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Spain: The pension reform underscores the need for private savings

19 September, 2013

Source: http://www.fundssociety.com

The pension reform in Spain is in the mouth of politicians, trade unions and social agencies. Regardless of the different evaluations, the experts agree that the text puts on the table the need for citizens to become aware of the issue of the sustainability of the system and take steps toward private savings.

“All the changes and the application of sustainability criteria introduce an element of awareness about future public pensions and the fact that present day generations will not receive the same pensions as their parents,”
says Angel Martinez-Aldama, Director General of the Association of Collective Investment Agencies and Pension Funds (INVERCO). And they will therefore have to complete their pensions with private savings.

In this regard, the expert also believes that a key factor is the draft of the regulations, which will be published before the end of this year, 2013 and will come into effect in 2014, which states that the ministry of Social Security will send workers over 50 years of age a physical envelope containing an estimate of their future pension, which will force citizens to do their accounts. “With the information in hand, individuals will be able to organize their economies and citizens will realize that future savings are their own concern and not the concern of the State,” say other sources in the industry.

Sustainability factor

The reform aims to ensure the sustainability of the public pension system in Spain and help the country to meet the deficit targets set by Brussels. The changes designed by the Government are somewhat milder than the initial proposal of the Committee of Experts, and are based on two main pillars: the sustainability factor and the revaluation factor. The sustainability factor is a kind of automatic adjustment of certain pension parameters (such as the years of contribution, the retirement age or the initial amount of the pension) that are linked to the evolution of the life expectancy of citizens. It is a system which, with its own nuances and peculiarities, is already in place in countries such as Austria, Germany, Portugal, Greece and Denmark.

Thus, in the initial calculation of the pension, and once only, a corrective factor will be applied for calculating the new pensions, which will take into account life expectancy at that time and will be reviewed every five years. The purpose is that during the retirement stage the pensioner will receive the same contribution he made to Social Security during his working life “in order to avoid leaving financial burdens to future generations due to the increase in longevity,” explains Aldama. In other words, as life expectancy increases, the amount the pensioner receives will decrease if he does not contribute more to the system. “The factor introduces elements of objectivity for making the system sustainable,” said Aldama. “The PAYGO system has to be adjusted on the basis of the population and its aging. This is the purpose of the multiple reforms that have taken place in Spain, since 1985 to the present, including the 2002 and 2011 reforms and the partial retirement reform last year,” he adds. “The public system cannot be maintained with the current population pyramid and the evolution of the active population. It is a matter of necessity,” other experts say.

This change will be introduced as of 2019. “Brussels asked Spain to speed up the indexing of pensions: the 2011 reform established the introduction of these changes in 2027, but they will now be brought forward to 2019,” says the expert. Other parametric changes already considered in the 2011 reform that could be accelerated now are the increase in the number of years of contribution necessary for receiving the entire public pension (from 35 to 37), the increase in the retirement age to 67 – progressively until the year 2027, or the extension of the period of calculation of future pensions from the current 16 years to 25 years – also progressively up to 25 years in 2022, but without ruling out further increases in the future, according to Aldama.

The weight of State accounts

The second pillar on which the reform is based is the revaluation factor, which aims to dissociate the annual review of pensions from the evolution of the inflation rate: inflation will now be just another reference, but the evolution of the economy, the public deficit and Social Security revenues and expenses will also be taken into account. The Spanish Government would consider a period of 11 years (the immediately preceding six and the following five) for applying these criteria, instead of taking a single fiscal year as a reference.

The Government proposes establishing a minimum floor of annual revaluation of about 0.25%, with which pensions would never fall nominally and would also not be frozen, but if their adjustments are less than that year’s inflation, there would be a loss of purchasing power for the pensioner. There would also be an increase ceiling equivalent to the CPI plus 0.25%.

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