Who gets pensions “right”?
Britain has a lesson for other pension systems
Pensions experts talk about Australia or the Nordics as examples of countries with strong pensions systems. Should we be doing more to emulate them? Is it possible to structure the retirement system in such as way that takes account of the twin problems of an ageing population and low interest rates?
It’s not as if we’re facing a conventional problem; the pensions industry faces a constantly shifting set of problems. Small wonder that George Osbornetalks about radical solutions, as he faces the problem that his electorate’s expectations are out of kilter with what’s in the pension pot.
Politicians need some yardsticks by which to compare state pension systems. The OECD, the club of developed economies, publishes an annual appraisal of the national pensions systems, called Pensions at a Glance. The three main criteria that it uses are: what percentage of the population is covered; what percentage of average salary do people get when they retire; and can the fiscal and financial systems carry on delivering?
A different approach is adopted by the consultancy Mercer which publishes a league table of national results. Like the OECD, Mercer’s research is based on three pillars—adequacy, sustainability and integrity. The Melbourne Mercer Index, which compares the adequacy of pensions systems round the world, is widely referred to by evangelists for whichever system happens to come top. For the record, Denmark and the Netherlands are currently on Mercer’s A list, Australia merits a B+, while Britain rates a B along with Sweden, Switzerland, Finland, Canada and Chile.
Both the OECD and Mercer surveys recognise and promote a high level of spending on pensions relative to GDP. An alternative lens through which to examine pension systems focuses on “efficiency” and “value for money.” Thomas Philippon, the US economist, has researched the cost of delivering pensions over the past 120 years. He’s established that private pensions cost 2 per cent of the assets managed and this number remains consistent over time and jurisdiction—a substantial amount.
Research in the 1990s by British actuary John Shuttleworth found that the Department of Work and Pensions could manage a pension system at around a quarter of the cost of the private sector. Efficient delivery increases in value as prospective returns fall.
Countries like France and Germany, which have unfunded pension systems, meaning that pensions payments are made out of income rather than from the revenue of invested funds, score much higher on an efficiency measure than countries that place a greater emphasis on market mechanisms.
But to develop a pension system that is unfunded, where payments are made out of current income, is to create a system that is especially sensitive to political change. It also assumes that governments are creditworthy—that they will have enough money to meet their pensions obligations. Britain, Australia and the United States, countries with funded pension systems based on market investments, may deliver less efficiently than other countries, but people like the sense of confidence it brings.
Should governments do more to force people to save for retirement? John Stuart Mill once remarked that “The only purpose for which power can be rightfully exercised over any other member of a civilised community, against his will, is to prevent harm to others.” The amount of “power” that can be “exercised” in order to persuade voters to save varies considerably by country.
Australia, Chile and Singapore are, in pension terms, command economies—saving for retirement is compulsory. At the other extreme, the US operates a voluntary savings system with a fragile safety net of state support for the elderly. Despite the best efforts of the Obama administration to introduce more structure into its pensions system, the US is largely happy to leave its citizens to make their own arrangements.
So how do we rate ourselves? The Office for Budget Responsibility believes that Britain spends too much on tax relief to encourage private saving. It’s the same story for the new state pension. Britain’s Government Actuary in its latest review of our National Insurance Fund says that Britain is living beyond its means by continuing with the Triple Lock (see p6) on the new state pension. Auto-enrolment is increasing coverage at a fantastic rate and may allow government to alter the terms of the Triple Lock in time, to make it less expensive.
The trick for a Chancellor keen to balance the books will be to continue to increase coverage and improve replacement rates. He need not set his sights too high, if he can make it through to 2020 without the system suffering a crisis, then he will have achieved a great deal.
Britain may not have got its pensions system right, but unlike many of our neighbours, we seem to be trying to have constructed a system that combines elements of both the liberal and more coercive approach to retirement saving. Thugh not perfect, it seems a good enough balance—for now.