Pension reform as defined ambition

Frank Vandenbroucke University of Amsterdam

Seminar Belgische Petroleum Federatie - Fédération Pétrolière Belge

Brussels, 30 March 2017

Resources

• European Commission, The 2015 Ageing Report, European Economy 3/2015

• Belgian Commission on Pension Reform 2020-2040 • www.pensioen2040.belgie.be • www.pension2040.belgique.be

• Schokkaert, Devolder, Hindriks, Vandenbroucke, Towards an equitable and sustainable points system. A proposal for pension reform in Belgium, Discussion Paper Series 17.03 Department of Economics, KULeuven, February 2017.

• Hindriks, Devolder, Schokkaert, Vandenbroucke, Réforme des pensions légales: le système de pension à points, Regards Economiques, numéro 130, Mars 2017.

• Schokkaert, Devolder, Hindriks, Vandenbroucke, Het pensioen op punten: naar een nieuw sociaal contract tussen jongeren en ouderen, Leuvense Economische Standpunten (forthcoming)

Dependency and demographic change in the EU

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2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

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Old age dependency ratio, EU Total economic dependency, EU Life expectancy at 65, EU

Old age dependency ratio in Belgium [65+]/[20-64]

2010

2040 2060

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1950

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Belgium Belgium with constant life expectancy

Old age dependency ratio in Belgium [65+]/[20-64]

2010

2040 2060

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1950

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Belgium Belgium with constant life expectancy

Postwar baby-boom: certainty Long-term impact migration & longevity: uncertainty

Dependency and demographic change in the EU

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0

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2015 2020 2025 2030 2035 2040 2045 2050 2055 2060

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Old age dependency ratio, EU Total economic dependency, EU Life expectancy at 65, EU

Increasing uncertainty

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2013 2020 2025 2030 2035 2040 2045 2050 2055 2060

Impact of dependency (no change in coverage, benefit ratio, labour market ratio)

actual forecast (incl. interaction)

Public pension spending, % GDP, EU

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101214161820

2013 2020 2025 2030 2035 2040 2045 2050 2055 2060

Impact of dependency (no change in coverage, benefit ratio, labour market ratio)

actual forecast (incl. interaction)

Public pension spending, % GDP, EU

Coverage: (pensioners)/(population 65+) Labour market: employment (=> GDP) Benefit ratio: (average public pension)/(average wage)

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101214161820

2013 2020 2025 2030 2035 2040 2045 2050 2055 2060Impact of dependency (no change in coverage, benefit ratio, labour market ratio)

with impact of change in coverage

with impact of change in coverage + labour market ratio

with impact change in coverage, labour market ratio + benefit ratio

actual forecast (incl. interaction)

Public pensions spending, % GDP, EU - decomposed

coverage

labour market

benefit ratio

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Public pensions in %GDP, Belgium

Public pensions in %GDP, EU

EU average conceals diversity: pension spending

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Public pensions in %GDP, Belgium

Public pensions in %GDP, EU

Public pensions in %GDP, BR2013, Belgium

Public pensions in %GDP, BR2013, EU

Benefit ratio Belgium

Benefit ratio EU

EU average conceals diversity: pension benefit ratio

Change in public pension benefit ratios, 2013 to 2060

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Benefit ratio 2013

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Change in pension benefit ratios, including private pensions

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Benefit ratio 2013

No change Benefit ratio all pensions

Intergenerational risk sharing: the social contract

• Pensions = managing uncertainty – by integrating adjustment mechanisms in the pension system – EU Commission: by indexing parameters of pension systems to

longevity (e.g. career requirements & retirement age)

• Options for risk sharing

– Conditional on macro demographic & economic context – Conditional on individual choice

Defined benefit Defined contribution

Musgrave rule

Fix… Pension Contribution rate (net) pension benefit ratio

Economic risk Risk for workers Shared risk Shared risk

Demographic risk Risk for workers Risk for retirees Shared risk

Intergenerational risk sharing: the social contract

• Pensions = managing uncertainty – by integrating adjustment mechanisms in the pension system – EU Commission: by indexing parameters of pension systems to

longevity (e.g. career requirements & retirement age)

