Financial Sustainability of Pension Systems in the European Union

Abstract

1. Introduction Improvements in health and welfare have increased life expectancy in the world. Increasing life expectancy together with low fertility rates (in other words population ageing) is one of the greatest challenges that countries are facing now and in the future. Public pension spending increased 6.4% in the OECD (Organisation for Economic Co-operation and Development) between 1980-2007 in parallel with growing retired population (Adema, et al., 2011, p.3). Public spending on pensions and other retirement benefits in OECD countries grew on average 17.5% faster than national income between 1990 and 2005 (OECD, 2009, p.2). It will become harder for the governments to sustain fiscal sustainability of public pension systems in the long term. Life expectancy at birth for males is projected to increase by about 8 years over the projection period, from 76.7 in 2010 to 84.6 in 2060. Life expectancy at birth is projected to increase by 6.5 years for females, from 82.5 in 2010 to 89.1 in 2060 in the EU (European Union). On the other hand the total fertility rate is projected to rise from 1.59 in 2010 to 1.64 by 2030 and further to 1.71 by 2060. The EU population is projected to increase (from 502 million in 2010) up to 2040 by almost 5%, when it will peak (at 526 million). Thereafter, a steady decline occurs and the population shrinks by nearly 2% by 2060. Nonetheless, according to the projections, the population in 2060 will be slightly higher than in 2010, at 517 million. The age structure of the EU population is projected to change dramatically during projection period. It is projected that the population aged 15-64 will drop by 14%, and the population aged 65 and above will almost double, rising from 87.5 million in 2010 to 152.6 million in 2060 in the EU. Consequently the demographic old-age dependency ratio (people aged 65 or above relative to those aged 15-64) is projected to increase from 26% to 52.5% in the EU as a whole over the projection period (European Commission, 2012a, pp.24-27). The purpose of this study is firstly to present the public pension systems briefly and then evaluate the financial sustainability of public pension systems in consideration of pension expenditures, ageing and the Eurozone sovereign debt crisis. 2. Structures of Pension Systems in the EU Member Countries Pension systems in EU-27 differ from each other in a lot of ways such as general and financial structures, pension schemes, eligibility requirements, and conditions of normal and early retirements, historical past, income sources, economic development levels and demographic structures of member countries. However pension systems of many EU member countries rests on three pillars which are called as public pensions, funded occupational pensions and personal pension plans. The share of these pillars within the overall architecture varies from country to country. Classifications of mandatory parts of the pension systems of EU member countries in accordance with OECD are given in Table 1. EU countries generally use multiple programs which are designed to ensure pensioners achieve some absolute, minimum standard of living. Similarly the mandatory second-tier, savings components of pension systems are different across EU countries. Defined benefit (DB) plans are provided by the public sector in 12 EU countries and by the private sector in the Netherlands. Defined-contribution (DC) plans are compulsory in 6 EU countries. In Denmark and Sweden, there are quasi-mandatory, occupational DC schemes in addition to smaller compulsory plans. The notional-accounts schemes (sometimes call defined-contribution plans (NDC)) used by 3 countries (Italy, Poland and Sweden) and points schemes used by 4 countries (Estonia, France, Germany and Slovak Republic). When the pension schemes in EU member countries are analyzed, it is seen that public pensions dominate the pension system mostly, occupational pension schemes are mandatory only in Austria, Netherlands; mandatory for public sector employees in Ireland, Malta, Spain; mandatory for only for selected professions in Portugal, Slovenia and quasi mandatory in Denmark, Sweden and it does not exist in 8 countries. …