"The pension funds are built on the principle of mutual guarantee. This means that when a person receives a payment from the fund, the source of the payment is from within the fund. The payment currently given to those who receive their pensions from these funds exceeds what was predicted, and the excess falls upon all the members of the pension fund," and therefore "we propose a mechanism the object of which is to bring about fairness. At the moment, it reduces the pensions of those who are just about to retire, but it raises the pensions of those who will retire in the future."
This was the explanation offered today by Supervisor of Capital Markets, Insurance and Savings Prof. Oded Sarig, commenting on the measure he introduced on Monday whereby the interest rate on the basis of which pension payments are calculated will be adjusted to the low rates currently prevailing in Israel and globally.
This step will result in a 10% reduction in the monthly payment that a pension saver will receive in the future for the savings he or she has accumulated. This has given rise to considerable public anger, and today Sarig explains that it is made necessary by force of circumstances, and actually solves problems and prevents unwelcome subsidies that now exist in the new pension funds.
Sarig says that this is one of his last decisions as Supervisor, before he leaves the Ministry of Finance. "Around the world and in Israel, a pretty sharp fall in interest rates has taken place in recent years, chiefly in the past year. As a result, we had to act. But what's more, alongside the low interest rate we are seeing a fairly sharp rise in the number of people expected to retire in the coming years in the new pension funds. In the next two years, we will see about 100,000 people retire, and in the following years about 70,000. For these two reasons, we must deal with the problem now.
"When a person switches from being an active saver to a pensioner," explains Sarig, "the calculations of the monthly pension he or she will receive are made according to assumptions dictated by the Ministry of Finance.
"These assumptions suited the Israeli economy in the past. Today, the interest rate in the economy is not 4%, but 2.5%, and so the existing assumptions are problematic, and give people retiring more than their due. And when someone retires, the money is taken from the total amount in the fund. So when a person receives more than is due to them, the consequent burden falls on the shoulders of those remaining in the fund, so that their future pensions will be lower.
"Therefore," Sarig stresses, "we are changing the allowance to make it fairer, in order to avoid a situation in which someone who retires earlier will receive more than they should, while someone who retires later will receive less. We want fairness that will reflect what is due to savers."
But, in the past, when the interest rate was over 4%, pension fund members received a pension derived from a gross interest rate of 4% only.
"At that time, when interest rates were high, there was a different regime. Then, most pension funds held designated bonds, mostly bearing interest rates lower than the rates prevailing in the economy. At that time, the state did indeed receive loans that were cheaper than the market rates.
"We must remember however that we are talking about the past. Before 1995, the rules of the game were completely different. The pensions system at that time included rights and obligations of savers and of the government, and was very very unstable. In 1995, the Ministry of Finance instituted some very wise measures, foreseeing the problems that Europe finds itself in today, and set out the problem before us.
"They did transfer responsibility to the saver, and essentially said to the public that 'you are responsible and know what's good for you,' and changed the rules of the game, but countries that did not change their pension promises ended up insolvent. We have seen this in European countries, and we have seen this in Detroit as well. On the day of reckoning, it's not possible to meet these promises."
You waited a while before adjusting the interest rate basis to the prevailing rate. Why not wait a little more until interest rates climb again.
"This is a long-range step that can't wait until there are 70,000 retirers a year in the funds. We are dealing with it now and not burying our heads in the sand, but we are not doing it at a stroke, but gradually, spread over three years. Our aim is that those who have retired should not be harmed, and that for those close to retirement we will minimize the damage caused them."
What will happen if interest rates rise in the future?
"We are thinking of creating a mechanism that will take into account prevailing interest rates annually, and of implementing it in such a way as to cause minimum damage."
Why not include in the change those who have already retired and receive pensions. After all, they have benefitted from the subsidy in the mutual fund?
"We are weighing whether to include those already retired in the change. That's legitimate. But, in line with accepted practice around the world, we almost always strive to minimize the impact on those who have already retired, and to impose the changes on those who are saving and who can take action accordingly. We have to protect those who have already retired, because they are in the weakest position, in pensions and altogether."
What about those saving in exective insurance plans?
"Executive insurance works differently, and in any case each person has his or her own amount, allocated in such a way that the calculation changes over their lifetime. So the 4% assumption in executive insurance only affects the payment profile of the executive insurance saver. The change we are now introducing will create greater equality in payments to executive insurance savers over the years."
What's your view on raising the retirement age?
"This is part of a much weightier and more important question. How to ensure that people who will retire in the future will have a decent pension? To that end, there have to be complementary measures: raising the retirement age, changing the investment structure, and a switch to the duration model (the Chilean model whereby the type of saving changes with age, older savers holding lower-risk portfolios than younger savers, R. S.), changing the allocation of designated bonds so that they are given only to older savers in all long-term savings plans, and raising the rate of saving. These are all important steps towards bringing about decent pensions for people in ten and twenty years' time."
Published by Globes [online], Israel business news - www.globes-online.com - on August 14, 2013
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