11 Jun, 2012

OECD’s First Pensions Report: Those Who Live Longer, Will Have To Work Longer

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Paris, 11 June 2012 – In a move that could impact on travel trends from the industrialised countries, especially by the growing numbers of senior citizens, the OECD report has issued a report calling for a revamp of pension schemes in order to keep ageing citizens at work for several years beyond present retirement age.

The report, The Pensions Outlook 2012, is the first of its kind issued by the OECD. It is intended to highlight the growing costs of pension schemes to the public exchequer and pave the way for a transfer of these schemes into private hands. Depending on how these schemes are adjusted, it could impact on frequency, seasonality and duration of travel by retirees, long-stay visitors and health and wellness clients.

The report says that OECD 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. 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.

Says the report, “Taken together with the increases in pensionable ages, nearly all OECD countries are taking action to ensure that people “live longer, work longer”.”

According to the report, “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. 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.”

OECD Secretary-General Angel Gurría is quoted as saying, “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. 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.

The report says that “the financial, economic and fiscal crisis experienced over the last five years has exerted major stress on funded, 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% yearly. Such disappointing performance puts at risk the ability of both defined benefit (DB) and defined contribution (DC) arrangements to deliver adequate pensions.

“Policy makers’ reaction to the crisis was focused on regulatory flexibility and risk management. Initiatives include an extension in the period to make up funding deficits in defined benefit pension plans, greater flexibility in the timing of annuity purchases (to avoid locking in unattractive rates), and new rules on default contribution rates and investment strategies to ensure better member protection.”

The report says that making private pensions compulsory is not necessarily the answer for every country. It says that 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.

The 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).

Full text of the Editorial in the report, headlined: Pensions: Past, Present and Future

It may not feel like it, but today’s retirees are living through what might prove to have been a golden age for pensions and pensioners. Far fewer older people live in poverty than in the past: about a quarter fewer than in the mid-1980s. They can expect to live longer: 65 year olds today are projected to live 3.5 years longer than their parent’s generation.

Today’s and tomorrow’s workers, in contrast, will have to work longer before retiring and have smaller public pensions. Their private pensions are much more likely to be of the defined-contribution type, meaning that individuals are more directly exposed to investment risk and bear themselves the pension cost of living longer.

The financial shock of 2007-08 has reverberated during the succeeding years with a profound impact on economies and the public finances in most OECD countries. Pension systems, already transformed by a wave of change over the previous decade, were further reformed, often under the pressure of fiscal consolidation and international financial markets. The most obvious change has been increases in pensionable age, adopted by more than half of OECD countries. In the long term, pension ages will be 67 or more in 13 countries, with a common age for both sexes in all but one country. Other, less visible measures to encourage people to work longer – tighter conditions for early retirement or greater rewards for continuing after the normal pension age – were implemented in 14 countries.

This is a welcome development for four reasons. First, working longer as people live longer improves the financial sustainability of pension systems, and in a less painful way compared with increasing taxes. Secondly, it ensures a fairer distribution of the costs of ageing across generations. And contributing for longer periods can mitigate the impact of planned reductions in pension benefits on retirement incomes. Thirdly, it suggests a clear break with failed past policies of pushing older workers out of the labour market and into early retirement, through long-term sickness or disability as well as old-age pensions. The ostensible reason for the failed policy was that it would free up more job opportunities for youth. But the evidence shows that this is just another example of the “lump-of-labour” fallacy: keeping older workers in the labour force does not reduce job opportunities for the young.

Fourthly, extending working lives in a situation of slowly growing or even declining workforces should provide an important boost to economic growth in ageing economies. Given these clear benefits, the trend to higher retirement ages – even beyond 67 – should be encouraged. One effective and transparent way to do so is to tie institutionally the retirement age to life expectancy, as in Denmark and Italy.

Pension reforms over the past decade have also led to a reduction in public pension promises in many countries, typically between a fifth and a quarter. Such cuts have been necessary to ensure the financial sustainability of pension systems for both current and future retirees. Since 2007, half of OECD countries took further steps to improve the sustainability of the public pension system, including changes to indexation requirements and benefit formulas.

On average in OECD countries, people starting work today can expect a net public pension of about half their net earnings if they retire after a full career at the official retirement age. This so-called “net replacement rate” from public benefits is less than 50% in half of OECD countries. In 13 of those countries, private pensions are mandatory. The law or social contracts require that all workers participate in such plans. As a result, total mandatory benefits – including these private schemes – offer a net replacement rate averaging about 69% on average in OECD countries.

Nevertheless, there is a large “pension gap” in a dozen OECD countries, with net replacement rates from mandatory schemes of less than 60%. In most of these countries private pensions are voluntary and rarely cover more than half of the workforce. A greater role for private pensions in these countries is inevitable to fill this pension gap. Even if further increases in retirement ages are implemented, private pension provision should be promoted to allow workers to draw on their savings in old age, complementing their working income and public pension benefits. This can be particularly attractive for those seeking flexible working conditions after a certain age or a phased retirement.

Making private pensions compulsory would be the ideal solution to eliminate the pension gap and ensure benefit adequacy. However, some countries have shied away from such a policy partly because of the concern that the contributions would be seen as a new tax. An alternative way to achieve a similar result is to enrol individuals into such plans automatically, while allowing them the possibility of opting-out within a certain time frame – so-called “auto-enrolment”. By requiring people to opt out of rather than into retirement saving, it aims to use natural inertia to expand coverage. The first nationwide auto-enrolment retirement savings scheme in the OECD, the KiwiSaver introduced in New Zealand in 2007, has been highly effective in ensuring high participation rates among new employees, with opt-out rates as low as 20%. This kind of arrangement will be rolled out in the United Kingdom between 2012 and 2017, and other countries are likely to follow suit.

Another key policy that can be used to expand the role of private pensions is to provide financial incentives. The traditional way of encouraging people to save for their old age has been tax incentives. While some countries have recently extended tax incentives, Australia, Ireland, New Zealand and the United Kingdom have all moved to limit them to reduce the fiscal cost in the form of foregone tax revenues. Costs have been questioned elsewhere, including Germany.

The problem with the traditional design of tax incentives is that it benefits high earners most as they pay the highest marginal tax rates. Indeed, in most countries with voluntary pension systems, low-income workers are the least likely to participate in private pension plans. A more effective way to reach out to lower income individuals is to provide savers with flat subsidies and matching contributions capped at a certain level to ensure greater progressivity. Such financial incentives can benefit low earners more including those that pay no income tax or at a low rate. In Germany and New Zealand, two countries that have introduced such incentives for some of their retirement savings products, coverage rates are more similar across different income groups.

In addition to expanding private pensions coverage, policy makers need to act on three fronts to improve benefit adequacy. First, they should ensure that contributions to such plans are sufficient to meet retirement income goals. This is straightforward in mandatory systems, as in Australia, which recently announced an increase in the minimum contribution rate from 9% to 12% of wages. Secondly, they should limit leakage from such systems by restricting early withdrawals and lump-sum benefit payments. Thirdly, they should promote investment strategies and products that have low costs and mitigate risks during both the period of asset accumulation and retirement, when benefits are paid out. As they address these challenges, policy makers should pay great attention to the menu of investment and benefit options to simplify and facilitate complex financial decisions. They should also improve the design of defaults for those who do not make active choices so that they better meet individual needs and expectations.