1

ACTUARIAL AND FINANCIAL ACTUARIAL AND FINANCIAL REVIEW OF THEREVIEW OF THE

GENERAL PENSION SCHEME GENERAL PENSION SCHEME OF LUXEMBOURGOF LUXEMBOURG

15 February 2001

The International Financial and Actuarial Service (ILO-FACTS)

ILO Social Protection Sector

2

Structure of the presentationStructure of the presentation

0. International comparison

1. Assumptions of the valuation

2. Status quo results

Scenario 1

Scenario 2

3. Alternative reform options

4. Conclusions and recommendations

3

International comparisonInternational comparison- retirement 65 years old with - retirement 65 years old with

40 years contribution40 years contribution

Replacement ratioContribution rate for individuals

One point contribution rate buys … replacement ratio

Luxembourg 77.35% 16.00% 4.83%

France 45.00% 19.85% 2.27%

Germany 42.30% 19.50% 2.17%

Belgium 53.33% 19.86% 2.69%

4

AssumptionsAssumptions- Net cross-boarder workers- Net cross-boarder workers

Assumptions - Net cross-boarder workers

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Nu

mb

er o

f n

et c

ross

-bo

ard

er w

ork

ers

Scenario 1

Scenario 2

200,000 more over 50 years

constant

5

AssumptionsAssumptions- Real GDP increase- Real GDP increase

Assumptions - Real GDP increase

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Rea

l GD

P in

crea

se

Scenario 1

Scenario 24% on average

2% on average

6

AssumptionsAssumptions- Employed (Domestic) and- Employed (Domestic) and

labour force (National)labour force (National)Assumptions - Employment (Domestic) and labour force (National)

0

100'000

200'000

300'000

400'000

500'000

600'000

700'000

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

YearScenario 1 Employment (Domestic) Scenario 2 Employment (Domestic)

Scenario 1 Labour force (National) Scenario 2 Labour force (National)

7

Status quo resultsStatus quo results

1. Scenario 1(a) Demographic ratio(b) Financial ratio(c) PAYG cost rate(d) Reserves and funding ratio

2. Scenario 2(a) Demographic ratio(b) Financial ratio(c) PAYG cost rate(d) Reserves and funding ratio

8

Demographic ratioDemographic ratio- - Scenario 1Scenario 1

Demographic ratio(pensioners / active contributors)

0%

10%

20%

30%

40%

50%

60%

70%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Dem

og

rap

hic

rat

io (

pen

sio

ner

s / a

ctiv

e co

ntr

ibu

tors

)

Orphans

Widows

Invalids

Retired

9

Financial RatioFinancial Ratio- - Scenario 1Scenario 1

Financial ratio(average pension / average contribution base)

0%

10%

20%

30%

40%

50%

60%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Fin

anci

al r

atio

(ave

rag

e p

ensi

on

/ av

erag

e co

ntr

ibu

tio

n b

ase)

Total

Retired

10

PAYG cost ratePAYG cost rate- - Scenario 1Scenario 1

Pay-as-you-go cost rate(annual expenditure / annual contribution base)

0%

5%

10%

15%

20%

25%

30%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Pay

-as-

you

-go

co

st r

ate

(an

nu

al e

xpen

dit

ure

/ an

nu

al c

on

trib

uti

on

bas

e)

Others

Orphans

Widows

Invalids

Retired

Present contribution rate

General Average Premium

11

Reserves and fundingReserves and funding ratio ratio- - Scenario 1Scenario 1

Reserves at the end of the year(in million Euros)

0

10'000

20'000

30'000

40'000

50'000

60'000

70'000

80'000

2000 2010 2020 2030 2040 2050

Year

Res

erve

s at

the

end

of th

e ye

ar (i

n m

illio

n E

uros

)

Funding ratio(reserves / annual benefit expenditure)

0

1

2

3

4

5

6

2000 2010 2020 2030 2040 2050

Year

Fund

ing

ratio

(res

erve

s / a

nnua

l ben

efit

expe

nditu

re)

12

Comparison between two Comparison between two scenarios - demographic ratioscenarios - demographic ratio

Comparison between two scenarios - demographic ratio(pensioners / active contributors)

