EFRP is happy to respond to questions regarding occupational pension provision. Please send us an email if your question is not contained in the frequently asked questions below.
European pension systems
Does EFRP have an overview of European pension systems?
Does EFRP have statistics on workplace pension provision in Europe?
Does EFRP have information on prudential regulations and social and labour law?
Pension terminology
What is meant by the so-called three-pillar model?
What is meant by ‘defined contribution’ and ‘defined benefit’?
What is the difference between ‘average earnings’ and ‘final pay’ plans?
What does inter-generational risk-sharing mean?
What is the difference between ‘asset pooling’ and ‘liability pooling’?
Pension fund investment policy
Are stocks safer than bonds in the long run?
Why do pension funds invest in risky assets?
Does EFRP have an overview of European pension systems?
EFRP does not have such an overview, yet there are a couple of organisations that do:
- The European Commission (DG Employment and Social Affairs) has a website containing a lot of information. The reports entitled ‘Adequate and sustainable pensions’ (2006) and ‘Privately managed funded pension provision and their contribution to adequate and sustainable pensions’ (2008) provide a good overview of Europe's pension systems.
- The Organisation for Economic Cooperation and Development (OECD) publishes comprehensive studies about pension systems in OECD countries. The report entitled ‘Pension markets in focus’ can be downloaded and the publications entitled ‘Pensions at a glance’ (2005 & 2007), ‘Private pensions outlook 2008’ and 'Complementary and private pensions throughout the world 2008' can be ordered from the website. The last publication was written in cooperation with the International Social Security Association (ISSA) and the International Organisation of Pension Supervisors (IOPS).
- Allianz Global Investors makes very accessible studies on worldwide pension systems available on its website, such as ‘Funded pension systems in Western Europe 2008’ and ‘Central and Eastern European Pensions 2007’.
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Does EFRP have statistics on workplace pension provision in Europe?
EFRP conducts an annual survey among its members on the amount of assets managed by private institutions operating workplace pension schemes. The data originate from national sources, such as statistical offices, supervisors and own surveys. EFRP collates the data that is gathered and ensures consistency.
A distinction is drawn between mandatory and voluntary pension arrangements accessed trough paid work:
- mandatory schemes linked to paid work are defined as supplementary private pension arrangements for which the product characteristics are set down in national legislation
- voluntary schemes linked to paid work are defined as supplementary private pension arrangements whose product characteristics are negotiated by social partners or at company level within a legally defined framework
A further breakdown is made of voluntary schemes with respect to the type of financing vehicle used: pension funds, book reserves and insurance companies.
We refer to the websites of the OECD (Global Pension Statistics) and Eurostat for additional statistical information on – for example – asset allocation, plan members, benefits and contributions. At member-state level, the prudential supervisors provide extensive statistics (see the CEIOPS website for a list and websites).
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Does EFRP have information on prudential regulations and social and labour law?
EFRP does not publish information on prudential regulations for pension funds or on social and labour law in the different member states. However, there are a couple of organisations that do:
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What is meant by the so-called three-pillar model?
Pension systems are often described using a three-pillar model. Traditionally, the three pillars represent (I) state pay-as-you go pensions, (II) funded occupational pensions, and (III) individual savings. Today, there are various pension models in existence as the number of approaches to pension provision has grown. The model of the World Bank – intended as a blueprint for developing countries – consists of (I) state pay-as-you-go pensions, (II) mandatory, privately managed pensions, and (III) voluntary individual accounts.
The traditional three-pillar model is a natural fit for the old EU member states, but not for the new member states from central and eastern Europe. These countries have introduced mandatory defined contribution schemes for their employees over the past decade.
EFRP has proposed a new pension terminology model that takes into account the pension systems of all member states (click here for the publication). It combines the traditional model and the World Bank model and is made up of the following three pillars:
- a basic state pay-as-you-go pension
- voluntary and mandatory funded pensions accessed through paid work
- voluntary individual pensions
EFRP is convinced that an EU-27 pillar structure on this model will offer member states a useful reference framework. In addition, it will facilitate analysis and communication on the different pension systems.
