes and auxiliary pension funds for ment age is 65, but retirement is also possiblevarious professions. The biggest of the main after 30 years of contributions, or based onschemes is the Social Insurance Institute a combination of age and contribution peri-(IKA). Through a reform passed in March ods. The generosity of the pension system2008, these 133 vehicles are to be merged will be a heavy burden on public finances ininto 13. Other parts of the reform eliminate the years to come. According to OECD data,many early retirement options and give public pension expenditure will increasegreater incentives for longer working lives. from today’s 12.4% of GDP to 24.8% in 2050,The schemes operate based on pay-as-you- which is about twice as high as the valuego principles, but have accumulated a con- projected for the EU-25.siderable amount of assets. 71
  • 72. Country Profiles Greece International Pension Studies Western EuropeOccupational pensions First pillar designInstitutional framework and governanceAs a result of the exceptionally high replace- Contribution rate [% of gross salary] Employer: 13.33ment rate of the public pillar, the occupation- Employee: 6.67al pension market is very underdeveloped. Gov: 10In fact, the legal foundations for occupation- Replacement rate [% of last income] Gross: 105al pensions were only introduced in 2002. Net: 115Through a collective agreement, employers Legal retirement age 65and employees can establish OccupationalInsurance Funds on a voluntary basis in com- Public pension expenditure [% of GDP] 2005: 12.4panies and in some sectors. The pension funds 2050: 24.8are autonomous, non-profit private entitieswith own legal personality. They are super- Source: EU, OECDvised by the Ministry of Employment andSocial Protection. products or private retirement plans availa- 1 Data for Luxembourg orRegulation, asset allocation and taxation ble. While tax relief is not granted specifical- Greece’s savings rate arePension funds are subject to quantitative ly for pension products, there is tax relief of not available.limits, which include the following: EUR 1,000 a year for all insurance contribu-• A maximum of 70% of assets may be tions. invested in equities or corporate bonds• No more than 5% may be invested in investment funds Life insurance• Investments in non-EU and non-EEA Greece’s overall life insurance market has countries are generally not permitted considerable potential. The life premium per capita stood at EUR 202 in 2007, about 11 % of According to industry sources, taxation the EU-15 average. The penetration rate is alsoof occupational pension funds is unclear low. While life premiums amounted to 5.9%at the moment, as the relevant law does not of GDP on average in the EU-15, in Greeceexplicitly refer to it (IPE June 2008). The tax they accounted for just 1.0% of GDP (Swiss Restatus of new plans is therefore unclear and 2008). Unit-linked contracts accounted forthe government has not yet taken steps to 27% of premiums in 2005; group life insuranceclarify the situation. This is another reason made up 33% of life premiums in the samewhy second pillar funds have been slow to year. This is around 10 percentage pointsstart. higher than the EU-15 average (CEA 2007). The provision of group insurance is commonTrends among large Greek companies or the sub-The delimitation of occupational pensions sidiaries of multinational companies. Small-in Greece is difficult and depends on the and medium-sized companies are muchquestion whether auxiliary funds are includ- more hesitant to offer such plans.ed or not. The financial accounts for Greecerecord a value of EUR 1.4 billion, which we tookas a starting point for our projection. The Savings and financial marketscoverage of the newly created Occupational Household financial assets in GreeceInsurance Funds is very limited, with only amounted to EUR 318 billion at the end offour funds currently in operation. At the end 2007. In terms of per capita assets, Greeceof 2006, these four funds had 47,000 mem- ranks at the bottom of the Western Europeanbers and assets of EUR 18.7 million. league. In relation to GDP, the figure is 139%, which is among the lowest values of the 17 countries considered in this study1. Insti-Private retirement savings tutional investors’ assets account for 17%In Greece, private retirement savings general- of GDP, while pension fund assets accountly take the form of life insurance (endowment for less than 1% of GDP. The correspondingor unit-linked policies) with lump-sum pay- figure for Switzerland and the Netherlands,ments. There are no other specific retirement the most developed pension markets in Eu-72
  • 73. Country Profiles Greece International Pension Studies Western Europerope, is around 120% of GDP. At 5% and 11%respectively, the assets of insurance compa- Savings and financial marketsnies and investment funds are far below theEuropean average. Household assets [% of GDP] 139 Average per capita financial wealth [EUR] 28,500 The lion’s share of Greek households’financial assets is held in bank deposits. Assets of institutional investors* [% of GDP] 17Together with bond investments, Greek in-vestors hold around 60% of their portfolios * Only insurance companies and pension funds, data for investment funds not availablein low-risk assets. However, the proportion Source: OECD, EFAMA, Data from 2006of shares and investment funds accountsfor 33%, which is a high value in Europeancomparison. This is partly due to positive Household asset allocation, 2007 [%]stock market development in the second halfof the 1990s. In 1996, Greek households held Life andonly 17% in shares and mutual funds. Life 3 pension fundsinsurance and pensions funds play a subor- Investment funds 5 3 Otherdinate role in Greek household portfolios,accounting for only 3% of assets. To a certain Debt 9extent, this is a reflection of Greece’s under- securitiesdeveloped funded pensions and the very highreplacement rates of the first pillar socialsecurity system. Quoted 28 shares 52 Currency and depositsFuture Market TrendsHousehold assets Source: EurostatBy the end of the projection period, we esti-mate that savings as a percentage of dispos-able income will increase from around 10% to of Western Europe, which means there is a 2 Pension investment12.5%. We also expect the total financial assets great deal of development potential. assets include the assetsof private households to increase by about of autonomous pension7.2% a year, from EUR 318 billion in 2007 to In 2007, pension investment assets funds and otherover EUR 790 billion by 2020. This high growth amounted to EUR 1.4 billion and life insurance (non-insurance type)rate stems from the relatively low level of technical reserves stood at EUR 6.4 billion. occupational pensionaverage wealth, high inflows and a high por- We expect high growth in both segments. funds, while the assetstion of stock market engagement. We have Pension assets will benefit slightly more than of life insurance com-assumed an equity performance of -30% in insurance products, and we expect the total panies are referred to as2008 and of 7% a year from 2009 onwards. market to grow by 13.9% p.a. until 2020, at pension insurance assets. which point assets will reach EUR 42 billionPension investment and insurance assets2 (pension investment assets +14.8% CAGR toGreece is still at the beginning of the pen- EUR 8 billion; insurance assets +13.7% CAGRsion reform process. At present, regulations to EUR 34 billion). The share of pension/in-are not transparent and the system remains surance products of total financial assets isopaque. Steps to strengthen the second and expected to reach 6.9% in 2020, which is stillthird pillars are likely to be taken during the far below the forecast European average of 39%.next decade. We expect pension reforms toreduce pension levels and result in a greaterindividual need to set money aside for retire-ment. In the years ahead, the government will Greece is subject to two unfortunatelikely succeed in lowering the public deficit developments. It is not only one of(high on the policy agenda). This will open up those Western European countries that willa financial scope for tax incentives for private be hardest hit by upcoming demographicand occupational pensions, which would in developments, it also runs the most generousturn give the market some impulse. The mar- state pension system in the EU. In the mediumket is still in its infancy compared to the rest and long term, this will seriously threaten the 73
  • 74. Country Profiles Greece International Pension Studies Western Europesustainability of public pensions. Despite this, Greece: Financial household assets [EUR bn]reform efforts in Greece have lagged behindother European countries. One of the main 800challenges is the complexity of the first pillar, 54 Other assetswith its main schemes and auxiliary pensions 700 Insurance/as well as its unparalleled generosity. Another 600 260 pension fundsmajor challenge is the further promotion of Shares/mutual fundsfunded pensions. While the introduction of 500 Bondsa legal framework for occupational pensions 400 Bank depositsin 2002 was a first step, more reforms may benecessary to achieve a more balanced retire- 300 105ment income structure. 200 407 100 100 22 165 103 72 0 1996 2000 2007 2020e Source: Eurostat, Allianz Dresdner Economic Research Greece: Pension market development [EUR bn] 45 Life insurance assets 40 Investment assets 35 30 34 25 20 15 10 5 6.4 8 1.4 0 2007 2020e Source: Allianz Dresdner Economic Research74
  • 75. Country Profiles Ireland International Pension Studies Western Europe Ireland Further Encouraging Occupational Pensions in a Multi-Pillar SystemPension system designThe Irish pension system attributes a high Demographics and macroeconomicslevel of importance to occupational and pri- Population 4.2 millionvate pensions. Since state pension benefitsare modest and provide only basic pension Old-age dependency ratio* 2005: 17 2050: 45provision, supplementary pensions are keyto maintaining living standards after retire- GDP [EUR] 161 billionment. To secure the sustainability of the pub- GDP per capita [EUR] 38,600lic pillar, a pension reserve fund has been inoperation since 2001 that receives 1% of Irish GDP growth, 2002–2007 [av. in % p.a.] 5.6GDP each year. Unemployment rate [%] 4.6 In Ireland, there is an ongoing and heated Data from 2007 or latest available yearpolitical discussion on how to increase sup- * Ratio of over 65-year-olds to 15–64-year-oldsplementary pension coverage. Proposals range Source: Allianz Dresdner Economic Researchfrom providing better incentives to introduc-ing mandatory occupational pensions. Themain ongoing trend in the occupational pen- of less than EUR 356, and 10.75% for thosesion market is the shift from defined benefit above this threshold. There is no ceiling forto defined contributions plans, which is very employer contributions. Maximum weeklypronounced in Ireland. pension benefits amount to EUR 193, and there is also a means-tested pension. The Demographic change in Ireland is not as replacement rate of Ireland’s public pensionsevere as in most other European countries. pillar is low, amounting to 38% in net terms.The old-age dependency ratio is projected to The Irish system is designed to avoid old-agereach 45 in 2050, while the EU-25 average will poverty, but not to replace income. Despitebe 52. Currently, total retirement assets under this, Ireland’s public pension expenditure willmanagement amount to EUR 164.3 billion. more than double in the coming decades,Our projection foresees that assets will grow from 4.6% in 2005 to 11.1% in 2050. While thisat 5.6% per year until 2020. will be lower than the projected EU-25 aver- age (12.8%), the gap is decidedly shrinking. Today, Ireland’s pension expenditure is lessPublic pensions than half of the EU-25 average.Shape of the public pillarIreland’s public pillar covers both private The National Pensions Reserve Fundand public sector employees. Employees with In 2001, the Irish government establishedweekly earnings of less than EUR 300 do not the National Pensions Reserve Fund (NPRF)have to contribute, while everyone else must to help ensure the stability of public pen-contribute 4% of their earnings up to a ceil- sions. The fund will receive 1% of GDP eaching of EUR 46,600. Employers contribute 8.5% year until at least 2055. It aims to cover asof wages for employees with weekly earnings many costs as possible stemming from public 75
  • 76. Country Profiles Ireland International Pension Studies Western Europepillar and public service pensions between2025 and 2055 at the earliest. Capital inflows First pillar designto the fund are taken from general taxation.According to projections, the fund’s assets Contribution rate [% of gross salary] Employer: 10.75% (8.5%will peak at 50% of GDP around 2040 and will for low- income earnerscover a quarter of total pension costs by mid- Employee: 4% (0 for low- income earners)century. If these projections prove accurate,the fund will be depleted by 2070. Current as- Replacement rate [% of last income] Gross: 32sets stand at EUR 21.2 billion (NPRFC 2007). Net: 38 Legal retirement age 65 The fund is legally required to achieve Public pension expenditure [% of GDP] 2005: 4.6the best possible investment return under 2050: 11.1the condition of prudent risk management.Consequently, there are no investment re-strictions except that the fund is not allowed Source: EU, OECDto invest in Irish government securities. Thisis a major difference to many other reservefunds, which are obliged to invest a consid- NPRF target asset allocation, end of 2009 [%]erable portion or even all of their assets ingovernment securities. 2 Currency Infrastructure 1 funds The target asset allocation of the fund, Real estate 8which is to be reached by the end of 2009, 2 Commoditiesis based on the principle of diversification. Private equity 8Two-thirds of assets will be devoted to equi-ties. 21% will be allocated to alternative in- 13 Bondsvestments such as private equity, real estate,infrastructure, commodities and currencies. 66 EquitiesAt the end of 2006, allocation in equitiesamounted to 76.5%, which was invested pri-marily in large caps. There is no overweightof Irish equities, the fund views the Eurozone Source: NPRF 2007as its domestic market. The Minister of Finance appoints the seven can be of the defined contribution or themembers of the NPRF Commission, which defined benefit type. Employers and employ-manages and controls the NPRF. For the first ees generally contribute to both. Benefitsten years of existence, the operating manager can be paid out as annuities or as a lumpis the National Treasury Management Agency. sum coupled with a pension.It advises the Commission, selects investmentmanagers, implements the investment strat- Regulation, asset allocation and taxationegy and fulfils administrative roles. The Com- In Ireland, the prudent person principlemission is required to perform its functions prevails. The law requires trustees to act inthrough the National Treasury Management accordance with it, especially with regard toAgency. asset diversification. There are no limits for investments in equities, real estate, bonds, investment funds, loans and bank deposits,Occupational pensions nor is there a limit for international invest-Institutional framework and governance ments. At least 50% of assets must be invest-Occupational pension funds in Ireland must ed in regulated markets.be established in the trust form. Trusteescan be individuals selected by the employer, Equities account for the largest share ofpossibly after consultation with scheme Irish pension fund assets, with two-thirdsmembers, or corporate trustees, for example of assets invested in equities. Eurozone equi-specialised trustee service firms or the spon- ties dominate, followed by the US and Ireland.soring company itself. Occupational plans Although there is significant overexposure to76
  • 77. Country Profiles Ireland International Pension Studies Western Europethe domestic market if its international Occupational pension funds’ asset allocation 2007 [%]weight is considered, investments in Irishequities have decreased in recent years. 2 Other Taxation of occupational funds is of the Cash 4EET type. The tax-deductible amount depends Real estate 9on age and is capped at a certain earninglimit. For members up to 30 years of age, itamounts to 15% of total pay; it progressively Bonds 19increases up to 40% of total pay for peopleaged 60 and over. 66 EquitiesTrendsThere is an ongoing shift from defined bene-fit to defined contribution plans in Ireland; Source: IAPF 2008this particularly applies to new schemes andto the affiliates of multinational companies.In total, 20% of pension assets are managed 2007 that outlines possible reform options.in defined contribution schemes. 76% are The government intends to reform themanaged in defined benefit schemes, and the system based on the results of the consul-rest is managed in special schemes (IAPF tation process. One of the key questions2008). Total assets under management is whether coverage should be increasedamount to EUR 86.6 billion. through higher incentives in the voluntary systems or by introducing some form of Of the 795,000 members (a coverage rate mandatory participation.of about 50%) in occupational plans, 255,000are in defined contribution schemes. How-ever, if only private sector schemes are con- Occupational pension fund statistics, 2007sidered, almost 50% of members are enrolled AuM [EUR bn] 86.6in defined contribution plans. What is more,the share of firms that offer solely defined Members 795,000benefit plans has decreased from 67% to 37%, Taxation EETwhile the share of firms that offer only definedcontribution plans increased from 8% to 24% Source: IAPF 2007/2008between 2002 and 2007. 39% of defined bene-fit schemes are completely closed to newmembers (IAPF 2007). In slightly more than Private retirement savingshalf of defined contribution schemes, mem-bers are required to make an active choice. The distinction between occupational andIf investment options are available, five or private pensions in Ireland is fluid, and bothmore investment options are offered (IAPF pillars are often subsumed under the heading2007) in 54% of the cases. Some large schemes of supplementary pensions. Consequently,have taken action and introduced hybrid plans individual pensions are often linked to occu-in an attempt to combine defined benefit and pational pensions in some way. This is thedefined contribution advantages and accom- case for Retirement Annuity Contracts (RAC),modate the preferences of trade unions. which are open to employees and the self- employed, except for those who are enrolled Pensions are a central topic in the Irish in a company pension plan. Employers canpublic policy debate. The political aim is to contribute to RACs. RACs are insurance con-reach a supplementary pension (occupation- tracts of the defined contribution type andal and private) coverage rate of 70%, from can be combined with various types of insur-62% today. There are also worries that current ance coverage. Benefits are payable from ageinflows into defined contribution plans are 60 onwards; retirement is not a prerequisite.too low. To initiate discussion on the future Contributions are tax-exempt up to 15% ofof public, occupational and private pensions, net earnings for people under 30, increasingthe government published a green paper in to 40% for those over 60. The earnings cap is 77
  • 78. Country Profiles Ireland International Pension Studies Western Europeset at EUR 262,382. While investment incomeis tax-exempt, benefits are taxed. Up to 25% Savings and financial markets, 2007of funds can be paid as a tax-free lump sum.RACs are offered by insurance companies Household savings ratio [%] 5and have different investment options. Household assets [% of GDP] 193 Personal Retirement Savings Accounts Average per capita financial wealth [EUR] 74,700(PRSA) are another type of retirement saving Assets of institutional Investors [% of GDP]* 131that was introduced in 2003. It is a definedcontribution type pension plan that is of- * insurance companies and pension funds without investment fundsfered by authorised PRSA providers. Everyone Source: OECD, Central Statistical Office Ireland. Financial Regulatorunder 75 years of age can take out a standardor non-standard PRSA. The former is subjectto maximum charges and investments are least EUR 63,500. If this is the case, additionalin pooled funds only. Employers who do not money can be put into an ARF.offer company pension plans are obliged toprovide access to at least one standard PRSA.Employers may contribute on a voluntary Life insurancebasis. PRSAs are taxed in the same way as Ireland is one of the most mature life insur-Retirement Annuity Contracts. They are of- ance market in Europe. In 2007, premiumsfered by banks, investment managers, in- per capita amounted to EUR 3,882; the EU-15surers, building societies and credit unions. average stood at EUR 1,716. The country’sEach PRSA offers several investment options life premiums as a share of GDP accountedand must provide a default investment for 9.3% compared with the EU-15 averagestrategy. The plans are transferable, even to of 5.9% (Swiss Re 2008). Both values excludecompany pension plans. At the end of 2006, cross-border business that is very significant131,000 people participated, with total assets for the Irish life insurance industry.amounting to EUR 1.25 billion. Introduced in 1999, Approved Retirement Savings and financial marketsFunds (ARF) and Approved Minimum Retire- Ireland’s household savings rates have de-ment Funds (AMRF) are a specialty of the Irish creased over the past few years, from aroundsystem. These funds are designed for the post- 7.5% at the beginning of the millennium to 5%retirement phase and have done away with in 2007. At the end of 2007, Irish householdthe requirement for annuitisation. ARFs are assets amounted to EUR 312 billion. Assetsinvestment funds into which pension fund stood at 193% of GDP, which is slightly below(additional voluntary contributions), RAC the Western European average, but aheadand PRSA capital can be invested; they are of larger EU member states such as France,managed by a Qualifying Fund Manager. Germany and Spain. The asset volume ofTo put money into these vehicles, several Irish pension funds stands at 50% of GDP, andprerequisites must be met. For example, ARF those of life insurance companies accountholders must have a pension income of at for 81%. This value is high compared withleast EUR 12,700 per annum for life. If they most countries in Continental Europe. For in-do not, they must purchase an AMRF. The stance, Austria, Belgium, France, Spain andcapital in an AMRF cannot be withdrawn several other countries have pension fundbefore the age of 75 and must amount to at assets of significantly less than 10% of GDP. The Netherlands and Switzerland have val- ues of around 120% of GDP, mainly due to the Third pillar statistics (PRSA, end of 2006) mandatory or quasi-mandatory character of AuM [EUR bn] 1.25 their occupational pension systems. Members 131,000 Taxation EET Source: The Pensions Board 200878
