Recent developments in Spanish pensions

The rhythm of developments on the Spanish pensions scene is perhaps best characterized by the Spanish saying sin prisa, pero sin pausa, which is loosely translated into English as “don’t rush, but don’t dawdle either.” In line with this, successive Spanish governments have found that it is better to carry out pensions reforms with the cooperation of business and the unions, rather than implementing such changes unilaterally, thereby provoking general strikes such as those of recent years in France and Italy.

The Toledo Pact

The principal axis of Spanish pensions reform to date has been the so-called Toledo Pact, signed in 1995 by all political parties and ratified by the unions in 1997. The Toledo Pact brought about changes such as extension of the period used in calculating state retirement benefits, automatic inflation-proofing of state pensions, and funding reform for the social security system, including the creation of a “reserve fund” to guarantee short-term payment of state pensions in times of deficit. The Pact has also brought in a new system for encouraging late retirement that came into force in 2002.

In September 2003, the Toledo Pact was revised to set the framework for pensions reform over the next five years. The new text contains 22 recommendations and represents the consensus reached between political parties and unions during the talks to renew the Pact. This need for multilateral support and the proximity to the general elections held earlier this year means that the latest version of the Pact contains weak measures rather than robust reforms, with many recommendations simply a continuation of those of the original Pact.

The new recommendations include proposals for irregular career patterns (due to unemployment, or temporary or part-time working), and for limiting the use of early retirement programs by employers. Overall, the Pact notes the urgent need to address Spain’s currently high level of unemployment, with particular emphasis on part-time working, together with extending working life on a voluntary basis and promoting flexible retirement.

Demographic time bomb

Spanish state pensions continue to be generous compared to many European peers, despite the tentative steps toward reform taken via the Toledo Pact. The Spanish research association ICEA provides an example of a 30-year-old worker with a current annual salary of €50,000. According to ICEA’s assumptions, the social security system is currently projected to provide this person with a pension equivalent to 30% of final salary on retiring at age 65. This percentage falls to 17% for those on a current annual salary of €90,000. Workers on salaries of €15,000, however, are said to expect a state pension representing 85% of final salary.

Real reform to cut back state benefits will need to come sooner or later, as falling birth rates, projected increases in life expectancy, and the aging of the Spanish population confirm that funding such high levels of state benefit will become prohibitive. Calls for urgent reform have come from many quarters, including the OECD and the European Central Bank, while the European Commission (EC) has chided the Spanish government on its slow progress in this regard.

A report for the EC carried out towards the end of 2003 by Allianz Dresdner Asset Management projects Spain to be the EU country with the highest state pension costs by 2050. As a percentage of GDP, state pension costs are estimated to rise from 9.4% in 2000 to 17.3% in 2050. The dependency ratio is projected to increase from 25.5% to 60% by 2050, topped only by Italy at 61.5%. The report refers to Spain’s “immense demographic problem” and calls for urgent reforms, with the measures taken so far dismissed as insufficient. The Government has countered that the figures do not fully account for the effects of projected immigration levels, and notes that until 2015 the state pension system will be over-funded. However, it is precisely at this point that the first generation of “baby boomers” is due to begin drawing pensions.

Occupational pension provision

With most Spanish workers therefore continuing to look to the state for their retirement income, pension provision by employers is mainly limited to multinationals and large domestic companies, and in many cases arises out of collective agreements. Figures released by ICEA show that just 4% of Spanish workers are covered under some form of company pension scheme, with just 3% of all pensions in Spain being derived from occupational arrangements.

Spanish insurers’ association UNESPA (Unión Española de Entidades Aseguradoras y Reaseguradoras) has further underlined the low level of coverage, noting that around 3.5 million workers are currently employed by the 0.05% of companies where it is viable to establish a pension scheme (defined by UNESPA as companies with 500 or more employees). Another 8.5 million workers are employed within companies where occupational pension provision is not currently viable. UNESPA has called for the legislation governing private sector pension provision to be changed to encourage and enable more companies to set up occupational schemes.