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What is meant by ‘defined contribution’ and ‘defined benefit’?
Occupational pension plans are often subdivided into defined contribution (DC) schemes and defined benefit (DB) plans:
- In DC schemes, a fixed contribution is made to the individual account of the employees every year. Pension income upon retirement is dependent on the returns on the investment portfolio.
- In DB schemes, employees accrue pension entitlements as a percentage of wages every year. For example, 1.75% per year resulting in pension income of 70% of wages after 40 years. Contributions are adjusted in the event of higher or lower-than-expected investment returns.
In recent decades, many hybrid pension plans have been introduced, which occupy the middle ground between DC and DB schemes. For example, cash balance plans extend DC plans with a minimum return guarantee. DB schemes with conditional indexation allow for a reduction of pension indexation to price or wage inflation.
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What is the difference between ‘final pay’ and ‘average earnings’ plans?
The accrual of pension entitlements under defined benefit plans is mostly calculated using final pay or average earnings:
- In final wage schemes, employees may annually accrue 1.75% of their future wage upon retirement. This will yield retirement income of 70% of the final wage after 40 years of employment.
- In average earnings plans, employees may every year accrue 2% of their current wage. This will result in pension benefits of 80% of average earnings after 40 years of service. Accrued pension entitlements are usually increased by wage or price inflation for pension rights to maintain their real value.
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What does inter-generational risk-sharing mean?
The main justification for defined benefit plans and hybrid schemes is that they allow for risk-sharing between generations – sometimes referred to as inter-generational solidarity. Pension funds are able to spread surpluses and shortfalls forward in time. In the event of disappointing investment returns, not only current generations, but also future generations bear some of the burden. Of course, in the event of returns exceeding expectations the reverse holds true – both current and future generations share the benefits.
Inter-generational risk-sharing means that – with given contribution rates and investment policy – the volatility of pension outcomes is reduced. Economists estimate the welfare gains to reach as much as six percent of wage income, which is equivalent to two years of work for an average employee.
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What is the difference between ‘asset-pooling’ and ‘liability-pooling’?
Some multinational companies combine the assets of their various pension funds in a single investment fund. Such asset-pooling may yield lower investment costs by exploiting economies of scale. Moreover, it may widen the range of asset classes available for investment, resulting in enhanced diversification and lower risk.
The stakeholders may also reap these benefits by setting up a pan-European pension fund. Besides asset pooling, a cross-border pension fund allows for the added advantage of liability pooling. Liability pooling occurs when the assets of the pension fund are not ring-fenced and, therefore, can no longer be attributed to the different pension schemes. In that case, a shock to the liabilities in one country – due to a change in inflation, interest rates or life expectancy – affects plan members in the other countries. This means that liability risk is shared between the company’s employees in the various member states.
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Are stocks safer than bonds in the long run?
It is widely accepted that the risk of equities decreases with the investment horizon. Stock markets are very volatile on a day-to-day basis, but in the long run these movements have a tendency to revert to their mean. In other words: stock returns exhibit mean reversion. This phenomenon is – for example – found in historical return data over the past two centuries in the United States.
Mean reversion should not be misunderstood to mean that stocks are without risk in the long run. A long-term investor aiming for a safe real return should still invest in index-linked bonds with appropriate time to maturity. However, mean reversion does indicate that very long-term investors like pension funds are able to invest a larger proportion of their portfolio in equities at a given level of risk.
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Why do pension funds invest in risky assets?
European pension funds allocate about 40 percent of asset to equities. Stocks may increase the risk of the investment portfolio, but history has also shown that stocks yield higher returns. These higher expected returns are indispensable for pension funds to provide for adequate pensions at reasonable costs. A decrease in expected return by one percentage point would necessitate an increase in contribution rates of 35%. Or – were contribution rates to be kept at their existing levels – it would result in a decline of 35% in expected retirement benefits.
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