  • 79. Country Profiles Ireland International Pension Studies Western Europe Since Ireland offers only a basic pension Household asset allocation, 2007 [%]level in the first pillar, the lion’s share of Irishhousehold portfolios is invested in the insur-ance/pension segment (41%). A high portion Quotedof these savings is held in equities, meaning shares/that a waning stock market has put pressure investment funds 26 41 Life andon Irish households’ financial assets. After pension fundsyears of double-digit growth resulting fromstrong equity market performance, the assetvolume was only 1% higher in 2007 than atthe end of 2006. In addition, about 26% ofassets are invested in the stock market and 33 Currencymutual funds, which makes Irish portfolios and depositsvulnerable to current financial turbulence.However, much like their counterparts in Source: Central Statistical Office Irelandother European countries, the Irish havealready reacted to this development by in-creasing the weight of bank deposits in their Funds, contributions must double to guar- 1 Pension investmenthousehold portfolios. antee a 50% replacement rate. There may assets include the assets therefore be more potential than we can cur- of autonomous pension funds and other rently consider, as the next steps for reformFuture market trends have not yet been planned. The projection (non-insurance type) occupational pensionHousehold assets indicates a growth rate of around 6.5% p.a., funds, while the assetsContinuing financial market uncertainty will which will amount to pension investment of life insurance com-put pressure on Irish investors in the imme- assets of EUR 197 billion by 2020. panies are referred to asdiate future. However, this very uncertainty pension insurance assets.will also open up opportunities throughout Pension insurance assets 2 There are no separatethe projection period, as the portion of shares While Ireland’s life insurance market is quite figures for pension fundheld directly or indirectly (through pension strong with technical reserves of EUR 77.7 assets and insurance assets in Irish flow offunds) is quite high. According to our projec- billion in 2007, there are no strong impulses funds statistics. In thetion, total financial wealth will increase to to be expected for this mature market. PRSAs pension asset projec-EUR 621 billion by 2020, from EUR 312 billion are still very small and only partly used as tion, we used the figuresin 2007. This represents an approximate an- insurance plans. RACs, which are open to reported by the Irishnual increase of 5.4%. This projection assumes those without an occupational plan, might Association of Pensiona 30% stock market decrease from the end of be substituted as soon as second pillar cov- Funds (IAPF). The insur-2007 to the end of 2008 and an equity market erage increases. We therefore expect very ance figures are takenperformance of 7% a year from 2009 onwards. moderate growth of 4.4% p.a. in the coming from the statistics of theIt also presupposes that Irish households will years. Assets will amount to EUR 136 billion European Insurance and Reinsurance Federationsave moderately throughout the projection at the end of 2020. (CEA). The sum ofperiod and that economic and income growth both differs from thewill be above average. The overall retirement market will reach mathematical techni- assets of EUR 333 billion by 2020, growing cal reserves, which arePension investment assets1 5.6% per year on average. reported as pension/Irish pension fund assets2 are highly ex- insurance assets in theposed to the stock market and have been flow of funds statisticsaffected by the stock market downturn. From for private households.the end of 2006 to 2007, Irish pension fund This may be explained by different classificationsassets had already declined from a peak of of schemes (whetherEUR 87.7 billion to EUR 86.6 billion. Since Ire- already attributed to theland is discussing reform options for its pen- individual or not). In thission system and the introduction of higher context, the projectionincentives for voluntary pensions or a man- is based on the broaderdatory system, more impulses for old age definition of pension andsavings can be expected. Ireland aims to insurance assets (IAPF/increase coverage to 70% of the workforce. CEA), as they can beAccording to the Irish Association of Pension externally managed. 79
  • 80. Country Profiles Ireland International Pension Studies Western Europe The main challenge for Irish pension Ireland: Financial household assets [EUR bn] policy has been tackling the coveragerate of occupational and private pensions. This 700is vital, as the replacement rate from the public Other assets 600pillar is only moderate. New schemes have Insurance/ pension fundsbeen introduced to increase coverage, and 500 253 Shares/mutual fundsthere is a growing link between second andthird pillar pensions. The topic remains high 400 Bondson the political agenda and a reform frame- Bank deposits 300work is currently being developed. In the 158 127occupational market, Ireland is experiencing 200a strong shift from defined benefit to defined 64 79contribution plans. Although it is less affected 100 59 203by demographic change than most other Euro- 55 102pean countries, Ireland has taken measures 0 2001 2007 2020eto cushion the impact of ageing on public pen- Source: Central Statistics Office Ireland, Allianz Dresdner Economic Researchsions in the form of a pension reserve fundwith very reliable sources of finance and bestpractice investment management. All in all, Ireland: Pension market development [EUR bn]funded pensions play a crucial role in Ireland’sretirement income, and the expected reforms 350are likely to expand this role. Life insurance assets 300 Investment assets 136 250 200 150 77.7 100 197 50 86.6 0 2007 2020e Source: Allianz Dresdner Economic Research80
  • 81. Country Profiles Italy International Pension Studies Western Europe Italy Strengthening Formal Occupational PensionsPension system designThe Italian pension system is dominated by Demographics and macroeconomicsits public pillar, which provides a very high Population 58.5 millionreplacement ratio. As a result, other pensionpillars have traditionally been underdevel- Old-age dependency ratio* 2005: 30 2050: 66oped and have a short history. The first pillarwas gradually transformed into a notional GDP [EUR] 1,535 billiondefined contribution system in the mid-1990s. GDP per capita [EUR] 26,300The main vehicle for occupational retirementsavings was traditionally the TFR, a kind of GDP growth, 2002–2007 [av. in % p.a.] 1.0severance pay scheme. However, it was not a Unemployment rate [%] 6.1dedicated retirement plan. Closed and openpension funds were legally introduced in 1993, Data from 2007 or latest available yearbut the first emerged only in 1997. Reforms * Ratio of over 65-year-olds to 15–64-year-oldsin 2004 aimed at strengthening occupational Source: Allianz Dresdner Economic Researchpensions by re-directing TFR contributions topension funds. Third pillar pensions consistmainly of PIPs, which are tax-favoured life in- with more than 18 years of contributionssurance contracts. Individual, tax-favoured remained in the old system. A 2004 reformcontracts are also possible in the framework set the retirement age to 65 for men and 60of open pension funds. for women. However, as the length of contri- butions also counts, actual retirement ages Except for Spain, no country in Western can be considerably lower.Europe will be more severely hit by demo-graphic change than Italy. Its old-age de- With a net replacement rate of almostpendency ratio will rise from 30 today to 66 90%, the Italian public pension system is veryin 2050, while the EU average for the same generous. However, coupled with the adverseyear is projected to be at 52. Overall pension demographic situation, this generosity mademarket assets currently amount to EUR 435 reform necessary. The main aim of reformsbillion, and our projections foresee that they introduced to date has been to stabilise pub-will grow at a CAGR of 5.9% until 2020. lic pension expenditure. The introduction of the notional defined contribution system will lower the replacement rate substantially in thePublic pensions future, which will stabilise pension expen-The Italian public pillar has seen many re- diture at around 15% of GDP. Private sectorforms. In the 1990s, reforms gradually uni- employees currently contribute 8.9% of theirfied systems that were once very fragmented. gross wages, and employers pay up to 23.8%.The 1995 reform introduced a shift to a no- Under the new system, benefits are directlytional defined contribution scheme, which linked to annual contributions. For low-has applied to new labour market entrants income earners a minimum pension exists.from 1996 onwards. At this time, employees As part of the first pillar, there are different 81
  • 82. Country Profiles Italy International Pension Studies Western Europeschemes for certain professions, such asarchitects or engineers. 19 of such schemes First pillar designare in operation with a total of 1.3 millionmembers and EUR 30 billion in assets. Contribution rate [% of gross salary] Employer: 23.8 Employee: 8.9 Replacement rate [% of last income] Gross: 79Occupational pensions Net: 88Institutional framework and governance Legal retirement age 65 men, 60 womenClearly, the replacement rate of first pillarpensions determines the need for and the Public pension expenditure [% of GDP] 2005: 14.2size of occupational pensions. Basic legis- 2050: 14.7lation for occupational pension provisionwas introduced only in 1993. There are four Source: EU 2006, OECDtypes of occupational pension:• Pre-existing funds: occupational pension schemes that were introduced prior to the In 2004, a potential sea change in Italian 1993 legislation and are still in operation, occupational pensions was initiated though even though they cannot accept new mem- a change in the legal framework. With a view bers. The plans can be structured as defined to developing funded retirement savings, a benefit, defined contribution or hybrid, reform was passed stipulating that TFR con- but an increasing number of funds has tributions should be redirected into pension been converted into defined contribution funds. The transfer works as follows: In the schemes. Almost all pre-existing funds are first half of 2007, employees had to choose sponsored by financial companies, and which pension fund they wanted to join (they they are not subject to the rules and regu- could not decide on employer contributions). lations of the other pension funds. They could opt for either industry funds, com-• TFR (Trattamento di fine Rapporto): a man- pany funds or open pension funds. If they did datory severance pay scheme for private not make an explicit choice, the rule of “silent sector employees. During employment, consent” stipulated that TFR contributions 7.4% of the employees’ salary is set aside would be transferred to a closed pension fund. in the form of book reserves to pay a lump If there were no such fund, contributions sum when employment ends for whatever would be directed to a government pension reason. Additional employer contributions fund for TFR (FondINPS). If employees pre- are not mandatory, but may be required ferred to stay in the TFR system, they had to by collective agreements. Combined em- write to their employer. While employees ployee and employer contributions can who joined the new system could not return amount to 12% of taxable income, up to to the old TFR system, those who remained a contribution ceiling of EUR 5,154 per in the TFR system may join a pension fund at year. Contributions appreciate each year any time. at 1.5% plus 75% of the inflation rate.• Closed pension funds are funds that can According to Italian regulator Covip’s be set up at the company, industry or re- data, subscriptions to the occupational pillar gional level. They are negotiated between doubled to 2.7 million accounts in the first six trade unions and employers. Membership months of 2007. Given that the reform affected is restricted to participating companies. over 12 million employees, this meant that They offer defined contribution plans only. only 22% were enrolled in second pillar funds.• Open pension funds: membership is open Originally, the Italian government aimed to to all employers and individuals, allowing see 40% of all employees diverting their TFR them to join either the occupational or contributions to pension funds by mid-2007. private pillar. Banks, insurance and asset management companies manage open Closed and open pension funds differ in pension funds; only defined contribution their governance structures. Closed pension schemes are possible. funds have their own legal personality, are separate from the sponsoring company and can be set up as foundations or associations. Asset management and benefit payments82
  • 83. Country Profiles Italy International Pension Studies Western Europemust be delegated to authorised institutions. Asset allocation of closed pension funds, 2007 [%]On the boards of closed pension funds, em-ployers and employees are represented in Investmentequal numbers. The biggest closed funds are funds (OICR) 4found in the mechanical and engineering 2 Other Deposits 5industry, the chemical and pharmaceuticalindustry and the oil and energy sector. Openpension funds operate in the contractual Equities 20form, do not have a legal personality andare offered by financial institutions that areauthorised to manage them. The managing 69 Bondscompany must appoint a general manageror supervisor of all the managing company’sactivities related to the open pension fund. Source: Covip 2008Regulation, asset allocation and taxationItaly applies a fairly liberal regulatory regimeto pension funds, with some quantitative Asset allocation of open pension funds, 2007 [%]investment restrictions in place. There areno limits for bond and equity investmentsin OECD member countries. The main limitsinclude the following: Deposits 7• A maximum of 20% of pension fund assets can be invested in bank deposits, including Investment short-term bills funds (OICR) 23• No more than 20% of fund assets can be invested in retail and private closed-end funds 44 Bonds• A maximum of 5% can be invested in Equities 26 equities and debts issued by non-OECD residents if they are traded on regulated markets; if they are not traded on regulat- Source: Covip 2008 ed markets, a 0% limit applies• No more than 15% of assets may be invest- ed in securities issued by a single issuer or Trends a connected group of companies Closed pension funds are the most wide-• A maximum of 20% may be invested in the spread retirement plans in terms of members. sponsoring employer In 2007, 1.9 million members were enrolled in closed pension funds. Open pension funds The asset allocation of closed and open counted 745,000 members and pre-existingpension funds differ with regard to the use of funds had 650,000 members. The pictureinvestment funds. While these figure promi- changes when the number of plans and assetsnently in the portfolios of open pension funds, is considered. There are 42 closed pensionthey are insignificant in the portfolios of funds in operation, 84 open pension fundsclosed pension funds, where bonds dominate. and 455 pre-existing funds. The latter still hold the bulk of assets, EUR 36 billion. Closed In terms of taxation, Italian pension funds pension funds hold EUR 11.6 billion in assetsare subject to an ETT regime. Employee con- and open pension funds hold EUR 4.3 billion.tributions are tax-exempt up to 2% of salary, Until recently, employees covered by closedwhile benefits are taxed at a flat rate of 15%. funds were not allowed to join open pensionTo encourage long-term contributions, the funds.15% flat rate is reduced by 0.3% for every yearbeyond 15 years of membership, with a min-imum tax rate of 9% after 35 years of member-ship. To encourage employer contributions,tax credits have been introduced. 83
  • 84. Country Profiles Italy International Pension Studies Western Europe The dominance of the pre-existing fundsis mainly due to their longer history. The first Private retirement savingsclosed funds emerged in 1997 and the first The main schemes for individual pensionopen funds were established in 1998, mean- provision are PIP (polizze individuali pension­ing that they have had much less time to istiche) personal insurance policies, whichaccumulate assets. It should also be consid- were introduced in 2001. Since open pensionered that the pre-existing funds cannot accept funds are open to all citizens and also gearednew members. The trend is therefore much towards the self-employed, the boundariesmore favourable to open and closed pension between these two schemes are blurred. Onefunds, both of which increased their assets main difference is that PIPs are insured plans.3.5-fold between 2002 and 2007. While open Almost 70 insurance companies currentlyand closed pension funds are exclusively of offer PIPs, and there are 1.3 million partici-the defined contribution type, the trend to- pants with total assets of EUR 5.8 billion.wards defined contribution is also visible in PIP schemes enjoy the same tax advantagespre-existing funds. Although all sorts of plans as pension funds. The split between tradi-are permitted, around 84% of the funded plans tional insurance and unit-linked products isare currently of the defined contribution varie- around 60 to 40.ty (a significant share are book reserve plans). The development of individual choice is PIP statistics, 2006very significant. While open pension funds AuM [EUR bn] 5.8have generally offered participants threeto five portfolio options with different risk/ Members [m] 1.3return characteristics, closed pension funds Taxation EETdid not. However, this has been changing. In2006, 36% of closed fund members were able Source: Covip 2008to choose. By 2007, the figure had increasedto 93%. In the majority of cases, three to fourinvestment options are offered, with mostmembers opting for very secure options with Life insurancelow equity shares. All closed and open funds PIP schemes are part of the broader life in-offer an option with guaranteed return, as surance market. Group life insurance playsthis is a precondition for receiving TFR con- only a subordinate role in the life market duetributions by default. The overwhelming to the high replacement rate of public pen-majority of members does not choose, and is sions. According to European Insurance andtherefore enrolled in the default option with Reinsurance Federation data, in 2005 indi-a low to modest equity share. vidual contracts had a share of 96% in total life premiums and unit-linked contracts ac- In Italy, the decisive driver of occupational counted for 36% of premiums (CEA 2007). Ifpensions will be the acceptance of pension the total market is considered, life premiumsfunds and employee willingness to redirect per inhabitant stood at EUR 1,102 in 2007, andTFR contributions to open and closed pen- the proportion of life premiums to GDP wassion funds. Estimates for annual TFR contri- 4.2%. Both values are lower than the EU-15butions that could be redirected to pension average, which amounted to EUR 1,716 andfunds range between EUR 15 and 19 billion. 5.9% of GDP (Swiss Re 2008). Savings and financial markets Occupational pension fund statistics, 2007 At 6.8%, Italy’s 2007 household savings ratio AuM [EUR bn] 51.9 was slightly higher than the Western Europe- an average. However, it has decreased signif- Members [m] 2.4 icantly in recent years, dropping from 11.4% Taxation ETT in 2002. Recent economic stagnation in Italy is likely to have been the major reason behind this decrease. At 240%, household financial Source: OECD assets are higher than the Western European84
  • 85. Country Profiles Italy International Pension Studies Western Europeaverage of 219%. The assets of institutionalinvestors amount to 61%, which is below av- Savings and financial markets, 2007erage in a European comparison. Insurancecompanies are the biggest institutional inves- Household savings ratio [%] 6.8tors in Italy, with assets of 37% of GDP. They Household assets [% of GDP] 240are followed by investment funds (22% of GDP)and autonomous pension funds (2% of GDP). Average per capita financial wealth [EUR] 63,000 Assets of institutional investors [% of GDP] 61 In absolute terms, household financialwealth amounted to EUR 3.69 trillion in 2007, Source: OECD, Banca d’Italia, EFAMAthe third highest value in Western Europebehind the UK and Germany. Italian house-holds have a relatively high proportion of Household asset allocation, 2007 [%]shares and mutual funds in their portfolios(34%). This is the result of an extreme real-location of assets in the 1990s. In 1996, 70% Investment 2 Other funds 7of financial assets were in bank deposits andbonds; only 19% of Italians’ portfolios weremade up of shares and mutual funds. By Life insurance 17 27 Currency2000, this had changed, as the equity market and depositsboom dramatically increased demand forshares and mutual funds. The combinedshare of equities and mutual funds rose Debt 20sharply at the expense of bank deposits and securities 27 Quoted sharesbonds, increasing to 44% in 2000. After 2001,the bear market led to a decline in the valueof financial assets. Thereafter, Italian house- Source: Banca d’Italiaholds withdrew from direct and indirect en-gagements in the stock market. and assuming an equity market perform- 1 Pension investment Coupled with high replacement rates, ance of 7% a year (from 2009 onwards; -30% assets include the assetsthe slow pension reform process did not help in 2008), we expect to see total financial of autonomous pensionthe pension segment develop compared with assets reach EUR 5.96 trillion in 2020. This funds and othermany other European countries that have translates to an annual growth rate of 3.8% (non-insurance type)initiated pension reforms. Only the life in- from the current level of EUR 3.69 trillion. occupational pensionsurance market developed fast after the de- funds, while the assetsregulation processes of the 1990s, and it has Pension investment and insurance assets1 of life insurance com-caught up well. The share of insurance and Italian pension investment and life insurance panies are referred to aspension assets in household portfolios, which assets currently amount to EUR 435 billion, pension insurance assets.stood at only 10% in the mid-1990s, increased making it one of the largest European mar- 2 The higher value forto about 17% in 2004 and has stayed at that kets2. In recent years, insurance and pension pension/insurance assetslevel since. fund products have gained in importance. in the preceding section In light of measures to strengthen the second is due to the inclusion of and third pillars of the pension system, we ex- TFR assets in the financialFuture market trends pect this trend to continue. The life insurance flow statistics. As TFRHousehold assets market dominates the retirement segment, assets are not specificallyFinancial market turbulence will have an with technical reserves of EUR 377 billion in earmarked for retirementimpact on asset formation in the immediate 2007. Given this relatively high level and more provision, we did notfuture. For the projection period, we have as- conservative asset allocation, we expect include them as pensionsumed relatively slow economic and income these assets to grow at a compound annual assets.growth, but have also considered that Italian growth rate of 5.3% until 2020, reaching EURhouseholds will intensify efforts to compen- 742 billion.sate decreasing levels of public pensions. Wetherefore expect a slight increase in savingsrates. Furthermore, given the asset allocationpreference during the last couple of years, 85
