Public pension system

Spanish Pension System
Problems and Challenges
Uniwersytet Ekonomiczny w Krakowie
Jose Antonio Pérez García
International Finance

1
Index
1. Introduction
2. Definition and kinds of pensions
2.1. Contributive and non-contributive
2.2. How is it calculated?
3. Structural problems
3.1. Demographic problems
3.2. Economic problems
4. Moneybox pensions
4.1. Chronology
4.2. What does the fund invest in?
4.3. Historical evolution
4.4. Repurchase agreement
5. Other countries as example
5.1. Norway
5.2. Chile
5.3. Poland
6. Conclusions
Bibliography

2
1. Introduction
The public pension system has become a recurring issue nowadays. Not only in
Spain, but also in other countries where demography and population aging are
causing great havoc in those systems where pensions are maintained with
current workers ‘contributions. Sample of this is the question that are constantly
asked daily by taxpayers questioning the sustainability of the system or if it will
break. So much so, that the Spanish pension system has slipped among the
issues that most concern Spanish people currently, surpassing the housing
(Fuentes, 2016). Maybe that was the reason I ventured into this everyday topic.
We have a clear example outside our borders with the famous TV commercial in
Denmark (well known for maintaining a solid state of well-being) where birth was
clearly promoted with the sole aim of maintaining the economic system that the
Danes possess. Currently the country keeps a birth rate about 1.73 children
(fertility rate). Apparently, is not enough for the country´s authorities.
To know the origin of this system, which prevails in most of the world, we must
go back to the nineteenth century, specifically to 1889, when Otto von Bismarck
(also known as iron chancellor) implanted it in the German Empire. As a curious
fact, at that time in the country life expectancy was around thirty-eight years. It
was not too far from Sweden (at that time it owned the largest in the world), which
was forty-five years. If we cross the Atlantic, we can see that Franklin Delano
Roosevelt established the distribution system in the middle of the third decade of
the twentieth century (in 1935) when in the United States it had a life expectancy
of sixty-one years (Rallo, Una Revolución Liberal para España, 2014).
The creation of the distribution system was associated with the establishment of
a network of state protection for those over sixty-five years’ age and without
economic resources. The passage of time has turned it into what was originally
not conceived, transforming itself into a pyramid scheme (pensions depend
exclusively on the number of workers who have been affiliated to Social Security).
With the data shown above, I only want to demonstrate the great demographic
change that society has been experiencing since the nineteenth century.
Population aging, the steady decline in infant mortality or the birth rate are just
some of them.

3
Throughout this paper I have tried to show the different types of pensions
(contributory and non-contributory) that exist in Spain, the structural problems
(demographic and economic) that devastate the country, the famous pension
fund that was created in the 1990s as a forecast for future imbalances between
income and expenditure. And as the last part of the paper, I wanted to show as
an example to different countries that have different pension systems among
themselves.

4
2. Definition and kinds of pension
2.1. Contributive and non-contributive
The Spanish public pension system consists of a single, earnings-related benefit
in the contribution level, with a means-tested minimum pension. There is also a
non-contribution means-tested level, which replaces the previous special social
assistance scheme. Following the pension reform of 2011, the retirement age for
a full pension benefit has been increased from 65 years to 65 years and two
months in 2014 (although this number has increased in 2013 –It will be necessary
35 years and 6 months- and in 2027 it will be a total of 37 years. The legal
retirement age will be 67 years for both men and women in 2027. However, if a
person has 38.5 years of contributions retirement with full-pension benefits is
possible from age 65. It is necessary to have 1 year of contributions to qualify for
a pension benefit. (OECD Pensions at a Glance, 2015). There are two kind of
pensions:
Contributive Pension: This kind of pension are economic benefits and of
indefinite duration whose concession is subject to a certain number of
years worked during your labor life. (35 years for receiving the total amount
of the pension). It´s amount depends on the amounts that you have been
contributing. There are different classes such as: retirement, permanent
disability (total, absolute and great disability) and death.
Non Contributive Pension: This sort of pension is recognized to those
citizens who don´t have contributed the enough time for receiving its
correspondent pension. People who receive this kind of pension are in a
precarious situation. (Ministerio de Empleo y Seguridad Social, 2016).
There are different classes such as: old age, disability and survivor.

