Europe's pension reform plans face serious obstacles

EU pensions analysis: Political resistance to attempts to raise the pension age to increase the sustainability of public pension systems has been considerable, writes Kyran Fitzgerald

People walking along the Zeil shopping street in Frankfurt, Germany. The pension contribution rate of workers is set to rise from 18.6% to 22.3% of gross salary by 2045.

Europe’s population is aging fast. There are serious concerns about the future viability of State pensions at a time when the Continent’s business sector lacks dynamism and external challenges grow more daunting by the day.

Its lead economy, that of Germany — the European Union’s traditional engine and leader — is facing serious headwinds. Ironically, it is the future of its huge auto industry which now appears to be in doubt as a result of the rise of China’s Electric Vehicle sector.

Clearly, business as usual is no longer an option. The former European Central Bank head, Mario Draghi, has called for a major overhaul aimed at boosting the Continent’s competitiveness. He argues that innovation must be given priority. In particular, Europe’s savings must be put to more productive use.

Draghi has suggested that an annual investment of up to €800 billion in innovation will be required. Much of this will have to come from private sources given the fiscal burdens on national governments He warns that if such change does not occur, Europe will fall further behind the US and China as the AI revolution takes hold.

Increasingly, policymakers are looking to the pension industry and the funding it attracts as a source of business renewal.

The sector has tended to attract cautious financiers. Trustees are obliged by law to handle the funds entrusted to them with great care.

The result is that funds have flowed into “safe” investments from real property including offices, and Government bonds. The returns on many such investments have been poor as retail and commercial office investment values have been badly hit by the growth of Amazon remote shopping and home working.

Paradoxically, a herd effect has led to excess construction in key areas and some of the blame for this lies with an investment community that has been reluctant to commit to ventures with greater risk attached, but often larger potential rewards.

It is vital that returns are boosted at a time when charges for savers remain at a high level. A boost in investment returns would help to make the case to the public for private pensions.

A surge in the flow out of savings into funds could remove some of the pressure on the property market at a time when house prices are at elevated levels.

This flow would also take some of the pressure off the Pay as You Go State pension system.

The annual public pension bill has reached 10% of GDP in 17 of 27 EU states. It is at 16% in Italy. This is not sustainable.

At the same time, a minority of people — less than 25% of adult EU residents have an occupational pension. Less than 20% have a personal pension.

Pension reforms are at an early stage of development:

Jerry Moriarty, the CEO of the Irish Association of Pension Funds, is the current Chairman of the EU industry body, Pensions Europe. In a recent interview with the publication, European Pensions, he suggested that a lot is going on in Europe around the pensions policy agenda.

Initiatives around the protection of financial, data, and measures to promote the spread of pension takeup aimed at reducing the yawning gender gap are being developed.

National member states are pushing ahead with reforms. In Ireland, the current focus is on auto enrolment aimed at younger employees. AE is viewed as a means of promoting the savings habit.

Political resistance to attempts to raise the pension age to increase the sustainability of public pension systems has been considerable.

Germany is an interesting case in point. The Government has proposed a range of reforms including the establishment of an investment fund whose value is expected to reach €200bn within ten years. The contribution rate of workers is slated to rise from 18.6% to 22.3% of gross salary by 2045. It had been proposed that the State pension would fall from 48% to 45% of the average wage by 2040, but it should now be held at 48% until the 2030s.

David Pinkus of the Breughel Institute, says this will mean an increase in the burden on younger generations. He argues that the Government should enliven a “tame private pensions market” which has failed to take off because of the high cost of management. At present, more than 40% of German household assets are held in cash and bank deposits.

Across the EU, one-third of EU savings — €34 trillion in total — are held in bank deposits. “Funded pensions can activate savings to finance real investment and support growth,” says Pinkus.

Across Europe, pension funds have €5 trillion (€5,000bn) to invest. At the same time, Europe needs to finance climate projects and update its infrastructure. Matching the two goals must surely be a priority.

The EU has put in place what are known as pan-European pension products, or PEPPS. These are uniform EU wide products allowing a person to accumulate a pension and other benefits in a member state. The PEPP is portable EU-wide. The investor can use a provider in another European country.

Management fees should account for no more than one 1% of the assets under management.

To date, take-up since its 2022 launch has been limited. The regulatory body, EIOPA, the European Insurance & Occupational Pensions Authority has suggested some improvements in the design of the PEPPs.

One problem is the lack of uniform tax treatment across the EU.

Providers are concerned that existing products could be undermined.

The cost of living crisis has not helped.

EIOPA has suggested that occupational and personal pensions could be combined into a single product. It would allow the transfer of funds from other personal pensions into a PEPP. The 1% cost ceiling could be removed to bring more providers on board. It also suggests that auto-enrolment be introduced at EU level with younger workers in particular enrolled by into a company scheme from which they can opt out.

EIOPA insists that PEPPS core characteristics, simplicity, cost efficiency, transparency, mobility and flexibility should ultimately be a winning formula.

Such measures form part of a greater vision, that of an EU capital markets union. Mario Draghi, for example, has put this goal at centre stage. Supporters such as Sebastian Mack of the Jacques Delors Centre point out that currently a handful of EU countries have developed capital markets. This has hindered the ability of the financial sector to channel savings into high-tech start-ups, many of whom have moved their stock market listing across the Atlantic.

Ironically, resistance to further capital market integration is being led by states such as Ireland and Luxembourg which are keen to protect their financial sectors from central EU regulatory control.

Finally, a statistic worthy of mention.

EU pension fund invest less than one in five hundred of their assets in venture capital projects. US pension funds invest almost 2% — a huge gap.

In the view of reformers, it will be necessary to tackle market fragmentation so as to overcome risk aversion.