Opinion of the Economic and Social Committee on the 'Green Paper from the Commission on Supplementary Pensions in the Single Market` (98/C 73/28)

On 21 April 1997 the European Commission decided to consult the Economic and Social Committee, under Article 198 of the Treaty establishing the European Community, on the 'Green Paper from the Commission on Supplementary Pensions in the Single Market`.

The Section for Industry, Commerce, Crafts and Services, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 3 December 1997. The rapporteur was Mr Byrne, and the co-rapporteur was Mr van Dijk.

At its 350th plenary session (meeting of 11 December 1997), the Economic and Social Committee adopted the following opinion by 92 votes to two.

1. Introduction

1.1. The Commission has launched this green paper to draw attention to the significant demographic changes occurring in the EU and the implications of these changes for state pension arrangements.

1.2. Over the last few decades a decline in the birth rate has been accompanied by an increase in life expectancy. Consequently it is estimated that the current ratio across the EU of four people of working age to support each pensioner will, by 2040, have reduced to two people of working age to every pensioner.

1.3. The potential budgetary implications of these demographic changes on state pension arrangements, if no corrective action is taken, would be considerable. For example, over the period 1995 to 2030 the weighted average of pensions expenditure to GDP ratios in 11 Member States for which projections are available will increase by 3 to 4 percentage points.

1.4. In fact 88 % of all pensions paid in the EU are accounted for by state pensions which are funded on a pay-as-you-go basis. Demographic changes are important factors which are a burden on pay-as-you-go schemes.

1.5. Even the figure of 88 % does not tell the full story as it is the average across the EU; the position in individual Member States varies widely. For example, from Table II of the green paper it can be seen that, while pension fund assets represent 20 % of GDP for the EU against 59 % and 45 % respectively for the US and Japan, within the EU two Member States, the Netherlands and the UK, are at one end of the scale at c. 80 %, whereas many Member States have ratios in single digits.

1.6. The differences in approach between Member States can be clearly observed from Tables 1 and 2 attached to this report. In Table 1 the ratio of mandatory state pensions to earnings (1½ times national average earnings) are shown and it can be seen that Ireland, the Netherlands and the UK are at the bottom of the table ranging from 31 % upwards, whereas Portugal, Spain Italy and Greece are in excess of 70 %. In Table 2 supplementary pensions are also included and as a result the ratios - although still showing differences - are much more closely aligned.

1.7. The payment of adequate pensions to persons in retirement is a cornerstone of the social structure in the EU. In view of the threat posed to these pensions by the forecast demographic changes, the ESC welcomes the Commission's initiative in addressing this issue. The development of the problem will be gradual, but the earlier corrective action can be commenced, the more likely it is to be successful.

1.8. In summary the ESC notes that pension practice varies greatly as between Member States and that it is not the intention of the Commission to proscribe a detailed course of action which Member States should follow.

2. Action options

2.1. The ESC notes from the Commission's introductory statement to the green paper:

a) that Member State's social security schemes (Pillar 1) will continue to provide the bulk of pension payouts;

b) that Pillar 2 (occupational pension schemes) and 3 (life insurance based - predominantly - personal pension plans) schemes discussed in the paper are not a panacea for tackling the difficulties caused by demographic change;

c) consistent with the principle of subsidiarity, it is for Member States to decide on the role they wish each of the three pillars to play in providing retirement income.

2.2. The ESC endorses the Commission's analysis outlined in 2.1 above and states that the Committee's major concern is that appropriate steps are taken to protect the expectation of European citizens that they will enjoy reasonable pensions in retirement. The ESC would stress that the viability of retirement arrangements, both private and public, depends not solely on demographic factors but also on the economic, sociological and legal environment, for example, high unemployment has a negative impact.

2.3. Given the importance of Pillar 1 schemes Member States should seek ways to improve the sustainability of these schemes. The ESC notes that some Member States have already initiated modifications to their schemes with this objective in view and it is important that this process continues.

2.4. Supplementary pension arrangements are nevertheless growing in importance and the ESC agrees on the need above all to provide a legally secure environment for their operation.

2.5. There are two main routes by which supplementary pension arrangements are normally provided:

a) pension arrangements linked to employment, normally financed through either book reserves of the enterprise or funded via external investment in separate assets held under group life insurance or pension fund arrangements, and

b) individually insured arrangements.

