Pension reform as defined ambition Frank Vandenbroucke University of Amsterdam

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1 Pension reform as defined ambition Frank Vandenbroucke University of Amsterdam Seminar Belgische Petroleum Federatie - Fédération Pétrolière Belge Brussels, 30 March 2017

2 Resources European Commission, The 2015 Ageing Report, European Economy 3/2015 Belgian Commission on Pension Reform Schokkaert, Devolder, Hindriks, Vandenbroucke, Towards an equitable and sustainable points system. A proposal for pension reform in Belgium, Discussion Paper Series Department of Economics, KULeuven, February Hindriks, Devolder, Schokkaert, Vandenbroucke, Réforme des pensions légales: le système de pension à points, Regards Economiques, numéro 130, Mars Schokkaert, Devolder, Hindriks, Vandenbroucke, Het pensioen op punten: naar een nieuw sociaal contract tussen jongeren en ouderen, Leuvense Economische Standpunten (forthcoming)

3 Dependency and demographic change in the EU Dependency (old age & total economic) Old age dependency ratio, EU Total economic dependency, EU Life expectancy at 65, EU Life expectancy at 65

4 Old age dependency ratio in Belgium [65+]/[20-64] Belgium Belgium with constant life expectancy

5 Old age dependency ratio in Belgium [65+]/[20-64] Postwar baby-boom: certainty Long-term impact migration & longevity: uncertainty Belgium Belgium with constant life expectancy

6 Dependency and demographic change in the EU Dependency (old age & total economic) Increasing uncertainty Old age dependency ratio, EU Total economic dependency, EU Life expectancy at 65, EU Life expectancy at 65

7 Public pension spending, % GDP, EU Impact of dependency (no change in coverage, benefit ratio, labour market ratio) actual forecast (incl. interaction)

8 Public pension spending, % GDP, EU Coverage: (pensioners)/(population 65+) Labour market: employment (=> GDP) Benefit ratio: (average public pension)/(average wage) Impact of dependency (no change in coverage, benefit ratio, labour market ratio) actual forecast (incl. interaction)

9 Public pensions spending, % GDP, EU - decomposed coverage labour market benefit ratio Impact 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)

10 EU average conceals diversity: pension spending Public pensions in % GDP, Belgium Public pensions in % GDP, EU

11 EU average conceals diversity: pension benefit ratio Public pensions in % GDP, Belgium Public pensions in % GDP, EU Public pensions in % GDP, BR2013, Belgium 6 45 Public pensions in % GDP, BR2013, EU 4 40 Benefit ratio Belgium Benefit ratio EU

12 Change in public pension benefit ratios, 2013 to Benefit ratio MT BE CZ AT DK DE NO LT NL UK SK HU SI PL BG IE SE RO EE HR LV LU IT EL FI CY PT FR ES Benefit ratio 2013 No change

13 Change in pension benefit ratios, including private pensions dk nl Benefit ratio MT FI BE CZ lt DK DE FR AT NO LT NL UK SK HU SI PL pl BG IE ee ro SE RO lv EE HR LV LU IT EL CY PT pt se ES Benefit ratio 2013 No change Benefit ratio all pensions

14 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 Defined benefit Defined contribution Musgrave rule Fix Pension Contribution rate (net) pension Conditional on macro demographic & economic context benefit ratio Conditional on individual choice Economic risk Risk for workers Shared risk Shared risk Demographic risk Risk for workers Risk for retirees Shared risk

15 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 nnnnnn pppppppppppppp iiiiiiiiiiii aaaaaaaaaaaaaa nnnnnn iiiiiiiiiiii aaaaaaaaaaaa pppppppppppppppppppp (Musgrave Rule) Conditional on macro demographic & economic context Conditional on individual choice

16 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

17 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

18 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

19 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

20 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

21 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)

22 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)

23 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

24 Sustainable reform Requires large consensus Based on sense of common purpose: defined ambition