  • 86. Country Profiles Italy International Pension Studies Western Europe The comparatively small market for occu- Italy: Financial household assets [EUR bn]pational pensions will likely grow faster. Weexpect 8.8% growth, which will split into di- 7,000verging segments: the pre-existing schemes, Other assetsthe open and closed funds and the PIP. The 6,000 Insurance/former still make up the bulk of the market, pension funds 1,231with a market share of 62%. However, as these 5,000 Shares/mutual fundsschemes are closed to new entrants, this Bonds 4,000portion is decreasing rapidly, down from 80% 2,174 610 Bank depositsfive years ago. We expect this segment to 3,000grow by about 3.4%, while the other segments 329 1,247should see much stronger growth of around 2,000 1,209 19114%. Although the process of transferring 336 1,000TFR contributions into pension funds is pro- 1,418 986 684ceeding more slowly than expected, it will 662 0fuel pension fund assets, as TFR accruals are 1996 2000 2007 2020esubstantial. Given these diverging trends, Source: Banca d’Italia, Allianz Dresdner Economic Researchwe expect pension investment assets to riseto EUR 172 billion by 2020. Overall, we expectthe Italian pension/insurance market to Italy: Pension market development [EUR bn]grow at a compound annual rate of 5.9% upto 2020, reaching EUR 914 billion. 1,000 900 Life insurance assets Investment assets 800 Italy has begun to move away from 700 a first pillar-centred to a more multi- 600 742pillar system by encouraging occupational 500pensions and introducing third pillar pension 400plans. Greater diversification of retirement 377.4 300income seems critical for Italy to cope withdemographic change and to ensure pension 200sustainability and security. The short and 100 172medium-term outlook for Italy’s pension mar- 0 57.7kets will clearly depend on employee willing- 2007 2020e Source: Allianz Dresdner Economic Researchness to transfer TFR contributions into pensionfunds. The implementation of individual choicemay also help create an awareness of individu-al responsibility for retirement. In the long run,the outlook for Italy’s pension markets dependson the path towards political reform and accept-ance of funded pensions as an integral part ofold-age retirement income provision.86
  • 87. Country Profiles Luxembourg International Pension Studies Western Europe Luxembourg Favourable Demographics, Dominating Public PensionsPension system designLuxembourg’s pension system is clearly Demographics and macroeconomicsdominated by the first pillar, which almost Population 0.5 millionfully replaces pre-retirement income for av-erage earners. A legal framework for pension Old-age dependency ratio* 2005: 21 2050: 36schemes was first established in 1999, butcoverage is still very low. Tax advantages for GDP [EUR] 36 billionthird pillar products were increased in 2002, GDP per capita [EUR] 77,800which opened up the market. Demographicdevelopment in Luxembourg is the most fa- GDP growth, 2002–2007 [av. in % p.a.] 4.4vourable in Western Europe. In 2050, its old- Unemployment rate [%] 4.1age dependency ratio will stand at 36; at thesame point in time, the EU-25 average will Data from 2007 or latest available yearhave reached 52. * Ratio of over 65-year-olds to 15–64-year-olds Source: Allianz Dresdner Economic ResearchPublic pensionsShape of the public pillarLuxembourg operates a very generous first First pillar designpillar with an exceptionally high gross re-placement rate of 91% of pre-retirement in- Contribution rate [% of gross salary] Employer: 8come and a net rate of 98%. According to EU Employee: 8forecasts, this rate will remain stable over (Gov: 8)the next decades. The public scheme covers Replacement rate [% of last income] Gross: 91employees in the private and public sectors Net: 98as well as the self-employed. Employers Legal retirement age 65contribute 8% of wages, as do employees.Luxembourg’s government also subsidises Public pension expenditure [% of GDP] 2005: 10.0the system with 8% of salary, boosting the 2050: 17.4overall contribution to 24%. There is a con- Source: EUtribution ceiling for monthly earnings ofEUR 7,500 and above, and the maximumpension is EUR 6,270. There are also mini- or more (reduced pro rata for those with lessmum earnings for contribution purposes than 40 years of participation). There is also(EUR 1,500) and a minimum pension (1,350 an end-of-year allowance of up to EUR 50 afor 40 years of insurance). month. The earnings-related component is measured over lifetime earnings and accrues The public scheme has flat rate and at a rate of 1.85%. The rate is higher for olderearnings-related components. The flat-rate workers and those with longer contributioncomponent amounts to EUR 353 a month if periods. Public pension expenditure is pro-the insured have participated for 40 years jected to increase by 7.4 percentage points to 87
  • 88. Country Profiles Luxembourg International Pension Studies Western Europe17.4% of GDP; the EU-25 average is projected Asset allocation of occupational pension funds, 2006 [%]to rise to 12.8%.The Pension Reserve Fund Cash and 1 EquitiesTo stabilise the first pillar and secure its deposits 3sustainability, Luxembourg introduced therequirement of a reserve fund that could Bills and 21cover 150% of total yearly benefits. Thanks to bondssurpluses in the system, the fund surpassedthis minimum requirement and reachedEUR 6.6 billion in 2005. In 2004, a new law 75 Mutualestablished a Pension Reserve Fund andchanged the investment policy for reserves, fundsaiming at strategic portfolio managementand asset outsourcing. Until then, the fund Source: OECDhad held most of its assets in bank reserves.The target asset allocation foresees that 50%of assets should be invested in fixed-income These funds can be established as singlesecurities from the Eurozone, 17% in other or multi-employer funds. As a third option,fixed-income securities and one-third in employers can continue to use book reservesequities (Oxera 2007). for pension provision. It is also possible to establish pension funds as insurance vehi- cles. Employers may restrict membership toOccupational pensions employees above the social security ceiling;Institutional framework and governance employee contributions to occupationalDue to the generosity of first pillar pensions, plans are voluntary, but they may not con-Luxembourg’s occupational pension pillar is tribute in book reserve systems.underdeveloped. Before 1999, there were sev-eral insured schemes, but most occupational Regulation, asset allocation and taxationschemes were of the book reserve type. Auton- Pension funds in Luxembourg are subject toomous pension funds did not exist. At the the prudent person principle. This means thattime, most occupational schemes targeted only a few quantitative restrictions apply.upper management and were more common These include limits for investments in theat multinational enterprises. There was gen- sponsoring employer and related compa-erally no explicit legal framework for pension nies. There are no limits for investments inschemes. This changed in 1999 with a new other asset classes or for international in-law that established a framework for pension vestments. Three-quarters of pension fundfunds. Under this law, two types of autono- assets are invested in mutual funds, for whichmous pension funds can be created: a more detailed distinction according to• SEPCAV (Societies d’épargne pension à capi­ asset classes is not available. tal variable) is a corporate pension fund company. Members (future beneficiaries) In terms of taxation, the system is of are shareholders that own a set number of the TEE type for employer contributions; shares in the SEPCAV. They can withdraw employee contributions are subject to EEE their capital at retirement. The SEPCAV is taxation. Pension benefits are not taxed, therefore similar to an investment fund as a considerable number of retirees are (SICAV). Under this arrangement, only de- expatriates who are unlikely to stay in fined contribution plans and lump sum pay- Luxembourg after retiring. ments are possible. SEPCAV plans offer their members different investment options. Trends• ASSEP (Associations d’épargne­pension) At the end of 2006, there were 14 occupation- are pension funds in the form of non- al pension funds on the market. Four of these profit associations. Defined benefit and were SEPCAVS, and the remaining 10 were defined contribution plans are possible ASSEPs. The coverage rate of occupational under this structure, as are lump sum pensions is very low, and stood at 5.4% of the payments and annuities. economically active population in 2006. In88
  • 89. Country Profiles Luxembourg International Pension Studies Western Europe2005, pension fund assets amounted to Savings and financial assetsEUR 315 million. Luxembourg strives tobecome a destination for cross-border and While Luxembourg does not currentlypan-European pension funds. To this end, publish flow of funds statistics for privatethe country has introduced several tax ad- households, this is likely to change from 2010vantages for its pension pooling vehicles as onwards. At present, there is no comparablewell as tax neutrality. information on savings and financial assets for Luxembourg. Occupational pension fund statistics, 2005 The only comparative information availa- AuM [EUR m] 315 ble is for institutional investing. Luxembourg has a sizeable institutional investors sector. Members 12,000 The assets of insurance companies account Taxation TEE (employer for 151% of GDP, by far the highest number contributions) in Europe. However, this figure likely includes insurance policies issued in Luxembourg, but not sold there. With pension funds account- Source: OECD ing for only 1% of GDP, Luxembourg is clearly a tiny pension fund market.Private retirement savingsIndividual, tax-favoured pension provision Future market trendsis open to all citizens and is available from Due to the lack of flow of fund statistics forbanks and insurance companies. Tax advan- private households in Luxembourg, we havetages were strengthened in 2002. While the no starting point and input data for compara-system in place until 2002 required the pur- ble financial asset and pension asset forecasts.chase of insurance policies with minimumguarantees, the new system is of the definedcontribution type. The maximum annual taxdeduction is EUR 1,500 for members up to Much like in several other Westernthe age of 40. Members over 40 can deduct European countries, Luxembourg’san amount that increases as they age, up to first pillar almost completely replaces wagea maximum of EUR 3,200. Half of the benefits income. For this reason, private and occupa-are tax-exempt and can be taken out as a tional pension provision lags behind mostlump sum. The remaining annuity is taxed other European countries. The foundationsat a low tax rate. for occupational pensions were first introduced in the late 1990s, and the coverage rate is very low. The extent to which this situation willLife insurance change in the future depends on reforms toRegulations applying to insured group pen- the public pillar.sion schemes in Luxembourg were updatedin 2005. They are sometimes referred to asCAA pension funds and are named after theinsurance regulator. Other pension fundsare supervised by the bank and investmentfund regulators. CAA pension funds can offerdefined contribution and defined benefitschemes as well as supplementary benefitssuch as death or disability coverage. Con-trary to the other two types of pension fund,its investments are subject to quantitativelimits. In 2007, life premiums per inhabitantamounted to EUR 961, while life premiums asa share of GDP stood at 1.3%, excluding cross-border business (Swiss Re 2008). 89
  • 90. Country Profiles The Netherlands International Pension Studies Western Europe The Netherlands Setting Occupational Pension TrendsPension system designThe Netherlands has the most developed Demographics and macroeconomicspension market in Continental Europe. In Population 16.5 millionfact, the country’s pension system is oftenportrayed as a role model. This is because of Old-age dependency ratio* 2005: 21 2050: 39the very strong second pillar and its institu-tional set-up. The first pillar provides flat-rate GDP [EUR] 567 billionpensions to all residents. The occupational GDP per capita [EUR] 34,400pillar is quasi-mandatory and dominated byindustry-wide funds, while the third pillar of- GDP growth, 2002–2007 [av. in % p.a.] 1.9fers insurance options for additional retire- Unemployment rate [%] 3.2ment savings. Data from 2007 or latest available year The Dutch occupational market is strong- * Ratio of over 65-year-olds to 15–64-year-oldsly dominated by defined benefit schemes. Source: Allianz Dresdner Economic ResearchSome changes have been made to definedbenefit plans, and average career plans arenow the prevalent form of defined benefit pension benefits from age 65 onwards, in-plans. Defined contribution plans have be- cluding civil servants, non-working spousescome more widespread, but only in the form and the self-employed. There is a minimumof collective defined contribution. New regu- and maximum limit for contribution pur-lations drive the interest among Dutch pen- poses. Employers do not contribute to thesion funds in liability-driven investments public system, which is unique to the Dutchand fiduciary management. system. The contribution rate of 17.9% is borne by plan members alone. Demographic change in the Netherlandsis much less pronounced than in most other The pension benefit aims to replace 70%Western European countries. The old age of the minimum wage. A full pension for adependency ratio will worsen to 39 in 2050; single person currently amounts to EUR 932the EU-25 average in the same year will be 52. a month; couples over 65 receive EUR 637 perOverall pension assets in the Netherlands cur- person. In both cases, there are additionalrently amount to EUR 922.9 billion. According holiday allowances. The full pension is payableto our projections, the overall Dutch pension to persons who have resided in the Nether-market will grow at 4.5% per year until 2020. lands for 50 years between the ages of 15 and 64. Benefits are reduced by 2% for each year of non-contribution, and are adjusted twicePublic pensions a year in line with minimum wage changes.Holland’s public system (AOW) aims to pro- What is more, benefits are subject to incomevide basic old-age retirement income that tax. Social assistance is available to thoseis linked to the minimum wage. All persons with a total income of less than 70% of theresiding in the Netherlands are eligible for minimum wage.90
  • 91. Country Profiles The Netherlands International Pension Studies Western Europe The gross replacement rate of the publicscheme amounts to 30% of an average em- First pillar designployee’s last income. However, the combinedgross replacement rate of state and occupa- Contribution rate [% of gross salary] Employer: 0tional schemes stands at 71%, or 92% net. Employee: 17.9The overall target replacement rate from all Replacement rate [% of last income] Gross: 30 (includingpillars stands at 70%. The 30% replacement funded pensions: 71)rate from the public pillar is forecast to re- Net: 92 (including fundedmain constant until 2050. As the Dutch pop- pensions)ulation ages, the constant replacement ratio Legal retirement age 65will result in increasing pension expendi-ture, which is projected to rise from 7.7% of Public pension expenditure [% of GDP] 2005: 7.7GDP in 2004 to 11.2% in 2050. 2050: 11.2 In 1998, the AOW Spaarfonds was estab- Source: EU 2006lished. It is a public pension reserve fundthat is financed through general tax revenueand is meant to reach assets of EUR 135 bil- below an agreed performance target, referredlion by 2020. From then on, it is expected to to as the Z-score.use its capital to support the public scheme.The fund does not invest in assets, but is The foundational form (Stichting) domi-rather a notional reserve fund that exists nates. Pension funds are governed by aonly in the general budget (Oxera 2007). board, which is responsible for deciding on the pension scheme, investment policy and other strategic issues. The boards of industry-Occupational pensions wide funds must be composed of an equalInstitutional framework and governance number of employee and employer repre-The occupational system in the Netherlands sentatives, who are appointed by employeris quasi-mandatory and covers over 90% of associations and trade unions. Companythe workforce. The system rests on collective pension funds must have at least as manybranch agreements; a branch can request employee representatives as employer re-that the Ministry of Social Affairs and Em- presentatives. While operational functionsployment declares membership obligatory can be delegated to external institutionsfor the respective industry. Contribution such as a pension fund managing company,levels and plan design are subject to collec- asset management can only be delegated totive bargaining, and plans must be funded. institutions licensed by the Dutch SecuritiesThe overwhelming majority of occupational Board.schemes are of the defined benefit type.There are four types of occupational pension Further co-determination is achieved byprovision: a council of members, which is composed of plan members and pensioners. The council• Company pension funds (730) is obligatory for industry pension funds and• Industry-wide pension funds (71) can be instituted for company pension funds• Group insurance contracts (30,000) if the parties concerned request it. Plan mem-• Professional pension funds (11) bers and pensioners are represented on the council in proportion to their numbers in the Industry-wide pension funds, which coveraround 80% of all occupational plan members,are the biggest vehicle by far, with the largest Occupational pension fund statistics, 2007funds originating in the public sector. Dutch AuM [EUR bn] 759pension funds are of the closed type and ac-cessible only to participating members of Members [m] 5.9*the respective industries, as they are tied to a Taxation EETspecific collectively bargained scheme. Com-panies can leave the industry-wide pension * active members Source: OECDfunds if returns over a period of five years are 91
  • 92. Country Profiles The Netherlands International Pension Studies Western Europeplan. The representatives are nominated by Asset allocation of occupational pension funds, 2007 [%]plan members and pensioners, but can alsobe designated by associations that representthe respective interests. The council of mem-bers has the right to be informed by the board 5 Other Real estate 11and has an advisory function. The board mustmeet with the council at least twice a year.Regulation, asset allocation and taxation 44 Fixed incomeDutch pension fund investment regulationsare very liberal and follow the prudent per- Equities 40son principle. There are no investment limitsfor equity, real estate, bonds, investmentfunds, loans, bank deposits or internationalassets. There is, however, a 10% limit on in- Source: De Nederlandsche Bankvestment in shares of the sponsoring employ-er. In terms of asset allocation, Dutch pensionsinvest 44% of their assets in fixed income The new funding regulations imply thatinstruments, 40% in equities and 11% in real the average pension fund must be funded atestate. The bulk of equity investments are in approximately 130%. If the pension fund fallsnon-euro currencies, while most bond invest- below the 105% level, it has a recovery periodments are denominated in euros. Interest in of three years. If it has a funding level betweenalternatives such as private equity and hedge the targeted solvency balance (130% for thefunds is increasing, but from low levels. average fund) and the minimum funding level (105%), it is requested to prepare a re- Since most Dutch funds are defined bene- covery plan with a planned recovery periodfit, other types of regulations are also impor- of up to 15 years. This plan must get regula-tant, particularly indexation and solvency tor approval. Pension funds must also passrules. In most average-salary schemes, the a continuity test every three years, whichaccrual rate is between 1.75% and 2% per year serves to prove their long-term financial sta-of service. The maximum accrual rate is 2.25%; bility, including their indexation objectives,it stands at 2% for final salary plans. The lat- on the basis of an ALM study.ter results in a replacement rate of 70% aftera 35-year career. Benefit indexation is condi- Pension rights are portable and benefitstional and depends mainly on the funding generally vest after one year of membership.level. Approximately half of all pensions in They can be paid out as a lump sum or aspayment are indexed to wage growth in the annuities; the latter enjoy advantageous taxrespective industry, and around a quarter is rules, making lump sum payments very rare.indexed to prices or other indicators. The ma- Employer and employee contributions to anjority of Dutch schemes employs conditional occupational plan are tax-deductible. Whileindexation, which makes benefits depend- investment returns are tax-free, benefits areent on the pension fund’s financial situation. subject to income tax. In 2007, a new set of regulations came Trendsinto effect in the form of the Financial Assess- The quasi-mandatory nature of occupation-ment Framework (FTK). The main points of al pension provision and the long history ofthe FTK are the following: the system, which was expanded shortly after• Assets and liabilities must be calculated the second World War, make the Netherlands according to their market value rather Continental Europe’s largest pension market. than with a predetermined discount rate In 2007, the assets of Dutch pension funds• Pension funds must fully fund their nomi- amounted to EUR 725 billion, and 5.9 million nal liabilities with a solvency buffer of 5% active members are enrolled in the system.• The probability that the funding ratio falls The asset volume corresponds to 130% of below 100% may not be larger than 2.5%, GDP, the second highest value in the OECD and this must be proven in a solvency test after Iceland.92
  • 93. Country Profiles The Netherlands International Pension Studies Western Europe Defined benefit schemes dominate the a vehicle for cross-border asset and pensionDutch pension market, accounting for 91% fund pooling, has been another develop-of occupational scheme assets. Nevertheless, ment. It was intended to strengthen thethere is significant ongoing change in the Dutch position in the competition amongdefined benefit market. In 1998, 67% of plan several European countries as a location formembers were enrolled in final-pay schemes. cross-border pension funds.By 2006, the number had dropped to 10%.Average-pay schemes benefited from thistrend; in the same period, their share of plan Private retirement savingsmembers increased from 25% to 76%. Defined The third pillar of private retirement savingscontribution schemes increased their share is voluntary and not linked to an employmentfrom 0.5% of members to 3.6%. relationship. There are two options: annuity or endowment insurance; the latter provides The advent and increasing interest in lump sums and is tax-advantaged only undercollective defined contribution schemes has certain conditions. These schemes are pro-been another significant development in vided by insurance companies, and annuityterms of plan design. These schemes aim to insurance contracts must offer a minimumcombine the characteristics of defined bene- return of 3% to 4%. Contributions to annuityfit and defined contribution plans. There is contracts are tax-deductible up to EUR 1,036.still a collective pension fund, but the spon- Further tax relief is possible if the plan par-sor’s contribution is fixed for a certain period ticipant does not reach the targeted overallof time, and sponsors are under no obligation pension entitlement of 70% of final salary.to compensate future shortfalls. Benefits While investment income is tax-exempt, ben-accrue according to an average-pay formula. efits are subject to income tax. Benefits canHowever, if contributions are insufficient, be paid out as a fixed or unit-linked annuity.pension rights are lowered, making benefitsconditional. Contrary to individual definedcontribution schemes, participants share the Life insurancerisk of underfunding, and the possible cut in Insurance companies play a significant rolebenefits is applied to all plan members. in the Dutch occupational pension market, even if their role is subordinate to that of pen- The rise of fiduciary management and sion funds. Around 30,000 group insuranceincreased demand for liability-driven invest- contracts or direct arrangements are in force,ments (LDI) are two further market trends; mainly for smaller enterprises. In 2006, theseboth are driven by the new FTK framework. schemes had 886,000 members (pensionComplying with the new requirements for funds: 5.9 million). Surprisingly, the sharepension fund risk management is difficult of defined contribution contracts is muchespecially for smaller pension schemes with higher than in the case of pension funds.limited internal resources. Fiduciary man- In terms of members, around 50% of peopleagement makes it possible for pension funds participating in direct arrangements are en-to outsource either the entire value chain or rolled in defined contribution contracts.certain parts of it to external asset managers.This means that the pension fund board Still, the Dutch life market is more drivenmakes decisions that include setting bench- by individual life insurance, the premiumsmarks and determining the strategic asset of which accounted for 70% of the entiremix. In turn, the fiduciary manager takes over market in 2005. Around one quarter of pre-operational functions and asset management. miums flow into unit-linked policies (CEA 2007). In 2007, the Netherlands’ overall pene- The strong interest in LDI is driven by tration rate, which is defined as life premi-new market-based accounting standards ums to GDP, stood at 4.6%. This was belowand the new funding regulations. Both fac- the EU-15 average of 5.9%. Life premiums pertors highlight the need for pension funds capita, which amounted to EUR 1,596, wereto focus on the liability structure when mak- also below the EU-15 average (EUR 1,716) ining asset allocation decisions. The political the same year.promotion of the FGR (Fonds voor GemeneRekening / Fund for Joint Account), which is 93