0%

20%

40%

60%

80%

100%

120%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Dem

og

rap

hic

rat

io(p

ensi

on

ers

/ act

ive

con

trib

uto

rs)

Scenario 1

Scenario 2

13

Financial ratioFinancial ratio- Scenario 2- Scenario 2

Financial ratio(average pension / average contribution base)

0%

10%

20%

30%

40%

50%

60%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Fin

anci

al r

atio

(ave

rag

e p

ensi

on

/ av

erag

e co

ntr

ibu

tio

n b

ase)

Total

Retired

14

Comparison between two Comparison between two scenarios - PAYG cost ratescenarios - PAYG cost rate

Comparison between two scenarios - pay-as-you-go cost rate(annual expenditure / annual contribution base)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Pay

-as-

you-

go c

ost r

ate

(ann

ual e

xpen

ditu

re /

annu

al c

ontr

ibut

ion

base

) Scenario 1

Scenario 2

15

Reserves and funding ratioReserves and funding ratio- Scenario 2- Scenario 2

Reserves at the end of the year(in million Euros)

-350'000

-300'000

-250'000

-200'000

-150'000

-100'000

-50'000

0

50'000

2000 2010 2020 2030 2040 2050

Year

Res

erve

s at

the

end

of th

e ye

ar (i

n m

illio

n E

uros

)

Funding ratio(reserves / annual benefit expenditure)

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

2000 2010 2020 2030 2040 2050

Year

Fund

ing

ratio

(res

erve

s / a

nnua

l ben

efit

expe

nditu

re)

16

Summary of Summary of Financial situationFinancial situation-- Status quo Status quo

1. Sound financial situation at present, but sensitive to assumptions, especially economic ones(a) Scenario 1

Contribution rate increase necessary after 2050(b) Scenario 2

Contribution rate increase necessary after 2010

2. Financial situation deteriorates in the second half of the projection period because of demographic reasons- Relatively large cohort of residents at present

between the age of 30 – 34- Higher number of pensioners because of present commuters

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Alternative reform optionsAlternative reform options1. Parametric reform options

1.1 Yearly adjustment of pensions

1.2 Increase in the level of pensions

1.3 Payment of a thirteenth pension

1.4 Unspecified increase of payment

1.5 Higher weight to contribution periods close to retirement

1.6 Change of retirement age

1.7 Reduced invalidity incidence rates

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Financial effectsFinancial effects- parametric reform options- parametric reform options

General Average Premium Absolute increase in

Scenarios and reform options Long-term cost indicator Relative increase in cost contribution rates

(GAP) in points

Present contribution rate 24% points

Scenario 1 points points

1 Status quo 22.9 0.0% 0.0

2 Indexation 23.1 1.2% 0.3

3 Increase in the level of pensions 24.5 7.4% 1.7

4 Thirteenth payment 25.6 11.8% 2.7

5 Unspecified increase 23.8 4.3% 1.0

6Higher weight to contribution periods close retirement

23.4 2.2% 0.5

7 Change of retirement age (1 year) 22.6 -1.2% -0.3

8 Reduced invalidity incidence rates (50%) 21.6 -5.7% -1.3

Scenario 2

1 Status quo 31.9 0.0% 0.0

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Alternative reform optionsAlternative reform options

2. Systemic reform proposals

2.1 Bonus accounts

2.2 Two-tier pension scheme(introducing DC scheme)

2.3 Value added contribution (VAC)

20

Bonus accountsBonus accounts- Funding ratio comparison- Funding ratio comparison

Funding ratio comparison (different interest rates)(reserves at the end of the year / annual benefit expenditure)

0

1

2

3

4

5

6

7

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Year

Fu

nd

ing

rat

io(r

eser

ves

at t

he

end

of

the

year

/ an

nu

al b

enef

it e

xpen

dit

ure

)

Annual interest rate of 6%

Annual interest rate of 5%

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Bonus accountsBonus accounts- Development of account balances- Development of account balances

Hypothetical balances of individual surplus accounts(individual savings / monthly average old-age pension)

0

1

2

3

4

5

6

7

8

9

10

1 6 11 16 21 26 31 36

Years of excess income

Rel

ativ

e su

rplu

s(i

nd

ivid

ual

sav

ing

s / m

on

thly

ave

rag

e o

ld-a

ge

pen

sio

n)

10 years savings

20 years savings

30 years savings

40 years savings

22

Introduction of two-tier pension Introduction of two-tier pension scheme (DC scheme)scheme (DC scheme)

Assumptions1. Introduction

In the year 2010

2. Contribution rate(a) First pillar (DB scheme) 18%(b) Second pillar (DC scheme) 6%

3. Financial transfers between the two pillars in case of invalidity and survivorshipHigher administrative cost in 2nd pillar

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Introduction of two-tier pension Introduction of two-tier pension scheme (DC scheme)scheme (DC scheme) (Contd.) (Contd.)

