The financial crisis may force EU countries to adjust pension systems. But most Europeans retiring today have little cause to worry about their retirement finances.
Although no pension scheme is immune from ups and downs in the economy, the European system is relatively robust, says a recent EU paper. The crisis has, however, drawn attention to some aspects of pension systems, particularly funded pensions, which have been more directly and more immediately impacted by the crisis.
Noting that the long-term nature of pension schemes provides some protection from swings in the market, the paper looks at different types of pension schemes, including pre-funded and pay-as-you-go schemes.
Private pension funds have seen a sharp drop in the value of their assets over the past year. But there is little evidence that pension funds have invested heavily in the kind of toxic assets that have undermined the global banking system.
How people in private pension plans are affected by the lower return on investments depends on the type of scheme. In general, people in defined-benefit occupational pension schemes will get the pensions they expect because the investment risk is covered by the scheme, and payouts are guaranteed in principle. But this may change through adjustments to the fund to compensate for the losses.
More serious impacts cannot be ruled out, the paper said. It noted that both the EU and member countries have laws to protect workers in case of insolvency of companies that sponsor defined benefit schemes.
Defined-contribution schemes, on the other hand, shift the risk entirely to the individual. This is because the pension paid depends directly on the performance of the investments in the fund. For people who still have many years left to work, there may be time for investments to recover. Even those close to retirement may be able to weather the crisis – if their plan uses a lifecycle strategy, which seeks to reduce risk as the investor gets close to retirement.
But older people without lifecycle plans who were counting on defined contribution schemes may have to live on a smaller pension – or work longer to make up the loss.
Such cases aren’t typical, though. Most Europeans retiring today still rely heavily on public, pay-as-you-go schemes. So far the financial crisis has not had a big impact on these. But if the economic slump drags on and unemployment continues to rise, governments may need to review the plans to ensure their long-term health.