  • 94. Country Profiles The Netherlands International Pension Studies Western EuropeSavings and financial markets Savings and financial markets, 2007Compared with other Western European Household savings ratio [%] 7.2countries, the Netherlands has an averagesavings rate. In 2007, the Dutch saved 7.2% of Household assets [% of GDP] 280their disposable income. This is significantly Average per capita financial wealth [EUR] 96,500lower than savings rates in Austria, France,Germany and Spain, which have values of Assets of institutional investors [% of GDP] 206more than 10%. However, household assetsamounted to EUR 1.59 trillion in 2007, or Source: OECD, Statistics Office of the Netherlands, EFAMA280% of GDP. This ratio was the third highestvalue in Western Europe after Switzerlandand the UK. The assets of institutional inves- Household asset allocation, 2007 [%]tors are also considerable, amounting to206% of GDP. Disaggregating them makes Debtit possible to see the role of the pension sys- securities 4 1 Othertem for Dutch household assets. The assetsof investment funds amount to 17% of GDP, Quoted 15while insurance assets make up 64% and shares/assets of pension funds account for 125%. investment fundsThe assets of pension funds have increasedconsiderably in recent years, rising 36 per- Currency 22 58 Life andcentage points as a share of GDP since 2002. and deposits pension fundsIndeed, pension funds are by far the biggestinstitutional investors in the Netherlands,making a major contribution to the highvolume of household assets. Source: Statistics Office of the Netherlands This is also evident in the way house-holds allocate their assets. 58% of household trillion by 2020. Our projection is based on 1 Pension investmentportfolios are invested in life insurance or the Netherlands’ solid savings rate and its assets include the assetspension funds. This portion has increased by mature insurance and pension market with of autonomous pension7 percentage points over the past ten years. increasing outflows. We have also consid- funds and otherThis high level of financial protection for old ered asset allocation preferences over the (non-insurance type)age covers major future financial uncertain- past years and assumed equity market per- occupational pensionties. As a result, additional saving efforts are formance of 7% a year starting in 2009. funds, while the assetsrelatively limited. Only about a fifth of the of life insurance com-portfolio is held in currency and deposits, and Pension investment and insurance assets1 panies are referred to as15% is invested in shares and investment In 2007, the Dutch retirement market was pension insurance assets.funds. These portions are among the lowest split into EUR 163.6 billion in insurance as-in Western Europe. sets and EUR 759.3 billion in pension fund assets. We expect the Dutch pension market to grow mainly from performance and con-Future market trends tributions due to the quasi-mandatory natureHousehold assets of occupational pensions. Rising outflows asSince Dutch household portfolios are char- the first baby boomers reach retirement ageacterized by a high share of insurance and also have to be taken into consideration. Pen-pension assets and relatively high exposure sion fund assets are expected to grow by 4.7%to the stock market through pension funds, a year to around EUR 1.38 trillion by 2020.current financial turbulence will put pres- The insurance market will see slower growthsure on wealth formation. In our projection, due to more conservative investment regula-we assumed a stock market decrease of 30% tions. We expect insurance assets to increasefor 2008, which will result in a decrease in by 3.4% p.a., amounting to about EUR 253 bil-overall financial wealth. We expect the total lion in 2020.financial assets of private households to in-crease by about 4.1% a year to over EUR 2.6794
  • 95. Country Profiles The Netherlands International Pension Studies Western Europe Overall, the retirement market will reach The Netherlands: Financial household assets [EUR bn]assets of EUR 1.64 trillion in 2020, growing atan average annual rate of 4.5%. 3,000 Other assets 2,500 Insurance/ pension funds The Dutch pension system relies very 2,000 Shares/mutual funds strongly on funded pensions. The Neth- 1,636 Bondserlands’ occupational pension pillar is strong 1,500 Bank depositsand nearly all-encompassing. The system is arole model for occupational pension provision 923 1,000through industry-wide pension funds. This 642 386makes near universal coverage easier, supports 424 500 239acceptance for the system, and facilitates the 167 325 538inclusion of unions. Thanks to its long history, 177 219 346 0the occupational market is among the most 1996 2000 2007 2020esophisticated in Europe. Many pension industry Source: Statistics Netherlands, Allianz Dresdner Economic Researchinnovations started here, including fiduciarymanagement. The Netherlands continue tohave a strongly defined benefit oriented mar- The Netherlands: Pension market development [EUR bn]ket. This is made possible by the flexibility ofDutch defined benefit schemes and the shift 1,800from final career to career average schemes. Life insurance assets 1,600 253 Investment assets 1,400 1,200 1,000 800 163.6 1,383 600 400 759.3 200 0 2007 2020e Source: Allianz Dresdner Economic Research 95
  • 96. Country Profiles Norway International Pension Studies Western Europe Norway Making Occupational Pensions MandatoryPension system designThe Norwegian pension system features a Demographics and macroeconomicsfirst pillar that combines residence-based Population 4.6 millionand earnings-related pensions. The publicsystem is supported by a pension reserve Old-age dependency ratio* 2005: 22 2050: 41fund that is one of the biggest pension fundsworldwide. Occupational pensions are cur- GDP [EUR] 286 billionrently experiencing an upswing after they GDP per capita [EUR] 61,800were made mandatory in 2006. Defined con-tribution plans, which have been allowed for GDP growth, 2002–2007 [av. in % p.a.] 2.4a few years only, are also becoming increas- Unemployment rate [%] 2.6ingly popular. Tax incentives for third pillarproducts were initially abolished when occu- Data from 2007 or latest available yearpational pensions became mandatory, but * Ratio of over 65-year-olds to 15–64-year-oldshave been re-introduced on a lower level. Source: Allianz Dresdner Economic Research Similarly to its other Scandinavian neigh-bours, Norway’s population is not ageing as system have no ceiling, but are limited fordramatically as many other countries in West- employees older than 62. Recent reformern Europe. The old-age dependency ratio is initiatives focused on increasing incentivesexpected to increase to 41 by 2050, which is for longer working lives and on consideringconsiderably lower than the projected EU-25 longer life expectancy in benefit calculation;average of 52. Our pension asset projections these will be phased in from 2010.foresee that the overall pension market, whichcurrently amounts to EUR 104.5 billion, will Norway’s retirement age is 67. However,grow at a CAGR of 6.3% until 2020. there are several collectively bargained early retirement schemes (AFP) that allow retire- ment from age 62 onwards. The plans arePublic pensions financed mainly by employers and the state,Shape of the public pillar and cover around 60% of the Norwegian work-Norway’s public pillar consists of a flat-rate force. Their reform is currently under discus-basic pension and an earnings-related com- sion and subject of government initiatives.ponent. Persons between the ages of 17 and The gross replacement rate for average earn-66 who have resided in Norway for at least ers in the Norwegian system is 59%, or 69%three years are entitled to the basic pension. in net terms. At 5.2% of GDP, public pensionFull benefits require a 40-year residence peri- expenditure is currently very low. However,od. The basic pension is the equivalent of OECD projections foresee that it will moreapproximately 17% of average earnings. The than double by 2050.earnings-related component is based on pen-sionable income and the number of pensionpoints earned. Contributions to the pension96
  • 97. Country Profiles Norway International Pension Studies Western EuropeThe Government Pension FundThe Government Pension Fund (GPF) was First pillar designestablished in its current form in 2006 andis one of the biggest pension funds in the Contribution rate [% of gross salary] Employer: 14.1world. It includes the former Petroleum Fund, Employee: 7.8which was established in 1990, and the Na-tional Insurance Scheme Fund, into which Replacement rate [% of last income] Gross: 59surpluses from national insurance accounts Net: 69flowed. These schemes continue to exist in Legal retirement age 67the form of the Government Pension Fund Public pension expenditure [% of GDP] 2005: 5.2Global and the Government Pension Fund 2050: 12.9Norway. The goal of the fund is to supportgovernment savings for the public pillarscheme and ensure the long-term manage- Source: EU, OECDment of revenues from oil and gas resourcesin the North Sea. The fund is not specificallyearmarked for pension liabilities. GPF benchmark portfolio 2007 [%] At the end of 2007, the fund had assets of Asian/EUR 268 billion (NOK 2,136 billion). It is fully Oceanian 2 Asian/integrated with the Fiscal Budget. Revenues equities 9 Oceanian bondsfrom petroleum activities are directed to theGovernment Pension Fund Global, which US/African 14also holds 95% of assets. The GPF Global is bonds 30 Europeanmanaged by the Ministry of Finance, while equitiesthe Norges Bank, Norway’s central bank, isresponsible for operational management. US/African 21 equities 24 European While the GPF Global invests only out- bondsside Norway, the scope of its investmentshas evolved considerably in recent years. Source: Norwegian Ministry of Finance, 2008The fund has been investing in equities since1998 and in emerging markets since 2000.In 2002, assets were invested in non-govern-ment guaranteed bonds for the first time. Occupational pensionsInvestments in small caps were included in Institutional framework and governancethe benchmark portfolio in 2006. The same In 2006, Norwegian pensions underwent ayear, the equity portion increased from 40% major change. From then on, occupationalto 60%. In years to come, real estate will be pensions became mandatory for companiesincluded in the portfolio at the expense of with at least two employees. The obligationbond investments. The benchmark portfolio to establish occupational plans did not applyfor the GPF Global foresees an asset alloca- to companies that already had pensiontion of 60% in equities and 40% in bonds. schemes, provided that they fulfilled the new minimum requirements of the act. If employ- The GPF applies guidelines based on the ers opt for a defined contribution scheme,principles of ethical investing. Companies the minimum contribution is 2% of salary.may be excluded if screening reveals a nega- For defined benefit schemes, benefits musttive ethical record. While a Council on Ethics be at least as high as the expected benefitsadvises the Ministry of Finance on these with mandatory contributions. Employeesissues, the Ministry makes the final decision. may be required to contribute.The Norges Bank exercises ownership rightsof the fund’s equity holdings. The fund itself Norwegian pension funds are closed. Theyis a purely financial investor; its ownership operate as foundations and are independentshare in listed companies is usually less than institutions. Most funds are established at1%, with a maximum of 10%. the company level. The governing body is the board of directors, which must comprise at 97
  • 98. Country Profiles Norway International Pension Studies Western Europeleast four members, two of whom must Occupational pension funds’ asset allocation, 2007 [%]be elected by pension plan members. Theemployer selects the remaining members.The board of directors can decide to out- 2 Othersource assets to an external asset manager, Cash 5which must be either life insurance com- 5 Real estatepanies licensed for group pension fund man-agement or specialised companies licensedfor pension fund asset management. Equities 33Regulation, asset allocation and taxation 55 BondsNorwegian investment regulations are cur-rently in transition. In 2007, the governmentannounced a reform that will lift the 35%limit on equities and the 30% limit on cor-porate bonds. The limit for alternative in- Source: OECDvestments will be increased from 5% to 7%of assets. While the current asset allocationof Norwegian funds is dominated by bonds, Private retirement savingsa third of assets is invested in equities. Individual pension products in Norway are available in the form of individual pension Contributions to defined benefit and de- contracts and livrente (annuity) contracts.fined contribution plans are tax-deductible, In 2006, the government abolished tax reliefwith certain maximum limits for pension for individual pension contract premiums,benefits from the first and second pillars com- and did the same for livrente contracts inbined. Investment income is tax- exempt and 2007. This move was based on the govern-benefits are taxed. ment’s view that tax-favoured third pillar pensions were no longer justified followingTrends the introduction of mandatory occupationalIn Norway, defined contribution plans were pensions. However, a compromise waslegalised in 2001. Traditionally, defined bene- reached that foresees tax-deductibility forfit plans have dominated the overall occupa- individual retirement savings of NOK 15,000tional pension environment. Nevertheless, (EUR 1,880), down from the previous amountand despite maximum contribution limits to of NOK 40,000 (EUR 5,020). While banks anddefined contribution plans that range from fund managers hold small fractions of the5% and 8% of wages, most new plans are of market, insurers dominate the individualthe defined contribution type. They are espe- pension business. The asset volume of indi-cially popular with small and medium-sized vidual pension contracts is estimated to becompanies without prior plans. Since occu- around EUR 12.5 billion.pational plans were made mandatory in 2006,the occupational sector has been expanding.It is estimated that around 560,000 new par- Life insuranceticipants have joined the new system. Norway is one of the more mature life insur- ance markets in Western Europe, at least in terms of life insurance density. In 2007, the Occupational pension fund statistics, 2007 life premium per capita stood at EUR 1,823, around EUR 110 more than the EU-15 average. AuM [EUR bn] 19.5 Nevertheless, premiums as a share of GDP are Taxation EET far below the Western European average and amounted to 3.0% in the same year, while the Source: Statistics Norway EU-15 average stood at 5.9% (Swiss Re 2008). Contrary to most other European markets, most premiums are written in the group business, which had a share 54% of total life premiums in 2005. At 6.9%, the share of unit- linked contracts is very low (CEA 2007).98
  • 99. Country Profiles Norway International Pension Studies Western EuropeSavings and financial markets Savings and financial assets, 2007Thanks to strong economic growth rates inrecent years, Norway’s private consumption Household savings ratio [%] 0.9has increased considerably. In 2007, it grew Household assets [% of GDP] 105at the strongest rate since the mid-1980s.This resulted in a strong decline of the sav- Assets of institutional investors *[% of GDP]* 41ings rate, which dropped to 0.9% in 2007 from8.8% in 2005. Household financial assets to- * Insurance companies and pension funds without investment fundstaled EUR 294 billion in 2007, or 105% of GDP. Source: Norges Bank, OECD, data from 2006 or latest available yearThis is the lowest value in Western Europe.Assets of autonomous pension funds, whichamounted to 7% of GDP, were also modest Household asset allocation, 2007 [%]in international comparison. In Europe, thefigure ranges from 0.6% of GDP in Greece to125% in the Netherlands. Investment 6 funds 1 Debt securities The financial portfolios of Norwegian Quoted 12households hold a lower portion in shares/ shares 35 Insurancemutual funds than many other WesternEuropean countries. This means, however, and pension Other 14that they are not as highly exposed to vola-tile equity markets. As a result, Norwegian Currencyportfolios saw a steady increase in financial 32 and depositsassets even at the beginning of this decade.Around 30% are invested in banking prod-ucts, a portion close to the European average. Source: Norges BankThe bulk of assets (35%) are held in insur-ance and pension products. In part, this isdue to relatively strong second pillar pen- we do not expect any further impetus to the 1 Pension investmentsions in the public sector. market within this projection period2. assets include the assets of autonomous pension In Norway, there is no clear distinction funds and otherFuture market trends between pension and insurance assets. (non-insurance type)Household assets This is because the lion’s share of assets in occupational pensionThe relatively risk-averse portfolio will the Norwegian pension market is funded by funds, while the assetsleave Norwegian households relatively un- insurance contracts. According to Statistics of life insurance com-affected by current financial market turbu- Norway, the autonomous pension fund seg- panies are referred to aslence. Assuming that savings rates remain ment stood at EUR 19.5 billion in 2007. We pension insurance assets.low and that recent asset allocation patterns expect this segment to develop slightly more 2 We do not considerdo not change drastically, and assuming an slowly than the insurance segment, as it has assets of the Governmentequity market performance of 7% from 2009 not yet profited from new mandatory arrange- Pension Fund as theseonwards (-30% in 2008), we expect the total ments as much as the insurance industry assets are subject to polit-financial assets of private households to in- has. Pension investment assets will increase ical decisions and there-crease by 5.1% a year to about EUR 563 billion from EUR 19.5 billion in 2007 to EUR 42 bil- fore impossible to predict.by 2020. lion (6.1% CAGR). The insurance segment Moreover, they are not dominates the market; with its image as a available for externalPension investment and insurance assets1 traditionally strong industry for old age pro- asset management.The introduction of the mandatory occupa- visioning, it is getting new inflows from thetional pension system will lead to regular new mandatory system. In 2007, assets wereinflows into pension products. But given more than four times as high as pension in-the low minimum contribution rate of 2%, vestment assets. We expect insurance tech-the additional impulse will be rather weak. nical reserves to amount to EUR 188 billionWhat is more, government tax advantage in 2020, a CAGR of 6.3%.cuts for other products, particularly in thethird pillar, will hamper growth. Thus, 99
  • 100. Country Profiles Norway International Pension Studies Western Europe In recent years, changes to Norway’s Norway: Financial household assets [EUR bn] pension market have mainly beendriven by the emergence of mandatory occu- 600pational pensions. Since 2001, many of these Other assetsnew plans have been of the defined contribu- 500 Insurance/tion type. In terms of asset volume, the pension pension fundsreserve fund is clearly dominant, as it is one the Shares/mutual funds 400 230biggest pension funds in the world. The fund Bondshas evolved gradually, especially with regard to 300 Bank depositsthe scope of investments. Mandatory occupa-tional plans and the reserve fund have made 108 200 103funded pensions the focus of pension provisionin Norway, even though this form of funded 59 52 100 41 161pensions differs from most other European 30 16 93 * Calculated on the basis ofcountries. 43 56 end-of-year exchange rates. 0 1996 2000 2007 2020e Source: Norges Bank, Allianz Dresdner Economic Research Norway: Pension market development [EUR bn] 250 Life insurance assets Investment assets 200 150 188 100 85 50 42 19.5 0 2007 2020e Source: Allianz Dresdner Economic Research100
  • 101. Country Profiles Portugal International Pension Studies Western Europe Portugal Dominating Public Pensions With a New ComponentPension system designPortugal’s pension system is characterized Demographics and macroeconomicsby a generous public pillar. The country took Population 10.6 millionsteps early on (at the end of the 1980s) tocreate a pension reserve fund to help rein- Old-age dependency ratio* 2005: 26 2050: 58force its public pillar for the long term. In thisrespect, Portugal was a forerunner among its GDP [EUR] 163 billionEuropean neighbours. Due to the size of the GDP per capita [EUR] 15,300public pillar, occupational pension provisionis modest. It is concentrated in certain sectors GDP growth, 2002–2007 [av. in % p.a.] 0.9only. When it comes to tax-favoured third Unemployment rate [%] 8.0pillar pension schemes, the Portuguese canchoose between several products. Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-olds Portugal will be one of the countries in Source: Allianz Dresdner Economic ResearchEurope hardest hit by demographic change.The old-age dependency ratio in Portugalwill climb to 58 in 2050, whereas the EU-25 ability of the system will be under threat.average will be 52. Only Italy and Spain are Public pension expenditure will rise fromforecast to have more unfavourable ratios. the 2005 level of 11.1% of GDP to 20.8% inAccording to our projections, the overall Por- 2050. This is one of the highest values in thetuguese pension market, which currently EU and one of the largest increases. Pensionamounts to EUR 62.8 billion, will grow at a expenditure in the EU is forecast to rise toCAGR of 6.9% until 2020. 12.8% on average until 2050. A sustainability factor that adjusts futurePublic pensions pension benefits to changing life expecta-Shape of the public pillar tions has been introduced, thanks to reformsPortugal’s first pillar covers employees and agreed upon in 2007. As part of these reforms,the self-employed who earn above a certain the calculation base is about to change fromthreshold. Individual plans exist for specific the best ten of the last fifteen years to lifetimeoccupational groups such as civil servants, earnings (phased in until 2017) and pensionrailway workers, fishermen, lawyers and oth- benefits have been capped (at EUR 4,774 iners. The public pillar provides generous ben- most cases). Benefits are now indexed basedefits. The gross replacement rate is 75% and on inflation and earnings growth. The coun-the net replacement rate is 91%. The overall try provides a minimum pension as well associal security contribution amounts to 34.75% a means-tested social safety net. Early retire-of earnings, 16% of which is earmarked for ment is possible from the age of 55, but re-old-age benefits. According to EU projections, quires 30 years of contributions. Benefits arePortugal’s pension system will heavily burden reduced if early retirement is taken.fiscal resources in the future and the sustain- 101
