OECD analysis of UK pensions: reason to be cheerful?

2 December 2015

Yesterday’s publication of the OECD’s Pensions at a Glance 2015 brought good news to the Department for Work and Pensions. Pensioner poverty is falling faster in the UK than in OECD countries; and UK replacement rates – the level of retirement income relative to working-life income – were above average for median earners, and in the top five for low earners. These outcomes were also achieved at relatively low cost. The UK’s State Pension is the fourth cheapest in the OECD, and future cost increases are modest by comparison.

This benign picture, however, says more about the state of public service reform in other countries than the UK’s retirement landscape. Looking into the detail of the OECD report there are reasons to be less positive.

First, the future cost of the UK’s State Pension is relatively muted thanks to recent reforms to the State Pension Age (SPA). In 2013, the Chancellor announced future changes to the SPA would be guided by the principle that a third of adult life should be spent in retirement. But the success of this policy depends on UK workers’ ability to remain in work in later life. Labour market participation for those between 50 and the SPA has increased significantly in recent years – also good news – however health outcomes for the over 60s deteriorate more rapidly in the UK than in other countries. In the absence of improvement, working lives will simply end before the SPA – with detrimental consequences for the individual’s income in retirement.

Second, the UK is able to sustain relatively modest levels of state pension expenditure because of high levels of private pension saving. However the phasing out of final salary pension schemes, uncertainty created by the Chancellor’s freedom and choice reforms, and the increasingly mobile careers of today’s workforce call the strength of the private pillar into question. Auto-enrolment was a significant step towards remedying concerns about private pension coverage. Yet the current default contribution level is too low to make a significant difference to the retirement of those on medium or high incomes. Even with auto-enrolment taken into account, the number of undersavers in the UK will remain constant over the medium term at around 2.5 million.

These problems are not insurmountable. Tailoring the work programme to the needs of older people could help individuals with complex health conditions return to the labour market. Auto-escalation – whereby workers contributions’ automatically increase after a pay rise – might offer a solution to the growing concerns about future savings adequacy. Following five years of reform, it would be tempting to leave the weaknesses highlighted by the OECD unaddressed. But without action to strengthen the private pillar now, the government’s dependency on the expensive triple lock to deliver positive outcomes for pensioners will only grow.

 

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