France
compiled by Allianz Global Investors
Pension System Design
The pension system in France consists of a pubic pillar financed on a pay-as-you-go basis, a mandatory occupational system and voluntary occupational and personal arrangements.
Traditionally, pensions in France have been state-centred, with a dominating role for public pension provision. According to our projection, the French pension market, currently amounting to EUR 1.2 trillion, will grow at a CAGR of 6.1% until 2020.
A public pension reserve fund (Fonds des Réserve pour les Retraites, FRR) was established by the Social Security Financing Act 1999. The fund will play an important role to secure the sustainability of public finances by cushioning the high burden on the pension system predicted between 2020 and 2040. It is funded predominantly by social tax on income from estates and investments, surplus sums from the French National Old Age Fund and the proceeds from the sale of certain state-owned assets such as privatisation and UMTS licences.
Asset accumulation will continue until 2020, after which assets will be used to contribute to the long-term survival of mandatory old age insurance plans. The capital stock increased form EUR 7.1 billion in 2001 to EUR 17 billion in 2003, and reached EUR 34.5 billion at year-end 2007. 64.5% of these assets are allocated to equities and 33.5% are invested in bonds. The investment of the funds assets follows a strategic asset allocation (SAA), which was revised at the end of 2006. For diversification purposes and to achieve an improved risk and return objective ten per cent of the fund’s assets can be invested into alternative asset classes such as private equity and hedge funds.
The government plans to have a capital stock of EUR 150 billion accumulated by 2020, which amounts to 10% of GDP. As the assets are externally managed, this offers significant opportunities for private asset management companies. The asset management selection process follows a defined procurement process based on requests for proposals
As of June 30, 2007, 44 asset management mandates had been awarded to 28 different investment management firms. The asset manager selection process partly takes socially responsible investment (SRI) aspects into consideration. It was only recently announced that the fund is considering to extend its SRI strategy to all its investment portfolios.
Public Pensions
The statutory pension insurance scheme is a compulsory basic social security system, which provides earnings-related benefits for employees in the private sector.
The pension benefit depends on the professional life record, income level and a multiplier applied. There is both a maximum and a minimum pension. The maximum benefit one can receive in a year is 50% of the contribution assessment limit. Low-income earners are expected to receive a pension that equals at least 85% of the French minimum wage.
The required number of years to qualify for a full pension has only recently increased to 40 years. To ensure a stable employment period/retirement period ratio, which was set at 2:1, the required contribution period will further increase to 41 years by 2012. The duration of a worker’s period of employment and period of retirement will be continually reviewed and adjusted thereafter.
To give an incentive to postpone retirement, everyone who decides to keep on working after having reached the statutory retirement age, and having paid contributions for 40 years, is granted an additional 0.75% for every additional quarter (max. 3% per annum).
Besides the basic pension regime there are also dedicated public sector pension schemes and special schemes for employees of state and local authorities, employees working in arduous professions and employees in certain branches. Altogether, these special pension schemes cover approximately 500,000 workers and 1.1 million pensioners.
Current reform efforts focus on the harmonisation of the special schemes towards an alignment with the public sector pension schemes. But measures that have been proposed so far faced a strong opposition. At least the special pension schemes for railway employees will be reformed effectively from July 1st, 2008. These schemes will have to adopt the minimum contribution years applicable to private sector employees and civil servants required for a full pension. However, the time frame to align the contribution period is extended by 4 years. In addition, the reform will establish disincentives for early retirement.
Occupational Pensions
Private retirement income in France is almost entirely based on compulsory systems. In addition to the
basic social system all employees are members of compulsory supplementary plans. The two systems together provide a benefit level which was traditionally considered as adequate. Because of the importance of these compulsory occupational schemes, voluntary occupational pension schemes are still only a small part of the market.
I. Compulsory occupational pension schemes (AGIRC and ARRCO)
The compulsory schemes are known as AGIRC (for executives) and ARRCO (for non-executives), and are based on collective agreements. They offer defined benefit plans. The AGIRC and the ARRCO schemes merged in 2003. Legal retirement age is 65 for men and women in both systems.
Both systems allow early retirement from the age of 60 (or even earlier in the case of disability or employees having started work before 18 and having a long contribution record) without pension reduction if the employee is entitled to a full social security pension (i.e. 40 years of contribution record); otherwise the pension is reduced.
The pension is based on a career average formula. Pension points are accrued during working life and are based on the amount of the employees’ and employers’ contributions in relation to the salary for the year. The sum of all credit points accrued during an employee’s career is then multiplied by the value of the points (depending on inflation and income developments) at the time of retirement.
