OECD warns on pension funding fracture-lines

The OECD has warned that pension funds will come under increasing pressure as national governments cut old-age pensions, expecting the private sector to deliver ever-higher returns to fund increasing longevity, with a report citing Germany, Ireland, the UK, and New Zealand as addressing these issues in reform agendas.

Government pensions account for 60 per cent on average of old-age incomes in OECD countries, with the other 40 per cent coming from work and from private pensions. As public benefits are cut, these other two sources will need to fill the gap, said OECD Secretary-General Angel Gurria.

Gurria said people needed to be encouraged to invest in private pensions – whether they were from a government or a private pension fund – and that countries such as Germany, Ireland, the UK, and New Zealand were taking innovative steps in this direction.

The OECD report, Pension at a Glance 2011, said government pension expenditures had grown 15 per cent faster than national income between 1990 and 2007.

As pension funds had not fully recovered from the 2008 losses, funds needed to reconsider their methods in encouraging people to work longer, the report said.

With the expected duration of retirement in 2050 projected to be 25 years for women and 20 years for men – 50 per cent longer than it was in 1960 – increasing pension ages would not be sufficient across all OECD countries to offset future growth in life expectancy.

The long-term trend to earlier retirement came to an end for men in the mid-1990s, for women, slightly later. While the average age of labour-market exit was broadly constant for a few years, according to the OECD report, the trend had been to later retirement in recent years.

As life expectancy continued to increase, significant increases in the effective retirement age would be required to maintain control of the cost of government pensions.

“In 2050, only an effective retirement age of 66.6 for men and 65.8 for women would leave the duration of retirement at the same level as it is now (based on the United Nations population projections),” the report said.

The report criticised countries’ choices to link benefit levels to life expectancy rather than pension age.

“If people simply continue to retire at the same as present, then benefits will fall as life expectancy continues to grow,” it said.

The report argued that a link of pension age to life expectancy was much better suited to countries with redistributive public pension programs, such as Belgium, the Czech Republic, Canada, Ireland, Korea, Switzerland and the UK.

The report suggested that improving incentives to work longer was needed and had been a “motif of most OECD countries’ pension reforms over the last two decades”.

Tightening the qualifying conditions for early retirement was one method of encouraging people to work longer, the report said, citing Austria, Belgium, Denmark, France, Greece, Hungary, Italy and Poland.

Removing tax incentives for private, occupational early retirement schemes as the Netherlands had done was another option.

European countries were the major players when it came to encouraging people to work longer through the means mentioned, but they neglected to offer attractive terms for deferring pensions.

Austria, Poland, Spain and the Swiss offered small increments in pension benefits for people who deferred claiming the pension after normal pension age, while Belgium and Italy offered none.

Canada, the Czech Republic, Japan, the UK and the US offered the most attractive terms for deferring pensions, according to the OECD report.

European countries had also largely fixed the problem of people retiring once earnings had peaked due to calculating pension benefits based on a limited subset of ‘best’ or ‘final’ earnings.

Austria, Finland, Italy, the Netherlands, Poland, the Slovak Republic, Sweden and the UK based benefits on earnings across the career. Greece still based benefits on the final five years’ pay and Spain on the final 15 years.

The OECD report also recommended reviewing seniority-based wage structures as they made it expensive to employ older workers. “Employers, competing for an ever diminishing pool of young workers, will simply have to adjust to a greying workforce,” said the report.