Pension adequacy in an aging world
Creating the outline for a new type of plan that can work around the globe
As economies large and small grapple — or fail to grapple — with the social and economic effects of aging populations, the issue of pension adequacy is becoming one of the most challenging dilemmas of the 21st century.
Developed nations such as the U.S. and the U.K. are limping through a global recession and, faced with enormous deficits, are seeking long-term solutions that might fray the social safety nets their citizens count on for retirement. Meanwhile, emerging nations from Brazil to China and India cannot ignore retirement realities such as demographic trends in their populations and governance issues, despite their impressive economic growth.
Unfortunately, obtaining a clear view of the world’s diverse retirement income systems — in an effort to codify constructive approaches to the global retirement challenge — is difficult. There are, obviously, no perfect systems, while each has evolved from its country’s unique economic, social, cultural, political and historical circumstances.
This led Mercer to partner with the Australian Center for Financial Studies for a unique comparative study, the Melbourne Mercer Global Pension Index, which launched in 2009 with a rating of 11 countries. The index expanded this year to 14 countries: Australia, Brazil, Canada, Chile, China, France, Germany, Japan, Netherlands, Singapore, Sweden, Switzerland, the United Kingdom and the United States. Each country was rated on the basis of three key factors: pension adequacy (derived from such indicators as benefits, savings, tax support and growth assets); sustainability (including such indicators as demography, government debt and total assets); and integrity (including such indicators as regulation, governance, communication and cost).
Not surprisingly, none of the 14 countries achieved an index value above 80 — an “A” rating descriptive of a first-class, robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity. Indeed, only five nations — Netherlands, Switzerland, Sweden, Australia and Canada — achieved a “B” rating for their sound structures (despite having areas for improvement). Most fell into the “C” category — the U.S., U.K., Chile, Brazil, Singapore, France, and Germany — for having system with good features but also major risks and shortcomings that should be addressed.
Melbourne Mercer Global Pension Index 2010
Values are based on a possible score of 100. Weightings of the subindex values in the overall index are: adequacy 40%; sustainability 35%; and integrity 25%.
Ranking Subindex values
Country 2010 2009 Overall index value Adequacy Sustainability Integrity
Netherlands 1 1 78.3 76.1 71,6 91.4
Switzerland 2 – 75.3 73.1 71.8 83.5
Sweden 3 3 74.5 72.8 72.9 79.5
Australia 4 2 72.9 68.1 71.7 82.4
Canada 5 4 69.9 75.0 56.8 80.1
U.K. 6 5 63.7 64.9 47.1 85.3
Chile 7 7 59,9 52.1 54.7 79.8
Brazil 8 – 59.8 72.9 29.1 81.7
Singapore 9 8 56.6 43.7 63.6 79.5
U.S. 10 6 57.3 54.3 59.0 60.0
France 11 – 54.6 74.9 29.7 56.8
Germany 12 9 54.0 64.1 42.3 54.4
Japan 13 11 42.9 42.2 27.9 65.2
China 14 10 40.3 48.3 29.0 43.4
Average 61.7 63.1 51.9 73.1
While these “C” nations fared better than Japan and China (which earned “D”s with index values no higher than 50), overcoming their common challenges is, of course, easier said than done. These challenges include such tough legislative hurdles as increasing the state pension and/or retirement age to reflect increasing life expectancy — a prospect that has sparked unrest in France, and is part of the bitter deficit medicine now being proposed in the U.S. and U.K. Other challenges are to require higher levels of saving both within and beyond the pension system; increasing coverage of employees in voluntary private pension systems; reducing the “leakage” from retirement savings systems prior to retirement; and promoting more diversity in the provision of retirement income, while requiring that at least a portion of the accumulated benefit be taken as income.
Is there, then, a global retirement design that can successfully address the needs of countries with varying economic, political and social circumstances? Rather than trying to anticipate what would be politically feasible in each country, there are issues that all employers should address now, by re-evaluating their existing plans within the constraints of current systems, going beyond the “DB vs. DC” debate to consider more critical questions: What types and levels of risk should the plan’s different stakeholders manage and/or bear? How can we better position retirement age and promote flexible retirement to manage risk and achieve the plan’s intended human capital and financial outcomes?
The fact is, all retirement systems face conflicting demands from diverse stakeholders: employees, retirees, labor organizations, employers, financial institutions, governments and others.
But some basic principles could apply. For example:
• The system should have a simple, transparent design and predictable costs.
• Tax-incentivized compulsory saving is essential to ensure universal coverage and adequate retirement income. Additional tax incentives should encourage supplemental voluntary saving.
• The system should be funded to avoid intergenerational subsidies and the financial risks from demographic shifts.
• Individuals should need to make only a few key decisions, although the system may offer additional discretionary options.
• The system should ensure predictable outcomes by encouraging risk-managed investments and regulating retirement payouts to guarantee lifelong minimum income.
• The system should have no or minimal leakage, reserving funds to provide retirement and death benefits and limiting withdrawals before normal retirement age.
• Governance should be at arm’s length from the government where possible, but some aspects should be regulated.
A resulting framework could balance the predictable costs of a DC system with the predictable outcomes typically associated with a DB system. The design tilts toward a DC system, which is appropriate in a global model, where a majority of countries do not have defined benefit structures to start from.