Experts talk about Australia or the Nordics as countries which have “got pensions right”, but what do they mean by “right”? Can we de-fuse the demographic time-bomb? Or must politicians resign themselves to playing pass the parcel with a suspect device?
It’s not like we’re fighting a conventional war; concepts such as “adequacy” and “affluence” mutate, actuaries face the demographic equivalent of terror tactics. Small wonder that George Osborne talks about radical solutions, the expectations of his electorate are quite out of kilter with what’s in the pension pot – witness the WASPI campaign.
Politicians need some system to measure state pension systems by – for those who run the OECD’s “Pensions at a Glance”, these are the big three;
- Coverage- what percentage of the population is covered
- Replacement rate- what percentage of average salary do people get when they retire
- Sustainability- can the fiscal and financial systems carry on delivering.
The OECD publishes exhaustive comparative data. But this data is based on yesterday’s demographics and perhaps because of the thoroughness of its approach, the OECD tends to deliver yesterday’s answer.
A more dynamic approach is adopted by the consultancy Mercer who publish 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 is widely referred to by evangelists for whichever system features at the top and ignored by everyone else. 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 pension spend relative to GDP. An alternative lens through which to examine pension systems focusses on “efficiency” and “value for money”. Thomas Philippon, the American economist has researched the cost of delivering pensions over the past 120 years. He’s established that private pensions cost 2% pa of the assets managed and this number remains consistent over time and jurisdiction.
Research in the 1990s by British Actuary John Shuttleworth found that the DWP could deliver a pound of pension at around a quarter the private cost. Efficient delivery increases in value as prospective returns fall. Countries with unfunded pensions like France and Germany score much higher on an efficiency measure than market-lead systems.
But to go unfunded is to place a high degree of confidence in the political system not to change the rules. It also assumes that Governments are creditworthy. Britain, Australia and the United States, countries with market orientated retirement benefit systems, may deliver less efficiently, but they do provide a sense of ownership to beneficiaries. Confidence in sustainability improves in proportion the amount of the promise that’s funded. Perhaps this trade-off between efficiency is a barometer of a nation’s faith in its politicians!
The politician’s faith in its electorate is a further differentiator between national pension systems. John Stuart Mill remarked that “The only purpose for which power can be rightfully exercised over any other member of a civilized community, against his will, is to prevent harm to others”. This definition of “reasonable force” can be placed upon a national workforce to participate in retirement savings varies considerably.
Australia, Chile and Singapore, are in pension terms- democratic command economies and each operate compulsory retirement saving. At the other extreme, the USA 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 structure into a pensions free for all, the United States seems to demand every citizen becomes their own pension manager.
So how do we rate ourselves? The Office of Budget Responsibility believes we are spending too much relative to our neighbors, especially on fiscal incentives for private saving (tax-relief). It’s the same story for the new state pension. Our Government Actuary in its latest review of our National Insurance Fund tells us we are living beyond our means by continuing with the triple lock on the new state pension. There appear to be two golden keys, the first is auto-enrolment which is increasing coverage at a fantastic rate and may allow us to turn down the volume on the triple lock in time. The second is fiscal reform, about which we expect to hear a lot in the Budget.
The trick for a Chancellor keen to balance the books will be to continue to increase coverage, improve replacement rates and keep things going. He need not set his sights too high, if he can make it through to 2020 without the bomb exploding, he will have achieved a great deal. We may not have got it right, but unlike many of our neighbors, we seem to be bothered!