2.6. While the level of use of Pillar 2 and 3 schemes is a matter for each Member State the rest of the green paper concentrates on how the single market can enable these schemes to operate more efficiently.

2.7. The ESC draws the Commission's attention to the existence of pay-as-you-go schemes which will have to be continued in order to provide the pensions of existing beneficiaries, and to provide for a very gradual transition to greater reliance on funded schemes, where funded schemes are being introduced to supplement pay-as-you-go schemes and to recognize the complementary nature of pay-as-you-go and funded schemes.

2.8. While drawing attention to the possible use of supplementary pension schemes the Commission points out there are advantages and disadvantages associated with both funded and unfunded pension arrangements. It should also be noted that any switch, however gradual, from pay-as-you-go to Pillar 2 or 3 schemes will involve more resources being devoted to pension provision since finance for existing commitments under the first pillar must be met while contributions are commenced to future funded schemes. Care should be exercised therefore to ensure that any initiatives on Pillar 2 and 3 can be sustained without undermining existing Pillar 1 commitments.

3. Chapter II Retirement provision and EU capital markets

3.1. The green paper highlights the significant differences in investment profiles which exist between the Member States in terms of the proportion of equities versus bonds (see Table 3). It points to the evidence that equities produce superior returns but questions whether the evidence is totally conclusive. However it does emphasize the dramatic reductions in long-term pension costs which relatively small increases in annual real rates of return can bring about.

3.1.1. There is also considerably disparity in the proportion of foreign assets held by pension schemes (see Table 4).

3.1.2. The green paper poses further questions about whether higher returns can be achieved without undue risk and whether EU capital markets can absorb the potentially large additional investment.

3.2. The ESC commends the comprehensive analysis set out in the green paper and offers the following comments:

3.2.1. Over the long term, pension liabilities increase in real terms because of the long term real increases in pay which, in turn, drive rising living standards. Past experience suggests that investment in real assets (equities and property) therefore provides a more appropriate match for pension liabilities than a fixed interest security.

3.2.2. The experience over very long periods in the past (see for example Table VI c attached to the green paper) provides impressive evidence of the beneficial real returns which equities can generate. Because pension investment is long term in nature short-term market fluctuations have little importance. As demonstrated in the green paper however, an increase of say 2 or 3 percentage points in the rate of annual return over a period of time can have a very material effect on benefits and/or costs.

3.2.3. Actuarial techniques have been developed which enable a pension fund to evaluate its asset mix against its liabilities and thus minimize risk by matching its investments to the age profile of its membership. Thus, a prudent manager reflecting actuarial advice, is likely to have a higher proportion of bonds in a fund with a mature membership than would be appropriate for a fund covering mainly young members. Diversification of investment in various asset categories, some of which are negatively correlated, is also used to minimize risk.

3.2.3.1. Stock markets enable investment to be spread across many industry sectors which are likely to perform differently at any point in time, and stock specific risk is managed by imposing a maximum investment limit on any individual security.

3.2.4. In regard to the ability of the EU capital markets to absorb the relatively significant funds which arise, it should first be noted that the funds would only become available over an extended period of time. It seems likely therefore the capital markets could and would develop to absorb the available funds as has happened for example in the US. More difficult to assess is the possible positive spin-off for the EU economies from this new source of investment.

3.2.5. Non-prudentially based investment restrictions which impose unjustified arbitrary limits on, say, equity investment or on non-domestic investment, can increase the risk of under-performance. Equally the ESC agrees that it is not the role of the Commission to advocate any particular investment strategy for pension funds. This is the function of the investment managers operating under appropriate supervision.

3.2.6. In summary the ESC believes that, subject to appropriate prudential controls being in place including supervision over the investment managers, higher returns can be achieved without undue risk and that EU capital markets are likely to develop sufficiently to absorb any additional investment funds.

4. Chapter III - Appropriate prudential rules for a single market

4.1. This chapter discusses what might be appropriate prudential rules in a single market for fund investment. The approach outlined in paragraph 36 seems an appropriate basis of regulation, subject to further refinements to be proposed by the Commission on which the ESC would ask to be consulted.

