Measuring up

In global surveys of the best pension systems in the world, certain countries always come out on top while others lag behind. Pádraig Floyd looks at what makes a winner and how European pension systems stack up against their international counterparts

It is said the UK pension system was the envy of the world. However, decades of neglect, particularly in the areas of state pension and defined contribution (DC), and over-regulation of defined benefit (DB) schemes, had resulted in a system in dire need of root and branch reform.

Policymakers looked abroad for inspiration and were particularly taken with the Australian and, to some extent, the US system as both structures offer mature DC systems. But assessing the relative merits of a pensions system is like measuring the proverbial piece of string. And even then, even if long enough, will it be right for the job?

All countries face the same dilemma about how to fund increased longevity in their populations. The Melbourne Mercer Global Pension Index is designed as a useful yardstick to show what’s working and what might be improved.

It is an annual study of the relative strengths of the pension schemes of 20 world economies. It assesses each system for adequacy, sustainability and integrity, providing relative scores for those qualities and an overall score as the categories are not weighted equally.

If the index is considered (for a moment) as a competitive table, the first country outside the medal positions and leading the UK’s section with a B grade, is Switzerland.

OECD data uses a weighted asset to GDP ratio to indicate how important pension savings are to the economy of those countries. The higher the ratio, the better able those investments will be to provide high benefits to individual savers, with the highest ratios being achieved by the Netherlands (160.2 per cent), Iceland (141 per cent) and Switzerland (113.6 per cent).

The next tranche of countries is led by the UK (95.7 per cent) and Australia (91.7 per cent), way ahead of the OECD average of 77 per cent and demonstrating that pension saving is an essential component to the economy.

In the Melbourne Mercer index, though the UK’s score improved from 2012 – largely the result of the current reforms to the basic state pension, extension of retirement age and of course, auto-enrolment – there is still room for improvement.

What makes a good system?
Coverage is the first consideration, with the better countries having most of the working population covered in a private pension plan, says Mercer senior partner and author of the index David Knox. The next is contribution levels.

“Not only do you have a funded scheme where money is being invested for the long-term future, but you have more and more people who are in those schemes,” he says. More people in schemes leads to more contributions and more assets being built up.

The three top countries also have contribution rates of at least 9 per cent of earnings, another important consideration, adds Knox. “If you’ve only got 3 per cent or 4 per cent going in, it’s not going to make a lot of difference and you’re still going to rely very heavily on social security.”

Those countries Knox is referring to are Denmark (A), the Netherlands (B+) and Australia (B+).

Land of the free
The US doesn’t make the grade for that group. In fact, it comes below Germany, with a similar C grade and an overall score considerably lower than the UK’s 65.4 per cent.

Though famous for its 401k private sector DC plans, the US has a history of dysfunctional DB, so there’s a problem with perceived integrity, much like the UK.

But its DC has problems in measuring up to the index, with 401k coverage being patchy and acting for many like a savings plan to be plundered in times of need with no requirement to covert savings into a retirement income.

A land down under
Pensions are important to the economy in Australia, with high levels of assets accumulated since the introduction of compulsion. But there are other characteristics of the system that align it more closely to its counterparts in the Netherlands and Denmark.

All three nations have applied their arrangements across the whole labour market, through agreement with employers and workers’ representatives, such as trade unions.

Their systems are mandatory and employ large scale industry-wide schemes run by professionals to manage the assets in the members’ interests.

For a successful pensions system, you need a well-regulated system that works in the members’ interests, says UNPRI managing director Fiona Reynolds, an expert on Australian super and former CEO of the Australian Institute of Superannuation Trustees.

“In the main, we have industry-wide schemes, so if you work in the construction industry, you will be in the fund for construction workers.

“The member has to come first,” adds Reynolds, “which all comes back to making sure you’ve got very good governance.”

Dutch courage
The Dutch system – like the Danish – has been in place since the 1950s and has time to fine tune the structure and amass huge schemes, says APG director of institutional business development Alwin Oerlemans.

“There is broad public support for the coverage and auto-enrolment,” says Oerlemans.

The state pension offers only around €15,000 per annum, which sounds good in comparison to the UK’s state pension, but is a long way short of replacing even 50 per cent of average career earnings. This is important and explains the 85 per cent to 90 per cent coverage of the system.

Coverage goes further in both the Netherlands and Denmark, as the self-employed are included in the legislation and some groups have organised to produce schemes for themselves and take advantage of economies of scale.

The exclusion of self-employed from the system in Australia combined with the cash fund approach is “a weakness” says Knox.

The inclusion of the self-employed as a metric of good provision is a major target for the Melbourne Mercer Index, he says, as entrepreneurs should not – and cannot – rely on their business alone to provide a retirement fund.

Hitting the Denmark
So why does the Danish system come out tops? The Dutch have been consolidating pension funds in recent years, but the Danish system has only around 15 funds in total, allowing for far greater economies of scale.

“These large entities are professionally run and have achieved very low costs as they are less dependent on advice from institutions,” says Affiliated Managers Group director of business development for the Nordic region Michael Moth-Greve. This has had a profound effect upon charges, with Denmark consistently achieving the lowest cost provision of around 10bps over all with consistent investment outperformance, according to OECD.

This self-reliance – replicated in both the Netherlands and Australia to a large degree – is the key reason for Denmark’s top position.

“Denmark is particularly unique, because pensions are separate from corporate entities, so the pension savers are not reliant upon the company’s balance sheet,” says Moth-Greve.

There is an argument that these three nations have it easier because they have relatively small populations and that can be the trouble with statistics. However, data from the OECD shows just how much has been achieved by the Danish system.

Though its autonomous pension funds – those dedicated to pension provision alone – show an asset to GDP ratio of just 50.1 per cent or half its GDP, the total private pension assets it held in absolute terms in 2012 was $636 billion. That is a mere drop in the ocean compared to the US, which in 2012 had the greatest amount of private pension assets at $19,391 billion. However, that amount is around twice the level of GDP in that year.

In the end...
We know the best way to save a meaningful sum for retirement is to start early and pay in as much as possible throughout. It is no different for national schemes – where coverage and contribution are the key determinants.

The UK has a long way to go, but unlike the US or Australia, it preserves pension savings for retirement and has an annuity industry in place to deliver secure retirement income.

The Melbourne Mercer index included post-retirement as a chapter for the first time this year, as it is an unresolved problem for many countries’ systems; how to deliver the income from savings.

Knox won’t be drawn on a structure, but suggests “a pooled solution, a bit like going back to the future with defined benefit pensions” might be an option considered, where risks are shared between stakeholders.

Knox says: “Annuities are not a very attractive proposition for most retirees at the moment and there are certain longevity risks, so there needs to be a solution in the DC world post-retirement.”

Pádraig Floyd is a freelance journalist

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