Pension points vest immediately. Therefore, the employee will receive a benefit even if accrued rights are very small. If the employee has not accrued a minimum amount of pension points, the benefit is paid as a lump sum.
The funds are financed according to the pay-as-you-go system based on employer and employee contributions.
II. Voluntary occupational pension schemes
Because of the importance of the mandatory systems, voluntary plans are not widespread. French companies are very reluctant to offer employer-financed occupational pension plans to their employees on a broad scale – they are usually only confined to executives.
But to encourage individual savings many companies have set up Company Savings Plans as a tax-efficient savings product for their employees with the option of an additional employer contribution. The five-year savings plan, which was effectively introduced in 1967, is a very successful, well-established product. A longer-term version (10 years) was introduced in 2001 but in its 2004 reforms, the government amended the life span of the plan “until retirement”, transforming it by this means into a core pension product rather than just a savings plan.
1. Insured pension plans
Voluntary occupational pension plans are usually insured using life insurance contracts. Pension funds are not established in the market. There are no rules regarding a minimum funding level or solvency margin.
The different types of plan are governed by the articles of the tax code which set out tax deductibility provisions. Therefore, the plans are usually referred to by the articles of the tax code containing the main provisions regarding tax treatment. There are three different types:
- Article 39 plans: refer to defined benefit plans,
- Article 82 plans: refer to individual defined contribution plans. As the 2004 pension reform abolished the tax break for Article 82 plans taken out after December 31, 2003, this type of plan will soon be discontinued.
- Article 83 plans: refer to collective defined contribution plans.
Once they are set up, general life insurance companies will govern the plans, as the pension assets become part of either the general or a segregated part of the life insurance companies’ balance sheet.
Defined contribution plans are quickly gaining in popularity. For a number of years there has been a definite shift from defined benefit to defined contribution plans and many defined benefit plans have been converted. Up to now, all pension plans were employer-financed with, in general, a compulsory participation of the employees. The pension reform introduced, for the first time, the possibility of voluntary employee contributions in defined contribution plans.
Tax treatment of contributions and benefits
Taxation of voluntary occupational pension plans has been substantially changed by the 2004 pension reform. In the case of defined benefit plans, contributions of usually 6% of the employees’ income are tax-deductible for the employer if the plan strictly complies with further regulations concerning vesting or eligibility.
For defined contribution plans, employer contributions are now tax-free up to 10% of the employees’ earnings, with an earnings cap of 8 times the social security ceiling.
The tax treatment of benefits under insured schemes is also favourable. Annuities are taxed on only a fraction of their value depending on the age of the pensioner at the start of his pension. Tax-free lump sums are not available.
It is very likely that the penetration of these plans will increase as a consequence of the improved tax treatment of such schemes in the 2004 pension reform.
Investment regulation
There are no specific regulations regarding asset investment other than general prudential requirements concerning the insurer’s overall life insurance portfolio.
2. Long-term Company Savings Plans (PERCO)
Since 2001 a type of plan has been in existence – the “Plan Partenarial d’Epargne Salaire Volontaire”, which had not really taken off. The 2004 reform changed the investment period from 10 years to “until retirement”, and rebranded it as PERCO, thereby creating a new core pension product.
Key-elements of the Long-term Company Savings Plan:
- The minimum investment period is “until retirement”
- The maximum annual company contribution is EUR 4,600;
- The plan has to be based either on an agreement with the union or the works council, or it has to be approved by the employees through a referendum;
- They can be paid out as a lump sum (tax-free) or as annuities (only a fraction of their value is taxed, depending on the age of the pensioner at the start of his pension);
- During the saving period a withholding tax of 10.3% on annual interest earned applies;
- The company contribution is subject to a flat-rate tax of 7.6%.
This could therefore form a solid foundation for the future development of occupational pension funds in France.
Outlook
France’s pension system is in a process of major change. Previously a showcase for the dominance of pay-as-you-go systems, even in an occupational pension context, new schemes are changing the shape of the pension market. Since 2003, a number of new and funded pension plans such as the PERCO, PERP, PESI and PERE have been introduced. These new plans are very likely to boost funded pensions in France. The introduction of a pension reserve fund also demonstrates the importance of funded pensions, even for French public pensions. Indeed, France has initiated a change in its approach to pensions. It is very much in line with European trends and aims to diversify retirement income by introducing new pension schemes.