| Sigma Policy Briefs |
To build professional public administrations, central and eastern European countries must adequately remunerate those working in the administration. One aspect of remuneration is pensions. Thus, as these countries reform their general basic pension systems in response to demographic trends and state budget concerns, they might want to develop specialised pension schemes for civil servants. These special schemes are different from, or supplementary to, the state’s general basic pension schemes. In preparing reforms, comparative experiences from European Union (EU) Member States can help to clarify national needs and highlight possible strategies related to introduction of the pension schemes for civil servants.
Over the last 30 years, the birth rate in Europe has fallen substantially and is now considerably lower than the rate necessary to sustain a stable population. With increasing life expectancy, the age structure will therefore undergo dramatic changes. Estimates indicate that the burden of supporting the elderly in Europe, expressed as the number of old-age pensioners in relation to the active population, is expected to double from just over 20 per cent in 1990 to over 40 per cent in 2040.
The trend is alarming. Total payments to old-age pensioners from existing pension systems in Europe are estimated at over 10 per cent of GDP. All other things being equal, this trend will, in the next 50 years, make it necessary to double expenditure on old-age pensions to 20 per cent and the financial demands on the systems will increase accordingly. If account is also taken of the probable increase in the real value of pensions and the fact that old people account for a large proportion of expenditure on health, the potential redistribution of income and expenditure from the working population to old-age pensioners assumes very substantial proportions.
All European countries, including those in Central and Eastern Europe, maintain statutory basic pension schemes through which the state guarantees a pension to everybody subject to the scheme. These schemes cover the entire population, although a major part of the final pension might be related to the level of income of the individual during his or her active life. These schemes are called general basic pension schemes in this Policy Brief. However, civil servants in western European countries are in addition to or instead of the general basic pension scheme covered by an occupational pension scheme related to their careers as civil servants. These schemes are called civil service pension schemes in this Policy Brief.
An overwhelming proportion of Europe’s pensions consist of general basic pensions financed on a so–called pay-as-you-go basis by transferring income from the active population to pensioners. In the light of the mounting burden of supporting the elderly, this is liable to put these pension schemes in jeopardy, since, to maintain a financial balance, they must either increase their revenues or reduce the benefits paid out. Revenues can be increased by raising taxes, including payroll taxes. Meeting pension obligations by increasing the budget deficit and the national debt cannot, of course, be regarded as a feasible option. The other alternative, reducing pension benefits, involves either lowering benefit levels or raising the “pensionable” age.
There is a growing understanding that the connection between savings, the national debt and economic growth is crucial to economic development. Indeed, the financing of pensions is the subject of growing attention on account of the repercussions on the national economy as a whole.
This situation has focused attention on the necessity of pension reforms. In several countries, more or less radical reforms of the national general pension system are being planned or have already been implemented. Pension schemes are being scrutinised in terms of costs and more adequate financing methods. The general view is that a larger proportion of pensions should be financed by pre-funding (explained in a section below) or other forms of provision for future pension payments. This applies even more to supplementary occupational pension schemes, ie schemes related to a professional career either excluding the general basic pension scheme or complementing it. Civil service pension schemes are examples of such occupational schemes.
Civil Service Pension Schemes in EU Member States
In most EU Member states, civil servants have separate and specially designed occupational pension schemes. Civil servants are either excluded from general basic pension scheme or covered by this system and a supplementary civil service pension scheme. For historical, economic and cultural reasons, civil service pension schemes vary considerably from one country to another. By and large, however, the problems they face are similar.
Today's general basic state pensions and occupational pensions both derive from the public sector occupational pension systems. The state was the first employer to assume responsibility for supporting its employees and their survivors by developing systems for old-age, invalidity and survivor’s pensions. The development has followed two main lines. These pensions have either been regarded as extended, albeit reduced, earnings, to be paid for out of the national budget in the same way as salaries for active civil servants. The pensions have thus been financed on a pay-as-you-go basis. Employees who were public officials during their working careers have been treated as such after their active careers too. According to the other way of thinking, pensions have been regarded as deferred earnings. Pension societies were set up and savings invested to support members during retirement.
In most countries, the extended earnings principle has become the norm for civil service pension schemes and their financing systems, even though occupational pensions are widely regarded as deferred earnings. The reason for this is probably that the pay-as-you-go system is a convenient way of improving pension conditions. It has been feasible, in the short-term, to defer the costs to the next generation.