  • 102. Country Profiles Portugal International Pension Studies Western Europe To offset the decrease in pension benefitscaused by the introduction of the sustain- First pillar designability factor, a new defined contributionscheme (Public Capitalization Scheme) was Contribution rate [overall social security Employer: 23.75introduced in March 2008 that enables work- contribution; % of gross salary] Employee: 11ers to make additional contributions of ei- Replacement rate [% of last income] Gross: 75ther 2%, 4% or 6% of earnings. Contributions Net: 91are invested in a fund managed by the insti- Legal retirement age 65tution in charge of the pension reserve fundand converted into shares called Retirement Public pension expenditure [% of GDP] 2005: 11.1Certificates. At retirement, the money can be 2050: 20.8used to buy a life annuity or taken as a lumpsum. The fund has investment limits: it can Source: EU, OECDonly invest in OECD countries. In addition, nomore than 25% of the fund can be invested inequities, 40% in investment grade corporate FEFSS asset allocation, 2007 [%]bonds, and 10% in real estate and infrastruc-ture. At least 50% must be invested in govern-ment bonds. Between March and August 2008, Cash 3 3 Strategic4,350 people joined the scheme. 3 Real estate reservePension reserve fund Equities 21In 1989, Portugal introduced the FEFSS, apension reserve fund that aims to bolster itspublic pension pillar against the pressurethat will inevitably arise from demographic 70 Bondschange. It is supposed to meet the pensionsystem’s future shortfalls. Capital from socialsecurity surpluses, a fraction of employees’social security contributions and unclaimed Source: epn 2008tax refunds feed into this fund. The FEFSS isa public institution controlled by the Minis-try for Labour and Social Security. The Fund plemented in 2006, it became necessary foris subject to several investment restrictions. SGFPs to form a steering committee withIt has to invest at least 50% of assets in Por- employee representatives when managingtuguese public debt, equities are capped at closed pension funds. Employer contribu-25% and the maximum amount of corporate tions in defined contribution plans usuallybonds cannot exceed 40% (Oxera 2007). amount to around 3% of wages; employeesAssets under management are currently normally do not contribute to occupationalaround EUR 8 billion. Asset allocation is plans.dominated by bonds. Regulation, asset allocation and taxation Until recently, Portuguese pension fundsOccupational pensions were subject to various quantitative invest-Institutional framework and governance ment limits, including an equity limit of 55%.There are two types of occupational pension However, new investment principles wereproviders in Portugal: pension fund manage- introduced in 2007 that follow the prudentment companies (SGFPs) and insurance com- person principle. As a result of these newpanies. Both may offer defined benefit and de- investment principles, the equity limit is ef-fined contribution plans. Pension funds can fectively abolished. However, the 30% limit onbe closed or open and they can be set up by a non-euro denominated assets remains validcompany, group of companies, associations (IPE 2007).or by a collective agreement between tradeunions and employer associations. The SGFPs Assets in Portuguese pension funds aremust have a general assembly and a board of allocated in diverse vehicles. Hedge fundsdirectors. When the IORP directive was im- are included in the portfolio. International102
  • 103. Country Profiles Portugal International Pension Studies Western Europeequity investments are higher than those Occupational pension funds’ asset allocation, 2006 [%]inside the country. Employer contributions to pension funds 1 Otherare tax-deductible up to a limit of 15% of Cash 5earnings, while 25% of employee contribu- 8 Real estatetions are tax-deductible up to a certain limit. 34 Fixed incomeInvestment income is tax-exempt, whilebenefits above a certain threshold are taxed 22 Mutual fundsat the normal tax rate for incomes.Trends 30 EquitiesPortugal’s occupational pension marketis small partly because of the small size ofthe country, but mostly because of the high Source: OECDreplacement rate of first pillar pensions.Occupational pensions mostly cover em-ployees at multinational companies and 20% of the amount invested, but there areemployees working in the banking, telecom- certain limits to this depending on the agemunications and transport sectors. Total of the member. The maximum tax deductionassets under management amounted to is EUR 400 for members under 35, EUR 350EUR 21.5 billion in 2007. However, some for members between 35 and 50, and EUR 300occupational schemes – schemes in the for those above 50 years. Investment incomebanking sector substitute state pensions for and benefits are taxed for the duration of theinstance – are not second pillar funds in the contract.true sense. By and large, pension funds aredefined benefit. Most of these plans, howev-er, are closed to new members. New plans Life insuranceare almost exclusively defined contribution. The share of life premiums as a percentageMost funds, measured both in terms of num- of Portugal’s GDP – 5.8% in 2007 – is slight-bers and assets under management, are of ly below the EU-15 average of 5.9%. At EURthe closed type. There are 27 pension fund 892 in 2007, Portugal’s life premiums permanagers on the market (14 life insurance capita were significantly under the Europeancompanies and 13 SGFPs). average of EUR 1,716 (Swiss Re 2008). Still, Portugal is ahead of countries like Spain and Greece. The individual segment accounted Occupational pension fund statistics, 2007 for 64% of the total life market in 2005. The group market accounted for 36%, significant- AuM [EUR bn] 21.5 ly above the EU-15 average. In 2005, around Taxation EET 37% of premiums came from unit-linked contracts (CEA 2007). Source: OECD Savings and financial marketsPrivate retirement savings While the savings rate in Portugal was stableTax-favoured third pillar products have been at more than 10% between 2000 and 2004, itavailable on the Portuguese market since the has fallen to 7.5% in recent years. Household1980s. The Portuguese have three products assets amount to 223% of GDP, which is aboveto choose from when building up their re- the Western European average. Measured intirement nest with voluntary payments. They absolute terms, Portuguese household assetscan use insurance products offered by life amounted to EUR 363 billion at the end ofinsurance companies, investment products 2007. Assets of institutional investors accountfrom investment companies, or individual for 65% of GDP. Pension funds manage assetspension plans from open pension funds that amounting to 13% of GDP, investment fundsare provided by SGFPs and life companies. 20% and insurance companies 32%.The amount invested is tax-deductible to 103
  • 104. Country Profiles Portugal International Pension Studies Western Europe The lion’s share of household financialassets in Portugal is held in low-risk assets, Savings and financial assets, 2007with roughly 42% invested in bank deposits Household savings ratio [%] 7.5and bonds. However, equities and mutualfunds are also very popular and come to 39% Household assets [% of GDP] 223of assets. Few other countries in Western Eu- Average per capita financial wealth [EUR] 34,200rope put so much of their household assetsin these sorts of products, especially direct Assets of institutional investors [% of GDP] 65investments. It could be argued that inves-tors are forced to channel money into these Source: OECD, Bank of Portugal, Eurostatriskier capital market products because ofthe low rates of return and relatively high in-flation rates that characterize the domestic Household asset allocation, 2007 [%]market. It could also indicate that Portugalhas a greater degree of income and wealthinequality than in other Western European Debt 6 securities 1 Othercountries, which allows those on a higherincome and with greater wealth to create a Investment 8more diverse investment portfolio that in- funds 36 Currencycludes capital market products in addition and deposits Life and 18to low-risk assets. The insurance/pension pension fundssegment plays a minor role in the portfolioof Portuguese households, accounting foronly 18%. Portugal thus allocates less of its 31 Quoted shareshousehold assets in insurance/pensionsthan almost any other country in WesternEurope. Source: Bank of PortugalFuture market trends Pension investment and insurance assets2 1 Differences betweenHousehold assets Some EUR 21.5 billion was invested in the the values for pension /Since a large portion of household assets pension fund segment in 2007. The life in- insurance assets in thisare held in shares, financial market troubles surance market is almost twice the size of section and those of thewill put pressure on wealth formation. In our the pension market in volume, with techni- overall retirement marketprojection we pencilled in a stock market de- cal reserves of EUR 41.3 billion in 2007. In the in the following sectioncrease of 30% between the end of 2007 and past, individuals and companies alike have are due to classificationyear-end 2008. Since the Portuguese are only found life insurance contracts more attrac- differences in the financialmoderate savers, their savings will not be tive than pension funds as occupational flow statistics of nationalable to compensate for stock markets de- pension vehicles. Since no new incentives for accounts and the specificcreases. We assume that the equity market pension fund membership have been intro- pension statistics we usedwill perform at 7% a year from 2009 onwards. duced, we do not expect this to change. If, for the market analysis.In our forecast, the allocation of assets in however, the fiscal deficit continues to shrink One major difference isPortugal will move towards the Western Eu- and new incentives were introduced, this that non-life insuranceropean average during the projection period. might change. products are included inWe expect the total financial assets of private the financial accounts.households to increase by about 4.9% a year By and large, we expect the total pensions/ 2 Pension investmentto EUR 676 billion by 2020. In 2007, household insurance segment to increase at an above assets include the assetsassets amounted to EUR 363 billion1. average rate, with the share of the pension/ of autonomous pen- insurance segment in household portfolios sion funds and other widening. This development implies that the (non-insurance type) asset mix of Portuguese households will move occupational pension towards the European average, meaning that funds, while the assets of the share of bank deposits will shrink further. life insurance companies Employee contributions are stagnating at a are referred to as pension very low level and occupational pension insurance assets. schemes rely on employer contributions.104
  • 105. Country Profiles Portugal International Pension Studies Western EuropeGrowth rates are thus lower than they could Portugal: Financial household assets [EUR bn]be. We expect the pension fund segment togrow by 6.0% (CAGR), resulting in assets worth 800EUR 46 billion in 2020. Insurance products Other assets 700will profit slightly more from savings for old Insurance/age provisioning. Technical reserves will in- 600 159 pension fundscrease by 7.4% p.a., with the total volume Shares/mutual funds 500amounting to EUR 104 billion by the end of Bondsthe projection period. 400 Bank deposits 257 67 300 We expect an overall growth rate of 6.9%,with the total volume of pension/life insur- 200 35 141ance products reaching EUR 150 billion by 20 74 62 100 2082020. The share of pension/insurance prod- 131 87 104ucts as part of household assets is expected 0to rise from 18% in 2007 to 24% in 2020, which 1996 2000 2007 2020eis still significantly below the forecast Euro- Source: Bank of Portugal, Eurostat, Allianz Dresdner Economic Researchpean average of 39%. Portugal: Pension market development [EUR bn] Portugal has not yet taken the sorts of 160 steps other Western European countries Life insurance assets 140have to reform their pension systems. Retire- Investment assetsment income diversification is lacking, as the 120high replacement rate provided by first pillar 100 104pensions makes supplementary pensions su-perfluous for many. The adverse demographic 80developments in coming decades will likely 60drive pension system reform. Such reformwould result in a more important role for funded 40 41.3pensions (occupational and private). The intro- 20 46duction of a voluntary defined contribution 21.5scheme to complement the first pillar is a step 0in this direction. The speed with which Portu- 2007 2020e Source: Allianz Dresdner Economic Researchgal’s pension market will develop further restslargely on the willingness of the Portuguese tomake contributions into voluntary schemes. 105
  • 106. Country Profiles Spain International Pension Studies Western Europe Spain Defined Contribution in a Small Occupational MarketPension system designThe three-pillar system in Spain is dominat- Demographics and macroeconomicsed by the first pillar, which is one of the most Population 43.9 milliongenerous public pension schemes in Europe.The occupational pension pillar is under- Old-age dependency ratio* 2005: 24 2050: 67developed as a result and covers only a smallpart of the workforce. In terms of assets, the GDP [EUR] 1,050 billionthird pension pillar is more developed than GDP per capita [EUR] 23,900the occupational pension pillar. A reservefund was established to help bolster the fi- GDP growth, 2002–2007 [av. in % p.a.] 3.4nancial viability of the public system. Occu- Unemployment rate [%] 8.3pational pension plans are common amonglarge enterprises, but less so among small Data from 2007 or latest available yearand medium-sized companies. Until the * Ratio of over 65-year-olds to 15–64-year-olds1990s, Spain was a defined benefit market. Source: Allianz Dresdner Economic ResearchThis has changed and today Spain has one ofthe most pronounced defined contribution before retirement. In net terms, it wouldmarkets in Europe. amount to 97%. The public system is pay-as- you-go and earnings related. It is mandatory Since Spain will experience one of the most for all employees and for the self-employedsevere demographic challenges faced by any and requires a minimum contribution periodcountry in the world, its generous public of 15 years. The total contribution is 28.3%pension scheme will likely come under acute of gross wages, with employers paying 23.6%pressure in coming years. Spain’s old-age and employees 4.7%.dependency ratio is projected to worsen to67 by 2050, the highest value in the European Early retirement is possible at the ageUnion. The average old-age dependency ratio of 60, but pension payments are reducedin the EU is forecast to be 52 in 2050. Accord- substantially when this option is taken.ing to our projections, the Spanish pension Pensions are adjusted each year in line withinvestment and insurance market will grow inflation. The maximum pension amountsfrom its current level of EUR 216 billion at a to EUR 32,000 a year. There is a minimumCAGR of 7.7% until 2020. pension and a means-tested pension for the elderly without claims on the earnings- related part.Public pensionsShape of the public pillar The state budget will be burdened signifi-Public pensions in Spain are exceptionally cantly in the years to come because of thegenerous. Workers who retire at 65 after work- current generous pension system and aing for forty years and earning an average gloomy demographic outlook. Expenditurewage can expect to receive a pension payment for public pensions in 2050 is projected tothat is only slightly lower than their income increase to 15.7% of GDP, three percentage106
  • 107. Country Profiles Spain International Pension Studies Western Europepoints higher than the EU-25 average. Spainis trying to tackle the issue of public pen- First pillar designsions at the political level through the ToledoPact. The main political parties and social Contribution rate [% of gross salary] Employer: 23.6partners signed the pact in 1995, agreeing Employee: 4.7to check the viability of the pension systemat regular intervals and make necessary ad- Replacement rate [% of last income] Gross: 91justments. This means consensus between Net: 97the main actors is ensured when reforms Legal retirement age 65are required. The pact was revised in 2003 Public pension expenditure [% of GDP] 2005: 8.6to set the framework for reform over the fol- 2050: 15.7lowing five years. Several reforms have beenintroduced as a result of the revision, includ-ing incentives for longer working lives and Source: OECD, EUextending minimum contribution periods.The Social Security Reserve Fund Occupational pensionsThe public pension system is complementedby the Social Security Reserve Fund. This fund The generosity of public pensions negativelybecame operational in 2000. Surplus from the affects occupational and private pensionspublic scheme and its assets is fed into the by restricting the need for them. The numberfund, which amounted to EUR 45.7 billion of people in occupational funds, which areat the end of 2007. The surplus in the public voluntary, is modest: 1.7 million people usedsystem stems mainly from the lower birth them in 2007. In addition to this system, thererate during the Spanish Civil War. As a result are mutual welfare companies that provideof the lower birth rate then, the number of pensions for certain occupational groups. Yetnew retirees is now below average. The sur- these institutions garner a very minor shareplus is expected to disappear by 2015. The of the market.assets of the reserve fund are to be used whenthe public scheme has been in deficit for three Institutional framework and governanceyears. The fund is directed by a management Qualified occupational pensions may becommittee, which is responsible for invest- implemented through pension plans (planesments and asset allocation. It is regulated by de pensiones) or group insurance contracts.the General Treasury of the Social Security Pension plans are implemented throughSystem. pension funds, which are autonomous en- tities. They can be closed or open. Pension Supervision is carried out by the Treasury, funds in turn are managed by authorisedan advisory committee and a monitoring pension fund management entities (Entitadcommittee comprising both employers and gestora) that are set up either by financial in-employees. Investment regulation stipulates stitutions or employers. The pension fundthat investments must be in public debt and management entity is appointed and super-that at least 50% of assets must be invested vised by a Pension Plan Control Commission.in Spanish bonds. A maximum of 50% may This Commission has between five and ninebe invested in foreign bonds, which in this members, a majority of which must be plancontext means German, French, or Dutch members. Employer participation is permit-bonds (Oxera 2007). At the end of 2007, 50.5% ted, but not required. The Commission iswere invested in Spanish bonds and 49.5% responsible for determining the investmentin foreign bonds (Fondo de reserve de la segu­ policy, unless it decides to leave that to theridad social 2008). There is a draft law that pension fund managing company.would allow greater flexibility in investmentpolicy by widening asset classes. This law has Regulation, asset allocation and taxationnot yet been passed. Spanish pension funds are subject to liberal investment regulation. Only a few quantita- tive restrictions exist. There are no limits to investments in equities, foreign assets, bonds, retail investment funds (when UCITs satisfy 107
  • 108. Country Profiles Spain International Pension Studies Western Europelegal requirements) or in bank deposits. Some lishment. Neither employers nor unionsrestrictions apply to securities traded on non- actively push for the introduction of pensionregulated markets within these categories. plans, as the generosity of the public systemInvestments in real estate are limited to 20% does not make them see the need for occu-(joint with mortgage loans), and several lim- pational pensions. This is the main reasonits apply for investments in securities issued for the modest penetration rate of pensionor guaranteed by the same entity and for self- plans in small companies. A pension fundinvestments. Spanish investment regulation for 500,000 central government civil servantsthus comes very close to the prudent person was set up in 2003, which might encourageprinciple. Bonds dominate the current asset the development of occupational pensions.allocation of Spanish pension funds, with two- In terms of investment management, a trendthirds of assets invested in this vehicle. Equi- towards multi-management is emerging,ties account for one-fifth of assets, mutual although it is still in its infancy. The marketfunds for 10%. is strongly dominated by domestic banks. Taxation of Spanish pension funds followsthe EET principle. Combined employer and Private retirement savingsemployee contributions of up to EUR 10,000 Individual pension plans are more popular(or 30% of salary) are tax-deductible if the than occupational pensions in terms of as-employee is younger than 50. If the employee sets and members. Individual plans are openis older than 50, EUR 12,500 or 50% of earnings to employees, the self-employed and the non-is tax-deductible. These limits were changed employed. The rules and tax advantages arein 2007. Another change introduced at this identical to those provided in occupationaltime concerns the partial tax deductibility of schemes. The providers are also the same.lump sum payments, which was abolished Participants can choose from a variety of reg-to encourage annuities. ulated products offered by banks or insurance companies. The total tax-deductible amountTrends refers to the sum of occupational and in-While Spain was a defined benefit market dividual plans. Some 8.3 million memberswith unfunded book reserves in the 1980s, participated in this pillar in 2007, with assetsthis has now changed. Since the 1990s, almost amounting to EUR 51.5 billion.all new pension plans are of the defined con-tribution type and unfunded defined benefitplans have been converted in most cases. Third pillar statistics, 2007Book reserves had to be dissolved by 2002. AuM [EUR bn] 51.5The OECD reports that 97% of occupationalassets are in defined contribution plans. Cur- Members [m] 8.3rently, there are 1,900 plans with 1.7 million Taxation EETparticipants and assets of EUR 30.5 billion.This means that around 8% of the workforce Source: Invercois covered by a pension plan. Pension plans are found primarily in large Life insuranceenterprises. Small and medium-sized firmsare very hesitant to introduce them, despite In addition to the qualified pension planstargeted incentives to encourage their estab- offered through pension funds, Spanish companies can also offer group insurance contracts (planes de jubilacion). From the Occupational pension fund statistics, 2007 employer’s perspective, the advantage of these compared to pension funds is that AuM [EUR bn] 30.5 there is no contribution limit. They also pro- Members [m] 1.7 vide a greater degree of control, owing to the fact that there is no control commission. Taxation EET Separate data for these group contracts are not available, as they are included in overall Source: Allianz Dresdner Economic Research, OECD life insurance statistics.108
