Learning from other countries’ pension reforms is difficult to do as the political and economic context from which such systems emerge are often very different.
This means that it is not usually possible to simply imitate the successful, although there are periodic exceptions, like automatic enrolment, which the UK imported from the US. However, these are rare and the learning process is usually more gradual.
So, we are launching our third volume in a series of books on international pension systems with a little trepidation. This edition focuses on the provision of income in retirement, something we see as the core function of a national pensions system. Some systems around the world achieve this better than others but, taken together, a range of factors emerge that are common, or should be common to all high performing systems.
The first two factors, coverage and adequacy are the most important and really define the system. Automatic enrolment has dramatically improved second pillar coverage in the UK but it is an open question as to whether it takes in as many people as it should.
Similarly, the statutory minimum contributions in the UK system are too low to lead to an adequate retirement. The Turner Pensions Commission saw 8 per cent of band earnings as leading to a much lower replacement r a t e t han t he ir t ar g e t o f t w o thirds of pre-retirement income for a median earner, with the anticipated shortfall coming from additional private contributions, which have yet to materialise. As with coverage, a serious debate about adequacy will have to wait until after the pandemic but, the increasing body of evidence showing how poorly prepared Generation X is for retirement worries us and should also worry government.
In terms of how the UK pensions system operates, it is a comparative outlier. Almost all peer countries insist on there being a fiduciary at some point in the investment chain, including the US. Some insist that pensions should be provided only by non profit companies in order to further mitigate the principal/agent problems inherent in pension provision.
Scale also emerges as a major theme. There are considerable economies of scale in pension provision and few observed scale diseconomies. Good governance also becomes easier as funds get bigger, as governance is expensive. But, success from scale is also contingent on incentive alignment: making sure that pension funds act in the best interests of their members.
Cost transparency also matters. After a slow start, the UK is making good progress in understanding and bearing down on investment costs. The charge cap on occupational DC has been effective, but not as effective as market- based competition, with the pressure brought to bear by employers driving the competitive price for a workplace pension scheme well below the cap. Charges remain much higher in UK non-workplace pensions.
The last two factors crucial to a high performing system – income targeting and longevity protection – highlight a strategic choice for UK policymakers. In our view, successful pensions systems make it easy or, in some cases, require people to take an income in retirement. They also pool longevity risk so that people do not have to manage it personally – something that is difficult unless you have resources considerably beyond those of the average person.
The 2014 Budget, in which then Chancellor George Osborne unveiled Pensions Freedoms, has aligned the UK much more with Anglophone pension systems that focus on accumulation and place few requirements on the individual in decumulation.
The challenge for the UK over the next decade or so as Generation X arrives at retirement, predominantly with DC savings and little DB, is to move closer to having a pensions system that targets a retirement income. It should be possible to develop a system that makes taking an income easier.
The challenge here is substantial and there are many economic and social headwinds, but should we be without an easy route to a stable income in 10-15 years’ time, retirees will simply vote themselves a more generous state pension.