5
2.2. How is it calculated?
The current law, which come into force in 2013, has progressively raised the age
required for retirement –from 65 in 2013 until 67 years in 2027- as well as the
number of years quoted to determine the amount of the benefit -15 years in 2012
until 25 in 2022-. This measures come in line with the needs of public coffers and
the increase in the life expectancy of the population. (El País, 2015).
I am going to develop this section in three steps:
1. The first step consists of collecting the contribution bases of the last
years prior to retirement.
Transition Period Computed Time
During 2013 16 years (192 months)
During 2020 23 years (276 years)
From 2022 25 years (300 months)
2. Once we have calculated the contribution bases, it is necessary to
calculate the regulatory base. To do that, we have to add all the
contribution bases and divide between the “divisor” (this number is the
result of multiplying the number of Computable Years and all the extra pay
during a year (14 in total).

6
3. Finally, we have to make some adjustment to the regulatory base. This
must be applied depending on the number of years quoted throughout our
working life.
For example, a worker with a regulatory base of 1000€ and 25 years quoted, it
will receive an adjustment of 75.2% (752€ in total). (BBVA, 2013).

7
3. Structural problems
The pension system of Spain is totally public. I mean, this consists of that the
current workers (employed population) is maintaining this system through so-
called “social contributions”, which are amounts of money paid every month. More
clearly, current workers are paying the pensions of the retirement people.
I titled “structural” because the current problems of this kind of pension are usual.
It comes from a long time ago, since the failure of the dictatorship. Basically, the
main problems are demographic and economic.
3.1. Demographic problems
First of all, demographic problems are due to the aging of the population and the
low rate of natality. If we pay attention to the countries of the European Union,
the date of the population is very similar. In the case of Spain, according to ONU
in June 2013, the population over 64 years has increased more rapidly since 60s
than in other countries. Over the five countries showed in the table 1, Spain was,
in 1960, the country with the lowest proportion of population over 64 years. In
2000 Spain passed countries such as The Netherlands and France and staying
behind Italy. Roughly, one out of 10 inhabitants will be 80 or more years in that
five countries.

8
Country/Year 1960
%
1970
%
1980
%
1990
%
2000
%
2010
%
2020
%
2030
%
2040
%
∑
1960-
2000
∑
2000-
2040
Spain
>64
8.2 9.7 11.2 13.7 16.9 17.1 19.5 24.1 30.1 1.06
Italy
>64
9.5 11.1 13.4 14.9 18.3 20.3 22.8 26.8 31.7 0.93 0.73
The
Netherlands
>64
8.9 10.1 11.4 12.8 13.6 15.4 20.1 24.6 27.5 0.53 1.02
France
>64
11.6 12.9 14 14.1 16.0 16.8 20.3 23.2 25.4 0.38 0.59
Germany
>64
11.4 13.6 15.6 15 16.3 20.8 23.1 28.2 31.8 0.43 0.95
Source: Own elaboration through United Nations, World Population
Prospects: The 2012 Revision (variant media)
(http://esa.un.org/wpp/unpp/panel_indicators.htm)
Spain´s image does not change if we pay attention to the dependency rate of the
aged population (over 65 years) respect to active population (15-64 years). In
Spain, as we can see in the second table, that rate doubled between 1960 and
2010, resulting in an intermediary position above all France and The Netherlands
and below Italy and Germany.

9
Dependency Rate
Country/Year 1960
%
1970
%
1980
%
1990
%
2000
%
2010
%
2020
%
2030
%
2040
%
∑
1960-
2000
∑
2000-
2040
Spain 13 15 18 21 25 25 30 38 53 0.92 1.12
Italy 15 17 21 22 27 31 36 45 58 0.80 1.15
The
Netherlands
15 16 17 19 20 23 31 41 49 0.33 1.45
France 19 21 22 21 25 26 33 39 44 0.32 0.76
Germany 17 21 24 22 24 32 36 48 57 0.41 1.38
Source: Own elaboration through United Nations, World Population
Prospects: The 2012 Revision (variant media)
(http://esa.un.org/wpp/unpp/panel_indicators.htm)
Although Spain is not the European country with forecasts of aging population,
according to the projections cited, is included in the group of the most aged. This
is caused in part by a strong drop in the natality and the persistent increases in
longevity. From my personal point of view, this a good news. Life expectancy has
increased spectacularly: In 1900, it was like 35 years and nowadays is 79 years
in women and 85 in woman. ( (Estadística, 2014).