4.2. The ESC supports the policy objectives set out in paragraph 40 which seek to:

a) remove the barriers to the completion of the single market in investment services, and

b) provide freedom to invest assets of pension funds subject only to adherence to the 'prudent man` principle.

4.3. The ESC agrees with the Commission that this would be unlikely to trigger dramatic short-term changes in investment profiles. Fund managers tend to be conservative and are likely to adjust gradually to new investment freedoms. The introduction of the euro will facilitate cross-investment in participating Member States as currency matching considerations are eliminated.

4.4. The ESC fully supports the view that pension funds must be subject to appropriate prudential supervision. A key aspect of this would be to ensure that the supervision take particular responsibility for the control of risk. However the Commission poses a very important question when it asks whether there should be common rules for pension funds and insurance companies.

4.4.1. The ESC would, however, emphasize here that prudential rules must include an evaluation of liabilities using proper actuarial standards, and a close correlation between the return on assets and the extent of commitments. The ESC would also stress the need to involve members in the management of their pension fund and to ensure that the managers are obliged to provide members with information and access to advice.

4.5. The ESC points out that there is a fundamental difference between insurance companies and pension funds in that the former sell their services while in most Member States the latter do not. Also life insurance companies are subject to supervisory rules which apply to the total business of each company which includes a range of protection and investment products. However, the objectives underlying the investment of assets by pension funds and the investment policy adopted by life companies in respect of their pension contract liabilities should be broadly similar.

4.6. Because of the specific characteristics of pension investment, the ESC recommends therefore that separate rules should apply to pension investment. To the extent that insurance companies offer products which provide matching benefits to those provided by pension funds, then it may be necessary to modify the Life Insurance Directive to ensure that insurance companies do not suffer from any distortion of competition in relation to pension products. The rules applied to pension investments should, without diminishing the quality of protection, endeavour as far as possible to ensure that pension funds including those operated through life insurance companies operate subject to similar rules 'on a level playing field`.

4.7. The ESC believes that it is necessary if the Single Market is to be realised that freedom of fund management is established. With modern communications it is not so much proximity to the market which matters but the quality and depth of the fund-management team.

4.8. In regard to the way forward, the ESC believes that in this instance the adoption of a broad directive embracing basic principles along the lines described in paragraph 47 (option 3) would be appropriate.

5. Chapter IV - Facilitating the free movement of workers

5.1. In this chapter the Commission deals with the current barriers which impede free movement of workers. It notes that Community legislation has already removed the obstacles to cross-border mobility in respect of statutory pensions but the legislation does not cover supplementary pension schemes.

In November 1996 the High Level Panel set up by the Commission to examine this area recommended that initial Community legislation should only deal with three aspects of this issue:

a) preservation of acquired pension rights for members who move to another Member State,

b) cross-border payment of benefits due under supplementary pension schemes should be facilitated in other Member States, and

c) workers temporarily seconded by their employer to work in another Member State should be permitted to remain in his existing supplementary scheme.

The ESC welcomes the recent action of the Commission in adopting a proposal for a directive dealing with these issues and is currently drafting an opinion on it.

5.2. Remaining issues identified by the Commission and not dealt with by the high level panel include:

a) qualifying conditions for acquiring rights - in particular the long period of years necessary in some Member States;

b) difficulties with transferability of vested pension rights from one Member State to another;

c) tax difficulties linked to acquiring pension rights in more than one Member State (taxation is also dealt with in Chapter V);

d) the position of a worker temporarily employed in another Member State, other than on a seconded basis.

5.3. The ESC agrees that the issues outlined in point 5.2 represent important obstacles to the free movement of workers and are inconsistent with the concept of a single market. In particular if it is accepted that pensions are a form of deferred pay earned during the years of work, then it is unreasonable to impose long vesting periods, e.g. up to 10 years, before pension rights are acquired.

5.3.1. When changing pension schemes, members must be given full information about the option of transferring rights by capital transfer where this is compatible with the funding methods of the schemes concerned. The ESC also feels that in any proposed directive on the coordination of pension schemes, consideration should be given to mechanisms for protecting the purchasing power of preserved pensions.

5.3.2. The ESC believes that employees temporarily seconded by their employer to work in another Member State with the company or an affiliate should be able to retain their membership of their home pension scheme, but it considers that it would not be reasonable to require an employer to retain in membership employees who resign to take up employment not connected with him in another Member State.

