Bovenberg, L.

van Ewijk, C.

English

There is a large variety of pension systems across EU members. This column argues for more private retirement saving as it is necessary to maintain old-age incomes and as it may also contribute to the stability of markets for government debt. But, it adds, governments should retain important responsibilities to prevent moral hazard due to intragenerational redistribution, to facilitate risk-sharing, and to minimise the agency issues due to financial illiteracy.<br/

International Migration, Integration and Social Cohesion online publications

UvA-DARE is a service provided by the library of the University of Amsterdam (https://dare.uva.nl)UvA-DARE (Digital Academic Repository)Private pensions for EuropeBovenberg, L.; van Ewijk, C.Publication date2011Document VersionFinal published versionPublished inVOX : Research-based Policy Analysis and Commentary from leading EconomistsLink to publicationCitation for published version (APA):Bovenberg, L., & van Ewijk, C. (2011). Private pensions for Europe. VOX : Research-basedPolicy Analysis and Commentary from leading Economists, 2011.http://www.voxeu.org/article/private-pensions-europeGeneral rightsIt is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s)and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an opencontent license (like Creative Commons).Disclaimer/Complaints regulationsIf you believe that digital publication of certain material infringes any of your rights or (privacy) interests, pleaselet the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the materialinaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letterto: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. Youwill be contacted as soon as possible.Download date:09 Mar 2023Private pensions for Europehttp://www.voxeu.org/print/7294[29-11-2012 12:10:08]Published on vox (http://www.voxeu.org)Home > Private pensions for EuropePrivate pensions for EuropePrivate pensions for Europe,There is a large variety of pension systems across EU members. This column argues for more privateretirement saving as it is necessary to maintain old-age incomes and as it may also contribute to thestability of markets for government debt. But, it adds, governments should retain important responsibilitiesto prevent moral hazard due to intragenerational redistribution, to facilitate risk-sharing, and to minimisethe agency issues due to financial illiteracy.aAThe current EU debt crisis makes more private funding of pensions desirable.First, more private retirement saving is necessary to maintain old-age incomes when public pensionsare being cut under pressure of the debt crisis.Second, private saving in pension funds may also contribute to the stability of markets forgovernment debt.Diverting risks from banks to pension funds reduces systematic risks in the financial system. Pensionfunds are better able to deal with macroeconomic risks than banks because pension funds adoptinvestment strategies with a long time horizon. Moreover, participants cannot withdraw their funds on shortnotice.One reason why the current Eurozone crisis has become so serious is that banks are major investors insovereign debt. Sovereign defaults would cause a banking crisis (see eg Wyplosz 2011). Non-Europeangovernments typically obtain more funding from unleveraged lenders, which makes the financial systemmore stable.There is a large variety of pension systems across EU members, some countries relying almost entirely onpay-as- you-go public pensions (first pillar) whereas others feature substantial funded private pensions(second pillar), see figure 1. These differences have contributed to the diverging performance of EUmember states in reaction to the financial shocks in recent years.Figure 1. Large variety in pension systems among EU membersPrivate pensions for Europehttp://www.voxeu.org/print/7294[29-11-2012 12:10:08]Source: Boeri et al (2006) and CEA (2007)The quality of domestic risk-sharing institutions is an important reason behind the European debt crisis.Countries with a solid pillar of funded occupational pensions on average are better able to cope withshocks than countries that rely primarily on public pensions, such as the southern European countries, andto a lesser extent Ireland and Belgium.Figure 2 depicts the default-risk premium on public debt – as measured by the credit-default-swap spread- in relation to the share of private funded pensions in total pensions.Figure 2. Default risk on public debt vs private share of pensions (October 2011)Source: Boeri et al (2006) and CEA (2007)A larger role for private pensions helps to diversify risks for citizens. Public pensions nowadays prove to bePrivate pensions for Europehttp://www.voxeu.org/print/7294[29-11-2012 12:10:08]less safe than often expected in the past. The current debt crises in southern European countries andIreland illustrate the vulnerability of the public finances and hence public retirement benefits to shocksaffecting the domestic