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French pension reform: a Trojan horse for a better control of the State budget?

The essential

After the reforms introduced in the 2000s, the financial sustainability of the current system appears to be assured under growth conditions. However, this is occurring at the expense of the replacement rate of wages by pensions, and with an extension of the retirement age in order to be brought into line with other European states. However, the complexity of the French system remains an issue.

The reform process, which began in April 2018 and should be completed by the end of 2019, appears justified by seeking a simplified, more understandable, fair and universal system that is better suited to individualised developments in today’s career paths.

However, the government will probably seek to assume the overall management of pensions and ensure a less burdensome and more flexible social cost than what exists today.

The objective of improving the competitiveness of businesses is not presently being put forward by the government, except through a funded pillar that will be introduced, but this is a component of the expectations of a portion of the right-leaning electorate.

Above all, this reform will, first and foremost, have trouble convincing the biggest losers in the harmonisation scheme, namely civil servants and specialised schemes (SNCF, ENGIE, etc.), while the popularity of the President continues to tumble and the left-leaning electorate accuses him of implementing only the liberal portion of his platform.

 

 

 

Flag-UK

 13 September 2018

 

 

 

 

Flag-FR

13 Septembre 2018

 

 

 

 

The Government’s objective as stated to employee representative bodies is that it is searching for a universal, fair and understandable scheme, but how is it possible to believe that all the financial concerns have vanished?

The Government’s objective as stated to employee representative bodies is that it is searching for a universal, fair and understandable pension scheme. As far as the President is concerned, the goal would be first and foremost to keep his campaign promises, namely that each euro contributed gives everyone the same right to a pension.

Jean-Paul Delevoye, the high commissioner responsible for the programme, underscores: “We are lucky that we have no budgetary constraints”. Is it true that the equilibrium of the financial system is not an issue?

However, the executive branch publicly lambasted the high cost of social spending in May and June. Social spending in France is among the highest in the OECD, as shown in the graph below. As a matter of fact, retirement pensions account for more than 80% of these costs. It would probably be easier for the government to control this money, but achieving this aim today is complicated matter, due to the lack of flexibility in the formula of wage replacement by pensions, the high number of schemes, etc.

Graphique 1

 

It is undeniable that the French pension system is very complex. It involves forty or so different schemes, each one with its own pension calculation rules. This makes it very difficult for the average insured person to navigate the system. Moreover, it appears to be no longer suited to the fragmented career paths of today’s workers, because the linear career path, where members had only a single retirement plan, is no longer the rule. As a result, the search for fluidity in professional mobility, an element that facilitates labour market flexibility, must be accompanied by the security of an understandable and fair pension for the worker. These are the important elements of the “flexicurity” sought by the government. Is this the issue that the executive branch would like to promote, rather than financial equilibrium?

This issue involves some major difficulties now that the President’s popularity is waning (60% viewed him favourably when he was elected compared to less than 40% in August).

The process will be long and socially hazardous. It has been organised in several blocks. Every one of them is crucial to the success of the whole process and the last includes the problem of specialised schemes, which Emmanuel Macron promised to eliminate if elected.

The timetable for reform: Legislative and regulatory texts dictating the objectives, the architecture and the timetable for systemic reform are planned for the summer of 2019. (The framework law was abandoned to avoid double passage in Parliament).

 

Official consultation with employee representative bodies began in the second half of April 2018 and is organised into six subject areas, of which the first three should be settled by the summer of 2019 and the second three in autumn of 2019, each prior to their passage through Parliament.

The first three areas have been defined as follows: the first covers defining a universal system where every euro contributed gives rise to the same pension rights for all (scope, degree of coverage, tax base and contributions); the second aims at recognising non-contributory rights (illness, maternity, unemployment, and minimum pension), and the third at family entitlements with respect to gender equality.

The next three cover the conditions of entitlement to a pension with the search for more freedom, the specific nature of career paths and eligibility for early retirement. Lastly, building a sustainable and responsible system that addresses the issues of governance, steering and transitioning from one scheme to another.