10
Life Expectancy
Years Man Woman
2013 79.99 85.61
2014 80.03 85.66
2019 81.43 86.7
2024 82.75 87.71
2029 83.99 88.68
2034 85.17 89.62
2039 86.29 90.53
2044 87.36 91.39
2049 88.37 92.22
2054 89.33 93.01
2059 90.25 93.75
2063 90.95 94.32
Source: Own elaboration through National Statistic Institute.
Following the demographic problems, I think it would be convenient to mention
the vegetative growing. First of all, vegetative growing, also known as growing
natural, is the difference between the number of births and the number of deaths
from a population in a certain period of time.
According to the National Statistic Institute, the number of births would continue
decreasing in the next years. Between 2014 and 2028, it would be born around
5.1 million children, 24.8% less than in the previous 15 years. In 2029 the annual
number of births would have fallen to 298,202, a 27.1% less than at present.
The decreasing in the number of births it is because of the reduction of the
number of women of childbearing age. In fact, the number of women between 15
and 49 years old would decrease in 1.9 million in 15 years, and in 4.3 million in
50 years.
In spite of the loss of population and the increasing in the life expectancy, the
number of deaths would continue increasing as a consequence of the population
aging. In the period 2014-2029 would have more than 6 million of deaths, a 7.1%
more than previous 15 years. (1999-2013). The decreasing in the natality and the

11
population aging would cause that in 2015 in Spain would have more deaths than
births, so the vegetative growing would be negative. The orange line means
births; the burgundy line means deaths and the grey line means vegetative
growing (see table below).
Source: National Statistic Institute.
Population pyramid
It is a key factor for the sustainability of the pension system because of if the
expenditure is higher than the income, it is impossible to guarantee the
effectiveness of the system.
In the next graph we can see the evolution from 1970 until nowadays and
what is to come until 2050.
Legend: The orange line means employees and the green line means
pensioners.
Source: National Statistic Institute.

12
As we can see, in 1970 every six employees kept one pensioner (20,402,000
/ 3,290,800), which generated a comfortable and sustainable situation.
Between 1958 and 1977 a great number of births were given in Spain, almost
fourteen million children being born. This stage of numerous births was called
the baby boom and it could be said that it is the cause of the investment of the
population pyramid, since then the birth rate fell a lot, generating a great
difference of population between generations.
In the graph correspondent to 2008 we can see how the baby boom
generation grows and are in age ranges between 30 and 39 years. At this time
three workers were holding a pensioner (22,189,900 / 7,303,500) and the
situation was still sustainable.
It is expected that in 2025 baby boom generation reach to the retiring age and
we would see a more complicated situation for maintaining the pension
because of that it estimates that for every worker will have one pensioner.
Regarding to the famous population pyramid, we would see a growth in the
upper half. In fact, all the groups from 70 years old would increase
considerably.
3.2. Economic problems
I think it is time to observe now the economic problems of the Spanish pension
system. I would like to mention the ratio between the number of affiliated and the
number of pensioners. The ratio provided by the Ministry of Social Security is
higher, about 2.26 affiliates per pensioner, because for the calculation it also
includes the number of affiliates in unemployment situation. But, personally, I
would be more accurate due to I would consider just the number of affiliates who
are working (employed population). And last ratio is about 2.08 employed
affiliates per pensioner. (Security, 2016, July)
𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 𝐴𝑓𝑓𝑖𝑙𝑖𝑎𝑡𝑒𝑠
𝑃𝑒𝑛𝑠𝑖𝑜𝑛𝑒𝑟
=
17,805,680
8,559,328
= 2.0802