4. Benefits(a) First pillar (DB pillar)

- Old-age pensionsannual accrual rate of 1.28%(instead of 1.78% at present)

- Invalidity and survivors’ pensionssame as the present scheme

(b) Second pillar (DC pillar)- Old-age pensions only

annual amount calculated by dividing accrued individual amount by unisex life expectancy

24

Two-tier pension schemeTwo-tier pension scheme- Development of reserves- Development of reserves

-100'000

-50'000

0

50'000

100'000

150'000

2000 2010 2020 2030 2040 2050

Defined contribution (DC) pillar Defined benefit (DB) pillar Both pillars combined

Development of reserves of two-tier scheme (in million Euros)

25

Two-tier pension schemeTwo-tier pension scheme- Replacement rates- Replacement rates

0%

10%

20%

30%

40%

50%

60%

2000 2010 2020 2030 2040 2050

Two pillars combined Defined contribution (DC) pillar (5% interest rate) Defined benefit (DB) pillar Status quo

Replacement rates comparison (old-age pensions) (average old-age pension / average contribution base)

26

Replacement rates of the Replacement rates of the second tier (DC tier)second tier (DC tier)

0%

2%

4%

6%

8%

10%

12%

2015 2020 2025 2030 2035 2040 2045 2050

Annual interest rate of 5% Annual interest rate of 3% Annual interest rate of 1%

Replacement rate comparison (DC scheme)(average pension / average contribution base)

27

Value added contribution (VAC)Value added contribution (VAC)Why:

1. Compensation of fiscal effects of decrease of labour income share in GDP

2. Possible increase in employment levelProblems:

1. Results of research are inconclusive2. Employment effects marginal3. Lobbying for exemptions is highly probable4. Administrative problems not yet solved or

unclear5. Loosen ownership rights of employers’

contributions6. Introduction only possible in a concerted

international actionConclusions:

Presently not recommendable and not necessary

28

Conclusions andConclusions and recommendationsrecommendations

1. Financial situation of the scheme

- Sound financial situation

- Sensitive to assumptions, especially economic ones

- Future demographic pressure onthe scheme in either scenario

29

Conclusions andConclusions and recommendationsrecommendations (Contd.) (Contd.)

2. Recommendations – ‘‘DO’’s and ‘‘DON’T’’s

- DO adjust benefits on annual basis

- DO increase early retirement age of57 and 60

- DO tighten the eligibility criteria for invalidity pensions after age of 50

- DO prolong the scaled premiumperiod to 10 years with a funding ratio of 2 at its end

30

Conclusions andConclusions and recommendationsrecommendations (Contd.) (Contd.)

- DON’T spend current surpluses andpresently high reserves, except for creating ‘bonus accounts’

- DON’T increase the level of the benefitse.g. - 10% increase in the flat part and

accrual rate of 1.9% instead of the present rate of 1.78%

- Thirteenth payment

- Higher weights to contribution periods close to retirement

31

Conclusions andConclusions and recommendationsrecommendations (Contd.) (Contd.)

- Introduction of two-tier system has no advantage for the individual.

- Introduction of VAC is not necessary from a financial point of view.

- It may be a good idea to introduce ‘bonus accounts’ through which ‘windfall profits’ could be

distributed.

32

ACTUARIAL AND FINANCIAL ACTUARIAL AND FINANCIAL REVIEW OF THEREVIEW OF THE

GENERAL PENSION SCHEME GENERAL PENSION SCHEME OF LUXEMBOURGOF LUXEMBOURG

15 February 2001

The International Financial and Actuarial Service (ILO-FACTS)

ILO Social Protection Sector