OECD warns UK pension reforms may not deliver

1 Dec 15

UK pension reforms may well fall down in practice unless the economy and employment levels stay strong, the Organisation for Economic Cooperation and Development has warned.

Launching its biennial review of pension provision across the OECD bloc and beyond, the organisation was also strongly critical of the triple lock policy, which raises the state pension by whichever is highest of inflation, earnings growth or 2.5%, describing it as “bizarre”.

The OECD said the UK’s old age support system seems to have struck a happy middle between adequacy and affordability. However, it cautioned that reforms may not work as well in practice as they do on paper.

Success could prove illusory as it depends on optimistic projections of full careers, voluntary contributions, good health and high wage growth and inflation.

Mark Pearson, deputy director of the OECD’s directorate for employment, labour and social affairs, said the idea that the UK has found a good balance in its pension system is tantamount to “some kind of Panglossian fantasy”. 

Pearson said that the rise in the state pension age, which will be 67 by 2028 and continue to rise in line with life expectancy thereafter, helps to find a good compromise between adequacy and affordability as people contribute for longer and collect pensions for a shorter amount of time.

But he added that the UK citizens are in general not healthy enough to go on working into their late 60s, something unlikely to change without further investments in health.

In a best case scenario, the OECD projects that the retirement income average earners in the UK will receive is 67% of their individual earnings – just above the OECD average. For low earners this ‘replacement rate’ looks even better, at 99%, putting the UK in the top five of countries measured.

However, these healthy projections rely heavily on contributions to voluntary private pensions in addition to mandatory contributions.

The UK’s new state pension replaces not only the basic state pension but also the second-state pension, meaning the UK joins Ireland and New Zealand as the only countries in the OECD without a mandatory second tier.

A full, uninterrupted career is crucial to these voluntary contributions, and Pearson said the UK would have to double its private coverage rate to ensure the system is adequate.

Without voluntary contributions, low earners’ replacement rate drops to 69% and average earners’ to 38%, putting the UK ahead of only Mexico and Chile in the generosity of its basic state pension.

Tom McPhail, head of retirement policy at pensions advisers’ Hargreaves Lansdown, said the OECD’s findings make for “embarrassing reading” for those responsible for setting UK pensions policy.

Pearson added that while the UK’s ‘safety net’ for those who have not contributed enough to benefit from a full state pension is around the OECD average, it is still not enough to keep people out of poverty.

Macroeconomic conditions also put pressures on pensions, for example the UK’s growing debt burden.

In such context, Pearson described the triple lock as the “most bizarre” pensions policy for some time. He warned that, in a tough economy with deflation and low wage growth, it would quickly become unaffordable.

Pearson also called for increased spending on social care, which he said was in crisis. Many pensioners in poor health experience a very low standard of living due to cuts to social care budgets, and their needs are left unaddressed in the UK’s support system for the elderly.

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