The change in the French pay-as-you-go pension system1 and its current and forward-looking financial position:

The basic pension system was created in 1945. New entitlements were gradually integrated until the 1980s (extending the range of beneficiaries and lowering the retirement age). The entry of the Baby Boom generation (1946-1964) into the workforce kept the ratio of pension system contributors to beneficiaries high, at around 4 during the 1960s according to the COR. However, as this generation began to retire beginning in 2000, this rate gradually dropped, reaching 1.8 in 2010 according to the COR2, and rendered the deficit trajectory unsustainable. The deficit reached €30bn in 2010, i.e. 1.5% of GDP3.

Graphique 2

By increasing the retirement age from 60 to 624 and by gradually extending the private sector worker contribution period from 40 to 43 years of age5 the reforms of the 2000s have led to better balance among retirement schemes while keeping contribution rates below 28%. In 2017, the deficit was ‑€1.1bn6 i.e. 0.05% of GDP.

Every euro contributes gives rise to the same pension rights for all.

The system is close to being balanced today.

What does it conceal about the status of retired persons and pensions?n And where it is going?

Accounting for less than 14% of GDP in 2015, pensions in France are 2.5 points above the eurozone average and 9 points above the member states of the EU7. This high rate is attributable to better coverage of the elderly population, increased life expectancy and higher overall retirees purchasing power.

In 2015, the French system had the third highest gap between the number of retirees and the over-65 population, after Switzerland and Luxembourg as the chart 3 shows:

Graphique 3

The system is close to being balanced today.

As of 2014, the life expectancy of workers exiting the labour force was 25 years, i.e. 5 years longer than the OECD average8 (this life expectancy is increased by a calculation that considers that all employees exit the labour force after 40 years of service). The 2014 reform to extend the contribution period took into account the increase in life expectancy until 2020. However, for the first time, life expectancy fell in 2015 for both men and women (it was already on the decline for women in 2012).

In the 1970s, the average purchasing power of retirees was 20 to 30 percent lower than that of the employed labour force9. Today it is close to that of the employed labour force, which is virtually unique in Europe.

In 2014, the net future replacement rate of pensions as a percentage of the final salary after an uninterrupted career was 75% all schemes combined, compared to 71% in the European Union and 63% in the OECD.

Graphique 4

At the end of 2014, the poverty rate for the elderly was among the lowest in the OECD, and the average income of persons over the age of 65 was the highest in the OECD10. Moreover, the gross average pension rose steadily in the 2000s.

Graphique 5

The average purchasing power of retirees is close today to that of the employed labour force, but there is an erosion in the purchasing power of older retirees.

However, since 1987, pensions have no longer been adjusted on average wage growth and they are less and less depending on inflation. Therefore, there is a gradual erosion in the purchasing power of older retirees of about 1% per year today, i.e. the annual growth rate of hourly labour productivity estimated by INSEE. Furthermore, the increases in the General Welfare Tax in 2017 and 2018, which impacted retires, are also expected to lower their purchasing power by about 3%.

The rise in the average pension is attributable to the retirement of new generations of baby boomers who enjoyed better careers that the generations of outgoing retirees (those who die), including female pensioners with direct entitlement who outnumber their predecessors.

By contrast, the average replacement rate of pensions relative to wages is falling11.

Graphique 6

 

This trend is expected to continue at least until 2035 without further reform. In fact, 2035 is the year when the extended 43-year contribution period in the private sector in order to draw a full pension will be reached by retiring generations. The average retirement age is also expected to approach 65, in line with the current retirement age in Germany, compared to 62 in 2015. However, it is still one year less than the average of OECD countries (including Denmark, Italy and Greece).

According to the OECD, without further reform the net future replacement rate as a percentage of the final wage after a full career could fall to 55% by 2050. As such, as baby boomer retirements that will taper off in the 2020s will closely coincide with the end of rising rates of female pensioners directly eligible for a pension, overall (or average) purchasing power is expected to diminish for several reasons, including fewer retirements of generations with high-quality careers due to lower numbers and also to the effects of unemployment and a lower replacement rate.

According to the COR12, the whole system would be in credit in 2035 or close to equilibrium under some scenarios.

Overall, pensions are expected to decline by 2.6 points by 2060 to 11.2% of GDP, according to INSEE13, with labour productivity growth ranging from 1% to 1.5% depending on the year. Accordingly, depending on the accuracy of growth assumptions14, the long-term financial stability of the system would be assured and would no longer require modifications in this respect.

The rise in the average pension is attributable to the retirement of new generation of baby boomers who enjoyed better careers.

