Spain is one of the countries that are going to suffer most from the consequences of an aging population, according to the United Nations. This situation has set off alarms concerning the viability of the public pension system, which must support an ever larger number of retirees on an ever smaller base of contributors. Amidst this storm, companies have launched their plans for early retirement as an alternative formula to laying people off. Yet while this system softens the traumatic nature of these sorts of job cuts, “it brings with it some harmful consequences for the public pension system,” warns Sandalio Gómez, professor of IESE and author of a study entitled, “Early Retirement and Its Impact on Personnel, Companies and the Pension System.”
“During the last decade alone, 250,000 workers have retired early in Spain,” says Gómez, adding that “in essence, these plans involve workers who are less than 60 leaving the company in exchange for receiving between 60% and 90% of their fixed salary; the company continues to finance their social security [payments].” By doing this, the company can cut the number of staffers who have higher salaries as a result of their seniority. Moreover, employees voluntarily accept these plans under advantageous economic conditions, which makes this type of arrangement less offensive than traditional ways of letting people go.
As Gómez notes, the key to the success of the early retirement formula is the double advantage that early retirement provides for both the company and its workers. But this is also a source of the formula’s abuse. “In the beginning, it was used for people on the verge of retirement, about 60 years old. But because the plan was well-accepted by labor unions and personnel, companies have gone on increasing its use and gradually lowering its cut-off age.” In fact, in the last decade, the average age at which these plans have been implemented has been reduced from 58 years to 54.8 years. In some cases, they have been implemented among professionals who are barely 50.
Currently, the average age of retirement in Spain is 62.5 years and only 3.7% of new retirees involve workers who are older than 65. “This drop in the retirement age has damaging consequences for the pension system because, although the company continues to finance social security for workers who accept early retirement, this trend goes against what countries now need,” says Gómez. “Countries need to raise the [average] age of retirement in order to deal with the impact of the decline in the birth rate.”
The Birth Rate Problem
In recent years, the population pyramid of the entire world has suffered a major setback. Along with an increase in life expectancy, there has been a sharp drop in the birth rate which has translated into the rapid aging of society. The United Nations estimates that there are 629 million people who are more than 60 years old, a figure that will reach the two billion mark in 2050. For the first time in history, there will be more people 60 and older than there are people 14 and younger.
“Spain is one of the countries that are going to suffer most from the consequences of this aging process,” warns Gómez. “Currently, we are the seventh-ranked country in the world when it comes to the highest proportion of people who are older than 60. (Twenty-two percent of Spain’s total population fits into that category.) As a result, we find ourselves in the group that has the most risk.”
In his study, Gómez notes that by 2050, 44% of Spain’s population will be more than 60. Moreover, by then, the average life expectancy will have grown from 78.8 years [today] to 82.6 years. “This increase means that the public [pension] system must deal with retirement over a longer period of time,” he notes.
Given these projections, logic implies that if there are going to be enough public resources, workers must expand the period during which they contribute in order to be able to enjoy their longer life in retirement later on. “However, the opposite is taking place. The reality is that fewer and fewer children are being born and, as a result, the base of contributors is getting smaller. And life expectancy is higher, so retirees enjoy their pensions over a period of more years.” Gómez believes that the only way to avoid the collapse of the system is to raise the retirement age to 70. “But what we are seeing is that companies are letting their workers retire earlier and earlier. That is contrary to what the system needs, and to what was agreed on in the Pact of Toledo.”
Gómez is referring to the agreements signed between the Spanish government and major political and social forces in 1995. Even then, it was clear that Spain’s population was going to confront a population problem if society did not provide for a solution beforehand. “To avoid a collapse of the system they endorsed three fundamental points,” recalls Gómez. “On the one hand, they decided to increase, in a gradual way, the minimum period of contribution for having the right to a pension, from eight years to 15 years, by 2003. Moreover, they attempted to create an incentive for delaying the age of retirement through subsidies to the social security system, and by increasing the pension that they contribute by two percent a year, starting from the age of 65 until the age of 70. Finally, they decided to create a fund for Social Security surpluses that would give greater solidity to the system.”
