EU report warns of private pension risk

A new report published by the European Commission yesterday (20 October) warns that the increasing number of EU citizens moving to private pension schemes could find themselves receiving “inadequate” pensions. The situation could get worse as the financial turmoil spreads to the real economy.

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Confronted with ageing populations and high levels of public debt, EU and national authorities have pushed for the adoption of private pension schemes as an alternative or a complement to state-managed pensions (EurActiv 27/08/08).

Direct contribution (DC) schemes, under which retired workers are paid according to their personal savings, are gradually replacing the traditional direct benefit (DB) schemes, in which longevity and financial risk are covered by governments through contributions made by those currently at work.

While providing all citizens with DB schemes is no longer a sustainable option, the problem with DC schemes is that they do not guarantee an adequate pension. The EU institutions are studying this complex issue and are promoting an increased level of financial education to allow savers to take informed decisions (Links Dossier).

More on this topic:

LinksDossier: Financial education

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“Future pension levels are subject to a number of uncertainties and risks: career break risks, longevity risks, inflation risks and financial risks,” warns the report.

The current turmoil inevitably increases such uncertainty. Pension schemes linked to stock exchanges will be affected by the recent downturn of global shares, implying lower investment returns for more prudent savers or loss of deposits for more risk-prone investors.

The high inflation rates recorded by Eurostat in the past months (3.6% in the euro area in September, compared to 2.1% last year and a European Central Bank target of 2%) also mean that even pensions linked to fixed returns will be affected, as they are usually set at rates below inflation.

On top of this, savers could find themselves affected by non-financial consequences of the crisis. Indeed, the Commission predicted last week that GDP growth would be halved in 2009 as a result of the turmoil, implying lower consumption and job losses. In this regard, the EU executive’s report stresses that the impact of career breaks on pension levels under direct contribution schemes “can be more significant”. The study does not exclude the use of minimum income provisions to cover these gaps and ensure a sufficient pension income for those temporarily without a job. But it stresses the “significant costs” of such an approach.

The European Parliament also underlined this risk in a draft resolution prepared by German Conservative MEP Gabriele Stauner and approved at committee level in October. MEPs urged member states to “take serious account of the need to redesign traditional pension systems which are based on systematic risk assessments and the assumption of a typical, standard life course, given that the assumed standard life course is changing rapidly and so-called patchwork biographies will become more and more common”.

“We need to continue to consider whether a better legal framework is needed to ensure that workers get the best pensions,” stressed Social Affairs Commissioner Vladimír Špidla, presenting the report.

Notably, the Commission highlights the need to keep charges for private pensions low, arguing that if they are too high savers could end up receiving too little once they retire. “For instance, a 1% annual charge over 40 years of contributions would represent 18% of total contributions by the time of retirement,” reads the EU executive’s press release.

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