Public or Private Orientation of Pension Systems in the Light of the Recent Financial Crisis

Abstract

This paper studies the appropriateness of a public or private orientation of pension systems in the light of the recent financial crisis, which has underscored the difficulties and contradictions associated with each system. The different institutional arrangements, in which public or private pension systems are embedded, are key components when assessing their responses to the crisis. Particularly, private pension systems are intertwined with financial markets, while social insurance-based pension systems are linked to the labour market mechanisms. This paper compares the British and French pension systems, as “archetypes” of private-oriented and public-oriented systems, respectively, the first relying on the market and private pension schemes, and the second on mandatory social insurance. This paper shows that the crisis has upheld the founding principles of the public (French) and private (British) pension systems to maintain the existing institutional configurations. At the same time, both systems have strengthened the role played by means-tested benefits and minimum pensions for low-income groups to offset the weaknesses of one or the other system, as emphasised by the crisis.

Keywords:

• pension systems
• financial crisis
• British pension system
• French pension system
• institutional configurations

Notes

¹ Public pension plans are traditionally PAYG-financed, although some are funded (OECD 2005). In France, this is the case for the Régime Additionnel de la Fonction Publique, a scheme created in 2005 for civil servants, which levied a mandatory contribution of 10% (paid half by the employer and half by the employee) on bonuses. The French complementary schemes for private-sector workers are often presented as public as they guarantee PAYG benefits but could be regarded as private in terms of their asset management (for more details, see Note 6). Private pension plans are generally pre-funded. Nevertheless, large companies have sometimes found it easier to finance a part of their liabilities towards retirees by means of a disbursement method (unfunded pension plans). This is the case of some types of private pensions in the UK (unfunded occupational salary-related plans, see Office for National Statistics 2012).

² This V-of-C approach, which is founded on the “comparative institutional advantage” linked to each type of capitalism, is open to criticism, as its “variety” is limited to a binary classification into LMEs and CMEs (Howell 2003). In particular, it covers a broad spectrum, depending on the degree of “liberality” or “coordination” of the market, and on the extent to which a political economy is, or is not, coordinated. As a result, it can be difficult to classify certain economies that do not conform to this ideal type pattern: France is considered a “coordinated market economy,” even if it is not a “pure” type, while UK is closer to a “liberal market economy”.

³ Institutional complementarities are important for understanding the process of change: a reform in one area of the economy induces changes in others, so that synergies between institutions can be preserved. Nevertheless, while this V-of-C approach is useful in explaining “on-path” changes (under the concept of path-dependency), it fails when it comes to any “off-path” (radical) changes occurring without any exogenous shock (Kang 2006).

⁴ To “opt-out” or “contracting-out” means leaving the S2P to build up benefits in an alternative pension scheme. There are two possibilities for this: a salary-related scheme (defined benefits) or a money purchase plan in an occupational, personal or stakeholder pension scheme (defined contributions). The beneficiary pays a reduced rate of NIC if he/she contracts out to an occupational pension scheme, or receives a National insurance rebate if he/she contracts out to a personal or stakeholder pension scheme. In April 2012, the government ended the possibility of contracting out on a money purchase basis and slightly reduced the contracted-out rebate.

⁵ The first pension tier for private-sector workers is calculated on the basis of the average of their 25 highest earning years, their total length of employment and a coefficient ranging from 0.25 to 0.50, depending on the age of the new retiree and/or his/her length of employment.

⁶ French wage-earners’ complementary schemes (Association pour le Régime Complémentaire des salariés, ARRCO, and Association Générale des Institutions de Retraite Complémentaire des Salariés, AGIRC) are always considered as public in international comparisons, although they are not managed by the State, but rather by unions and employers’ representatives, while they employ private asset managers to invest the limited reserves used as a buffer for their PAYG commitments. The State's involvement in these plans is central, as the social contributions are mandatory, pensions are financed on a PAYG basis and, while there is no guarantee as to the amount of the pension, they are price-indexed, and the point-value on which they are based cannot decrease by law.

⁷ The public sector's PAYG pension schemes “automatically” balance, as public employers pay a social contribution calculated to balance revenue and expenditures. Therefore, they cannot show a deficit. Instead, the sums paid by the State to balance the scheme are accounted for as overall public expenditures.

⁸ As Palier and Thelen (2010) remark, industrial restructuring in CMEs has involved shoring up the competitiveness of core sectors by reducing the size of the workforce and increasing the productivity of the remaining workers.

⁹ Originally, DB schemes were developed as a way to reduce employee turnover: occupational pension schemes, which are based on final salary level, tend to reward longer tenures at the same company. This model reduces labour market flexibility because the rights acquired through DB schemes are lost when employees leave the firm (Hannah 1986). But in recent decades, DC schemes have been developing more rapidly, and DB schemes are decreasing as employers are less focused on employee loyalty. At the same time, the new regulation on pension portability and transferability changes the employees’ and employers’ interests, promoting job mobility: the prospect of pension loss as a result of changing employers is eliminated (Emmerson 2003).

¹⁰ The Pension Protection Fund was established in 2005 to pay compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer and there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of compensation.

¹¹ Following the V-of-C approach, it appears that the advantages and performance of an economy as a whole depend not on a set of the best institutions in each area, but on the relationships and complementarities between institutions in different areas. These institutional characteristics can help provide an understanding of recent changes adopted by the British and French governments since the crisis.

¹² Amable (2003) offers a theoretical and empirical analysis of the diversity of capitalism, broken down into five types: neo-liberal or market-based capitalism, continental European capitalism, social democratic capitalism, Mediterranean capitalism and Asian capitalism. Institutions operating under these forms of capitalism differ in the areas of product-market competition, the labour market and labour relations, Social Security, the education system and their financial systems.

¹³ The term “institutional interactions” may be preferred to “institutional complementarities” as it implies less determinism.

¹⁴ The Fonds de Solidarité Vieillesse (old-age solidarity fund) was created in 1993 to support all old-age benefits not linked to social contributions. The fund finances the minimum old-age pension, the additional benefits for those who have raised children, and offsets the social contributions not paid by pensioners during unemployment spells. The Allocation de Solidarité aux Personnes Agées or ASPA (old-age solidarity allowance) is a means-tested minimum old-age pension benefit granted to persons of retirement age (65 or 60 years in the case of a disability). The ASPA old-age allowance supplements the pension collected by the retiree to reach the minimum vieillesse (see Table A1 in the Appendix).

¹⁵ The amount of the first-tier pension (private sector) cannot be less than a specific minimum, calculated on the basis of the length of qualifying employment. But as from 2010, this minimum will only be granted to retirees whose total pension benefits (all schemes combined) are less than a certain amount.

¹⁶ In 2012, the UK Government introduced a new system of pension savings accounts (NEST) in which all UK employees will automatically be enrolled unless they are already members of an occupational pension scheme which has contribution rates higher than those of the new NEST (under NEST, employers will have to contribute 3%, employees will pay in 4% of their salary and 1% tax relief will also be given). This new system is based on a life-cycle portfolio strategy, and will benefit from a National Agency Guarantee, to protect beneficiaries from fluctuating financial markets. This system will be instituted gradually from 2012 to 2017. It will help reinforce private pensions and make them more secure: it will increase pension scheme assets managed through private funds, there will be no guarantee on the future level of pensions, the investment risk will be borne by the beneficiary and the possibility for the employer to opt out will be maintained. It will also favour labour market flexibility, as the entitlements acquired in DC funds are more easily transferable from one company to another.