The outlines of these plans are similar to arrangements made in Austria, Germany and France. Gómez notes that they comply with some points [of the Pact of Toledo], such as creating a fund for Social Security surpluses (the fund currently has accumulated seven billion euros. But in some other respects, such as the notion of lengthening the retirement age, there has been a noticeable lack of progress.
The Social Impact
Early retirement has been converted into one of the favorite ways for Spanish companies to cut down the size of their staff. In his study, Gómez notes that each year, between 60,000 and 70,000 workers take early retirement [in Spain.] Among them are 20,000 workers from large companies. “Seventy percent of early retirement schemes have been carried out during the last six years, while only 30% percent of the plans were applied during the 1980s,” he states.
Although there are various reasons for setting up such plans, in most cases they involve cutting salaries rather than cutting the number of total personnel. Moreover, in 14% percent of cases, companies did not even consider other options before putting their early retirement plans into effect. “Companies show a lack of imagination when they face a crisis situation,” notes Gómez. “In fact, 43% of the companies analyzed in the study – which account for 40% of the early retirement plans that have been enacted in Spain – applied no other measures at the time when they enacted their early retirement plans.”
The high level of interest in early retirement and its great acceptance can be explained by the significant savings in salary expenses that this formula provides for companies in the medium term. Moreover, those workers who are affected leave the company in better economic condition than if they received some sort of compensation established by labor law. Nevertheless, its human cost is too high.
“Generally, when you consider solutions of this sort, the people who accept them are professionals of high value and broad experience. When they abandon the company, it involves a great loss of human capital that will take the company many years to make up for,” Gómez says. Fifty-five percent of the companies analyzed in the study fix a cutoff age that applies to all workers – without making distinctions with respect to their category, department or length of seniority at the company. By doing this, “they are respecting the principle of internal fairness, but they are also forgetting that they are letting go professionals who are quite necessary to the company and who form part of the team that is fundamental to the smooth functioning of the business.”
To avoid this problem, 44.4% of the groups studied combine different criteria in addition to age – such as length of seniority, personnel evaluations, department, and the number of years required for contributing to the pension plan. They also consider any unreasonableness on the part of the employee, as well as geographical area and/or professional level. These final two factors are usually considered very useful by companies when it is time to fix parameters for drawing up their retirement plans. Nevertheless, they are not very popular with labor unions, who defend the notion that every worker should be able to agree to a retirement plan if he [or she] so desires.
The human cost of this formula for retirement also has an impact on the personal life of each employee who retires early. Gómez explains that when a company publicizes its early retirement plans, “those workers who are just beyond their forties already begin to calculate how much time is left before they are affected by this sort of measure.” Moreover, leaving this early tends to have a serious impact on a person. “A worker who is 50 knows that he still has an extensive working life and yet, the worker sees how the company is going to cast him aside. This can be a strong blow to the worker because he can’t avoid thinking that, although he is still young, he is not valuable and he is going to be forced into inactivity.”
As a corrective measure, many early retirees look for new professional job opportunities “above all, as consultants and advisors, since they can count on using their long experience,” says Gómez. The problem is, they don’t want to lose out on the advantageous economic conditions in their retirement plan, which they have anticipated and which they will lose if they join a new company. To keep that from happening, it’s becoming popular for professionals to carry out their new work on the margin of the public system. This winds up creating a hidden market economy that is not at all favorable to the battered pension system.
Unemployment benefits are one of the reasons why early retirees prefer to keep their new jobs in the background. In 88% of cases, an employee who has retired early receives two years of unemployment coverage from INEM, the National Employment Agency. During this period, the company still pays for [his salary] up to the percentage that he is going to get in accordance with his agreement. In the other 12% of cases, including large banking firms, the company contributes the agreed-upon percentage from the very beginning, and that can be as much as 90% of the worker’s salary. Moreover, these expenses are paid off in a reserve fund so that they don’t affect the company’s accounting results.
“From the economic point of view, these plans have been quite profitable for companies because, in the medium term, they have managed to cut their high salary expenses and replace [senior] people with younger, cheaper personnel. But in the long run, these plans are damaging because they wind up undermining human capital and, as a result, depriving companies of competitiveness,” notes Gómez. “They also rupture the confidence and loyalty of workers who become aware of when they will be too expensive.” In the final analysis, abuse of early retirement is as damaging to workers as it is to their companies and the public system.