Governments will need to raise retirement ages gradually to address increasing life expectancy in order to ensure that their national pension systems are both affordable and adequate, according to a new OECD report. At a time of heightened global economic uncertainty, such reforms can also play a crucial role in governments’ responses to the crisis, contributing to fiscal consolidation at the same time as boosting growth.
Over the next 50 years, life expectancy at birth is expected to increase by more than 7 years in developed economies. The long-term retirement age in half of OECD countries will be 65, and in 14 countries it will be between 67 and 69. The Pensions Outlook 2012 says that increases in retirement ages are underway or planned in 28 out of the 34 OECD countries. These increases, however, are expected to keep pace with improved life expectancy only in six countries for men and in 10 countries for women. Governments should thus consider formally linking retirement ages to life expectancy, as in Denmark and Italy, and make greater efforts to promote private pensions.
“Bold action is required. Breaking down the barriers that stop older people from working beyond traditional retirement ages will be a necessity to ensure that our children and grand-children can enjoy an adequate pension at the end of their working life,” said OECD Secretary-General Angel Gurría. “Though these reforms can sometimes be unpopular and painful, at this time of tight public finances and limited scope for fiscal and monetary policy, these reforms can also serve to boost much needed growth in ageing economies.”
The Pensions Outlook 2012 finds that reforms over the past decade have cut future public pension payouts, typically by 20 to 25 per cent. People starting work today can expect a net public pension of about half their net earnings on average in OECD countries, if they retire after a full career, at the official retirement age. But in nearly all the 13 countries that have made private pensions mandatory, pensioners can expect benefits of around 60% of earnings.
Conversely, in countries where public pensions are relatively low and private pensions voluntary, such as Germany, Ireland, Korea, Japan and the United States, large segments of the population can expect major falls in income upon retirement.
This could cause pensioner poverty to increase significantly. Later retirement and greater access to private pensions will be critical to closing this pension gap, says the OECD.
However, making private pensions compulsory is not necessarily the answer for every country. According to the report, such action could unfairly affect low earners and be perceived as an additional tax. Auto-enrolment schemes – where people are enrolled automatically and can then opt out within a certain time frame – might be a suitable alternative.
Italy and New Zealand have already introduced such schemes and the UK is set to roll one out in October 2012. However, the report finds that results are mixed, with a major expansion of coverage of private pensions in countries like New Zealand, and having only a small effect in others like Italy.
More broadly, reforming tax reliefs to encourage private pension savings is also needed, as low earners and younger workers are much less likely to have a private pension. Facilitating matching contributions or giving flat subsidies to savers, such as in Germany and New Zealand, would improve their incentives to contribute. To boost confidence in private pensions, governments also need to improve their oversight of funds to ensure that charges are kept low and risks minimised.
This inaugural edition of the Pensions Outlook also includes the first comprehensive evaluation of national Defined Contribution systems, which are now a central feature of many countries’ pension systems. Among other recommendations, the report argues that it is critical to set the minimum or default contribution rate in Defined Contribution systems at an appropriate level.
Contributions to these systems need to be high enough so that together with public pensions they generate sufficient income at retirement. While Australia is moving in the right direction by increasing its contribution rate from 9% to 12%, it remains too low in countries such as Mexico and New Zealand (6.5% and 3%, respectively).
For comment or further information, journalists should contact Juan Yermo of the OECD’s Financial Affairs division (tel. + 33 1 45 24 96 62) or Edward Whitehouse of the OECD’s Social Policy division (tel. + 33 6 25 89 56 67).
Highlights of the report are available at www.oecd.org/daf/pensions/outlook.
Also available: Relever l’âge de la retraite et étendre le champ couvert par les pensions privées est essentiel, estime l’OCDE (French).
OECD PENSIONS OUTLOOK 2012 Recent pension reforms will lead to lower public pensions for future generations of retirees, around 20-25% on average. This first edition of the Pensions Outlook argues that countries should focus on two main policies to address the growing pensions gap: later retirement and extending the coverage of private pensions.
Overall, the pace of pension reform has accelerated over the last five years. Changes include increases in pensionable ages, the introduction of automatic adjustment mechanisms and the strengthening of work incentives. Some countries have also better focused public pension expenditure on lower income groups. However, some recent reforms have raised controversy, such as the decision of some Central and Eastern European countries to pull back earlier reforms that introduced a mandatory funded component.
Most OECD countries have already begun to increase pensionable ages, or plan to do so in the near future. Age 65 remains the modal age at which people normally draw their pensions, accounting for 17, or half, of OECD countries for men and 14 countries for women. But 67 – or higher – is becoming the new 65. Some 13 countries (12 for women) are either increasing pension ages to this level or, in the cases of Iceland and Norway, are already there. Italy, which links pension age and seniority requirements to life expectancy from 2013 and Denmark, which plans to link pension age to life expectancy from the mid-2020s, are forecast nearly to reach age 69 in 2050. The United Kingdom has accelerated the increase in the pensionable age, which will move from 65 to 66 by 2020 (6 years earlier than planned) and from 66 to 67 by 2026-28 (10 years earlier than planned).