The idea of supporting the old, the sick and surviving widows (or widowers) and children by pensions spread gradually from the public sector to other sectors and finally pensions emerged as an element of social security programmes. Since civil servants already had the right to a pension from the state, and usually on much better terms, it was natural in many countries to exclude them from the social security pension system. For employees in the private sector, the process was rather different. Here the employers’ obligation to provide adequate support for their former employees and their survivors was confined to a supplement to the general pension. Where the level of statutory protection was considered insufficient, and where tax treatment and other conditions made it possible, supplementary occupational schemes were established.
Pension Provisions for Public Employees in Central and Eastern Europe
Those employed in central and eastern European public administration are covered by general basic state pension systems with benefits often little above subsistence level. Unlike their colleagues in most EU Member states, public employees have typically not been covered by special occupational pension schemes.
As part of efforts to improve the “professionalisation” and quality of public administration, countries are defining civil service categories of personnel through civil service legislation. The question arises if special occupational pension schemes should be introduced for civil servants under this legislation. There are at least two reasons for doing so: to secure the independence of civil servants and to make a public sector career more attractive. Sometimes the intention is to shift the costs of current remuneration into the future. Necessary reforms of the general state pension systems is another reason why this question is on the agenda in several central and eastern European countries.
Obviously, there is no such thing as an “ideal” civil service pension scheme. It is a matter of priorities and the conditions in the country in question. Nevertheless it is worthwhile to outline some guiding principles that cut across national structures.
The viable civil service pension scheme is stable, reliable and sufficiently flexible to adjust to economic, demographic and other changes. It is easy to understand and administer. It is perceived as fair and there is a clear relationship between performance—as measured by earnings—and pensions. Benefits and costs are reasonable and predictable.
Designing a civil service pension scheme is a complex task. It raises issues of a very long-term nature that are of great economic importance both to those making the benefit commitment and to those entitled to the pension. There can be no doubt that it is much easier to introduce and improve benefits than to reduce or abolish them. Great caution is therefore essential. The consequences and precise nature of any new promises must be carefully considered.
Sound financing is a crucial element of a credible, stable and secure civil service pension scheme. The all-important task of financing pensions can be fulfilled either by a pay-as-you-go system or by pre-funding. In a pay-as-you-go system the pension amounts are paid for on a continuous basis as they fall due. No funding takes place and no capital is set aside for future pension payments. For the system to be acceptable, the employer must have a reliable, long-term source of income to cover the costs. Pre-funding means that provision is made for future pension payments by funding in advance, during the earning period. Special measures must be taken to ensure that pre-funded pension obligations can be met when pensions fall due.
For historical reasons, and simply because the state is in a position to promise pensions without pre-funding, most countries finance civil service pensions by means of a pay-as-you-go system. However, the trend today is towards an increasing element of pre-funding. The Dutch and Swedish models are examples of this.
A short-term advantage of pay-as-you-go systems is that it is simpler to change pension conditions and benefits, and the effect is immediate. It may be tempting to implement changes at a faster rate than would be possible if the scheme must be fully funded. Costs do not have to be paid as they arise but can be deferred until later. This applies not only to improvements, but also to changes for the worse. Under such a system a stroke of the pen can in fact deprive employees of benefits that they believed they had earned. The situation is quite different in pre-funding systems. These systems are more stable and more likely to deliver on their promises.
Once a pay-as-you-go system has been established, changing over to a pre-funding system puts a great strain on the economy. For more than a generation, the system will be burdened with two sets of costs, ie the cost of paying out pensions that are due, and the cost of allocating funds for future pensions.
Pre-funded pensions automatically sharpen cost-consciousness. Changes in pension conditions entail immediate consequences for those who have to bear the costs. Pre-funding thus has a sound restraining influence on pensions.
The fundamental difference between pre-funding and the pay-as-you-go system, is that in a pre-funding system the pension capital is irrevocably destined for the pensions in question. There are examples in EU Member states of pension funds or similar institutions where capital reserved for civil servants' pension schemes is managed by representatives of both employers and employees. If it is considered important for reasons of public finance, the rules on investment can stipulate that a specified proportion of the pension capital must be invested in government securities.
The fundamental question if civil servants should have their own pension scheme must, to be meaningful, be broken down into several questions. Should civil servants be included in the existing general basic state pension system and, if so, do they need, in addition, special provisions or even a separate supplementary occupational pension scheme? Or should they be excluded from the general basic pension scheme, but have a pension system of their own? Across the EU Member states, all kinds of solutions exist. Civil servants in Germany and France, for instance, have their own separate and totally independent schemes, while in the United Kingdom civil servants are covered by the general basic pension scheme and on top of that the main part of their pension provision is by means of a supplementary occupational civil service scheme.
It is impossible to generalise about what is the best solution. It should be guided by the specific national context, more specifically by the demands of civil servants and the civil service as compared with what the existing general state pension system offers. Is, for example, the retirement age and the pension level adequate? What possibilities exist for the individual to provide for himself or herself by voluntary pension savings? What solutions exist in the private sector?
