Flexibility in Retirement: Flexibility in Retirement: a framework for the a framework for the

analysisanalysis**

Turin, November 22nd , 2006Turin, November 22nd , 2006

**Based on a Report prepared by Miche Belloni, Chiara Monticone and Based on a Report prepared by Miche Belloni, Chiara Monticone and Serena Trucchi Serena Trucchi

for for the DG Employment, Social Affairs and Equal Opportunities the DG Employment, Social Affairs and Equal Opportunities

for for the European the European Workshop on Flexibility in the age of retirementWorkshop on Flexibility in the age of retirement (Madrid, October 26(Madrid, October 26thth, 2006), 2006)

Elsa ForneroElsa Fornero University of Torino and CeRP, Collegio Carlo University of Torino and CeRP, Collegio Carlo

AlbertoAlberto

2

Desirability and Effectiveness of flexible retirement

objectives objectives

a broad definition a broad definition

flexibility is not a free lunchflexibility is not a free lunch

is there a desirable benchmark?is there a desirable benchmark?

how can it be reached? how can it be reached?

how distant from it are European Countries?how distant from it are European Countries?

3

Objectives: extending working lives and making retirement gradual

The introduction of greater flexibility within The introduction of greater flexibility within European pension systems aims atEuropean pension systems aims at extending working lives by increasing the average

retirement age

reducing distortions embedded in rigid statutory retirement ages

granting workers a wider choice about the timing and patterns of retirement, as well as recognizing them greater responsibility as to the formation and use of retirement savings

Elsa Fornero - CeRP

4

Flexible retirement: a broad definition

Flexibility in retirement means allowing workers some degree of choice with respect to:

when to start drawing down their retirement wealth (flexibility in retirement age)

how much to draw (gradual retirement, with partial pension)

how to draw (which combination, if any, of annuity and lump sum; what kind of dynamics for the annuity, i.e. constant or increasing in in real terms)

Complete flexibility is however neither possible (a compulsory system has to establish minimum conditions, i.e. a minimum participation period), nor desirable (for the same reasons which support a public pension system)

Elsa Fornero - CeRP

5

Flexibility must not be a way to transfer resources from future to current generations

In all European pension systems it is possible, up to some extent, to reduce or to extend one’s working life with respect to the “legal” (statutory) retirement age(s)

In particular: • easier and earlier way out are provided for the disabled and the

unemployed

• all countries (possibly with the exception of ‘flat-rate’ ones: DK, NL, IRL, UK) have - or had, before the reform process - rather generous early retirement schemes, which typically reward early starts of working life

Flexibility in retirement should not be confused with rather generous early retirement provisions

Elsa Fornero - CeRP

6

The degree of flexibility is connected to the degree of actuarial fairness

A Beveridgean pension system with universalistic benefits, largely uncorrelated to contributions and awarded

at pre-determined age(s)

An actuarially fair and neutral pension system (as in the so called NDC case), characterized by:

a minimum age age-varying benefits a gradual drawing down of pension wealth possibilities of choosing different combinations of lump sum and annuities and different dynamics for the annuity

Little or no flexibility

Maximum flexibility

Increasing flexibility

Elsa Fornero - CeRP

7

Two sides of the same coin…

In this framework, flexibility in retirement age and partial retirement - two aspects of a more general problem - are very much two sides of the same coin

The first usually refers to the receipt of a full pension while the second provides a partial one

Both are flexible as far as their beginning is concerned, albeit within given age windows (which, when contemplated, usually do not coincide)

Actuarial corrections (more or less neutral) should apply

Elsa Fornero - CeRP

8

Characteristics

Formula Flexibility is the natural counterpart of (N)DC systems, although it can be applied also to DB systems

Age Flexible retirement age must be bounded below by a minimum, while a maximum may not exist (although it usually does). Partial retirement is necessarily bounded too

Benefits The principle of actuarial equivalence should guide the calculation of flexible pensions

Work The amount of the partial pension drawn is usually a fraction of the full pension, proportional to the reduction in hours or earnings

Contributions The contributions paid while getting partial pension

should (and often are) taken into account for future benefits

Elsa Fornero - CeRP

9

Elements of evaluation

Sustainability the more actuarially fair is the system, the more sustainable it also is

Effectiveness of the reforms in increasing retirement age, which depend very much on the transparency of the formula and on workers understanding of the mechanism

Equity If flexibility is based upon actuarial fairness – as it should - equity problems remain open, as the actuarial principle cannot in itself adequately cope with disadvantaged working conditions and histories (i.e. shorter life expectancy connected to certain types of jobs; shorter and more discontinuous careers of women)

Elsa Fornero - CeRP

10

Effects on labour supply and average retirement ageThe likely impacts on labour supply and on

average effective retirement age is difficult to establish a priori, as they crucially depend

on the actuarial properties of the system (whether it is actuarially neutral and whether it embeds the proper incentives), as well as

on individual behaviour (what the worker would have done, had not existed either form of flexibility, e.g. in the absence of partial retirement, would workers have chosen full (early) retirement – if any – or would they have worked full-time?)

Elsa Fornero - CeRP

11

The European panoramaEuropean provisions of flexible retirement are quite

diverse: some countries allow for both a flexible full retirement

and a partial pension, while others allow for just one of them, or none

However, the current state-of-art must be considered in a dynamic setting, looking not only at the past situation but at the future steady state, as defined by reforms, as well as at the transition period (which can be quite long)

Elsa Fornero - CeRP

12

Flexible retirement age Among the European NDC systems, three (LV,

PL, SE) allow for an age window for retirement, while Italy partially suppressed it a few years ago

Some degree of choice in retirement age – with national specificities – is possible also in DK, FI, ES, FR, DE, UK

Elsa Fornero - CeRP

13

Partial retirement In some cases (SE, FR) partial pension can be

drawn starting from the minimum retirement age. In other countries (DK, ES, FI) it can only be received before, making partial pension rather similar to early retirement

The amount withdrawn is proportional to the earnings loss (FI) or to the reduction in working time (DE, DK, ES, FR)

Elsa Fornero - CeRP

14

Income from pension at 55-59 (%)

0.08

0.21

0.31

1.40

5.55

5.55

7.37

29.83

0 5 10 15 20 25 30 35

Denmark

Sweden

Netherlands

Germany

Italy

France

Spain

Austria

Percentage of income from old-age pension as an income source for individuals in the age bracket 55-59 (2003). Source: SHARE

Elsa Fornero - CeRP

15

Income from work at 65-69 (%)

Percentage of income from work as an income source for individuals in the age bracket 65-69 (2003). Source: SHARE

0.7

3.4

7.6

9.5

15.2

16.1

21.4

42.1

0 10 20 30 40 50

France

Austria

Netherlands

Sweden

Italy

Germany

Denmark

Spain

Elsa Fornero - CeRP

16

Working at age 65-69 (%)

Percentage of individuals working in the age bracket 65 – 69 (2003).Source: SHARE

0.5

1.1

1.4

1.4

3.0

3.1

7.2

3.8

0 1 2 3 4 5 6 7 8

France

Spain

Netherlands

Austria

Italy

Germany

Sweden

Denmark

Elsa Fornero - CeRP

17

Concluding remarks

Flexibility allows to mitigate the contrast between the generality of rules and the variety of individual experiences and preferences

Flexible retirement age and partial retirement are perceived as two separate instruments, while they should be more integrated

Both should be designed in order to encourage (or at least not to discourage) a longer permanence in the labour force

Implications in terms of financial sustainability, adequacy and equity should all be equally considered

To enhance the positive aspects of flexibility, education to retirement savings is fundamental

Elsa Fornero - CeRP