This situation has led to increasing calls for the Government and business to come together to promote development of occupational pension schemes in Spain. In particular, measures to incentivize small- and medium-sized employers to establish schemes are most important. In line with this, the revised Toledo Pact recognizes that the number of workers currently covered by private sector pension arrangements is insufficient. The Pact recommends that company schemes should be encouraged and extended to cover more of the active population.

Civil servants’ scheme

An important first step toward this goal came near the end of 2003 when a defined contribution pension plan to cover state employees was announced following agreements with trade unions. The plan will cover over 500,000 civil servants, and on this basis will be the largest occupational scheme in the country. This is a significant move as establishment of the plan is seen by many industry commentators as a signal from the Government for the wider development of occupational pension provision, with the plan design inevitably likely to represent a benchmark for company schemes.

Benefits will be provided on old age retirement, ill-health retirement, and death. The Government is to contribute 0.5% of salaries each year. Participants must have a minimum of two years’ service to join the plan, and may make additional voluntary contributions. On leaving service after four years, the funds may be left invested within the plan. The Government hopes that within two years some 2.1 million civil servants from central, regional, and local authorities will be covered by occupational pension schemes. Local authorities will be free to set up their own schemes, but may not exceed the contribution limit of 0.5% of salaries.

External funding and tax-approved plans

Traditionally, most occupational pension arrangements were book-reserved, however, the legislation in recent years outlawed this practice for most companies and forced them to move to external funding of schemes. According to the Ministry of the Economy, some €17,000 million of funds were “externalized” over the period to the deadline of November 2002.

The vehicles allowed for external funding of pension liabilities are group insurance arrangements and tax-approved occupational pension plans. The latter offer tax advantages relative to the former, but are relatively inflexible and require a level of employee participation in running the plan that is viewed as unacceptable by many employers. This led many companies either to opt for group insurance arrangements, where they can retain more control and flexibility, or to use tax-approved plans accompanied by a change from defined benefit to defined contribution, shifting investment risk onto the employees. According to figures released by ICEA, of those plans that were “externalized” by companies in 2002, just 3% were defined benefit schemes. In many cases, defined benefit schemes have also chosen to restructure benefit formulae, de-coupling pension amounts from those of the state to protect against future cuts in state pensions.

However, pensions legislation passed in February of this year is set to introduce some flexibility into the rules governing the establishment and running of tax-approved occupational plans. Restrictions on plan administration and investment policy have been watered down, while the rules on early and partial retirement have also been made more flexible. Higher professional standards will now be expected of a tax-approved plan’s control commission (similar to a board of trustees), particularly with regard to investments. Actuarial and financial reporting on plan status will be required every three years, or annually in some cases. The new legislation is aimed at bringing Spain more into line with the European Pension Fund Directive, and a transitional period of a year has been set for plans to comply with the new regulations.

Of particular note is the change to the balance of power between employer and worker representatives on the control commission, which has now been set at 50/50, though this may be modified by collective agreement. This measure weakens what has been one of the main obstacles to the widespread use of tax-approved occupational plans in Spain, as under the original 1987 pensions legislation, effective control of such plans and their investment policy has been in the hands of worker representatives. In particular this has meant that companies have been reluctant to set up defined benefit tax-approved plans.

Early retirement programs

In recent years Spain has seen major early retirement programs affecting workers aged 50 or over undertaken by some of the country’s largest employers, such as Telefónica, Iberdrola, Altadis, and Renfe. Such large-scale early retirement programs have been seen as a rather abusive mechanism for radical restructuring, and have provoked some disquiet. In response, the revised Toledo Pact recommends that the Government place limits on such initiatives. In particular, where early retirement programs result in an increased burden on social security resources, they will only be allowed in properly justified cases of corporate restructuring.

Conclusion

It seems clear that the shifting sands of the Spanish pensions arena will continue to move for a long time to come, with the pressure to cut state benefits and the encouragement of personal and corporate provision likely to represent the major undercurrents driving pension policy. Employers will need to stay in tune with these trends, and more generally, with a legislative, demographic, and labor environment in continuous evolution, so as to take advantage of the opportunities presented and maintain competitive advantages.