  • 109. Country Profiles Spain International Pension Studies Western Europe With the exception of Greece, Spain has Asset allocation of occupational pension funds, 2006 [%]the lowest life insurance density and pene-tration rate within the EU-15. Life premiumsper capita in Spain amounted to EUR 518 in 1 Other Cash and2007 compared to EUR 1,716, the average of deposits 5the EU-15 countries. Life premiums as a per- Mutual funds 10centage of GDP were 2.2% in the same year,whereas the EU-15 average was 5.9% (SwissRe 2008). Unit-linked products had a share Equities 20of 11.5% in 2005. Individual life insuranceclearly dominates the life market, with a 64 Bondsshare of 80% in 2005 (CEA 2007).Savings and financial markets Source: OECDSpain, with a saving rate of slightly over 10%,is one of Europe’s top saving countries. OnlyFrance and Germany had higher savings ratesin 2006. Nevertheless, the country ranks in Savings and financial markets, 2007the lower half of European countries when Household savings ratio [%] 10.3it comes to the volume of household assetscompared to GDP. It reached 182% in 2007, Household assets [% of GDP] 182whereas the Western European average was Average per capita financial wealth [EUR] 43,500219% of GDP. In absolute terms, householdassets amounted to EUR 1.91 trillion. Assets Assets of institutional investors [% of GDP] 62managed by institutional investors are alsoquite modest in European comparison, Source: OECD, Banco de Espanaamounting to 62% of GDP. The correspondingfigure for the Netherlands for example is 205%.Pension fund assets accounted for 7% of GDP, of public pensions and the resulting under- 1 Differences betweeninvestment funds for 30% and insurance com- development of capitalised savings. the values for pension /panies for 25%. insurance assets in this section and those of the Spanish households tend to invest in Future market trends overall retirement marketreal estate rather than in financial vehicles. Household assets in the following sectionSpain has the highest share of home owner- In the years ahead, we expect the savings are due to classificationship in Europe (around 85%). Thus a large rate to stay at the relatively high level of differences in the financialportion of savings is used for building up around 10%. Although the coming years flow statistics of nationalreal assets. Until the mid-1990s, the bulk might be difficult given the problems in accounts and the specificof financial assets were invested in bank Spain’s real estate market, we expect wealth pension statistics we useddeposits. Shares and investment funds ac- to continue growing. The country’s strong for the market analysis.counted for a third of portfolios. These prod- engagement in the stock market will dampen One major difference isucts grew to 46% during the equity market growth potential in 2008, as we assume year- that non-life insuranceboom between 1995 and 1999. When turbu- end stock market valuations 2008 to decrease products are included inlence hit the stock market, Spanish house- by 30%. But given the longer term opportuni- the financial accounts.holds suffered a setback, and financial assets ties provided by capital market investments 2 Pension investmentmore or less stagnated. and the investment behaviour of Spanish assets include the assets of households, annual growth for the projection autonomous pension funds Spanish households, however, never with- period can reach 5.2% annually. This will push and other (non-insurancedrew substantially from the stock market and financial assets to EUR 3.7 trillion at the end type) occupational pensionthey continue to hold a higher proportion of of 20201. funds, while the assets ofstocks than most other Western European life insurance companiescountries. Insurance and pension funds have Pension investment and insurance assets2 are referred to as pensiona modest share of only 14%. As in several The insurance segment will show higher insurance assets.other European countries, Spain’s low level growth rates than total financial assets. Thisof household assets reflects the dominance is due to the low share of life insurance as 109
  • 110. Country Profiles Spain International Pension Studies Western Europea proportion of total assets, which again is Spain: Financial household assets [EUR bn]caused by the country’s strong state pensionsystem. High growth rates, however, were seen 4,000in the 1990s, and this development was boost- Other assetsed by Spain’s rising prosperity. After years 3,500 663 Insurance/of strong economic growth, some catch up pension funds 3,000demand still exists. Life insurance technical Shares/mutual fundsreserves were EUR 134 billion in 20073, and 2,500 Bonds 1,469we expect these assets to increase by 7.3% 2,000 Bank depositsannually to reach EUR 336 billion in 2020. 260 1,500 The pension investment segment is devel- 812 1,000 146oping more slowly than expected in terms 1,394 77 423of coverage, particularly with respect to oc- 500 237 730 417cupational pensions. High replacement rates 327 0in the first pillar and only small parametric 1996 2000 2007 2020ereforms do not encourage people to increase Source: Bank of Spain, Allianz Dresdner Economic Researchpension savings. However, interest in privatepension plans will increase as private house-holds become wealthier. Problems in the real Spain: Pension market development [EUR bn]estate market will likely retard pension assetgrowth. After that occurs, we expect pension 600fund asset growth to pick up speed during the Life insurance assetsprojection period. With an annual growth rate 500 Investment assetsof 8.2%, pension investment assets will jumpfrom EUR 82 billion in 2007 to EUR 229 billion 400 336in 20204. 300 Overall, we expect the Spanish pension/insurance market to grow at a compound 200annual rate of 7.7%, reaching EUR 565 billion 134in 2020. 100 229 82 0 2007 2020e Source: Allianz Dresdner Economic Research Spain has laid the foundations for creating a strong occupational pillarand the country has already undergone the 3 This figure is based ontransformation from defined benefit to defined the technical reserves ofcontribution schemes. However, owing to the EUR 130 billion in 2006generosity of the public pillar – which almost reported by CEA and anfully replaces the wage income of average asset growth of 2.5% forworkers – the occupational pillar still remains 2007, as provided in theunderdeveloped. Given that Spain faces the financial accounts of themost unfavourable demographic development Banco de Espana.in Europe, the financial pressures on the public 4 This figure is providedpillar will escalate. Thus, a further promotion in the financial accountsof funded pensions in Spain in the future is very of the Banco de Espana forlikely. The high participation rate in third pillar the pension fund sector.schemes shows that Spaniards are aware of thefuture need for additional retirement savings.In light of this awareness, diversifying retirementincome and increasing coverage of occupation-al pensions, especially among smaller enter-prises, seems to be the main challenge facingSpain’s pension policy.110
  • 111. Country Profiles Sweden International Pension Studies Western Europe Sweden Innovating the First Pillar, Shifting Toward DC in the SecondPension system designSweden’s pension system is based on the Demographics and macroeconomicstraditional three pillar design, but it features Population 9.1 millionsome remarkable innovations. The first pillarconsists of a notional defined contribution Old-age dependency ratio* 2005: 26 2050: 41system. A portion of contributions made topublic pensions is paid into the premium GDP [EUR] 325 billionpension system; this portion is invested into GDP per capita [EUR] 35,800investment funds, selected by the insured.The public pillar is complemented by five GDP growth, 2002–2007 [av. in % p.a.] 3.1buffer funds. Voluntary occupational pensions Unemployment rate [%] 6.1are based on collective bargaining, and cov-erage is very high as a result. The two mainschemes have been restructured towards Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsdefined contribution arrangements. In the Source: Allianz Dresdner Economic Researchtax-favoured third pillar, participants canchoose between insurance products, invest-ment funds and bank accounts. Public pensions Demographic change will be less severe in Shape of the public pillarSweden than in other parts of Europe. While Sweden’s public pension system was exten-the old-age dependency ratio in Sweden is pro- sively overhauled in the late 1990s. Reformsjected to rise to 41 in 2050, the EU-25 average to the public pillar apply fully to those bornwill be 52. According to our projections, the after 1954. While the old system was largelycurrent pension assets of EUR 203.5 billion based on tax-financed flat rate pensions,will grow at a CAGR of 6.8% until 2020. today there are different tiers within the first pillar: the guarantee pension, the income pension and the premium pension. The guar- antee pension is meant for low-income earn- ers. It is tax-financed and coordinated with the other first pillar programs. Other pension benefits reduce the guarantee pension. The income pension is a pay-as-you go scheme of the notional defined contribution type. This means that all members have an individual “notional” account into which their contributions (notionally) flow. The con- tributions are credited with a rate of return in line with average earnings growth. At re- tirement, the pension balance will be divided 111
  • 112. Country Profiles Sweden International Pension Studies Western Europeby cohort life expectancy to take into accountdemographic development and to have an First pillar designautomatic stabiliser for the scheme. The pen-sion contribution amounts to 18.5% of salary, Contribution rate [% of gross salary] 18.5the bulk of which is paid by the employer, Replacement rate [% of last income] Gross: 5316% of which flows into the income pension. Legal retirement age 65 The remaining 2.5% of pension contribu- Public pension expenditure [% of GDP] 2005: 10.6tions are deposited into an individual premi- 2050: 11.2um pension savings account. Members caninvest their money in one of 779 investment Source: EU 2006funds. If they fail to select an investmentfund, their contributions are transferred intoa default fund. The scheme is administeredby the Swedish Premium Pension Authority Assets AP funds 2007 [billion](PPM), which distributes the capital to fundmanagers, registers the funds and under- AP 1 AP 2 AP 3 AP 4 APtakes all clearance activities. EUR 23.2 EUR 24.2 EUR 23.8 EUR 22.0 EUR 2.1 [SEK 218.8] [SEK 227.5] [SEK 224.9] [SEK 207.3] [SEK 19.6] The normal retirement age is 65, but earlyretirement is possible from age 61 onwards. Source: AP funds annual reportsThe guarantee pension is only available atage 65. In 2004, the first pillar’s gross replace-ment rate was 53% of last income. Including no more than 40% of assets should be exposedoccupational pensions, the replacement rate to currency risk. In 2007, the funds managedwas 68%. This combined replacement rate a combined asset volume of EUR 95.3 billion.is projected to decrease to 56% in 2050 dueto decreasing first pillar benefits. Currently, The AP 6 is the smallest fund. It is alsoSweden’s public pension expenditure is ex- unique in that it invests only in the Swedishactly the EU average of 10.6% of GDP. Where- private equity market, directly or indirectly.as Sweden’s public pension expenditure as At least 10% of the AP funds’ assets must bea percentage of GDP will rise to 11.2% in 2050, outsourced to external managers (Oxerathe EU average will increase to 12.8%. 2007). The biggest of the AP funds, AP 2, has a strategic portfolio that aims to allocate as-The AP funds sets based on the following structure: 20%There are five buffer funds in Sweden. These of assets should be invested in Swedish equi-exist to even out temporary fluctuations in ties, 35% in foreign equities, 5% in emergingthe pay-as-you-go system. They are called AP markets, 36% in fixed income, 3% in real1 – AP 4 and AP 6 (AP 5 no longer exists) and estate and 1% in private equity.were reorganized as part of pension reformin 2001. Each of the five funds fulfils basically Sweden also has an AP 7 fund, which isthe same function and objective. The govern- not a buffer fund, but the default fund ofment brought them into existence to create the premium pension system. The Premiumcompetition and encourage investment Savings Fund had assets of EUR 9.2 billionstrategy diversity. [SEK 87.4 billion] in 2007. The AP 7 also runs the Premium Choice Fund, which can be The funds are subject to investment restric- chosen just like any other fund in the Premi-tions. For example, at least 30% should be in- um Pension System. The Premium Savingsvested in low-risk fixed income securities and Fund is by far the largest fund in the Premi- um Pension System, accounting for around 28% of the total capital invested in the scheme. 17 external managers are involved in managing its assets. The asset allocation of the fund is equity driven, with 82% invest- ed in this asset class.112
  • 113. Country Profiles Sweden International Pension Studies Western EuropeOccupational pensions Premium Savings Fund strategic asset allocation, 2007 [%]Institutional framework and governance US denomi-Around 90% of employees in Sweden are part Swedish 2 nated bonds inflation-linkedof a voluntary occupational pension scheme, bonds 4 2 Hedge fundsif public plans are included. Since voluntary Private 8 2 Sterlingoccupational pension provision is driven and equity funds denominatedbased on collective agreements, it is quasi- bondsmandatory for most of the workforce, espe- Emerging 10cially since agreements require employers to market equitiestake out pension plans for their employees.There are two main schemes: SAF-LO for blue 52 Global Swedish 20 equitiescollar workers and the ITP plan for white-collar equitiesworkers. Special plans for certain occupationalgroups, such as architects, or for certain in- Source: AP 7 2008dustries such as insurance, also exist. Compa-nies not bound to a collective agreement mayoperate their own plans. This refers mostly Occupational pension funds’ asset allocation, 2006 [%]to senior executives, who can opt out of theITP scheme, and to employees of Swedishsubsidiaries of multinational corporations. 3 OtherContributions are generally between 2% and Real estate 35% of wages. 8 Mutual funds The SAF-LO plan is a defined contributionplan and contributions can be invested with 31 Equitiesaround 25 providers. Following extensive re-vision in 2007, the ITP plan is now divided 55 Fixed incomeinto two parts. Part 1, introduced in 2007, isa defined contribution scheme and coversall employees born after 1978. Participantscan select among eight different providers Source: OECDand can choose between traditional and unit-linked insurance contracts. However, 50% ofcontributions must be placed in a traditional Regulation, asset allocation and taxationinsurance policy. ITP Part 2 has been operat- Swedish pension funds are subject to rela-ing for years and covers all employees born tively liberal investment regulation, butbefore 1979. It is largely a defined benefit plan some quantitative limits must be observedthat is based on final salary. A certain part of regarding investment policy. The quantita-the contribution, however, is directed into a tive limits depend heavily on the vehicle cho-defined contribution plan. The defined bene- sen. As occupational pensions are normallyfit part can be financed through a pension of the insured type, the investment restric-fund, book reserves or through insurance. tions differ between friendly societies, insur- ance companies and occupational pension In addition to these two plans, Sweden providers in accordance with the EU occupa-has a collective pension plan for employees tional pension directive. The prudent personin the municipal sector and for state employ- principle applies for occupational pensionees. Employees do not contribute to these providers. Insurance companies are allowedcollective occupational plans. Generally, pen- to hold a maximum of 25% in equities and asion funds in Sweden can be founded by one maximum of 75% in bank deposits. There isor more employers. no limit for investments in international as- sets, but no more than 20% of assets may be invested in assets not denominated in the cur- rency of the liabilities. The limits for friendly societies are more restrictive. 113
  • 114. Country Profiles Sweden International Pension Studies Western Europe In terms of asset allocation, the lion’s Private retirement savingsshare of Swedish pension fund assets isinvested in mutual funds, followed by fixed- Private retirement savings, the third pillarincome instrument and equities. Occupa- of Sweden’s pension system, are substantialtional pensions are taxed according to the and mainly comprise two products: tradi-ETT principle. Contributions of up to 35% of tional/unit-linked insurance or individualthe employees’ wage may be deducted, while pension accounts either held in investmentinvestment income and benefits are taxed. funds or bank accounts. Contributions are tax-deductible. The level of participation inTrends the corporate pillar determines the extentThe occupational pension market in Sweden to which contributions can be deducted.has changed tremendously since the 1990s. When people do not have occupational pen-In 1996, the defined contribution type SAF- sion rights, like the self-employed, then theLO replaced its predecessor, a defined bene- maximum amount that can be deducted isfit plan. The ITP was similarly overhauled in around EUR 50,000 (base amount plus 35% of2007. The market has been transformed as income). For employees with an occupationala result of these changes. When the occupa- pension, the tax-deductible amount is con-tional pension market was based on defined siderably lower at around EUR 4,300. Benefitsbenefit, all occupational business was split can not be taken before the age of 55. Invest-between two monopoly insurers, one respon- ment income and benefits are taxed. It issible for each plan. This has changed with estimated that around 40% of the workforcethe introduction of the defined contribution participate in the individual pension pillar.schemes. Members now enjoy choice amongseveral providers and between traditionaland unit-linked policies. Life insurance Sweden has a developed life insurance On the regulatory side, a so-called traffic market. The life premium per inhabitantlight system was introduced in Sweden in was EUR 1,889 in 2007, higher than the EU-152006. Pension funds have a set of bench- average of EUR 1,716. Life premiums as amarks – using stress tests – to help them share of GDP are 5.3% in Sweden, belowmonitor and calculate their exposure to risk. the EU-15 average of 5.9% (Swiss Re 2008).A trend towards alternative investments and Sweden’s high share of group business dif-socially responsible investments can be seen ferentiates it from the rest of Europe. Inin the investment strategy of Sweden’s pen- terms of life premiums, group business ac-sion funds. counted for 50% in 2005, which is almost double the European average volume. The share of unit-linked policies was 41%, which Occupational pension fund statistics, 2006 is also much higher than is usual for West- ern Europe (CEA 2007). AuM [EUR bn] 27 Taxation ETT Savings and financial markets Source: OECD Compared with their European counterparts, Swedish households have a high savings ratio of 9.9%. With 12%, France had the high- est savings ratio in 2007. Belgium, Spain, and Switzerland all had values of around 10%. The volume of assets in Swedish households amounts to 165% of GDP, well below leading European nations. UK households’ assets are 292% of GDP, for instance, and Swiss house- holds have assets amounting to 373% of GDP. In absolute terms, financial assets amounted to EUR 536 billion at the end of 2007. Institu- tional investors hold assets of 147% of GDP, one of the highest values in Western Europe.114
  • 115. Country Profiles Sweden International Pension Studies Western EuropePension funds, however, only have assetsamounting to 2.3% of GDP. The corresponding Savings and financial markets, 2007value for investment funds is 50% of GDP and Household savings ratio [%] 9.995% for insurance companies. The latter is thehighest value in Europe, even if data for some Household assets [% of GDP] 165countries are missing. The strength of insur- Assets of institutional investors [% of GDP] 147ance companies in the pension market con-tributes decisively to this top position. Source: OECD, Statistics Sweden The financial position of Swedish house-holds improved considerably during the bullmarket in the 1990s. During that time, Swedish Household asset allocation, 2007 [%]investors increased their direct and indirectequity exposure from 30% in the mid-1990s to45% in 1999. When the stock market collapsed, 3 Debtthey suffered badly. Although financial wealth securities Investment 11dipped in 2002, it regained strength in the fundsfollowing years. Equities and mutual funds are 36 Life andagain the most popular investment vehicles.This makes Swedish portfolios vulnerable pension funds Currency 20to financial turbulence. Change is afoot. and depositsSwedish households – like many of theirEuropean counterparts – started to withdraw 30 Quotedfrom the stock market in 2006 and began sharesinvesting in less risky assets, particularly inbank deposits. The share of bank deposits Source: Statistics Swedenin the portfolios of households is regainingweight (20%), up from the low level of 16%in 2005. This was in fact the lowest level in Given the comparatively high saving rate 1 Differences betweenWestern Europe. As Sweden supports a fund- in Sweden, the asset allocation patterns over the values for pension /ed pension system, the portion of this seg- the past years, and assuming an equity market insurance assets in thisment reached about 36%, slightly above the performance of 7% a year (from 2009 onwards), section and those of theEuropean average. we expect total financial assets of private overall retirement market households to increase by about 5.7% a year in the following section to over EUR 1.1 trillion by 2020, from EUR 536 are due to classifica-Future market trends billion in 2007. At the end of the projection tion differences in theHousehold assets period, pension and insurance products will financial flow statistics ofSwedish households’ high exposure to equi- contribute the bulk of financial assets1. national accounts and theties, directly and indirectly through mutual specific pension statisticsfunds and pension funds, has put pressure Pension investment and insurance assets2 we used for the marketon wealth formation. Assets increased by As the Swedish government supports occu- analysis. One major dif-only 1.8% from year-end 2006 to year-end pational pensions and as payments into ference is that non-life2007. We assume a stock market decrease of private pension schemes are tax-deductible insurance products are30% from year-end 2007 to year-end 2008. to a high degree, we expect strong inflows included in the financial into pension products in coming years. accounts. The new ITP scheme based on defined con- 2 Pension investment tribution will generate further inflows, too. assets include the assets Overall retirement assets will grow at a rate of autonomous pen- of 6.8% and rise to EUR 481 billion, compared sion funds and other with EUR 203.5 billion in 2007. (non-insurance type) occupational pension funds, while the assets of life insurance companies are referred to as pension insurance assets. 115