13
However, according to some experts, they are calling for more major changes,
as even the official ratio of 2.26 per pensioner is the second worst result since
December 1999 (the ratio was then 2.23).
Evolution of the ratio affiliates/pensioners
Source:http://www.libremercado.com/2016-04-05/la-ratio-afiliadospensionistas-sigue-
estancada-pese-a-la-creacion-de-empleo-1276571180/ through Social Security.
The urgency of the reforms is undeniable. As Miguel Angel Bernal, from IEB
(Stock Market Institute, by its acronym in Spanish), recalls, changes have been
made with the sustainability and the revaluation factor (in December 2013). In his
opinion, the changes introduced by the Minister Fatima Báñez “give air” to the
system, but it is not enough”. In fact, there are regions in Spain which are suffering
this ratio, even to the point that they cannot stand the pensions because of there
are no enough affiliates to support pension (Benayas, 2016).
The impact of the population aging on Social Security is highlighted by José
Ignacio Conde-Ruiz, deputy director of Fedea (Foundation of Applied Economy
Studies): “In an increasingly aging in Spain, where the number of pensioners only
grows, the income in the State do not rise at the same pace”, which requires
changes of draft.

14
4. Moneybox pension
4.1. Chronology
Moneybox pension, although officially called Social Security Reserve Fund, is a
sovereign investment fund created by Spanish government. This constituted an
institutional requirement to meet future needs caused by variations between
income and expenses.
In April 1995 arose the so-called Pact of Toledo, which establish several kind of
recommendations aimed at ensuring the sustainability of the system. Reforms
and measures which followed such recommendations conform the path that has
covered the social security system to the present. The chronological process is
as follows:
The economic situation of budget deficit in social security in recent years has
made the Reserve Fund an essential instrument to ensure the financial
sustainability of the pension system.
Law 18/2001:
•It was established
the application
priority of the
surplus of the
Social Security
system to the
Reserve Fund
Law 24/2001:
•It was determined
the constitution of
the Reserve Fund
in the General
Treasury of Social
Security.
Law 28/2003
•It was established
the legal regime
for the first time in
a specific law.

15
4.2. What does the fund invest in?
Once we have talked about Reserve Fund investment, I think is time to know
which are the requirements:
Reserve Fund will invest in:
Spanish Public Debt
Could
invest in:
German Public
Debt
French Public
Debt
Dutch Public
Debt

16
The investment in public deb of non-Spanish issuers shall be limited to the
amount total of the foreign debt over the total portfolio does not exceeds 55% in
face value. Therefore, the investment in public debt of Spanish issuers must be
at least 45%.
Regarding to the diversification of the Spanish assets from the Reserve Fund of
the Social Security, it must be no more than 16%. This is because of avoiding
concentrations of the same reference in the portfolio. However, this maximum
Issued in euros € High credit quality
Traded on regulated
markets (not Over the
Counter)
Assets issued by Institute
of Official Credit
Requirements

17
percentage of each reference shall be increased from 16% to 35% for those
references where strictly necessary to meet the conditions of the investment.
Source:
(Security M. o., 2015)
Maximum
16%
Nominal
balance of
each
Spanish
reference

18
4.3. Historical evolution
Spanish government has withdrawn often money several times since the
beginning of his government because of the economic situation of the country.
The result of this decision is that the Reserve Fund has accumulated about
70,000 million euros in 2011 to just over 25,000 million by mid-2016. The reason
for this kind of decision (retiring money) is to pay the pensioners the extra
payments of summer and Christmas during the past legislature.
Source: Ministry of employment and Social Security
According to the Budget Plan 2017 that the government sent to Brussels last
weekend, the Social Security will register a deficit of 1,7% of GDP at the end of
this year, which is equivalent to about 19,000 million euros, a new historical
record. The Fund would be reduced to just over 13 billion by the end of 2016.

