Pension reform needed across Europe
by Charles Cowling
27 July 2011
Retirement at the age of 70 or even 75 - increasing by at least one year in every decade - is the minimum we can afford as life expectancy grows
Public Sector pensions are a topic of huge current interest in the UK and across Europe - and rightly so. They affect the lives and wellbeing of millions of public sector workers. But they are also hugely expensive and potentially a massive drain on the public purse and taxpayers' limited funds.
We know that public Sector pensions also suffer two major curses, which make them hugely difficult for politicians in any democracy to tackle. First, the pay-as-you go system embraced by nearly all public sector pension schemes across Europe - and elsewhere - encourages financial ill-discipline. It is easy for politicians to make very expensive promises that do not need to be paid by the current generation of taxpayers. Indeed, public sector pensions had been income-generating for the British government for many years, as employee contributions were more than sufficient to cover the small level of pension payments in the earlier years. But it does not take a financial genius to recognise that this situation is not sustainable.
The second major problem for politicians is a system that is inexorably getting more and more expensive and is increasingly untenable in the long term. Any changes to the system bring significant short term pain, in the form of unhappy public sector workers, while the benefits will only be felt over many years. This is not soon enough to help the politician where it matters most - in the polling booth at the next election. But pension debts are mounting across Europe and politicians of all colours recognise that this issue must be addressed. Private sector employers, driven by a much more disciplined accounting environment, have forced through significant changes to schemes. So much so, that there is now a massive gap in the generosity of pension provision across the public and private sectors.
In the UK, the Treasury recently announced that public sector pensions represented additional debt calculated at more than £1.1trillion – as of March 2010. Ten years ago the equivalent figure was roughly £300bn. This government debt, now equivalent to £45,000 per household, is escalating at a frightening rate shows no signs of slowing. This is not just a UK problem. Many European countries are facing similar problems. The details vary depending on the generosity of the first pillar of state benefits. But for the large majority, the problems of spiralling pension liabilities, fuelled by increasing longevity, are the same. Although, not all countries have published as much information on the scale of the problem - as the UK has.
The current financial problems and the gap between private and public sector pension provision is having an impact on politicians and their willingness to tackle the problem. Private sector employees have seen significant cuts in their own pensions and, in these austere times, are far less supportive of the plight of public sector workers and their pensions. With public support turning, it is possible that politicians may consider the more radical measures that are fast becoming necessary.
Why are public sector pensions so expensive? Well, the main reason is that typically they are very generous. There are arguments over how to assess the cost of public sector pensions. Politicians and others - including public sector unions - have often sought to downplay these costs with the suspicion that this has been driven by ulterior motives. In his report for the Institute of Economic Affairs Facing up to the cost of Public Sector Pensions, Neil Record argues that UK public sector pensions should be valued in a manner consistent with other government debt. On this basis, he calculates the cost of public sector pensions to be at least 30 per cent of salary and in some schemes as much as 60 per cent, or even more. Worryingly, these calculated costs are typically at least double the costs recognised by the British government. There are plans to reduce the generosity of public sector pensions in the UK. But even with the significant changes planned, which are currently out to consultation, the benefits will still be far more generous than is now normal in the private sector.
The other key issue in this debate is that we are all living longer, much longer. When public sector pension schemes were introduced, typical life expectancy meant that on average, a pension to a former employee would likely be payable for only 10 years or so. Now, retiring workers can expect to draw their pension for more than 20 years. And the pace of longevity improvement is not slowing. Average life expectancy is currently increasing by two years every decade - or, put another way, five hours every day. It is clear that any society will struggle to afford a system that sees workers in employment for 30 or 40 years, but financing maybe more than 50 years of life out of work.
The obvious response to increasing longevity, raising retirement ages, is met with significant resistance. This is an issue right across Europe, not just in the UK - where plans to raise the retirement age to 66 by 2016 - are proving unpopular. In France, there have been strikes in protest at plans to increase the retirement age to 62. In Holland, Spain and Germany there are plans to raise the retirement age to 67. In none of these countries is the prospect of having to work longer before retirement going down well with the electorate. But the hard reality is that if we want to be able to afford a comfortable retirement, then retirement ages need to increase as life expectancy increases.
Given that retirement ages have changed little in the last 50 years or so, there is also some catching up to do. A target retirement age, therefore, of 70 or even 75 - increasing at least one year every decade is probably the minimum we can afford. So what does the future hold? I predict that the current round of changes will be just the start. Retirement ages will have to increase, to at least 70 and probably beyond, which will present many other social challenges around how best to keep an ageing workforce economically active. More significantly, defined benefit pension schemes will gradually be eased out in favour of less generous defined contribution schemes. But all this will come only after much painful debate and a lot of political angst.
Charles Cowling is managing director of JLT Pension Capital Strategies, in the UK
Public Sector pensions are a topic of huge current interest in the UK and across Europe - and rightly so. They affect the lives and wellbeing of millions of public sector workers. But they are also hugely expensive and potentially a massive drain on the public purse and taxpayers' limited funds.
