Europe faces a ticking timebomb from its burgeoning retirement liabilities, according to a new study.
Continental European countries will need to encourage development of private, advanced-funded pension systems or face a crisis in paying for future retirement benefits, warns the Federal Trust, a London-based think tank dedicated to European Union issues.
"This is a crisis that has to be faced," said Dick Taverne, a member of the trust, which urged Europe to adopt a public-private partnership to provide future retirement benefits. "If nothing is done soon, the prospect is pretty bleak."
The problem will heighten for employers, as nations attempt to shift the burden of providing retirement income to the private sector.
But a second study warns employers face serious threats to their ability to provide for their workers' retirements.
Any worsening of demographic trends, increased taxes on pension contributions and investment returns, a low-inflation environment, and growing government mandates to provide benefits would erode pension fund surpluses and would hurt corporate finances, according to the report by AMP Asset Management PLC and First Consulting, both based in London.
The AMP/First Consulting report urged employers to lobby more on retirement issues, more carefully monitor changes, focus greater attention to asset-liability matching, and consider shifting to defined contribution plans.
While unearthing little new information, the Federal Trust report provides a concise and compelling argument for reforming the current system.
The combination of falling population rates and increasing longevity is imposing an ever-increasing burden on state pension systems. By 2040, the ratio of retirees to active workers - defined as from age 15 to 64 -- will double, placing an impossible tax burden on workers, according to the Federal Trust report.
Without changes, pension contributions might have to double, said the report, titled "The Pension Time Bomb in Europe."
The problem actually is worse than it appears, Mr. Taverne said.
The actual working population is smaller than portrayed, he explained. In many countries, people don't start working until after age 20, while Europeans tend to retire early. While nearly 89% of Europeans, age 50 to 54 were employed in 1991, only 72.7% of those age 55 to 59 and 37.1% of those age 60 to 64 were actively working.
The so-called dependency ratio - retirees divided by workers - might be 20% higher than the official figures, the report said.
European states might have to look at substantially reducing benefits or increasing taxes to pay for those benefits. But higher taxes would hurt corporate profits, raise unemployment, boost inflation and generally reduce the global competitiveness of European industry, the report said.
Greatly lowering benefits is not politically feasible. While some countries, such as the United Kingdom, Germany and France, have made some benefit reductions, cuts generally are difficult. Already, a Pensioners' Party won 6% of the vote in the Netherlands Parliament, while threats of substantial state pension cuts in Italy resulted in a general strike.
That situation will worsen, as the number of people age 50 and older grows to nearly half of the population. "They will be a very powerful gray army," Mr. Taverne said.
The ensuing crisis led Federal Trust researchers to call for greater adoption of private, advanced-funded pension systems. The report leans in favor of compulsory systems, as have been adopted in Australia, Switzerland and Chile.
Now, only Britain, the Netherlands and Ireland have major pension systems among European Union states. Other states, such as Italy, France and Spain, are debating legislative proposals to encourage private pension plans, but have not yet acted.
The advantage of such systems is they reduce labor costs, providing better benefits at a lower cost than through social security systems; increase savings and investment; and boost the liquidity of capital markets, the report said.
The cost of a transition to private funding, however, can be expensive, as one generation could face the burden of paying benefits for current retirees as well as saving for their own retirement.
The Federal Trust report cites a plan outlined by the Dutch Central Planning Bureau that would move gradually toward private plans. Essentially, the agency proposes a modest increase in retirement age and phasing in funded plans financed by contributions equal to 3% of wages.
The bureau estimates that by 2040, private defined benefit plans would provide about 20% of retirement benefits and that European Union pension assets would grow to 50% of gross domestic product, up from 16% now.
To do their job properly, however, pension funds require freedom of investment, especially to invest across borders as a way to increase returns and diversify risk, the report said.
But the European Commission's draft directive on pension funds failed last year because of member state pressure to undermine the freedoms the commission sought to provide.
A dispute over letting states require funds to invest up to 80% of assets in domestically denominated assets was the most critical. But issues of regulatory control and efforts to impose maximum investment ceilings also touched off fights.
Ron Goldby, who developed the pension directive for the European Commission's internal market and financial services directorate, said the commission would take a tough line on any member state restrictions on investments that exceed the justifiable definition of "prudential." Restrictions on hiring non-domestic managers also would be challenged, he said.
The commission will challenge unacceptable restrictions in the European Court of Justice under its freedom of capital movements rules, he warned. Mr. Goldby solicited attendees at a Federal Trust conference to list restrictions that unduly impair investment activities.
But attendees believed the commission's response was inadequate. One questioned why the commission hadn't already challenged Germany's 20% ceiling on equity investments.
Mr. Goldby responded the commission is trying to determine its views on what qualifies as prudent.
In addition, Mr. Taverne said legal actions are too slow and unpredictable. He called for a renewed effort at drafting a directive.
Other experts similarly criticized a European Commission memo issued Dec. 17 when the draft directive officially was withdrawn. That communication also warned states could not impose unfair restrictions on pension investments and selection of money managers.
Experts said the memo has no teeth.
It's "not worth the paper it's printed on," said Brian Hill, a consultant with Pragma Consulting NV, Brussels.
Geoffrey Furlonger, head of the William M. Mercer's European Union practice in Brussels, said the memo would be helpful where a private party challenges the legality of a government restriction.