  • 116. Country Profiles Sweden International Pension Studies Western Europe Insurance contracts play a major role Sweden: Financial household assets [EUR bn]*in the second and third pillars of Sweden’sretirement market3, but because of a more 1,200conservative asset mix and the much bigger Other assetsmarket, growth rates will be lower than 1,000 Insurance/those of pension fund assets. We expect in- pension funds 500surance assets to grow at an annual rate of 600 Shares/mutual funds6.6% to EUR 403 billion by 2020, more than Bondsdoubling their current level of almost EUR 600 Bank deposits176.5 billion. The much smaller pension 190fund market will grow at 8.5%, to EUR 78 400 389billion in 2020. 130 223 200 69 152 * Calculated on the basis of 74 191 105 end-of-year exchange rates. 59 55 0 Sweden is one of the most interesting 1996 2000 2007 2020e pension markets in Europe. Innovative Source: Sveriges Officiella statistik, Allianz Dresdner Economic Researchreforms initiated over the past decade includethe introduction of a notional defined contrib-ution system in the first pillar and the creation Sweden: Pension market development [EUR bn]of a funded part within the public pension pillarin which members can freely choose between 600investment funds. A trend towards defined Life insurance assetscontribution is plainly visible in occupational 500 Investment assetspension schemes. These innovative elementswithin the pension system coupled with the 400near-universal coverage of occupational pen-sions and the high participation rate in third 300 403pillar schemes show that a true multi-pillarsystem is in place in Sweden; this enables 200Swedes to draw on retirement income frommultiple sources. 100 176.5 78 27 0 2007 2020e Source: Allianz Dresdner Economic Research 3 The distinction between insurance assets and pen- sion assets is not straight- forward; the flow of funds statistics (for household assets) show a 40/60 split between insurance and pension savings, whereas the OECD pension statis- tics and the CEA insurance technical reserve figures display a 15/85 split. This is probably due to the fact that “pension savings” encompasses more than just pension funds in the flow of funds statistics. In this context, we use the OECD/CEA distinction as base figure for our projection.116
  • 117. Country Profiles Switzerland International Pension Studies Western Europe Switzerland Operating a Truly Multi-Pillar SystemPension system designDespite its moderate population size, Switzer- Demographics and macroeconomicsland is the third-largest pension fund market Population 7.6 millionin Europe in absolute terms – behind the Unit-ed Kingdom and the Netherlands – largely Old-age dependency ratio* 2005: 24 2050: 39because its occupational pension system ismandatory. Switzerland is often viewed as a GDP [EUR] 308 billionrole model for pension policies, as it has suc- GDP per capita [EUR] 40,700cessfully created a pension system with bal-anced income streams from the respective GDP growth, 2002–2007 [av. in % p.a.] 2.0pillars. Swiss pensions are based on a truly Unemployment rate [%] 2.8multi-pillar system. The first pillar providesstate-run basic pension provision. The uni-versal social insurance policy underpinning Data from 2007 or latest available year * Ratio of over 65-year-olds to 15–64-year-oldsthe first pillar has a strong redistributive Source: Allianz Dresdner Economic Researchcomponent. The second pillar – the manda-tory occupational pension system – is basedon independent pension funds, which are the self-employed and all persons residing ineither attached to a specific company or open Switzerland, including non-working spouses,to all companies. The third pension pillar is students, unemployed persons or people liv-tax subsidised. Here participants can choose ing purely from capital income.between bank, insurance and investmentproducts. Employers and employees each have to contribute 4.2% of salary. The self-employed Demographic change in Switzerland will contribute 7.8%. The government (federalbe much less pronounced than in the rest and cantonal) pays approximately 20% ofof Europe. The projected old-age dependency benefits. These are adjusted against pricesratio of 39 in 2050 is far below the forecast and wages every two years.of 52 for the EU. Current retirement assets,investment and insurance, amount to EUR To be eligible for a full pension, members482 billion. According to our projections, the must have paid contributions for 44 years.overall retirement market will grow at a CAGR There is a minimum pension of CHF 1,075of 2.8% until 2020. (EUR 655) and a maximum pension of CHF 2,150 (EUR 1,309). Since the country has no assessment limit for contributions, redis-Public pensions tribution between low- and high-incomeThe first pillar, called AHV (Alters­ und Hinter­ earners is substantial. High-income earnerslassenenversicherung/old-age and surviving pay contributions on all of their income, butdependants insurance), offers truly universal receive only the capped maximum pension.coverage. In addition to including all employ- As a result, replacement rates for higher-ees in Switzerland, it provides coverage for income earners are significantly below the 117
  • 118. Country Profiles Switzerland International Pension Studies Western EuropeOECD average, whereas replacement ratesfor average earners, at 58% gross, are fairly First pillar designhigh and slightly above the OECD average. Contribution rate [% of gross salary] Employer: 4.2 Employee: 4.2Occupational pensions Replacement rate [% of last income] Gross: 58Institutional framework and governance Net: 67Occupational pensions constitute a very Legal retirement age 65 for menstrong pillar of the Swiss pension system. 64 for womenAround one-third of pensioners’ retirement Public pension expenditure [% of GDP] 2005: 13.1income comes from occupational pensions. 2050: n.a.Occupational pension provision was madecompulsory in 1985. Employees above a cer- Source: OECDtain income threshold (CHF 19,350) mustcontribute to the second pillar pension sys-tem. The coverage rate is around 80%. The Swiss pension funds are governed by aself-employed can join voluntarily. Contribu- board of directors and an investment com-tion rates vary between 7% and 18%, depend- mittee. The board of directors must compriseing on the participant’s age and earnings up an equal number of employer and employeeto a maximum of CHF 77,400 (EUR 47,120). representatives. Employer representativesEmployer contributions must at least match should not include senior managers. In theemployee contributions. The level of contri- case of multi-employer foundations, equalbutions is determined by the pension fund. representation takes place on the level ofHigher contributions are possible and com- each associated company. Every companymon in certain industries. The retirement constitutes a separate pension fund withinage in the occupational pillar is tied to that the foundation corresponding to a closedof the first pillar. Benefits are usually paid company pension fund. The investments canout as annuities, but members can take out be managed in-house or outsourced to third25% as a lump sum when they retire. parties. Pension funds must be created as inde-pendent institutions and can be established Occupational pension fund statistics, 2006in the legal form of a foundation or a cooper- AuM [EUR bn] 361ative society. Foundations dominate strongly,with 98% of private pension funds set up under Members [m] 4.3this legal form. Larger companies tend to have Taxation EETtheir own closed pension fund (Pensions­kasse), while smaller companies usually join Source: OECD, Swiss Federal Statistical Officean open multi-employer foundation (Sammel­stiftung). Members of professional associa-tions can usually join a professional pension Regulation, asset allocation and taxationfund (Gemeinschaftseinrichtung). A distinction Swiss pension funds have to consider severalcan be drawn between autonomous pension quantitative investment limits. The mainfunds that manage investment and actuarial limits include:risks by themselves and partially autonomous • 50% in equities and 30% in domestic funds that insure death and disability risks equitieswith an insurance company. Multi-employer • 50% in real estate; the combined limit foundations are mainly managed by life in- for real estate and equities is 70%surance companies and banks, and are fully • 30% for foreign assets overall; 25% for insured. The bulk of the market, however, foreign equities and 20% for foreignis made up of autonomous pension funds. currency bondsPension rights are fully transferable between • 10% for equities of a single company pension funds. and 5% for investments in the sponsoring employer118
  • 119. Country Profiles Switzerland International Pension Studies Western Europe Swiss investment limits, however, are Asset allocation of occupational pension funds, 2006 [%]not strictly enforced. When a pension fundcan show that it is in solid financial shape Alternativeand formally justify its actions, it can exceed 5 assetsthese limits, which most pension funds do. Other 7 19 Foreign bonds In terms of asset allocation bonds account Currency 8for 37.5% of assets; non-Swiss bonds have a and depositsslight preponderance in this class. The same Swiss equities 12 18 Swiss bondsis true for equities, foreign equities dominateclearly. The share of real estate in pension Real estate 14fund portfolios is high, with a strong bias to- 17 Foreignward domestic real estate. Alternative assets equitiesmake up a noticeable share, at 5%. So far,investments in alternative assets had to be Source: Swiss Federal Statistical Officeapproved by the regulatory agency. From2009 onwards, alternatives are included inthe list of approved assets and a 15% invest- has risen by 4.1 percentage points. Alterna-ment limit applies. tive assets experienced an upswing of 3.5 percentage points. It would appear that Mandatory occupational pension funds demand for external asset managers in theare subject to a minimum rate of return – at marketplace is increasing, especially for for-least on the mandatory part of their assets. eign currency bonds, international equitiesThis is reviewed annually. The rate of return and alternative investments, while domesticwas increased to 2.75% in January 2008 from asset classes tend to be managed in-house2.5%. In 2009 it will be lowered again, to 2%. (Mercer 2008).Taxation follows the EET principle. Benefits,however, are taxed separately from other in-come and at a lower rate. Private retirement savings In the realm of individual pension provision,Trends there is a distinction between two sub-pillarsThere is an ongoing, but gradual trend towards in Switzerland, 3a and 3b. Pillar 3a is tax-defined contribution schemes. Watson Wyatt subsidised, while pillar 3b generally offers noestimates that 54% of occupational pension tax advantages. It broadly encompasses allassets are now in defined contribution plans private savings, from house ownership to alland 46% in defined benefit plans (Watson other financial assets. Life insurance contractsWyatt 2008). Looking at active members, data enjoy some tax advantages.from the Swiss Federal Statistical Office showthat 2.6 million members were enrolled in de- The tax advantages in pillar 3a, estab-fined contribution pension funds and 730,000 lished in 1987, depend on whether or notin defined benefit funds in 2005. However, a participant is enrolled in a second pillarpure defined contribution plans are not pos- pension fund. If they are enrolled, they cansible in Switzerland owing to the guaranteed claim a tax allowance of at most CHF 6,365.minimum rate of return. Viewed from this If they are not enrolled in the second pillar,perspective, Swiss defined contribution plans the tax allowance is up to 20% of income upcan be considered as a form of cash balance to a maximum amount of CHF 31,824 (EURplans. Individual choice is not foreseen. 19,198). Taxation is of the EET type. Payments are taxed separately from other income and In terms of asset allocation, one signifi- at a lower rate.cant trend has become visible over the lastcouple of years: diversification of pension Participants have the choice between lifefunds has increased. Comparing asset allo- insurance products, bank deposits and in-cations in 2002 and in 2006, the share of vestment funds with different asset alloca-Swiss bonds decreased, while the share of tions. Structured products have also becomeforeign bonds increased by 3.2 percentage available recently. Regulations limit the sharepoints. The share of international equities of equities to a maximum of 50%. The amount 119
  • 120. Country Profiles Switzerland International Pension Studies Western Europeof assets in 3a accounts is estimated to bearound CHF 100 billion (EUR 61 billion). Savings and financial markets, 2007Insurances account for around 50% of these Household savings ratio [%] 10assets, roughly a third is invested in bankaccounts, and 17% is invested in investment Household assets [% of GDP] 373funds. Payout is possible in the form of lump Average per capita financial wealth [EUR] 152,000sums, withdrawal plans or, in the case ofinsurances, annuities. Lump sum plans are Assets of institutional investors* [% of GDP] 208most popular. Taxation is of the EET type. * Only insurance companies and pension funds, data for investment funds not availableLife insurance Source: OECD, Swiss National Bank, EFAMASwitzerland is a major life insurance market.Life premiums per capita were EUR 2,302 in Household asset allocation, 2007 [%]2007, considerably above the EU-15 average ofEUR 1,716. At 5.7%, life premiums as a shareof GDP were slightly below the EU average of 8 Debt5.9% (Swiss Re 2008). The importance of group securitiescontracts compared to individual contracts is Investment 11shown in a breakdown of the pension market. fundsTwo-thirds of life premiums stemmed from 42 Life andgroup contracts in 2005, whereas unit-linked Quoted 13 pension fundscontracts amounted to 11.1% (CEA 2007). shares Group insurance contracts are mainly 26 Currencyused for multi-employer contracts, the Sam­ and depositsmelstiftungen, but insurance companies alsoinsure the actuarial risks of semi-autonomous Source: Swiss National Bankpension funds. Life insurance is the dominantsaving vehicle in the state-promoted thirdpillar and is also important as a general sav- which are not available on a comparable 1 Calculated on the basisings product. basis. National data would suggest that in- of year-end 2007 ex- vestment funds accounted for 127% of GDP change rates. The value in 2006. of household financialSavings and financial markets assets was reported forWith a household saving ratio of 10%, the Household asset allocation is also domi- 2006 only; the 2007Swiss level is substantially above the Western nated by savings for old age. Some 42% of figure is estimated onEuropean average of 6.6%. In terms of (rela- household assets are invested in life insur- the basis of differenttive) household assets, the Swiss top the list ance or pension funds. A substantial share individual statistics fromof Western European countries by far with of savings is directed towards currency and the Swiss National Bank.assets of 373% of GDP. This is largely due to deposits, followed by shares and investmentthe important role of funded old-age provi- funds. In terms of volume, equity funds weresion in the country. The importance of funded the most popular type of fund in 2006, fol-old-age provision is also reflected in assets lowed by bond and strategy funds.held by institutional investors. Pension fundsaccount for 119% of GDP, while insurancecompanies account for 89%. This suggests Future market trendsthat putting savings in institutionalised ve- Household assetshicles has become the norm in Switzerland Household financial assets amounted toand that the bulk of assets are devoted to EUR 1.15 trillion at the end of 20071. Swissold-age provision. These numbers do not households are heavily exposed to the stockeven include the assets of investment funds, market, as their portfolios favour mutual funds and pension funds. Financial turbu- lence will put pressure on wealth formation. We project a stock market decrease of 30% from year-end 2007 to year-end 2008. How-120
  • 121. Country Profiles Switzerland International Pension Studies Western Europeever, we expect private households’ total Switzerland: Financial household assets [EUR bn]financial assets to increase by about 2.5%a year to over EUR 1.59 trillion by 2020. 1,600The reasons for this are the country’s solid Other assets 1,400savings rate, the mature insurance and Insurance/ 690 pension fundspension markets, the asset allocation pat- 1,200terns during the past couple of years, and Shares/mutual funds 1,000an equity market performance of 7% a year 482 Bonds(from 2009 onwards). 800 Bank deposits 397 433 600Pension investment assets2 274 228With an estimated EUR 361 billion in pen- 400sion investment assets in 2007, Switzerland 200 342is the third-largest pension investment mar- 215 294 * Calculated on the basis ofket in Europe. Being a mature market with 0 end-of-year exchange rates.high coverage and rising claims, growth is 2000 2007 2020eexpected to be driven by asset performance Source: Bank of Portugal, Eurostat, Allianz Dresdner Economic Researchand contributions to pension plans. As 30%of assets are invested in equity, we estimatean average annual growth rate of 3.2% up to Switzerland: Pension market development [EUR bn]2020. Pension assets will amount to EUR 542billion by the end of the projection period. 800 Life insurance assets 700Pension insurance assets Investment assetsSince pension funds dominate the Swiss 600 147retirement market, the insurance segment is 500clearly smaller. Insurance technical reservesreached an estimated EUR 121 billion in 2007, 400 121accounting for a third of pension assets. The 300market has a high portion of maturing con- 542tracts. At the same time, it is difficult to attract 200 361new business in an environment of low in- 100terest rates. The good stock market perform-ance of the years up to 2007 drove growth in 0unit-linked products and helped strengthen 2007 2020e Source: Allianz Dresdner Economic Researchthe market. With turbulence hitting finan-cial markets, growth perspectives will damp-en. We expect Swiss insurance technical re- Switzerland has managed to create 2 Pension investmentserves to grow by a mere 1.5% p.a., reaching a well-balanced pension system with assets include the assetsEUR 147 billion by 2020. a strong – and mandatory – occupational of autonomous pension pillar. The volume of the second pillar makes funds and other The whole retirement market will have Switzerland one of the biggest pension mar- (non-insurance type)assets of almost EUR 689 billion in 2020, kets in Europe. Switzerland is also a good occupational pensiongrowing annually by an average of 2.8%. example of how funded pensions can boost funds, while the assets financial assets, financial markets and institu- of life insurance compa- tional investors. An ongoing trend in the Swiss nies are referred to as market is the slow but gradual shift towards pension insurance assets. defined contribution plans, which must achieve minimum returns. A further trend is the increas- ing diversification of pension fund assets. Putting Switzerland in a European context, it can be argued that Switzerland is one step ahead of its neighbours as diversifying retirement income sources, which is a reality in Switzerland, has been the main goal of pension reforms in most Western European countries. 121
  • 122. Country Profiles UK International Pension Studies Western Europe UK Reforming Public Pensions and Extending Occupational Pension CoveragePension system designThe UK has one of the most mature occupa- Demographics and macroeconomicstional pension markets in Europe. Due to the Population 60.3 millionlow replacement rate of the public pillar, re-tirement income has to rely to a large degree Old-age dependency ratio* 2005: 24 2050: 45on funded pensions. Occupational pensionsare mostly implemented through pension GDP [EUR] 1,884 billionfunds or insurance schemes. In the third GDP per capita [EUR] 31,200pillar, there are two tax-favoured schemes,which are increasingly intertwined with the GDP growth, 2002–2007 [av. in % p.a.] 2.7occupational pillar. Unemployment rate [%] 5.3 The British pension system is in the Data from 2007 or latest available yearmidst of reform. Changes for schemes in * Ratio of over 65-year-olds to 15–64-year-oldsthe public pillar will be implemented in Source: Allianz Dresdner Economic Researchthe years to come. Regarding occupationalschemes, plans are well advanced to intro-duce personal pension accounts with auto- tures two pay-as-you-go schemes: the Basicmatic enrolment. This should increase the State Pension and the State Second Pensioncoverage of occupational pensions. The (S2P). Both are compulsory for employeespension market in the UK has been under- with weekly earnings between GBP 84 (EURgoing a pronounced shift from defined bene- 114) and GBP 645 (EUR 875). The Basic Statefit to defined contribution schemes. Only a Pension is a flat-rate scheme and financedminority of defined benefit plans is still open from National Insurance contributions.to new members. A complete contribution record, currently amounting to 44 years for men, will result The UK will experience a more favourable in a weekly Basic State Pension of EUR 123demographic development than the EU as (GBP 90.7).a whole. The old-age dependency ratio willworsen from 24 to 45 between now and 2050, The second element of public pillar pen-while the EU average will then be 52. Accord- sions, the S2P, started in 2002 and replaceding to projections, overall pension assets will the former SERPS scheme. S2P is earnings-grow at a CAGR of 5.2% until 2020. They cur- related, except for low-income employees,rently amount to EUR 3.1 trillion. who have a guaranteed flat-rate pension. It is possible to contract out of the S2P scheme by joining occupational pensions, stakeholderPublic pensions pensions or personal pension plans, provid-The UK has been actively reforming its public ed that the schemes grant benefits at least aspension system over the past years. Imple- high as in the S2P scheme. According to esti-menting the reforms will be the main task mates, around 60% of employees are in con-in the years to come. The current system fea- tracted-out schemes and receive a rebate122
