Pensions freedom pushes UK down the index

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The FINANCIAL — The Victorian Government of Australia and The Australian Centre for Financial Studies on October 19 launched its 7th annual Melbourne Mercer Global Pension Index (MMGPI) which objectively ranks both the publicly funded and private components of 25 countries’ pension systems.

For the 2015 index the United Kingdom’s pension system ranked 9th overall and remained strong, however measures need to be taken to improve the sustainability of the system.  The UK’s unfunded state pension promises, low level of retirement saving, increasing old age dependency ratio and substantial government debt threaten its ability to deliver adequate retirement incomes. 

The recent change in how people are allowed to use their retirement savings has seen the UK score drop.  “Pensions freedom” gives savers flexibility in how to take their money, but it also poses long term challenges to ensuring adequate incomes throughout retirement.

The UK’s pension system just managed to hold on to its ‘B’ grade with a score of 65.0 out of a possible 100, down from 67.6 in 2014. A ‘B’ grade system indicates a sound structure, with many good features, but has some areas for improvement.

The UK score is expected to rise again over the next few years as the impact of auto-enrolment (introduced in 2012, which has led to a record number of people enrolled in pension schemes) will become more apparent.  However, the report suggests that minimum required contributions alone are unlikely to lead to adequate retirement incomes for many.

Denmark, the Netherlands and Australia held onto the top three spots in the Index. Denmark continued to hold onto the top position in 2015 with an overall score of 81.7. Denmark’s well-funded pension system with its good coverage, high level of assets and contributions, the provision of adequate benefits and a private pension system with developed regulations are the primary reasons for its top spot. 

Author of the report and Senior Partner at Mercer, Dr David Knox, said, “Implementing the right reform to improve pension systems and provide financial security in retirement has never been more critical for both individuals and societies.

“The MMGPI is an important reference for policy makers around the world to learn from the most adequate and sustainable systems.  We know there is no perfect system that can be applied universally, but there are many common features that can be shared for better outcomes,” said Dr Knox.

Glyn Bradley, Senior Associate in Mercer’s UK Retirement business said: “The UK’s new pensions freedoms is a welcome once-in-a-lifetime change but it poses difficult challenges in ensuring that tax-privileged saving is used to provide an adequate income in the final years of life, and not exhausted in middle age. Annuities might be part of the answer, but they’re not the only way of taking an income instead of a one-off withdrawal.  We need to ensure sufficient retirement related products, guidance and incentives exist to avoid people outliving their savings.

“Despite the introduction of auto-enrolment and record numbers of people in the UK enrolled in pension schemes, the UK is unlikely to make the A grade soon.  ’Having a pension’ is not the same as having an adequate pension. The UK lacks the savings culture of other countries and current minimum auto-enrolment contributions are unlikely to deliver adequate retirement outcomes. We are also an ageing society, with relatively high debt, and our public sector and state pensions are almost entirely unfunded. Our pensions system has a high degree of integrity by international standards, but its low scores on adequacy and sustainability are putting us in danger of being relegated to the C league.”

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Geoffrey Conaghan, Agent General for the Victorian Government of Australia, who is based in London commented, “Over the last seven years, the Melbourne Mercer Global Pension Index has become a valuable resource for financial services professionals, regulators, academics and governments. The index showcases the depth and breadth of Victoria’s financial services research capabilities which are underpinned by strong public and private partnerships. The Index also affirms Melbourne’s global standing as a location for pension funds management.”   

Mr Conaghan added, “The strength of analysis contained within the report is proof of the strength of Victoria’s position as the home of world-leading research.  As Australia’s financial and business hub, Melbourne is regarded as a key centre in the Asia-Pacific region, boasting over 1,000 financial services operations, employing over 110,000 skilled professionals and housing six of the top 12 largest pension funds in the country.”

Amy Auster, Executive Director of the Australian Centre for Financial Studies said the Index continued to be used by policy makers and researchers to assess the merits of their pension systems.

“The Index is used internationally both to highlight the relative strengths of pension systems and to identify opportunities and options for improvement. Looking back at the results from the past seven years we can see several countries that have adopted recommendations from our annual reports to strengthen their pension systems.

“It is encouraging to see that the insight provided by the Index encourages and supports policymakers and industry practitioners to take a long-term view, and work toward the betterment of their pension systems.”

“This is not always easy in the face of demographic pressures and changing market conditions, but we see clear evidence that policy-makers are continuing to enhance their pension systems in order to adequately serve future generations.”

How can UK’s retirement savings system improve?

The MMGPI acknowledges that there is room for improvement in all countries’ retirement income systems.  Suggested measures to improve the UK’s scoring include:

Restoring the requirement to take part of retirement savings as an income stream

Raising the minimum pension for low-income pensioners

Further increasing the coverage of employees in occupational pension schemes

Increasing the level of contributions to occupational pension schemes

Increasing the labour force participation at older ages

“A critical take-away from this year’s report is the reminder that pension systems are like cargo ships that require a lot of lead time and preparation to safely adjust their course,” Ms Auster said.

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Seven years of the MMGPI: How sustainable are the world’s pension systems?

The 2015 MMGPI looked beyond the annual rankings to observe changes over the last seven years and to assess what pension systems will continue to deliver and which ones are at risk.

Our seven-year snapshot highlights the importance of measures such as adjusting the state pension age, increasing workforce participation amongst our ageing population, or funding additional retirement income,” said Dr Knox.

We’re spending longer in retirement

All countries have experienced an increase in the expected length of retirement from 2009 to 2015, with the average length rising from 16.6 years to 18.1 years.

Five countries – Australia, Germany, Japan, Singapore and the UK – have increased their pension age to offset the increase in life expectancies, but not enough to halt the increasing length of retirement.

The Index also looks at the average expected length of retirement in 20 years, and by this measure, three countries have witnessed a reduction.  For Canada and the Netherlands this is due to a projected increase in the state pension age from 65 to 67 during the 20 years, while for the USA, life expectancy has reduced slightly.

Increasing workforce participation of older workers: good for the economy & individuals

According to the MMGPI, the average labour force participation rate for 55-64 year olds has increased from 57.9% to 62.2% between 2011 and 2015, or just over 1% per year.

However, averages can be misleading. The labour force participation rate at older ages actually went backwards in the USA. In Brazil, India and China, it increased by less than 4%.

“Extending the years that individuals spend in the workforce is one of the most positive ways of developing sustainable retirement systems when life expectancies are increasing,” Dr Knox said.

“While there is a natural limit to the participation rate at older ages, with most countries still below 70% the scope for significant increases across the world remains, which would improve the sustainability of many pension systems,” Dr Knox added.

Preventing financial strain on the next generation

The sustainability of a pension fund cannot be assessed without reviewing the level of funds set aside today to pay future retirement benefits so that the expected pension are not a financial strain on the next generation.

There is an enormous variety in the level of pension assets held ranging from 1.8% of GDP in Indonesia and 6.0% of GDP in Austria to 160.6% of GDP in the Netherlands and 168.9% of GDP in Denmark.

“The diversity in pension assets held as a percentage of GDP recognizes that some countries have very limited private pension arrangements whereas others have well-developed and mature pension systems.  However, it is important warning for all countries to prepare, prepare, prepare,” said Dr Knox. 

 

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