19
Title: Social Security Deficit
The red line means ‘deficit’ and the blue one ‘surplus’. (Captor, 2016)

20
4.4. Repurchase Agreement
On 18th July, 2014, in the meeting of the Management Committee of the Reserve
Fund, is allowed the establishment of a procedure of the execution of “Repo”
operations, allowing exclusively as collateral financial assets of Spanish Public
Debt issued by the Public Treasury that form part of the investment universe of
the Reverse Fund, as long as Bank of Spain acts as an agent bank.
The efforts to make possible the realization of “Repo” operations through Bank of
Spain culminated on 30th January, 2015 in order to minimize the balances of the
Reserve Fund accounts opened at the Bank of Spain.
It has been executed in 2015 “Repo” operations with the balances not invested
at any time. A procedure has been introduced to minimize the impact of the new
negative remuneration measured established by the European Central Bank
(currently situated about -0.40%), in cash accounts that the Reserve Fund keeps
open at the Bank of Spain.
Here is a graph showing the process:
At Maturity:
Seller
Financial assets of Spanish public
debt as collateral
Lender of Money
Cash Funds
Seller
Cash Funds + Interest
Lender of Money
Securities Returned

21
5. Other countries as example
In this chapter I will describe the main features of different kind of pension. I will
provide information from a OECD report. The next countries are:
- Norway (a system between distribution and capitalization)
- Chile (private system)
- Poland (notional accounts system)
5.1. Norway
The new public pension system, beginning in 2011, consists of an income
pension, and a guarantee pension for people with no or only a small income
pension. In 2006, a mandatory occupational pension was introduced in the private
sector as a supplement to the public pension.
From 2006, employers must take a minimum contribution of 2% of the earnings
of their employees to a defined contribution pension plan. If employers offer a
defined benefit scheme instead, then the benefits must be at least the same level
as the expected benefits under the mandatory 2% contribution. Contributions are
Key Indicators
Public pension
spending (as % of GDP)
5,4
Life Expectancy
81,7 (at birth)
80,0 (at 65)
Population over age 65
(as % of population)
16,4

22
only required on earnings between the basic amount and 12 times the basic
amount.
5.2. Chile
The pension system has three components: a redistributive first tier, a second tier
of mandatory individual accounts and a voluntary third tier. The individual
accounts system was introduced in 1981 and is defined contribution.
Normal retirement age is 65 years for men and 60 years for women. Pension
benefits can be withdrawn any point from that age. Individuals are not required to
stop working to claim a pension benefit.
The contribution rate for the individual accounts scheme equals 10% of earnings.
Administrative fees are levied on top of the contribution rate. There is a ceiling on
contributions which was CLP 1,780,539 per month.
At retirement, the accumulated capital can be used to buy an immediate life
annuity, to get a temporary income with a deferred life annuity, to take a
programmed withdrawal, or to buy an immediate life annuity with programmed
withdrawals.

23
5.3. Poland
The system is based on two notional accounts schemes. Since 2004 participation
in the funded scheme is voluntary, as workers can opt in to allocate their
contributions to the NDC sub-account to the private DC scheme. According to
Javier Díaz from BBVA Pension Institute, a notional accounts system is a
distribution system, as in Spain, which the only thing that changes is the way of
of accounting for pensionable rights. This system allows a closer relationship
between what workers contribute to throughout their working life and the pension
they end up receiving when they retire. (Díaz-Giménez, 2015)
The pension age is 65 years and three months for men and 60 years and three
months for women in 2014. The pension age is gradually increasing from 1
January 2013 by a month in January, May and September until it reaches 67
years for both sexes, for women this will be in 2040 and for men 2020. The
KeyFactors
Public pension spending
(as % of GDP) 10.8%
Life expectancy:
At birth: 76.3
At age 65: 17.4
Population over age age
65 (as % of population)
15.3

24
minimum pension requires 21 years´ of contributions. This age is increasing to
25 years for men by 2020 and women by 2022.
There are two notional account schemes. A contribution of 16.6% is credited to
the main individuals´ notional accounts. The notional interest rate is the growth
rate of the covered wage bill but no less than price inflation. This notional interest
rate is applied retrospectively to accounts from the year 2000.
On February 2014, 51.5% of the net assets of privately managed pension funds
were transferred to the Social Insurance Institution (ZUS). Moreover, the assets
of those who chose to stay in privately managed funds will be gradually
transferred to the public system ten years prior to the retirement age. Alongside
with the changes in functioning of privately managed pension fund a payout
mechanism for assets accumulated in those funds has been set up. DC (defined
contribution) pensions are calculated and paid out by Social Insurance Institution
as a combined benefit with the NDC (non-defined contribution) part.