  • 123. Country Profiles UK International Pension Studies Western Europeon their National Insurance contributions.In addition to these two schemes, there is a First pillar designtax-financed and means-tested scheme inoperation, the Pension Credit consisting of Contribution rate [% of gross salary] Employer: 12.8the Guarantee Credit and the Savings Credit. Employee: 11 Replacement rate [% of last income] Gross: 17 The present system has a very low replace- (66 including 2nd andment rate. In 2005, it was 17% of pre-retirement 3rd pillar schemes)income in gross terms. However, including Net: 82second and third pillar schemes the replace- (including 2nd and 3rdment rate increased to 66% gross, or a net value pillar schemes)of 82%. Public pension expenditure between Legal retirement age 65 for men2005 and 2050 is projected to increase from 60 for women6.6% of GDP to 8.6%, which is very low when Public pension expenditure [% of GDP] 2005: 6.6compared to the EU-25 average of 10.6% now 2050: 8.6and 12.8% in 2050. Source: EU 2006 The past years have seen far-reaching re-form of the British pension system. In 2005,a new Pensions Regulator was established, Occupational pensionsas was the Pension Protection Fund, basedon the Pensions Act of 2004. The Finance Act The occupational pension system in theof the same year unified the taxation of oc- UK is voluntary and plans have traditionallycupational and private pension savings. In been implemented through pension funds2006, the government published two White and insurance schemes. Unfunded schemesPapers, which were largely based on the pro- are possible, but uncommon. However, theposals of an independent Pension Commis- occupational pillar is increasingly inter-sion and dealt with public and private pen- twined with the personal pension pillar, assions. In a first step of reform, mostly relating employers can also use third pillar plansto public pensions, the Pensions Act 2007 was as alternatives to traditional occupationalpassed, while the second part, the Pensions plans. Since 2001, employers with five orBill 2007/2008, is currently in the legislative more employees must provide access to aprocedure. Stakeholder Pension, a third pillar scheme, or operate an occupational pension scheme The Pensions Act 2007 decreased the nec- themselves. Similarly, the planned imple-essary period for a full Basic State Pension, mentation of mandatory personal accountsthe earnings-link of which will be restored. for those without occupational pensionAt the same time, the S2P will become fully coverage goes in the same direction.flat rate until 2030. The retirement age forwomen will rise from 60 to 65 by 2020. It will Institutional framework and governanceincrease to 68 for both sexes by 2046. The Closed pension funds, which dominatenew regulations also foresee that contract- the occupational pension landscape, musting out of the S2P scheme will no longer be be set up in the form of a trust. Trustees arepossible for defined contribution schemes. responsible for all pension plan functions,The Pensions Bill proposes the introduction are personally liable for their decisions andof personal accounts from 2012 onwards for are obliged to act for the exclusive benefitthose employees without access to occupa- of plan members and beneficiaries. In mosttional schemes; the plan is to introduce auto- cases, trustees outsource investment man-matic enrolment into this scheme. Employ- agement to external providers. Trustees nor-ees will contribute 4% of their wages and em- mally include representatives of the employ-ployers 3%; the state will contribute 1% in the er, members and beneficiaries. The Pensionform of tax relief. These measures are meant Act of 1995 states that one- third of trusteesto counteract the trend towards decreasing should be nominated by the members.coverage of occupational pensions. Schemes with over 100 members must have at least two employee trustees, schemes with less than 100 members must have one. 123
  • 124. Country Profiles UK International Pension Studies Western EuropeThere is no minimum number of members Asset allocation of pension funds, 2006 [%]for occupational pension plans. Pensionplans can be of the defined benefit, definedcontribution or hybrid type. Employers and 3 Cashemployees can contribute to occupational Real estate 3plans and employees can make additionalvoluntary contributions (AVCs). Other 17 37 EquitiesRegulation, asset allocation and taxationPension funds in the UK are subject to theprudent person principle and diversification Mutual funds 20is encouraged. The only quantitative limit 20 Fixed incomerelates to investments in the sponsoring securitiescompany, which is restricted to 5%. The assetallocation of British pension funds is geared Source: OECDto equities. Some 37% of assets are investeddirectly, and a significant part of mutualfunds – which account for a share of 20% – is increased financial market volatility (Clark,likely to be invested in equities. Around 8% of Monk 2006).assets are invested in unallocated insurancecontracts. Related to these problems of defined benefit plans, the past years also saw the Taxation was completely reformed in 2006 emergence of a pension buyout market,as part of the Finance Act of 2004. The new through which insurance companies takeregime greatly simplified taxation of pensions on the responsibility for the pension schemeby including all pension savings. There is now and assume its assets and liabilities. Hybrida universal lifetime allowance and an annual plans have gained in importance. Neverthe-allowance. The lifetime allowance is the over- less, due to their long history, defined benefitall limit of an individual’s tax-favoured retire- plans dominate the overall asset volume andment savings and amounts to EUR 2 million number of members. Defined benefit schemes(GBP 1.5 billion). The yearly limit for retire- (including public occupational schemes)ment savings is EUR 292,000 (GBP 215,000). have 22.2 million members, while there areContributions beyond this sum are taxed at 6.2 million defined contribution members.55%. The taxation principle is EET. A quarterof a person’s entire pension capital can be Currently two-thirds of private sectordrawn as a tax-free lump sum. companies offer a defined contribution plan. Defined contribution schemes can be trust-Trends based or contract-based. In the latter case,The UK is one of the prime examples for the arrangement is directly between thethe shift from defined benefit to defined con- members and the provider. This type of de-tribution plans. While defined benefit plans fined contribution plan has experienced awere traditionally the preferred option for considerable upswing over the past couplecompany pensions, this has changed re- of years. Most defined contribution schemesmarkably. Survey research by the Pensions are very small. Three- quarters of them haveRegulator shows that in 2007, 46% of defined five or less members. Current discussionsbenefit schemes in the sample were closed focus on investment choice and the designto new members, 15% were closed to new of defined contribution schemes’ defaultaccruals and 38% were open to new mem- option (Byrne, Harrison, Blake 2007).bers. The probability that schemes are openincreases with scheme size, survey researchshows (The Pensions Regulator 2007). Occupational pension fund statistics, 2006The reasons for the shift include the under- AuM [EUR trn] 1.4funding of pension plans, increasing labourmobility, the introduction of market-based Taxation EETaccounting standards, the (regulatory) Source: OECDcomplexity of defined benefit plans and124
  • 125. Country Profiles UK International Pension Studies Western EuropePrivate retirement savings Savings and financial markets, 2007There are two main schemes for private Household savings ratio [%] 3.3pension savings: personal pension plansand stakeholder pensions. Personal pension Household assets [% of GDP] 295plans were introduced in 1988. Eligible per- Average per capita financial wealth [EUR] 92,200sons are those under the age of 75 who fulfilBritish residency conditions. Personal pen- Assets of institutional investors* [% of GDP] 178sion plans are defined contribution in nature.They are increasingly used as occupational * Insurance companies and pension funds without investment fundsschemes due to their flexibility and cost Source: OECD, National Statistics Officeeffectiveness. In this case, they are set upas Group Personal Pensions. The taxationof personal pension plans and for stakehold- Savings and financial marketser pensions is subject to the general limitsfor pension savings, which were reformed The savings rate in the UK – 3.3% in 2007 – isin 2006 (see above). low when compared with the rest of Europe. Only Norway, Finland and Denmark have The second option for personal pension lower rates of saving. Nevertheless, house-savings is stakeholder plans, which were in- hold assets reached EUR 5.56 trillion, whichtroduced in 2001. Employers with more than is the highest financial wealth value in West-five employees must provide their employees ern Europe in absolute terms. Only whenwith access to stakeholder pensions if they do measured as a share of GDP does the UKnot offer an occupational pension plan them- rank second with a ratio of 295%, trailingselves. Stakeholder pensions are defined con- Switzerland’s 373%. In both countries, thesetribution in nature, with the employer select- high ratios can be attributed to the stronging the provider. Stakeholder pensions were role of funded pensions. The importanceintroduced to encourage higher savings for of institutional investors is reflected in theretirement, especially among the lower paid. asset volume that (autonomous) pensionFees on stakeholder products are limited funds manage, namely 76% of GDP. In this(maximum 1.5% of fund value per year, drop- respect, the UK is only surpassed by theping to 1% after 10 years of membership) and Netherlands and Switzerland. Insurancemust fulfil certain standards, for example with companies account for 102% of GDP, theregard to flexible contributions or low mini- highest value in Europe.mum payments. Stakeholder plans need tooffer a default investment option, which has Consequently, the bulk of British house-to include lifecycle concepts. hold portfolios is invested in life insurance and pension funds. With 56% of household portfolios comprising life insurance andLife insurance pension funds, Britain shares the top spotThe UK is Europe’s leading life insurance with the Netherlands among European na-market. At EUR 684 billion, it is by far the big- tions. Around one quarter of financial assetsgest market in Europe. The country has also are held in bank deposits and 13% in equitythe highest values in terms of life premiums and mutual funds. These shares are amongper capita and as a share of GDP. Life premi- the lowest in Western Europe. But in contrastums amount to 12.7% of GDP or to EUR 3,950 to pension funds and insurance reserves inper head. This is more than twice as high as other countries, Britons are heavily investedthe EU average of 5.9% of GDP or EUR 1,716 in capital market products, mainly indirectlyper head (Swiss Re 2008). In 2005, 63% of life through institutionalised savings, like inpremiums originated from individual con- pension funds. As a consequence, they weretracts, the remainder from group policies. hit hard by the stock market downturn at theIn the same year, unit-linked policies had beginning of the millennium. It took almosta share of 25%, identical to the EU average five years for pension/insurance reserves to(CEA 2007). regain the level reached in the late 1990s. In the aftermath of the downturn, institutional investors cut back their equity exposure, but 125
  • 126. Country Profiles UK International Pension Studies Western Europe60% remains invested in this asset class. Household asset allocation, 2007 [%]The portfolios of institutional investors andthus of British households are vulnerable tocurrent financial market turbulence. British 3 Other Investment 5households, however, have started to with- funds 1 Debtdraw from the stock market and diversify in securities (Un)quoted 8bank deposits. Bank deposits accounted for shares27% of household portfolios in 2007, up from19% in 1999. Currency 27Future market trends and deposits 56 Life and pension fundsHousehold assetsAs the bulk of wealth formation in the UK isdirected into pension and insurance assets, Source: National Statistics Officethis segment dominates asset developmentof households. The small additional savingsflow is divided into low risk investments such end of the projection period assets should 1 Pension investmentas bank deposits and into investments in grow to EUR 2.98 trillion. assets include the assetsequities and mutual funds. Overall, personal of autonomous pensionfinancial assets of British households are Pension insurance assets funds and otherexpected to rise to EUR 10.2 trillion by 2020, The life insurance market is even bigger (non-insurance type)from EUR 5.56 trillion in 2007. This increase than the pension investment market, as occupational pensioncorresponds to an annual rate of 4.8%. many arrangements are based on insurance funds, while the assets contracts. The total life technical reserves of life insurance compa-Pension investment assets1 amounted to EUR 1.68 trillion in 2007. Since nies are referred to asThe UK pension fund market currently has insurance assets tend to be invested in more pension insurance assets.EUR 1.41 trillion in assets under manage- traditional forms, performance might lagment. Since they are still highly exposed to pension asset growth. Growth will probablyequity markets, pension fund assets will lose be lower here than in the pension market,some of their value due to the market down- given the market’s already high level andturn (we assume a stock market performance maturing status. We expect assets to reachof -30% in 2008 and +7% from 2009 onwards). EUR 3.0 trillion by the end of 2020 (CAGRInflows will not be high enough to compen- 4.6%).sate for this downturn. In uncertain econom-ic environments, companies are reluctant to Overall, we expect assets under manage-pay extra money – in the form of single pre- ment in the British retirement market tomium payments – into pension schemes. almost double their EUR 3.1 trillion levelWhen it comes to saving, people also tend to in 2007 to EUR 6.0 trillion by 2020, growinghesitate when job and income prospects are at an annual rate of 5.2% a year. The shareclouded. of pension/insurance products within total financial assets is expected to rise from The outlook for pension savings is ex- 55.6% in 2007 to roughly 59% in 2020.pected to improve markedly when the newlegislation comes into force starting in 2012.In our projection, we have factored in theauto-enrolment process through increasingcoverage. The effect on average contributionlevels is not as obvious as the effect on cover-age. Employers who are already contributinghigher than required levels might reduce theircontributions. In our view, the additional in-crease might not be as dynamic as it couldbe. Considering this extra money stream,however, we expect an increase of 5.9% p.a.for this already very mature market. At the126
  • 127. Country Profiles UK International Pension Studies Western Europe Current pension reforms in the UK UK: Financial household assets [EUR bn*] are moving in a different direction thanreforms in most other European countries 12,000owing to the country’s unique starting position. Other assetsWhile reforms in Continental Europe often 10,000 Insurance/try to encourage funded pensions in general, pension fundsreforms in the UK strive to provide adequate 8,000 Shares/mutual fundspensions for lower-income earners, as its fund- 5,986 Bondsed pension sector as a whole is already very 6,000 Bank depositsmature. Attention is paid to lower-incomeearners as these are most affected by the low 4,000 3,092replacement rate of the public pillar. The first 2,228 1,357step towards improving this group’s pension 2,000 1,458 763 988situation was achieved by introducing stake- 560 2,588 1,475 866holder plans and forcing employers to facilitate 0 674access to them. The planned auto enrolment 1996 2000 2007 2020einto personal accounts is a second step. If * Calculated on the basis of end-of-the-year exchange ratesimplemented, these reforms will likely be the Source: National Statistics, Allianz Dresdner Economic Researchdriving force of an otherwise mature pensionmarket. UK: Pension market development [EUR bn] 7,000 Life insurance assets 6,000 Investment assets 5,000 3,003 4,000 3,000 1,679 2,000 2,983 1,000 1,413 0 2007 2020e Source: Allianz Dresdner Economic Research 127
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  • 129. Appendix
  • 130. Appendix International Pension Studies Western EuropeReferencesAP 7 2008. Annual Report 2007.http://www.ap7.se/dokument/redovisning/2007/Arsredovisning2007-En.pdfATP Group 2008. Annual Report 2007. http://www.atp.dkBlake, David 2003. The UK Pension System: Key Issues. Pensions, Vol. 8, No. 4, pp. 330-375.Broadbent, John; Palumbo, Michael; Woodman, Elizabeth 2006. The Shift from Defined Benefit to DefinedContribution Pension Plans – Implications for Asset Allocation and Risk Management. Paper prepared fora Working Group on Institutional Investors, Global Savings and Asset Allocation established by the Com-mittee on the Global Financial System, Bank for International Settlements, Basel.Bundesamt für Statistik 2007. Die berufliche Vorsorge in der Schweiz. Pensionskassenstatistik 2005.Neuchâtel.Byrne, Alistair; Harrison, Debbie; Blake, David 2007. Dealing with the Reluctant Investor. Innovation andGovernance in DC Pension Investment. The Pensions Institute, Cass Business School, London.http://www.pensions-institute.org/reports/reluctantinvestor.pdfCEA Insurers of Europe 2007. The European Life Insurance Market in 2005. CEA Statistics No. 29,http://www.cea.eu/uploads/DocumentsLibrary/documents/life.pdfClark, Gordon; Monk, Ashby 2006. The „Crisis“ in Defined Benefit Corporate Pension Liabilities:Current Solutions and Future Prospects. University of Oxford, School of Geography, Working Paper 06-10,2006Cutler, David; Poterba, James; Sheiner, Louise; Summers, Larry 1990. An Aging Society: OpportunityOr Challenge? Working paper 553, Massachusetts Institute of Technology (MIT), Department ofEconomics.De Nederlandsche Bank 2008. Pension Monitor.http://www.statistics.dnb.nl/index.cgi?lang=uk&todo=PenMonitorDREES 2008. L’épargne retraite en 2006. Direction de la recherche, des études, de l’évaluation et desstatistiques. No. 626. http://www.sante.gouv.fr/drees/etude-resultat/er-pdf/er626.pdfFMA (Austrian Financial Markets Supervisory Authority) 2007. Der Markt für die prämienbegünstigteZukunftsvorsorge 2006. Erste Sättigungstendenzen erkennbar.http://www.fma.gv.at/cms/site/DE/detail.html?doc=CMS1182861495255&channel=CH0156Epn 2008. Portugal. http://www.epn-magazine.com/news/fullstory.php/aid/3529/Portugal.htmlEuropean Commission 2008. Technical Specifications QIS 4 (MARKT/2505/08).http://ec.europa.eu/internal_market/insurance/docs/solvency/qis4/technical_specifications_2008_en.pdf.European Union 2006. Adequate and Sustainable Pensions. Synthesis Report 2006.http://ec.europa.eu/employment_social/social_protection/docs/2006/rapport_pensions_final_en.pdfFinnish Centre for Pensions 2007. The Finnish Pension System.http://www.etk.fi/Binary.aspx?Section=44670&Item=60250Fondo de reserve de la seguridad social 2008. Informe a las Cortes Generales 2007.http://www.seg-social.es/Internet_1//Estadistica/FondodeReservadelaS48074/Informes/Informesanuales/index.htmIPE 2008. Taking a Leap in the Dark. June 2008.IPE 2007. Phasing in Changes. December 2007.130
  • 131. Appendix International Pension Studies Western EuropeIrish Association of Pension Funds (IAPF) 2008. Asset Allocation Survey 2007.http://www.iapf.ie/Infosource/Surveys/AssetAllocationSurvey/PublicationFileForDownload,1617,en.pdfIrish Association of Pension Funds (IAPF) 2007. Pension Market Survey 2007.http://www.iapf.ie/Infosource/Surveys/2007PensionMarketSurvey/PublicationFileForDownload,1536,en.pdfLudwig, Alexander; Schelkle, Thomas; Vogel, Edgar 2007. Demographic change, human capital and endog-enous growth. MEA Discussion Paper 151, Mannheim Research Institute for the Economics of Ageing.Mercer 2008. Asset Allocation Survey and Market Profiles. European Institutional Market Place Overview 2008,London.Munnell, Alicia 2006. Employer-sponsored Plans: The Shift from Defined Benefit to Defined Contribution.In Clark, Gordon; Munnell, Alicia; Orszag, Michael (eds.), The Oxford Handbook of Pensions and RetirementIncome. Oxford University Press, Oxford.National Pensions Reserve Fund Commission (NPRFC) 2007. Annual Report and Financial Statements2006. http://www.nprf.ie/Publications/NPRF_Annual_Report_2006.pdfNorwegian Ministry of Finance 2008. On the Management of the Government Pension Fund in 2007.Report No. 16 (2007/2008 to the Storting),http://www.regjeringen.no/pages/2064594/PDFS/STM200720080016000EN_PDFS.pdfOECD 2007. Pension Markets in Focus. November 2007, Issue 4.OECD 2007b. Pensions at a Glance – Public Policies across OECD Countries. OECD, Paris.OECD 2006. Pension Markets in Focus. October 2006, Issue 3.OeNB (Austrian National Bank) 2006. The Austrian Pension System – How Recent Reforms HaveChanged Fiscal Sustainability and Pension Benefits. Monetary Policy and the Economy, Q2/2006.Oxera / EFAMA 2008. Defined Contribution Pension Schemes. Risks and Advantages for OccupationalRetirement Provision.http://www.efama.org/05Home/10AboutEFAMA/specialreport/Oxera_Report.pdf/file_viewOxera 2007. The Effect of Cross-Border Investment Restrictions on Certain Pension Schemes in the EU.Prepared for the European Commission DG Internal Market and Services.Peek, Jordy; Reuss, Andreas; Scheuenstuhl, Gerhard 2008. Evaluating the Impact of Risk Based FundingRequirements on Pension Funds. OECD Financial Market Trends, No. 94, Paris, OECD.Schneider, Lutz; Ragnitz, Joachim 2007. Demographische Entwicklung und ihre ökonomischen Folgen.Wirtschaft im Wandel, No. 6/2007, S. 195-202.Swiss Re sigma 2008. World Insurance in 2007: Emerging Markets Leading the Way. No. 3.The Pensions Board 2008. Annual Report and Accounts 2007.http://www.pensionsboard.ie/index.asp?locID=69&docID=-1The Pensions Regulator 2007. The Purple Book. DB Pensions Universe Risk Profile.http://www.thepensionsregulator.gov.uk/pdf/purpleBook2007.pdfWatson Wyatt 2008. Global Pension Assets Study.Watson Wyatt 2008b. Dax-Unternehmen: Pensionen im Konzernabschluss 2007. Informationen zurVersorgung und Vergütung. No. 2, July 2008.World Bank 1994. Averting the Old Age Crisis. Policies to Protect the Old and Promote Growth. OxfordUniversity Press, New York. 131
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  • 133. Appendix International Pension Studies Western EuropePension assets under management projections [EUR bn] Investment Insurance Total Investment Insurance Total Net increase Assets Assets Assets 2020e Assets 2020e 2020e 2007 2007 2007 CAGR CAGR CAGR Austria 14.8 60.5 75.3 40.0 126.0 166.0 90.7 7.9% 5.8% 6.3% Belgium 15.6 172.6 188.2 35.0 374.0 409.0 220.8 6.4% 6.1% 6.2% Denmark 68.3 151.7 220.0 152.0 285.0 437.0 217.0 6.3% 5.0% 5.4% Finland 19.0 110.0 129.0 42.0 239.0 281.0 152.0 6.3% 6.2% 6.2% France 21.0 1,208.0 1,229.0 71.0 2,570.0 2,641.0 1,412.0 9.8% 6.0% 6.1% Germany 358.3 716.0 1,074.3 684.0 1,235.0 1,919.0 844.7 5.1% 4.3% 4.6% Greece 1.4 6.4 7.8 8.3 34.0 42.3 34.5 14.8% 13.7% 13.9% Ireland 86.6 77.7 164.3 197.0 136.0 333.0 168.7 6.5% 4.4% 5.6% Italy 57.7 377.4 435.1 172.0 742.0 914.0 478.9 8.8% 5.3% 5.9% Netherlands 759.3 163.6 922.9 1,383.0 253.0 1,636.0 713.1 4.7% 3.4% 4.5% Norway 19.5 85.0 104.5 42.0 188.0 230.0 125.5 6.1% 6.3% 6.3% Portugal 21.5 41.3 72.8 46.0 104.0 150.0 87.2 6.0% 7.4% 6.9% Spain 82.0 134.0 216.0 229.0 336.0 565.0 349.0 8.2% 7.3% 7.7% Sweden 27.0 176.5 203.5 78.0 403.0 481.0 277.5 8.5% 6.6% 6.8% Switzerland 361.0 121.0 482.0 542.0 147.0 689.0 207.0 3.2% 1.5% 2.8% UK 1,413.0 1,679.0 3,092.0 2,983.0 3,003.0 5,986.0 2,894.0 5.9% 4.6% 5.2% Total 3,326.0 5,280.7 8,606.7 6,704.3 10,175.0 16,879.3 8,272.6 5.5% 5.2% 5.3%Comparable data for Luxembourg are not available Source: OECD, Central Banks, national statistics, CEA, Forecasts: Allianz Dresdner Economic Research 133
  • 134. www.allianzglobalinvestors.comAllianz Global Investors AGInternational PensionsSeidlstr. 24 –24a80335 Munich, Germany

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