Private pensions a needed complement to state system

After years of delays and dialogue with the so-called social partners, namely representatives of employers and employees, which have not really got anywhere, the Greek conservative government has finally decided to bite the bullet and push forward with some modest reforms of the country’s social security system. However, it has failed to do something equally important: try to encourage people to take their standard of living after retirement into their own hands. According to the committee of experts on social security set up by the government, Greece paid some 23.5 billion euros or 12.5 percent of its gross domestic product (GDP) on pensions last year. The same committee estimated that the country will have to pay 32.7 billion euros in 2007 prices for pensions in 2015 if no reforms are undertaken. Demographics This is mostly the result of the so-called «demographics time bomb,» that is, the declining number of workers per pensioner, and, secondarily, the inefficiencies of the state «pay-as-you-go» (PAYG) system, where current employees support current pensioners, as well as the evasion of social security contributions by both employees and employers. The government has finally decided to proceed with an overhaul of the state pension system, aiming at generating annual savings of some 309 million euros from 2018 onward as well as additional savings of 1.5 billion euros. Even if one accepts the figures at face value, especially the 1.5 billion euros – something that would be unwise given the fact that the grouping of the myriad pension funds into 15 will not result into any layoffs of administrative personnel and others – it is easy to predict that these measures will not suffice to address the problem. So, a few years from now, the same or another government will be forced to take additional, more restrictive measures to ensure the long-term viability of the PAYG system. It is not difficult to imagine what the new measures will be like. Most likely they will change some of the parameters of the system, namely the retirement age or/and the level of pensions. One way to do this would be to limit the real growth rate in state pensions. Another way would be to systematically raise the retirement age in line with increased longevity. According to officials at Fitch Ratings, Italy has adopted the second option and every five years the country takes a look at life expectancy, compares it with the retirement age, and adjusts the replacement rate accordingly. The latter is defined by pension entitlement divided by pre-retirement earnings. State obligations Of course, some people, including unionists, argue that the current PAYG system is sound, provided the state pays the more than 12 billion euros owed to state pension funds, effective measures are taken to combat evasion of social security contributions and new funding is provided to the system via the increased taxation of individuals in higher income brackets. This kind of thinking ignores the adverse demographics of the Greek population, where each woman gives birth to less than two children and fewer workers correspond to each pensioner as time goes by. It focuses instead on a more optimistic view of the situation. This is not what one would expect in a country with one of the highest public debt-to-GDP ratios in Europe and one of the highest GDP growth rates which has failed to address both the issue of indebtedness and the ailing social security systems in the European Union. So, even though the government’s modest present reform of the PAYG is in the right direction, it will not last for long because it does not do enough to address the roots of the problem and deal more effectively with its consequences. Relying on people’s better understanding of the country’s social security problem to gain public support is a noble and smart way for any government to tackle the problem, provided it has the officials who can explain it and communicate it effectively. Incentives? Still, it will be more difficult to convince someone who has a lot at stake if you have not given him or her the choice to improve their standard of living at retirement without relying entirely on the pension entitlement. It should be noted that Greeks derive more than 95 percent of their pension income from the PAYG system, compared to 50-60 percent in other European countries. The only way to do this is for the government to give Greeks generous tax incentives to begin their own private pension, perhaps including credits to those at lower income levels who cannot afford to put money aside. This way it would promote lifetime savings plans which would benefit the economy because they could fund investment spending more easily, as well as providing employees with a future income stream to supplement their dwindling state pensions. Too little Certainly, this cannot be done by allowing an individual to deduct only 1,200 euros per year from his/her taxable income as is the case right now. This amount has been exhausted by anyone who has bought an insurance plan for health or other reasons, so there is not really a tax incentive. The imposition of a stamp duty amounting to 2.4 percent of the insurance premium creates further disincentives. The state withholds 24 euros for every 1,000 euros, so the money left for investment is less. Of course Finance Minister Giorgos Alogoskoufis has vowed to do away with this stamp duty for life insurance plans from 2009 but this will not make much of a difference. In addition to tax incentives, this includes the provision of a simple regulatory framework which will aim at minimal compliance costs and fee structures to maximize the value of pensions. It should promote the efficient management of pension assets and economies of scale. Encouraging private pensions, the so-called third pillar, is a must for Greece and the Greeks who will face a less generous pension PAYG system in the years to come. The government must understand that necessary state pension reforms will be better accepted by society when there are more generous private pension schemes in place.