If civil servants are to be covered by two pension systems at the same time, one providing general basic pensions and the other supplementary occupational pensions, rules must be laid down for the necessary co-ordination of these systems. There are two fundamentally different models. In one of these, the supplementary pension is calculated as a gross amount from which the amount paid out as a basic pension is deducted. If the occupational pension is reduced due to insufficient length of service, the basic pension deduction should be reduced correspondingly. In the other model, the supplementary pension is calculated net in relation to the basic pension. The net amount is determined on the basis of an assumed general basic pension level. Both models involve complications.
The implication of the gross co-ordination model is that the general basic pension scheme is irrelevant to civil service pensions. Both improvements and changes for the worse in the general basic pension scheme are neutralised, which from the employer's point of view is an advantage in good times and a disadvantage in bad times. Obviously, for employees it is the other way round. Changes in the general basic pension system only affect civil servants' pensions when their system is correspondingly adjusted. The net co-ordination model works the other way round.
Another consequence of the gross model is that the size of the supplementary pension benefit is not known until payments commence. This means in its turn that accurate pre-funding in accordance with direct actuarial principles is impossible. Therefore, the most appropriate technique for financing gross pensions is a pay-as-you-go system.
It should be recognised that the gross co-ordination model is much more difficult to apply, in terms of regulation and administration, than the net co-ordination model. Rules must be laid down for calculation of the individual amounts to be deducted and procedures established for the collection of individual data on basic state pensions.
For the state, as employer, pension costs and their financing does not have the same priority as for private employers. The state’s economic resources (the size of the budget and the power to levy taxes) are huge in comparison.
Where costs are not the focus of attention, the benefits are. This is probably the main reason why the pension promise to a civil servant is normally benefit-defined and not contribution-defined. The size of the benefit is defined in the pension scheme. The size of the contribution—ie the costs for the active generation—is a mere consequence of the benefits and indeed an uncertain factor. Complicated actuarial calculations are necessary if the benefits are to be financed by funding or if appropriate contributions are to be paid in a pay-as-you-go system. Even so, the final cost is still hard to predict and control. The consequence of this type of a promise is that the precise benefit amount is unknown until payment starts.
The alternative is a contribution-defined pension promise, where the size of the contribution is defined in the pension scheme. The benefit amount depends in this case on the total amount that has been contributed to the system and the growth of that amount during the employment period. Actuarial calculations will decide the size of the monthly benefit to be paid from retirement age.
The present trend is towards contribution-defined pension promises. The main reason is a desire to control and confine high and rising costs. It is also a result of the trend towards funded schemes, since a pension fund is best suited to handle a contribution-defined pension promise.
The question of what type of pension promise that should be given is often confused with the question of what earnings the pension should be related to. Since the prevailing view of occupational pensions is that they should be thought of as deferred earnings one would think that normally the employees’ total career earnings would count. Still, public sector pensions are usually calculated on the basis of some sort of final salary, which reflects a view of pensions as extended earnings. Such a pension is only conceivable if the pension promise is benefit-defined. The opposite alternative is to have the pension based on career earnings, ie all the pay received by the employee during his or her whole career. This alternative is associated with a contribution-defined pension promise, but it is also possible to obtain if the promise is benefit-defined.
Under some occupational pension schemes employees who leave their employment before attaining the normal retirement age, “early leavers”, risk losing the pension benefits to which they assume they are entitled. An employee who wishes to change jobs may not, under such circumstances, do so for fear of losing pension benefits. Pension conditions of that kind may be in line with the employer´s interests, but are an obstacle to labour mobility. They were common in earlier times but are in most countries no longer regarded as acceptable.
It is necessary, in this context, to introduce the question of vested pension benefits. Where entitlement is dependent on one or more conditions, the benefit is conditional. In the absence of such conditions, it is said to be a vested benefit. This concept may vary from one country to another, but it is nevertheless appropriate to discuss it in connection with the calculation and revaluation of benefits when an employment terminates.
Even where pension rights are not strictly conditional, the way pensions are calculated and the fact, in some schemes, that pension benefits are not revalued in the event of termination of employment may deter employees from changing jobs. This applies primarily to benefits based on final salary. To solve this problem it may be necessary to include rules in the pension scheme requiring co-ordination with other occupational pension rights.
The possibility of transferring pension rights or other forms of co-ordination between different schemes is an important factor in facilitating labour mobility and recruiting qualified staff. However, the co-ordination rules are often complicated and it is difficult to conclude agreements about them between different pension systems and even more difficult to alter such agreements. The rules are also difficult for employees to comprehend. One great advantage of contribution-defined promises and pensions based on career earnings is that such systems do not require co-ordination. Each employer is responsible for his share of the final pension, without having to take into account any pension rights accrued in earlier employment.