25
6. Conclusions
King William of Alexander in his first speech as monarch of the Netherlands
referred to the evolution of the welfare state during the twentieth and early twenty-
first century, emphasizing the important role that citizens should play in a "
Participatory society, "whose role lies in" the responsibility of their own lives and
those of their immediate environment ", with the duty to offer" opportunities where
possible and protection where necessary ". This evolution was presented as the
result of the unsustainability of "the programs (...) produced by the postwar
Classic Welfare State", but also as a transformation among the many necessary
to "preserve the strengths and qualities" of Dutch society. In spite of the constant
and ferocious critics that received the monarch by his speech, it is to recognize
that it deserves to make a reflection on the demographic changes that has
experienced the society throughout these years.
There have been major changes worth mentioning, such as the longer life
expectancy where it has practically doubled in less than 150 years (at the end of
the nineteenth century it was around forty, now in its eighties); the steady decline
in infant mortality; the low ratio between affiliates and pensioners (currently
situated at 2.26 in March 2016).
Apart from the demographic and economic problems, the great problem that, in
my view, this distribution system has is the vulnerability it has to economic cycles;
That is to say, it depends on the economic fluctuations, since the moments of
economic prosperity mean high occupancy rates and, therefore, a sufficient
number of social security contributors to maintain the pensions. But, on the other
hand, economic crisis situations will lead productive factors to be in a situation of
unemployment with the corresponding decrease in the employment rate; which
will ultimately lead to an insufficient number of employed persons to satisfy
pensions
Finally, and before finalizing this work, I believe that the current system of
distribution has become obsolete insofar as it was not conceived as we know it
today. When this system was created, it was conceived originally for those people
who lacked financial resources and were over sixty-five years old (something, as
I said, quite unusual). If the government does not take emergency measures to
make a mutation to a capitalization or mixed system, citizens will see how the

26
Reserve Fund runs out and, therefore, will see their tax burden increase to cover
a system that has the days counted.

27
Bibliography
 Rallo, Juan Ramón, <A Liberal Revolution for Spain>, Deusto editions,
2014.
 A Core Reform, Foundation of Financial Studies, 2016.
http://www.fef.es/new/publicaciones/papeles-de-la-fundacion/item/273-
estudio-pensiones-una-reforma-medular.html
 OECD and G20 indicators, Pensions at a Glance 2015.
 Méndez Ibisate, Fernando, <Pensions are a problema>, 2015.
 López-Zafra, Juan Manuel, <Aging, pensions and the labor market>, 2016.
 El País, <How is the pension calculated? 2015.
 BBVA Pension Institute, <Calculation of the pension base>, 2013.
 National Statistic Institute, <Projection of the Spanish Population 2014-
2064, 2014. http://www.ine.es/prensa/np870.pdf
 Montero, Pepa, <There are just two employees for every pensioner in
Spain>, 2015.
 Europa Press, <Almost half of Spanish people don´t trust in receiving a
public pension when they retired>, 2016.
 Ministry of Employment and Social Security, Spanish Government,
<Affiliates occupied to Social Security>, July 2016. http://www1.seg-
social.es/ActivaInternet/groups/public/documents/rev_anexo/rev_035324
.pdf
 Soriano, D., <The ratio affiliates/pensioners remains stagnant despite the
creation of employment>, 2016.
 Reserve Fund of the Social Security, Report to the General Courts,
<Investment and management criteria of the Reserve Fund of Social
Security>, 2015. http://www.seg-
social.es/prdi00/groups/public/documents/binario/212877.pdf
 Aspain 11 Financial Advisors, <Moneybox Pension: Get ready for
retirement>, 2016. http://inbestia.com/analisis/hucha-de-las-pensiones-
preparate-para-la-jubilacion?utm_source=dlvr.it&utm_medium=facebook
 Díaz-Giménez, Javier., Notional Accounts System, 2015.

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