However, these aggregate developments mask substantial differences across different generations of retirees and different socio-professional groups, even if they are smaller than among the employed labour force.

The average replacement rate over the generations hides heterogeneous distribution between the different pension schemes, wage levels (for newly retired workers, it is a decreasing function of wages) and between full careers and careers with interrupted periods of employment (unemployment and maternity)15.

The average pension depending on the scheme partly reflects this disparity. In 2015, the average gross pension was €1,376 (or €1,283, net), with women averaging €1,050 and men €1,728. Civil servants received a gross average pension of €2,280, members of specialised schemes received €2,120, members of the general scheme received €1,120, craftsmen €710, self-employed farmers €640, farm employees €570 and other self-employed €500. The old age minimum income was €800. In comparison, the average income was €2,250 and median income was €1,797.

In 2015, according to the COR, the retiree solidarity mechanism is more efficient than that applies to the people in activity. It reduces the inter-decile gap16 from 5.8 in terms of in-work incomes to 4.1 for pensions.

In 2015, according to INSEE, 7.6% of retirees were living below the poverty line (established at €1,008 per month) compared to 14.1% of youth. The number of recipients of the old age minimum income (€800 in 2015) steadily declined from 1948 to 2003, however this downward trend began to slow in 2004.

Despite a balanced system that affords retirees an overall favourable situation while concealing sharp disparities, although inferior to the employed labour force, the French retirement system is one of the most complex. There are 42 retirement schemes17 and 100 supplementary schemes, with each scheme having its own yield and vastly different calculation approaches between the public sector and the private sector. As the private sector uses defined benefit plans (75% of the gross month salary of the final 6 months of service) the private sector pays a pension based on the contributions during the 25 best years depending on a number of variables, such as life expectancy.

Most retirement funds have an operating cost estimated to be between €4 and €6 billion18 and a certain amount of complexity for members with multiple career tracks.

Careers are becoming increasingly fragmented and one-third of the population between the ages of 25 and 68 are members of at least four schemes19.

The changes suggested for the future reform:

The Government pledged not to touch the legal retirement age, which is 62. However, Jean-Paul Delevoye has also pointed to the disappearance of the idea of years of service thanks to a score-based system. Employee representative bodies hope to safeguard age limits: currently the full rate applied to private sector pensions is regarded as met at age 67, even though the contribution period may be shorter. It is a fact that raising the retirement age had devastating effects on the healthcare arm of Social Security, which led to a recent showdown between the government and (employee and employer) unions to ensure that time off for short-term illness was not in charge of employers.

During the presidential campaign, Emmanuel Macron alluded to notional defined contribution plans. However, the government majority and employee representative bodies prefer the points system currently used in supplemental retirement plans. It allows agreement on calculation assumptions, particularly productivity and life expectancy, and to set the purchase value by contributors and the service value of the score for retirees. It has already been adopted by executive supplementary retirement plans. This is also the system used in Germany, unlike Sweden which opted for the notional accounts system.

Indexation of the score has been ongoing since at least the last inflation-related reform and does not take growth into account, as Sweden does (-1%). This led to a significant time lag relative to the growth of the average wage, which tracks growth: the average pension, estimated at 52.1% of the average gross wage in 2014, would fall to 35.2% by 2060 at a national growth rate of 1.8% per year. Retirees will no longer have the right to share in productivity gains if this system is not revised.

Pension aggregate developments mask substantial differences but the retiree solidarity mechanism is more efficient than that applies to the people in activity.

To unify the system, all basic schemes and all supplementary schemes, whether public or private would be merged. Next, both would merge to obtain a score-based single universal scheme. The private sector basic scheme calculated as an annuity would be converted.

The reference period for calculating pensions would be based on lifetime earnings and not on the last 6 months of service or the best 25 years of service20.

Civil servants’ benefits (bonus points, survivor’s benefits) would be eliminated, representing savings of €2 to €3 billion by 2025.

The contribution rate, now just below 28% in the private sector21, would be unified and reduced temporarily to 25% and then to 20%, and the contribution ceiling could be reduced from 4 PASS22 to 2 PASS23. This change is designed to improve French competitiveness. (In 2016, France, at €36.30, was 5th in the ranking of EU countries with the highest hourly labour costs, while Germany, at €33.40 was 8th24).

