Where we sit in the world of pensions
Easily broken promises, conundrums for ministers and glacially slow implementation? OECD pensions supremo Edward Whitehouse gives John Greenwood a global perspective on the UK system
There can be few people with a clearer perspective on how the UK pension system compares with those in the rest of the world than Edward Whitehouse, principal administrator, directorate for employment, labour and social affairs at the Organisation for Economic Co-operation and Development. Just back from a four-week trip that has seen him researching pensions in Amsterdam, Zurich, Seoul and Washington, it is fair to say Whitehouse eats, sleeps and breathes the pensions systems of the world.
The OECD’s aim is to promote policies that improve economic and social wellbeing around the world by sharing examples of good and bad practice in different countries. So how does Whitehouse perceive the key challenges of public sector pensions, state retirement age and lack of private provision in the UK, and the government’s handling of them?
“There is a general move to harmonise the benefits between the public and private sectors around the world. We have seen significant reforms in Japan, Korea and France, all involving a reduction in benefits for today’s workers or harmonising pension ages.
“The UK has, at around 30 per cent, one of the highest shares of public pension spending going to public sector workers, making it the fourth highest amongst the 27 countries in the OECD. That is down to the small size of the state scheme,” he says. But he points out that overall state spending on pensions is, at 6.7 per cent lower in the UK compared to other countries. 8.4 per cent for the OECD average, and 9.1 per cent for the EU.
So doesn’t that put the UK in the ’affordable’ bracket, when it comes to state pension spending? Whitehouse thinks the UK cannot afford to rest on its laurels.
Even with the reforms, that is set to increase to 9 per cent of GDP by 2060. That is quite a lot of money. If you spend the money on pensions, you can’t spend it on anything else. So it is an issue for society and voters to think about. And in addition to the pension costs are long term care and healthcare costs, which are also being pushed up. So the costs of ageing are so great that even though we may look mean, there is still a case for reducing those costs.”
Unions and governments may be edging closer to agreement on a public sector pensions settlement, but some on the left still argue state workers are being pushed harder than is necessary.
Despite the fact that the RPI/CPI switch has already cut up to 20 per cent of benefits at a stroke, compounded by higher contributions, higher tax and later retirement ages, Whitehouse argues other countries are moving even more quickly.
“Other countries are hitting public sector pensions of workers who are retired. Greece has put a 25 per cent tax on high pensions, above €1,000 a month. Ireland has introduced a levy on pensions in payment and a 7.5 per cent contribution levy on current employees, which is much greater than the 3 per cent increase in contribution rates in the UK,” he points out.
By contrast to other Anglo-Saxon countries, UK public sector workers appear lucky to have any DB benefits left at all. “Australia abolished its DB scheme for public sector workers and replaced it with a DC one. New Zealand abolished its one too - each department can decide whether to have one or not. That said, the basic pension in New Zealand, at 38 per cent of average earnings, is worth more than in the UK where the figure is nearer 20 per cent. But these are still more radical changes. And the US dramatically reduced its DB benefits and introduced a DC scheme for federal employees,” he says.
And Whitehouse is not nostalgic for the now jettisoned RPI indexation, which he says was always an anomaly peculiar to this country.
“No-one else in the world knows what RPI is. CPI tends to be lower for a number of reasons, one of which is the weighting. If prices of goods go up in the year, people will consume less of those goods and consume more of those goods that have gone down in price. The other reason is mortgage payments appear in RPI.
“CPI is the internationally-accepted figure, although there are a few local exceptions. For example, in Belgium it is CPI excluding tobacco, alcohol and petrol. So pensioners are not allowed to drink, smoke or drive,” he says.
He suggests that pensioners are getting a better deal than they should be even through CPI, because it carries its own inaccuracies.
“In the USA the Boskin commission looked at the use of CPI for COLAs - Cost of Living Adjustments - the American term for indexation. Their conclusion was that CPI overstated the cost of inflation by around 1.1 per cent a year. So even CPI is overstating inflation. One of the reasons they said this is that changes in quality of products was very difficult to reflect. So these days getting a TV means getting a 36in plasma TV, whereas in the past you got a 14in cathode ray tube device. It is difficult to capture changes when technological developments are moving so fast,” he adds.
And while few will have that much sympathy for public sector pension fat cats, what does he make of the plight of high earning doctors and civil servants who are hitting the lifetime or annual allowance and facing a 25 to 55 per cent tax?
“A lot of countries have moved away from offering tax relief at the marginal rate - Ireland has recently done that for example. One reason for that is you would expect higher income people to save anyway. So better to use incentives for people on lower earnings. Some calculations I have seen for Ireland showed 80 per cent of tax reliefs went to 20 per cent of the people,” he says.
Whitehouse typifies the way pension reform in the UK is being implemented as painfully slow, and nowhere is that more apparent than in the now delayed even further auto-enrolment roll-out.
He believes there is a risk to the entire project if people save a 2 per cent total contribution for five years and find they have built up a pension of 90p a week? Whitehouse believes the delay caused by the postponement risks imperiling the success of the entire policy initiative.
“There is a potential political problem down the line that the credibility of the system is undermined by what has happened, and if we have continuing bad economic news, if investment returns are bad as well, that is clearly a political concern. You do have to guard against the credibility of the whole system,” he says.