We know that public Sector pensions also suffer two major curses, which make them hugely difficult for politicians in any democracy to tackle. First, the pay-as-you go system embraced by nearly all public sector pension schemes across Europe - and elsewhere - encourages financial ill-discipline. It is easy for politicians to make very expensive promises that do not need to be paid by the current generation of taxpayers. Indeed, public sector pensions had been income-generating for the British government for many years, as employee contributions were more than sufficient to cover the small level of pension payments in the earlier years. But it does not take a financial genius to recognise that this situation is not sustainable.
The second major problem for politicians is a system that is inexorably getting more and more expensive and is increasingly untenable in the long term. Any changes to the system bring significant short term pain, in the form of unhappy public sector workers, while the benefits will only be felt over many years. This is not soon enough to help the politician where it matters most - in the polling booth at the next election. But pension debts are mounting across Europe and politicians of all colours recognise that this issue must be addressed. Private sector employers, driven by a much more disciplined accounting environment, have forced through significant changes to schemes. So much so, that there is now a massive gap in the generosity of pension provision across the public and private sectors.
In the UK, the Treasury recently announced that public sector pensions represented additional debt calculated at more than £1.1trillion – as of March 2010. Ten years ago the equivalent figure was roughly £300bn. This government debt, now equivalent to £45,000 per household, is escalating at a frightening rate shows no signs of slowing. This is not just a UK problem. Many European countries are facing similar problems. The details vary depending on the generosity of the first pillar of state benefits. But for the large majority, the problems of spiralling pension liabilities, fuelled by increasing longevity, are the same. Although, not all countries have published as much information on the scale of the problem - as the UK has.
The current financial problems and the gap between private and public sector pension provision is having an impact on politicians and their willingness to tackle the problem. Private sector employees have seen significant cuts in their own pensions and, in these austere times, are far less supportive of the plight of public sector workers and their pensions. With public support turning, it is possible that politicians may consider the more radical measures that are fast becoming necessary.
Why are public sector pensions so expensive? Well, the main reason is that typically they are very generous. There are arguments over how to assess the cost of public sector pensions. Politicians and others - including public sector unions - have often sought to downplay these costs with the suspicion that this has been driven by ulterior motives. In his report for the Institute of Economic Affairs Facing up to the cost of Public Sector Pensions, Neil Record argues that UK public sector pensions should be valued in a manner consistent with other government debt. On this basis, he calculates the cost of public sector pensions to be at least 30 per cent of salary and in some schemes as much as 60 per cent, or even more. Worryingly, these calculated costs are typically at least double the costs recognised by the British government. There are plans to reduce the generosity of public sector pensions in the UK. But even with the significant changes planned, which are currently out to consultation, the benefits will still be far more generous than is now normal in the private sector.
The other key issue in this debate is that we are all living longer, much longer. When public sector pension schemes were introduced, typical life expectancy meant that on average, a pension to a former employee would likely be payable for only 10 years or so. Now, retiring workers can expect to draw their pension for more than 20 years. And the pace of longevity improvement is not slowing. Average life expectancy is currently increasing by two years every decade - or, put another way, five hours every day. It is clear that any society will struggle to afford a system that sees workers in employment for 30 or 40 years, but financing maybe more than 50 years of life out of work.
The obvious response to increasing longevity, raising retirement ages, is met with significant resistance. This is an issue right across Europe, not just in the UK - where plans to raise the retirement age to 66 by 2016 - are proving unpopular. In France, there have been strikes in protest at plans to increase the retirement age to 62. In Holland, Spain and Germany there are plans to raise the retirement age to 67. In none of these countries is the prospect of having to work longer before retirement going down well with the electorate. But the hard reality is that if we want to be able to afford a comfortable retirement, then retirement ages need to increase as life expectancy increases.
Given that retirement ages have changed little in the last 50 years or so, there is also some catching up to do. A target retirement age, therefore, of 70 or even 75 - increasing at least one year every decade is probably the minimum we can afford. So what does the future hold? I predict that the current round of changes will be just the start. Retirement ages will have to increase, to at least 70 and probably beyond, which will present many other social challenges around how best to keep an ageing workforce economically active. More significantly, defined benefit pension schemes will gradually be eased out in favour of less generous defined contribution schemes. But all this will come only after much painful debate and a lot of political angst.
Charles Cowling is managing director of JLT Pension Capital Strategies, in the UK
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COMMENTS
Good article, but: increasing the retirement age by one year every decade will not resolve the problem of an under funded ponzi scheme from the start.
We have a health system which, at vast expense, keeps people alive beyond their sell-by date, and then dumps them on the overloaded carer system at vast expense.
It's illogical, and unsustainable, nature will not put up with it, the consequences are becoming more apparent by the day: energy, food, water and finance, are all under stress from the one cause - too many people on a finite planet.
I am 71, and still working, so why does the public sector give the option of early retirement with a golden handshake and an earnings-related pension? The golden handshake should be deducted from their pension, their salary is more than some earn in their lifetime.
Bernard Clayson - Kent UK
Don't worry, governments fund it by printing money. Of course, they don't call it a tax so they can get re-elected.
Laurie LIta - Brisbane, Australia
