Sustainability and adequacy still dragging UK's pension system

The index, which compares 39 retirement income systems around the world, covering almost two-thirds of the global population, ranks retirement systems according to three principle metrics: adequacy, sustainability and integrity.

The UK’s overall score improved slightly by 0.5 points, to 64.9 in 2020 from 64.4 in 2019. It chalked up one of the highest scores for integrity, of 83.7, which measures the level of trust in the system’s ability to deliver. This was the 8th highest integrity score in the index.

The introduction of pension freedoms has made pension saving more popular. It is naive to think that this policy will simply be reversed

Steve Webb, LCP

But the total was brought down by poor ratings for sustainability (58, 14th place) and adequacy (59.2, 24th place), with the latter falling below the index’s overall average of 60.9.

The former metric measures factors such as coverage, demography, government debt and economic growth while the latter includes benefits, system design, savings and government support.

The ranking puts the UK in the C+ category with a range of 60-65 on the index, the same as it occupied last year, along with Belgium, Hong Kong, USA, Malaysia and France. C+ indicates “a system that has some good features, but also has major risks and/or shortcomings that should be addressed,” the report accompanying the index states.

“Without these improvements, its efficacy and/or long-term sustainability can be questioned,” it adds.

Only two countries received an A rating, the Netherlands and Denmark. There were no B+ ratings, while seven countries scored in the 65-75 range required to earn a B.

Commenting on the index overall, Dr David Knox, senior partner at Mercer and lead author of the study, says: “The economic recession caused by the global health crisis has led to reduced pension contributions, lower investment returns and higher government debt in most countries.

“Inevitably, this will impact future pensions, meaning some people will have to work longer while others will have to settle for a lower standard of living in retirement.

“It is critical that governments reflect on the strengths and weaknesses of their systems to ensure better long-term outcomes for retirees.”

Pension freedoms reversal ‘isn’t going to happen’

The report accompanying the index makes recommendations for each of the systems featured in the research. Last year its suggestions did not favour the pension freedoms reform introduced in the UK in 2015, and this year’s edition is similarly disobliging.

Among the recommendations that would make the UK’s overall index value rise are measures such as “restoring the requirement to take part of retirement savings as an income stream,” as well as raising the minimum pension for low earners, increasing the coverage of employees and the self-employed, hiking contribution levels and raising the level of household savings while reducing household debt.

Former pensions minister and LCP partner Steve Webb was critical of the report’s assumptions, telling Pensions Expert that, while it undoubtedly spots some global trends, its definition of what constitutes good pensions policy skews its outcomes.

In particular, he said, its assumption that a good pension policy should be about securing guaranteed income in retirement, rather than giving people choices about how to use their pension pot, biased the report against the UK’s pension freedoms policy.

“In the UK, the introduction of pension freedoms has made pension saving more popular and was a response to the problems of forcing people with modest pension pots to lock-in to annuities at historically low rates,” he explained.

“It is naive to think that this policy will simply be reversed. It is also striking that the Dutch system, rated top in this report, is going through a period of major reform. This is perhaps a sign that voters around the world tend to take for granted some of the strengths of their pension system, but that politicians are always under pressure to make reforms to tackle perceived shortcomings”.

Covid to impact index in future years

The report also notes the dire results of coronavirus and the various government measures aimed at tackling its spread. The impact, it states, has been felt across the board, with negative effects on interest rates, government debt and investment returns.

Professor Deep Kapur, director of the Monash Centre for Financial Studies, says many governments around the world have responded to Covid-19 with substantial fiscal stimulus, and central banks have adopted unconventional monetary policy.

“The outlook for investment returns is muted while volatility may be elevated, adding to the normal challenges of risk management in a pension portfolio.”

Mr Kapur also notes that some governments have “allowed temporary access to saved pensions or reduced the level of compulsory contribution rates to improve liquidity positions of households”, and that these developments will likely have “a material impact on the adequacy, sustainability and integrity of pension systems, thereby influencing the evolution of the Global Pension Index in the coming years”.

Nevertheless, “it is interesting to note that the top two retirement income systems in the Global Pension Index — the Netherlands and Denmark — have not permitted early access to pension assets, even though the assets of each pension system are more than 150 per cent of the country’s GDP,” Dr Knox concludes.