OECD Pension Outlook 2012
This first edition of the OECD Pensions Outlook takes a close look at the two main trends in pension design observed over the last two decades: first, the introduction of reforms to pay-as-you-go (PAYG), public pension systems such as later retirement and automatic adjustment mechanisms to pension benefits to improve the financial sustainability of these systems; second, the growth of funded private pension arrangements complementing PAYG public pensions. These developments are interlinked, as many pension reforms have ultimately led to a reduction in the replacement rate offered by PAYG public pension systems, increasing the need for later retirement and complementary forms of pension provision.
Overall, the pace of pension reform has accelerated over the period 2007-2010. Changes include increases in pensionable ages, the introduction of automatic adjustment mechanisms and the strengthening of work incentives. Some countries have also better focused public pension expenditure on lower income groups. However, some recent reforms have raised controversy, such as the decision of some central and eastern European countries to pull back earlier reforms that introduced a mandatory funded component.
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.
Other policies, though understandable given the economic situation, have been more controversial, such as the decision in countries like Australia, Denmark, Iceland and Spain to allow members to withdraw money from voluntary pension plans, and the reduction of contribution rates to funded private pensions in some countries that may have a negative effect on adequacy. The retroactive tax levy introduced on Irish pension funds has also raised eyebrows in the international pension policy community.
Over the last fifteen years, various OECD countries have introduced automatic links between demographic, economic and financial developments and the retirement-income system. The automaticity of adjustments means that pension financing is, to some extent, immunised against demographic and economic shocks. It provides a logical and neat rationale for changes – such as cuts in benefits – that are politically difficult to introduce.
However, any automatic stabilisation mechanism in place today, or implemented in response to the crisis, might pose problems in terms of adequacy of future benefits and the capacity of systems to protect the living standards of beneficiaries. What will be the destiny of systems based on such rules? These rules have already come under pressure in countries such as Germany and Sweden where discretionary amendments were made to the rule to avoid cutting benefits excessively at a time of economic downturn.
Furthermore, automatic adjustment mechanisms are often complex, difficult to understand and create uncertainty over future benefits. In order for individuals to adjust to these new pension designs – by working longer or saving more in private pensions, there is a need for gradualism and transparency in their implementation. A fair and predictable burden-sharing across generations should help individuals to adapt their saving and labour supply behaviour in line with the changes.