• ‘Conditional certainty’ for the individual citizen

– Stabilize 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑛𝑛𝑎𝑎𝑛𝑛 𝑝𝑝𝑎𝑎𝑛𝑛𝑝𝑝𝑝𝑝𝑝𝑝𝑛𝑛 𝑝𝑝𝑛𝑛𝑖𝑖𝑝𝑝𝑖𝑖𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑛𝑛𝑎𝑎𝑛𝑛 𝑝𝑝𝑛𝑛𝑖𝑖𝑝𝑝𝑖𝑖𝑎𝑎 𝑎𝑎𝑖𝑖𝑛𝑛𝑝𝑝𝑎𝑎𝑎𝑎 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑎𝑎𝑛𝑛𝑝𝑝𝑝𝑝𝑛𝑛

(Musgrave Rule)

– Conditional on macro demographic & economic context – Conditional on individual choice

Pay-as-you-go allows ‘defined ambition’, with point system

• Pension = (number of points) x (value of point) x (actuarial corrections) x (indexation to income growth)

• Number of points <= career

• Value of point ≈ f (average income employed)

Premised on a desirable and sustainable replacement rate for a ‘standard worker’ with a ‘normal career’; ‘normal career’ takes into account changes in demography etc.

• Positive / negative corrections ≈ f (career)

• Indexation ≈ f (growth real incomes), with flexibility

Pay-as-you-go allows ‘defined ambition’, with point system

• Pension = (number of points) x (value of point) x (actuarial corrections) x (indexation to income growth)

• Number of points <= career

• Value of point ≈ f (average income employed)

Premised on a desirable and sustainable replacement rate for a ‘standard worker’ with a ‘normal career’; ‘normal career’ takes into account changes in demography etc.

• Positive / negative corrections ≈ f (career)

• Indexation ≈ f (growth real incomes), with flexibility

Pay-as-you-go allows ‘defined ambition’, with point system

• Pension = (number of points) x (value of point) x (actuarial corrections) x (indexation to income growth)

• Number of points <= career

• Value of point ≈ f (average income employed)

Premised on a desirable and sustainable replacement rate for a ‘standard worker’ with a ‘normal career’; ‘normal career’ takes into account changes in demography etc.

• Positive / negative corrections ≈ f (career)

• Indexation ≈ f (growth real incomes), with flexibility

Pay-as-you-go allows ‘defined ambition’, with point system

• Pension = (number of points) x (value of point) x (actuarial corrections) x (indexation to income growth)

• Number of points <= career

• Value of point ≈ f (average income employed)

Premised on a desirable and sustainable replacement rate for a ‘standard worker’ with a ‘normal career’; ‘normal career’ takes into account changes in demography etc.

• Positive / negative corrections ≈ f (career), given social stratification of age of entry and healthy life yearsty

Pay-as-you-go allows ‘defined ambition’, with point system

• Pension = (number of points) x (value of point) x (actuarial corrections) x (indexation to income growth)

• Number of points <= career

• Value of point ≈ f (average income employed)

Premised on a desirable and sustainable replacement rate for a ‘standard worker’ with a ‘normal career’; ‘normal career’ takes into account changes in demography etc.

• Positive / negative corrections ≈ f (career)

• Indexation ≈ f (growth real incomes), with flexibility

‘Defined ambition’ : in between DC and DB

Two objectives: • Target replacement rate for ‘standard worker’ with ‘normal

career’

& stabilisation of income ratio pensioners/employed

• Stabilisation of the contribution rates on earned income

⇒ Postponing retirement

⇒ ‘Alternative’ funding (tax shift)

‘Defined ambition’ : in between DC and DB

Two objectives: • Target replacement rate for ‘standard worker’ with ‘normal

career’

& stabilisation of average income ratios pensioners/employed

• Stabilisation of the contribution rates on earned income

⇒ Postponing retirement (flexibility in pension system, but !)

⇒ ‘Alternative’ funding (tax shift)

Funded pensions in a supplementary second pillar

• Why funding? => diversification of risk

• Law on Supplementary Pensions, 2003 – ‘Democratization’ of supplementary pensions – Sector approach: coverage of SME – Embedded in social dialogue – Mobility – Guaranteed minimal return

Sustainable reform…

• Requires large consensus

• Based on sense of common purpose: defined ambition

www.frankvandenbroucke.uva.nl