Study Uncovers a Troubled Pension Landscape
by Thomas J. Healey and Catherine Reilly
The battle over funding pension benefits that’s roiled one state capital after another is
hardly indigenous to the U.S. Pension systems around the world are struggling to meet the
commitments they’ve made to provide employees with a livable income in their retirement
years. Part of the problem is aging populations which are putting systems designed for different
demographic times under severe pressure. Other factors are rising government debt ratios in
the wake of the global financial crisis and poor investment returns, both of which have
impacted funding.
To determine how efficiently countries have managed their retirement programs, we
conducted a study – Global Pensions Underfunding – of 33 countries across five continents. Our
goal was not only to identify the pressures and problems these governments face, but to
suggest practical ways they could provide for their retired citizens without putting an
unreasonable strain on public finances.
To that end, we employed two metrics: sustainability, that is, the burden that projected
spending for a pension system puts on public finances, and adequacy, the ability of a pension
system to provide a tenable retirement income, defined as 60% of the average wage of a
worker over 65. We called the desirable balance between the two efficiency. What we found
was that countries that wish to be truly efficient can’t simply trade-off sustainability for
adequacy, or vice versa. They must improve both metrics simultaneously.
As our study demonstrated, some countries are better positioned than others for this
fiscal feat (Table 1). Korea, India and China, for example, rank among the top five most
sustainable pension systems (placing a very low burden on public finances), but also rank
among the lowest five systems on adequacy. And if a large share of the growing elderly
population has insufficient retirement income, this will turn into a public policy problem even if
the pension system does not currently demand heavy public spending. At the other extreme,
Austria and Hungary are two of the most adequate systems, but among the bottom five in
sustainability. This group of countries appears to make ample provision for retirement, but the
projected burden on public finances is so onerous that unless they address the issue of
sustainability they will almost certainly fall short of their promises to retirees.
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The U.S. falls within the “inadequate group” of nations. Despite considerable private
retirement assets which put only a limited strain on public finances, it provides benefits
insufficient to meet the income needs of retirees. Other members of this group include
China, Mexico, India, Korea, Indonesia and Australia.
Toward Greater Efficiency
The most efficient group of pension managers provides decent payouts while
maintaining sustainable systems to meet those obligations. Netherlands is the clear-cut
leader, followed by Switzerland, the U.K., Denmark, Sweden, Poland, Estonia and the
Czech and Slovak Republics.
How can other countries move closer to this model? Our research and review of best
practices around the world reveal a number of pathways.
For countries with “overgenerous” systems -- like Belgium, Greece, Italy, France,
Russia and Brazil -- a key to improving sustainability is raising the retirement age and
incentivizing people to retire later (Sweden allows employees to choose their own
retirement age, with no ceiling, and adjusts the pension payment accordingly). Other
novel steps could include introducing a longevity coefficient into the benefit equation
to limit the growth of pension expenditures (as life expectancy increases, the
longevity coefficient reduces the recipient’s monthly payment). Using lifetime rather
than final earnings to calculate benefits is another effective way to align payouts more
closely with actual employee contributions.
Countries low on the adequacy scale should aim to increase the share of
population covered and/or the level of benefits to ensure sufficient income at
retirement. One way to grow income is to introduce compulsory or default enrollment
into a pension scheme with an adequate contribution rate. Governments should also
ensure employees easy access to pension schemes which they can carry with them if
they change employers.
New approaches to pension system design can also help thread the needle
between sustainability and adequacy. These include notional defined contribution
(NDC) plans (where contributions are recorded in notional accounts, to which a rate
of return, typically GDP growth, is applied), and collective defined contribution (CDC)
plans (which pool contributions into a collective, centrally administered investment
fund rather than individual accounts). Another way to improve efficiency is to
advance fund at least some of the pension spending. Unlike typical “pay-as-you-go”
plans, prefunded plans are funded concurrently with the employee’s accrued benefits
so that monies are set aside well before retirement.
Despite the many complexities and pitfalls of pension plan design today, it’s
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worth noting that most countries in the “efficient group” have undergone extensive
and relatively recent reforms. Sweden and Denmark, for instance, have introduced
NDC and CDC schemes, while the U.K. and Poland have expanded their direct
contribution systems. Laudably, these countries have designed or re-tooled pension
systems to reflect their current demographic profiles, while incorporating best
practices from other systems globally. They should serve as a beacon of
encouragement for governments everywhere faced with inadequate pension
programs in desperate need of change.
Table 1. Top and bottom scoring countries on “sustainability” and “adequacy”
Sustainability Index
Adequacy Index
Country
Score
Country
Score
Top five
Korea
82
Luxembourg
97
Australia
75
Russia
83
India
74
Hungary
74
Indonesia
72
Netherlands
74
China
70
Austria
67
Bottom five
Italy
Austria
Greece
Hungary
Belgium
12
11
10
9
9
Germany
China
Mexico
Korea
India
30
22
20
4
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Tom Healey is a Senior Fellow of the Mossavar-Rahmani Center for Business and Government.
Catherine Reilly is currently pursuing her MPA studies at the Harvard Kennedy School of
Government, with a particular interest in pensions and behavioral economics.