economy. One may in fact view pay-as-you-go pension schemes as a claim ofcitizens on future provisions by their national government. This leaves citizens heavily exposed to thecredit risk of their own governments. With funded private pensions, credit risks can be diversified. Just asthe European banking system becomes more robust if banks diversify their holdings of public debt overvarious countries, so do European pension systems become safer if pension promises are backed byfinancial instruments of various countries rather than by a single country only.By stimulating private funding of pensions and limiting the scope of pay-as-you-go arrangements, memberstates of the EU help create a deeper, more integrated European capital market. Hence, pension saverscan finance investments in other EU countries and can enhance their retirement security by betterdiversifying country-specific and firm-specific risks. The creation of more scope for international risk-sharing within Europe enhances financial stability and the growth potential of the European economy.In organising private pensions one should avoid the mistakes of traditional, ill-designed defined-contribution systems as well as unsustainable defined-benefits systems, which exposed participants to thespecific risks of the firm they work for. Mutual, stand-alone pension funds could offer optimal pensionschemes to their participants. They back their obligations with financial assets and do not rely onsponsoring companies to guarantee pensions. Hence, participants are not exposed to credit risk of theirown firm.A good pension is a risky pension. Risk-taking is optimal for the economy as a whole because risk-takingcontributes to innovation and economic growth. Risk-taking is optimal also for individuals because it yieldshigher expected returns. Pension funds should therefore embrace risk by exploiting the tradeoff betweenreturn and risk and share risks among participants. Efficient risk-sharing implies that shocks should bespread out over as many investors as possible, including the elderly generations who own most financialcapital. Hence, EU regulation of financial markets should not prevent pension funds from exploiting the riskpremia on financial markets, but rather should mandate funds to communicate to individual participants therisks that result from their investment policies and risk-sharing mechanisms. Indeed, the investmentperspective rather than the insurance perspective should be the dominant perspective in governmentsupervision of pension funds. The supervision of pension funds and related EU regulations shouldtherefore not be modelled on that of insurance companies providing guarantees.Policy conclusionsIn the presence of more private pension provision, governments retain important responsibilities. Toprevent moral hazard due to intragenerational redistribution, governments should mandate individuals toparticipate in funded pension saving plans. Mandatory or semi-mandatory participation in specific pensionplans can give private plans sufficient scale. Moreover, governments can facilitate risk-sharing in privatepension funds by providing tradable financial assets such as GDP bonds and longevity bonds. By buyingthese public securities to match their liabilities, private pension providers do not have to hold substantialsolvency buffers. Moreover, participants can hold individual accounts with transparent property rights thatcan be valued on the basis of objective market prices.Financial illiteracy combined with the nature of the pension products as an experience good give rise toserious agency issues. Collective standalone pension funds can play an important role as trusted partnersfacilitating intergenerational risk-sharing. The scale and type of collectives may vary, depending on theinstitutional setting and preferences of each specific European country. The welfare effect of moreindividual choice raising competition on costs is ambiguous and depends on the specific institutions.Private pensions for Europehttp://www.voxeu.org/print/7294[29-11-2012 12:10:08]Hence, the EU should resist imposing free competition and unlimited individual choice in the market forpensions in order to not block the emergence of collective standalone pension funds.ReferencesBoeri, T, AL Bovenberg, B Coeuré, and AW Roberts (2006). Dealing with the New Giants: Rethinking theRole of Pension Funds [1]. CEPR Geneva Reports on the World Economy.CEA (Comité Européen des Assurances) (2007), The role of insurance in the provision of pensionrevenue, CEAStatistics 28.Wyplosz, C (2011) “Resolving the current European mess [2]”, VoxEU.org, October 25.Topics: Tags:VoxEU.orgSource URL: http://www.voxeu.org/article/private-pensions-europeLinks:[1] http://www.cepr.org/pubs/books/cepr/booklist.asp?cvno=p182[2] http://voxeu.org/index.php?q=node/7127

Private pensions for Europe

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Private pensions for Europe

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