He says the delay, which will see obligatory contributions limited to 1 per cent employer, 1 per cent employee until well into the next parliament as creating a series of problems for the policy as a whole. Other countries, he says, have moved far more quickly, with successful outcomes.
“It does seem to be taking an extraordinarily long time between the Turner report being delivered and agreed upon by all three of the major parties, and it being fully implemented.
“Other reform processes have been quicker. For example the Swedish introduction of a compulsory defined contribution plan took a decade, but most of that decade was spent in negotiations of the system and the political consensus, not on the implementation stage,” he says.
He also cites the example of Australia, which introduced compulsion in 1992. “There was a national agreement between the government, the employers and trade unions, that people would not get a pay increase that year, but employers instead would put 2 per cent into the new Superannuation. That contribution is now up to 9 and there are discussions about taking it up to 11 or 12 per cent,”
“Australia was in a similar position to the UK, with half of people in schemes and half not. Switzerland was too. In the 1980s the Swiss made it compulsory for the other half of employers to set up schemes or go to an insurance company to set one up, and again that was pretty quickly set up,” he says.
Whitehouse says this delay does create issues for the contribution charge in Nest. “That payoff period is likely to be longer now,” he says.
And would a failure of auto-enrolment affect the UK’s long-term finances? Much of the pressure on Eurozone currencies has been down to concerns over their public sector expenditure liabilities, so would a failure to successfully wean UK citizens onto private sector pension saving impact the UK’s overall economic prospects? The question produces an intriguing insight into the mechanics of international ratings agencies and their views of politics and politicians, particularly when it comes to pension promises.
“Standard & Poor’s produces a report- Global Ageing, an Irreversible Truth, which sounds like a movie by Al Gore,” says Whitehouse. “This shows long term financial figures of public spending that is affected by ageing - pensions, healthcare and long term care. They cover all the economies, and they show this is going up everywhere. They then produce a projection for what the ratings of those sovereign bonds will be in the future, as a result of this expenditure. So it shows them going down and some of them ending up at junk by 2050. But what I have never understood is why this is not taken onboard today,” he says.
Whitehouse says he has often wondered why, given the fact that we know some countries have more financially unsustainable systems than others, ratings agencies do not feed that into today’s ratings.
“I have informally asked one of the people at the ratings agencies why they did this and their answer was that they do not actually believe these payments will ever be made. Even if there are these projections out there, they believe the government will renege on their promises.
“It is quite an extreme assumption. We are assuming public spending on health, pensions and long term care will be the same in the future until we get to that point and we realise it is higher than we anticipated,” he says.
So are the ratings agencies behind the curve on their own information?
They are collating information that is out there, but they then don’t take it into account today. But pensions are always a long-term game. It is surprising any pension reform gets done at all,” he says.
But Whitehouse believes the delay in auto-enrolment creates problems down the line for the DWP, as better private pensions had been just a part of the overall Turner settlement.
“The major pressure caused by the delay in the auto-enrolment delay is of political pressure for a bigger basic pension or a bigger pension credit in the future. But I do not think that will be a big enough pressure for them to change,” he says.
The flat-rate pension is inextricably linked to the debate over means testing, a policy that Whitehouse believes has never received its full credit in the UK.
“Means-testing is a policy that has an undeservedly bad name,” he says. “It does save you money. It is not true that the administrative cost is outweighed by the savings in benefits. If you compare two neighbouring countries, Australia with some means-testing and New Zealand without, there is great difference in the pension expenditure of the two.
“But the way we have done it in the UK has not been great. We have a top-up, whereas the Australians do it in reverse. They pay the state pension to everyone apart from the richest slice of people. And that is a lot easier to test. In Australia the rich don’t even bother claiming it. You don’t save as much money as you do by giving a top up to the lowest 30 per cent, by affluence testing rather than poverty testing, but you still save a lot of money. So since we are moving towards this basic pension, why not have an even higher basic pension but take it away from the richest 25 per cent” he suggests.
So will the flat-rate pension see the light of day, particularly given some say it will be sacrificed as part of the public sector pension settlement?
“Originally we would have seen a flat-rate S2P by 2045 anyway. So everyone would be getting 40 per cent of the lower earnings threshold minus the lower earnings limit. The original Labour proposal was to bring that forward by a decade. The current government is saying lets bring that forward another decade,” he says.
This creates expense for the government, he says. The flat-rate versus means-tested conundrum faced by pensions minister Steve Webb is one Whitehouse takes a touch of professional glee in pointing out, not least since Webb used to be his boss when they both worked at the Institute for Fiscal Studies.
“Turner proposed a merger of S2P and basic into one new bigger pension. That is more what is favoured on the grounds of simplification by the current government. The cost of paying a basic pension equal to the Pension Credit today would cost a number of billions of pounds. It would also only affect people not on Pension Credit, going to the richest 70 per cent of pensioners,” says Whitehouse.
“When I put that to the pensions minister he said “well yes, we do realise this component is regressive, however, the fact that we would make the state second pension flat rate means we are taking some money away from higher earners”. He said that balances it out.” And was Whitehouse satisfied with Webb’s answer? “I couldn’t possibly comment.”