Early leavers may have terminated their employment not only voluntarily, but also for reasons such as redundancy and ill-health. In such cases, additional benefits may be due, to be paid out before normal retirement age and before payment of accrued old-age pension rights starts. But that is another story.
In view of the far-reaching financial commitment involved in a pension promise, occupational pension schemes for civil servants often have the formal status of an act of parliament. Detailed rules of minor economic importance are usually adopted by the government.
Although the conditions are formally laid down in regulations issued by the employer—the state—there should be a structure enabling employees to influence them prior to their adoption. It is also important that there should be a close connection between the party or parties who will bear the costs of the pension scheme and those who decide on its content.
Pension provisions should be exhaustive. The rules applying to the pension system as a whole, both with respect to benefits and financing, should be included. It may be practical, though, to issue purely administrative rules separately from the pension scheme itself. The rules should be formulated in such a way as to be readily understandable. The effort put into producing a simple and well-structured text is eminently worthwhile, both from the point of view of those who need information about their pension rights and of those whose task it is to administer and develop the rules.
The administration of occupational pensions depends on the design of the pension scheme. Generally, it consists in collecting and registering data on pensionable earnings, calculating contributions and benefits, regulating and fixing benefits, collecting contributions and accounting for contributions and pension assets. The calculations may involve actuarial methods. In the case of pre-funded pensions, there is also the task of managing the pension capital. In addition, administrators usually have the task of informing members of pension conditions and supplying appropriate information to individuals. Administrative details vary considerably depending on whether pension promises are benefit- or contribution-defined, whether benefits are based on final salary or career earnings and whether they are financed by pre-funding or by a pay-as-you-go system.
It is impossible to generalise about which solution is simplest to administer, it depends on the specific mix of options chosen. For example, contribution-defined promises are simple to administer, but that also goes for benefit-defined pensions based on final salary and financed by a pay-as-you-go system. However, administration in these cases is completely different. The former is basically traditional pension savings, while the latter only requires calculations to be made when pension payments commence.
The administration of civil service pensions should preferably be the responsibility of a central body. This body should be responsible to those who decide on the pension conditions and should be independent of the institutions where the civil servants are employed. Central administration ensures legal certainty and equal treatment. Modern information technology makes it possible to deal with large volumes rationally and reliably. This is particularly important when new pension schemes are introduced.
Capital management, where this occurs, should not be the responsibility of the administration. If pension capital is set aside for contribution-defined pensions, its management is crucial to the benefit amounts that can be paid out. Those who are entitled to the benefits should therefore have a say, or at least some control over, capital management.
European Commission (1994). Supplementary Pensions in the European Union: Development, Trends and Outstanding Issues, Brussels.
OECD (1997). Civil Service Pension Schemes, SIGMA Papers: No. 10, Paris.
World Bank (1994). Sharing the Responsibility: Public and Private Schemes, Development Brief, No. 41, Washington, D.C.
World Bank (1994). Redistributions Across Income Levels in Pay-as-you-go Systems, Development Brief, No. 44, Washington, D.C.
The SIGMA Programme launched the Policy Briefs series in August 1997 to make public policy subjects accessible to a wide audience interested in governance in Central and Eastern Europe. The Programme draws upon its extensive international network of experts to write these concise documents, which provide non-specialists and specialists alike with comparative information on important matters affecting citizens in all democracies.
SIGMA is a joint initiative of the OECD Centre for Co-operation with the Economies in Transition and the European Union Phare Programme, mostly financed by Phare. SIGMA supports public administration reform efforts in thirteen countries in transition. The Programme offers beneficiary countries access to a network of experienced public administrators, comparative information, and technical knowledge connected with the OECD’s Public Management Service (PUMA). Views expressed herein do not represent the official views of the European Commission, OECD Member countries, nor the central and eastern European countries participating in the SIGMA Programme.
As part of SIGMA’s ongoing activity providing advice and comparative information on public administration, Staffan Ekebrand wrote SIGMA Policy Brief No. 2: Civil Service Pension Schemes. Mr. Ekebrand, serves as Deputy General-Director at the Swedish National Government Employees Salaries and Pension Board (SPV Lön & Pension) in Sundsvall.
For more information, contact: SIGMA-OECD, 2, rue André-Pascal, 75775 Paris Cedex 16, France. Tel: (33.1) 45.24.79.00. Fax: (33.1) 45.24.13.00. E-mail: sigma.contact@oecd.org