Extending working lives will help enhance both the sustainability and adequacy of pension systems. However, planned increases in retirement ages are generally insufficient to address expected rises in life expectancy. In many countries, cuts in public pensions will also widen the gap between pre and post retirement income. In order to close this pension gap, a growing role for private pensions will be essential.
Currently, thirteen OECD countries have either compulsory private pension systems in place (e.g. Australia, Chile) or quasi-mandatory systems based on nation-wide or industry-wide collective bargaining agreements (e.g. Denmark, the Netherlands) to ensure that most workers are covered and therefore have access to a sufficiently high complementary pension. However, in some countries with relatively low public pension benefits, private provision remains voluntary and the highest coverage rates observed are around 50%. In all the countries analysed in the report, the young, low income, part-time and temporary workers are least likely to participate in voluntary private pension plans (see UK case below).
An alternative to compulsory enrolment that has gained popularity in recent years is automatic enrolment. At its essence, it involves signing up people automatically to private pensions but giving them the option to opt out with different degrees of difficulty. Auto-enrolment was introduced in New Zealand in 2007 and partly explains the rapid increase in the coverage of the KiwiSaver (about 55% of the working age population, the highest level among non-compulsory systems in the OECD). On the other hand, in Italy, the introduction of auto-enrolment in 2007 has only had a small effect on coverage rates.
In October 2012 the United Kingdom will also see the introduction of a nation-wide auto-enrolment retirement savings system for all those workers who are not currently covered by private pension plans. This new mechanism should increase further the coverage rate of occupational pension schemes, currently standing at 43.3% of the working age population.
The design of financial incentives for retirement savings also needs to be reformed. Germany (Riester) and New Zealand (KiwiSaver) have introduced financial incentives based on direct state subsidies from the state to retirement savings accounts that also benefit workers that pay no or low taxes. In Germany, the state subsidy provided to Riester pension plans has promoted greater participation among lower income workers than among other private pension arrangements (see Figure 3 below). Low income workers do not normally benefit much from the tax incentives traditionally used to promote private pensions.
The success of these countries in expanding coverage in a relatively short period largely vindicates these policies, though financial incentives can create a heavy burden on already stretched public budgets. Furthermore, coverage gaps also remain in these countries, and overall enrolment rates are still below those observed in countries with mandatory or quasi-mandatory systems (over 70% of the working age population).
Private pension plans, particularly mandatory and auto-enrolment ones, are increasingly of the defined contribution (DC) type. Such plans require careful design and regulation as individuals are often ill-prepared to manage their savings in an effective manner. The starting point for a successful DC plan is a sufficiently high contribution rate.
The chart below compares projected public pension benefits with the mandatory contribution rate in mandatory DC plans or the typical or average contribution rate to voluntary DC plans, depending on the country. The public pension projections are shown as replacement rates (benefits as a percentage of final salary) for a young male worker earning average wages and entering the workforce in 2008 who accumulated benefit rights throughout his whole career and retires at the official or normal retirement age.
The graph shows a broadly inverse relationship between public pension benefits and DC contribution rates. For instance, in the United Kingdom the contribution rate of 8% in the auto-enrolment system should allow the average worker with a full career to reach a gross replacement rate of nearly 70% (32% from public PAYG pensions and 37% from the auto-enrolment retirement savings system). The net replacement rate would be around 80% for workers on average earnings.
On the other hand, there are some countries that clearly stand out in having both relatively low public pension benefits and DC contribution rates that do not seem to be sufficiently high. Such countries include Belgium, Germany, Japan, New Zealand, and Norway. These are also among the countries that fall below the black diagonal line, which shows the combination of public pensions and DC contribution rates (with a 40-year contribution period) that delivers an overall replacement rate of 70% on average. Other countries below the black line include Australia, Chile, New Zealand and especially Mexico. The Australian government recently announced that it would raise the mandatory contribution rate from 9 to 12%, which would bring the country above the black line.
Another major concern in private pensions is investment risk. The financial and economic crisis has exerted major stress on private pension arrangements. Most countries’ pension funds are still in the red in terms of cumulative investment performance over the period 2007-11 (-1.6% annually, on average, in real terms). Even when measured over the period 2001-10, the pension funds’ real rate of return in the 21 OECD countries that report such data averaged a paltry 0.1%. Such disappointing performance puts at risk the ability of private pension arrangements to deliver adequate pensions. The United Kingdom follows the general trend, with average real investment returns of pension funds of -1.1% over the period 2007-10 and -0.1% over the period 2001-10.
In DC pension systems, one clear goal for policymakers should be to improve the design of default investment strategies so that investment risk is reduced as the worker approaches retirement. Such life-cycle investment strategies may need to be carefully regulated to ensure that workers are offered sufficient diversification and protection from market shocks in old age.
L'accompagnement des parcours de mobilité, 28 et 29 juin 2012, Université de Toulouse 1 Capitole.
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