A mandatory funded pillar (with a contribution rate of 2%) may be introduced. It could represent 2% of GDP, i.e. approximately €45bn per year, in the form of pension funds or life insurance, whose investment decisions would be guided by a joint employer/employee supervisory board with the introduction of social and environmental criteria in each occupational sector. This pillar could give rise to capital outflows and not only in annuities. By being fiscally tilted in favour of French employers, these funds would allow funding through equity and renew France’s production infrastructure, which is double the age of Germany’s.

There would be a transitional period between the old and the new systems which will not affect persons four to five years away from retirement, or current retirees (government pledge). However, nothing has been decided. Several difficulties must be overcome.

The difficulties

They are of a technical, financial and/or social nature.

  • The technical hurdles will probably not jeopardise the completion of the reform but will have an impact on its implementation: a gradual switch-over will require knowledge of members’ history, i.e. a calculation designed to maintain earned rights with certain assumptions, notably regarding life expectancy (calculation called crystallization) and the human and technical resources required to manage both systems.
  • The transfer of money between the State and the schemes should be neutral for the latter: the State would make up for the difference between the contributions paid by civil servants switching over to the universal plan and this deficit will be gradually eliminated.
  • Fears of plundering by the State of the reserves of the existing schemes, for instance the €60bn in assets of the Agirc-Arrco scheme will need to be allayed. 
  • Contributions are extremely variable among the private, public, crafts, farming and retail sectors, etc. The self-employed do not pay the employer’s contribution but the pensions are calculated on the contributions effectively paid. 
  • Two social issues constitute major obstacles standing in the way of the success of the reform. One is limiting or convincing the losers to switch over to a unified system:

The government pledge not to touch the legal retirement age… It is a fact that raising the retirement age has devastating effects on the healthcare arm of Social Security.

Admittedly, reduced pension contributions, at least for some socio-economic groups (a target of a 20% reduction proposed by one of Parliament’s think tanks) might lead to lower pensions for these same groups for the sake of financial equilibrium and fairness. However, at this stage, such an objective is not being put forward by the government, even though it is espoused by its right-leaning electorate.

 

To overcome these difficulties, the government is launching a wide-ranging consultation with trade unions, political parties and the French public. Jean-Paul Delevoye, responsible for steering the process, has promised permanent consultation with all political parties. As a result, on 31 May a consultation was launched with the general public via an interactive platform26. It will continue until 25 October. President Macron may intervene personally in February or March 2019 to explain the reform to the public.

The government is launching a wide-ranging consultation with trade unions, political parties and the French public.

 

1 In pay-as-you-go systems, the workers’ contributions pay for the pensions of the retirees.
2 Pensions Advisory Council
3 Universal schemes and Old Age Solidarity Fund
4 Law of 9 November 2010
5 From 40 to 41 years pursuant to the Law of 21 August 2003, and later the target of 43 years in 2035 pursuant to the Law of 20 January 2014
6 Data provided by Social Security, including the basic scheme and the Old Age Solidarity Fund
7 According to Eurosta
8 OECD “Pensions at a Glance 2017”
9 Pensions Advisory Council
10 OECD “Pensions at a Glance 2017”
11 Etude & Résultats, DREES, July 2015, Number 0926
12 Pensions Advisory Council, Changes and prospects for retirees in France, June 2017
13 INSEE Analyses No.21, August 2015
14 Moreover, the birth rate is projected to be 1.95 children per woman and net migration 70,000 per year
15 Etude & Résultats, Directorate for Research, Studies, Evaluation and Statistics, July 2015, Number 0926
16 Ratio between the pensions of the richest 10% and the poorest 10%
17 According to the Office of High Commissioner on Pension Reform (HCRR), which is responsible for steering the process.
18 GIP or Accenture
19 INSEE
20 Basic public and private schemes, respectively.
21 Public sector contribution rates will be gradually harmonised with the private sector by 2020.
22 Annual Social Security ceiling; 1 PASS (month) = €3,311 gross per month
23 Proposed by IFRAP (Administration and Public Policy Research Foundation)
24 Employment, earned income, 2017 Edition – INSEE Références
25 Supplemental retirement of private-sector executive level employee
26  https://participez.reforme-retraite.gouv.fr/blog/lancement-du-dispositif-de-participation-citoyenne

 

 

LETORT Valérie , Fixed Income Strategy
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