5.4. In its Opinion adopted on 15 May 1992 on supplementary social security schemes (rapporteur: Miss Maddocks) the ESC recommended that the Commission explore the possibility of devising the format and rules of a model European occupational pension scheme which 'European` companies could use to cover their employees in all Member States; the ESC now repeats this recommendation.

5.5. The High Level Panel proposed the setting up of a Community Pensions Forum to discuss problems relating to pensions which hamper the promotion of the free movement of persons. The ESC is still hesitant about this proposal. At the moment there is an Advisory Committee on migrant workers which discusses social security problems within the context of the free movement of workers. And secondly such proposals can be discussed as part of the social dialogue, especially if supplementary pensions are regarded as deferred wages. The Committee would suggest that within the Advisory Committee on migrant workers a special working group be established to propose as soon as possible solutions for the actual problems with supplementary pensions

6. Chapter V - The importance of taxation for supplementary pensions

6.1. In this chapter the green paper sets out the importance of taxation in the provision of pensions. In most Member States, pension schemes enjoy tax privileges in regard to the accumulating fund, which is offset by the taxation of the actual pension ultimately paid to beneficiaries.

6.1.1. However the current tax rules can constitute a barrier to the freedom of movement of workers. The green paper asks for views as to how this situation might best be improved and in particular if Community legislation is appropriate and feasible.

6.2. The ESC supports the broad principle that pension funds as they accumulate represent a deferred benefit for scheme members and that taxation should similarly be deferred until the benefits are paid out to individual members.

6.2.1. While fully respecting the principle of subsidiarity, the ESC believes it would enhance the mobility of workers if a common set of rules for the recognition of pension schemes domiciled in one Member State, in relation to all other Member States, could be developed for approval by the Council.

6.3. In general Member States give tax exemptions to pension schemes in the expectation that they will receive tax on the benefits ultimately paid. It is important that the common rules do not significantly distort this principle; in the next century pensioners will represent a significantly higher proportion of the total population and it would become progressively more difficult to finance government expenditures if taxation on pensioners' income was not available.

6.4. To deal specifically with the issue of worker mobility, the common rules might therefore have the following characteristics:

a) Tax relief on contributions to a non-domestic pension scheme should be granted on a like basis with a domestic scheme. This concession should only be available for a limited period to facilitate short-term work transfers (workers on secondment) - it is not uncommon for employees of a multinational to work successive periods of, say, three to five years in a number of different countries, but with the intention of ultimately retiring in their home country. Considerable problems and inequities are created if workers like these are forced to change pension scheme each time they move.

b) On a permanent transfer to another Member State, the worker would have the option to retain his accrued benefits in his previous scheme or where funds exist to transfer these accrued benefits into an approved scheme in his new country of residence. It is also important that the worker would have access to appropriate information and advice.

c) Pensions paid would be taxed in the country of residence. Although this could pose some problems for those Member State for whom the loss of tax revenue would not be compensated by movement of pensioners.

6.5. While it would be beneficial if a Community-wide approach to removing these barriers could be found, it is probably more realistic to rely on bilateral or multilateral arrangements if progress is to be made. This could be facilitated if the Commission developed a model set of tax rules relating to pension provision.

7. Conclusions

7.1. The ESC welcomes the green paper and reiterates its concern that timely action be taken to ensure that adequate pension provisions will be available to those retiring in the next century.

7.2. It agrees that supplementary pensions will have an important part to play in providing for pensions in the future.

7.3. The ESC acknowledges that progress on supplementary pensions has been, and will continue to be, complicated by the different approaches traditionally adopted in the Member States. It is clear that not only does the use of supplementary pensions vary widely but, where supplementary pensions are well established, a more liberal investment policy exists in relation both to equities and derived financial instruments, and to foreign investment. Conversely in those countries where supplementary pensions are in their infancy, there is a much higher level of bond investment at the expense of equities and foreign assets.

7.4. Although not strictly relevant to the specific pensions issue, the increase in investment funds available is likely to have further beneficial economic effects in EU Member States.

Brussels, 11 December 1997.

The President of the Economic and Social Committee

Tom JENKINS

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