Brussels, 10 June 1997
Commission issues Green Paper on Supplementary Pensions in the Single Market
A Green Paper on Supplementary Pensions in the Single Market has been agreed by the European Commission. The Green Paper features an analysis of the social, economic and financial context of supplementary pension provision in the European Union (EU), and examines the role the Single Market for investment funds could play in improving supplementary pension provision. State pensions currently make up on average 10 per cent of EU Gross Domestic Product (GDP), but given the major demographic changes expected, this rate might increase by the year 2030 to around 15 per cent. State pensions account for the bulk of pension payouts, but other sources of supplementary retirement provision could offer an alternative way to maintain retirement income levels. "Coordination at Community level, on the basis of Single Market principles, could optimise the conditions for the development of supplementary pension schemes, and so help Member States to face one of the main challenges of modern society: ensuring sustainability of the welfare state while not reducing retirement income" said Single Market Commissioner Mario Monti.Although it is up to Member States to decide the balance between different pension schemes, the Green Paper asks whether appropriate EU prudential rules for pension and life insurance funds, the removal of obstacles to the free movement of workers related to supplementary pensions and appropriate taxation rules could facilitate the development of alternative sources of pension provision. Member States, the European Parliament and all interested parties are requested to comment by the end of 1997.
The Green Paper underlines that retirement provision is fundamentally important to each and every citizen of the European Union, and that all Member States are faced with pension policy decisions, notably as a result of the ageing population in the EU. The Green Paper therefore builds upon the Commission Communication on modernising and improving social protection in the European Union issued on 12 March this year, focusing on the need for funded supplementary pension schemes to be able to grow efficiently in the context of the Single Market and the freedom of movement of workers.
As the average age of the EU's population increases, and the ratio of people in work to retired people accordingly declines, this percentage is likely to increase significantly over the next 30-40 years. At present, there are 4 people of working age to support each pensioner; by 2040 there will be only 2.
Member States are looking for ways to ensure the sustainability of state schemes in the light of their increasing cost. Measures such as increasing state pension contributions and reducing benefits are already being taken. Several Member States have also introduced legislation to encourage funded supplementary pension schemes to develop.
The amount of funds invested on behalf of supplementary schemes is likely to grow considerably over the coming years as a result of initiatives taken in the Member States. The Green Paper looks at the role the Community can play to help these schemes take advantage of an efficient Single Market.
The importance of rate of return
A major area of discussion in the Green Paper is how to improve returns on pension fund investments without compromising their integrity. Even a very slight improvement of investment performance can give rise to major gains in financial returns over the 40 years or so of a person's working life, and so reduce significantly the cost of pension provision. For example, if one assumes that a supplementary pension aims to provide 35% of salary after a 40 year working life, and the real rate of return on assets is 2%, the cost of the pension contributions amount to 19% of salary. If the real rate of return is 4%, the cost falls to 10% of salary and if the real rate of return is 6%, the cost falls to just 5% of salary.
Improved returns on pension fund investments are in the interests not only of workers, who have to contribute out of earned income to their pension schemes, but also of employers who also contribute. Reducing the costs of supplementary pensions for employers can reduce the cost of employing a person and so directly contribute to creating jobs and to economic growth, in accordance with the Confidence Pact launched by Commission President Jacques Santer in 1996. Moreover, if low returns on pension fund investments are reflected in lower pensions rather than higher contributions, this serves to increase the burden on state pensions.
Restrictions on investments
The Green Paper analyses the extent to which restrictions on the selection of investments by pension funds (such as requirements to invest within a particular Member State or in government bonds) can seriously impair investment performance to the detriment of workers and employers. Whereas the Commission recognises that it is essential to protect workers who belong to pension schemes, it considers that alternatives to current investment restrictions could be introduced in Member States, giving fund managers greater flexibility in investment choice.
Greater flexibility for fund managers could over time have a significant impact on the European capital market, improving liquidity and increasing the availability of capital for investment in the Union to the benefit of job creation and competitiveness. The introduction of the euro will help in this process. Pension funds are already major institutional investors in certain Member States, and are currently worth a total of ECU 1,200 billion. There is potential for these to grow throughout the EU, not just in those States where they are already well established, and to make an even more important contribution to the European capital market and therefore to growth and employment.
The Green Paper notes that many Member States currently impose restrictions on pension fund investments on prudential grounds, in which cases pension funds tend to hold a high proportion of assets in government bonds. For example, Germany imposes investment ceilings on pension funds of 30% in equities (of which maximum 6% in non-EU equities), 25% in property (which must be in the EU), 6% in non-EU bonds, 20% overall in foreign assets and 10% in own assets.
The Green Paper recognises that protecting the future pensions of workers is of fundamental importance. Allowing fund managers the freedom to invest in a diverse range of instruments itself increases the security of the overall investment portfolio, particularly by the use of modern risk management techniques. However, the Green Paper also stresses the importance of appropriate prudential rules for Member States' supervision of pension and life insurance funds and fund managers which ensure a high level of protection for workers and their families against, for example, the effects of volatility in the market.
For the moment, there is no coordination at the EU-level of rules on prudential supervision of pension funds, so that Member States are free to apply their own rules as long as they do not violate EC Treaty rules on the free movement of capital. In view of possible EU-level action in this field, the Green Paper asks for comments on the extent to which quantitative restrictions on pension fund investments currently limit in practice the investment strategy of pension funds, and whether the effect of such restrictions may change should much greater funds be available for investment in the future.
The Green Paper also asks whether offering pension fund managers the freedom to offer services throughout the EU and to invest assets according to the 'prudent man principle', free of any requirements to invest in particular currencies or categories of asset, would offer adequate prudential security while offering the prospect of higher returns on investments. In addition, the Green Paper asks for comments on the idea that life insurance investments should be subject to the same rules as pension funds rather than the more restrictive rules currently applicable, and whether any current impediments provide actual barriers to the cross-border provision of services by pension fund managers.
The Commission seeks the view of interested parties on three alternative ways forward concerning coordination of prudential rules, namely relying on the introduction of the euro (rendering obligations to invest in one currency redundant, at least among participating countries), applying current Treaty rules on free movement of capital and free provision of services or adopting a harmonisation Directive which would apply Treaty freedoms in a manner agreed with the Member States.
Free movement of workers
The Green Paper also explores problems which affect workers who want to move to other Member States to work. At present, their mobility is curtailed by obstacles created by rules and tax provisions applying to pension schemes. Following the report of the high level panel on the free movement of workers, chaired by Mme Simone Veil, in November 1996, the Commission intends to introduce a proposal for a Directive in the near future to deal particularly with the preservation of accrued pension rights and the particular problems that apply to workers seconded to another Member State. The Green Paper also considers some of the other obstacles to mobility that were identified in its 1991 Communication on supplementary social security schemes (SEC(91)1332): qualifying conditions for supplementary schemes; the difficulties of transferring accrued rights to another Member State; tax difficulties where rights are acquired in more than one Member State; the case of those seeking to work for a short time in another Member State. The Green Paper asks for views on the best way to overcome these obstacles.
The availability of tax relief has a crucial influence on the design of individual pension schemes, and each Member State has rules to ensure they are properly targeted. These rules can also create obstacles to the free movement of capital, free movement of workers and the freedom to provide services within the Single Market. The Green Paper provides an opportunity for tax obstacles to be considered in the context of supplementary pensions and the role of these schemes in the promotion of enterprise and employment.
Copies of the paper can be obtained from the Commission, at the following address:
Rue de la Loi, 200
or via the EU's Europa World Wide Web site:
Comments should be addressed to the Director General, DGXV, no later than 31 December 1997.