A brief review

The previous edition of Mercer’s Global Retirement, Risk and Finance Perspective introduced the Melbourne Mercer Global Pension Index, which represents the first time that national retirement income systems have been compared and an index value calculated for each country.

The overall index value represents the weighted average of the three sub-indexes, as shown in the following diagram, which also shows some of the topics used in each sub-index. In total, more than 40 indicators were used.

As outlined in the previous article, the final index value for each country enables us to grade each country’s system according to the following table:

The outcome and some suggestions

The following table shows the overall index value as well as the sub-index values for each of the 11 countries included in this initial study. More details are available in the report, which can be found on www.mercer.com/globalpensionindex.

The Dutch retirement income system scored the highest index value, followed closely by the Australian, Swedish and Canadian systems. There was then a clear gap between the first four countries’ systems and those of the UK, the US, Chile and Singapore. It is notable that some countries were, relatively, ahead in one aspect represented by the sub-index values: for example, Singapore in sustainability and the UK in integrity. However, it should also be noted that no country achieved an index value above 80, which would give it an A-grade rating. Hence, there is room for improvement in every system.

The report makes several suggestions to improve each country’s system and hence its index value. Although the development of each country’s system reflects a unique history, many countries will face similar problems in the decades ahead stemming from the social and economic effects of aging populations. These common challenges include:

• Increasing the state pension age to reflect increasing life expectancy, both now and in the future
• Promoting higher labor force participation at older ages, particularly as many individuals now remain in good health for longer periods
• Encouraging higher levels of saving, both within the pension system and beyond
• Increasing the coverage of employees in the private pension system
• Promoting a diversity of retirement income products, including but not limited to annuities

The key questions

Although the overall index considered more than 40 indicators, they were not equally weighted, and some questions were considered more important than others. The following six questions had the highest weightings in the overall index – three of them with respect to adequacy and three with respect to sustainability.

The main adequacy questions were:

• What is the net replacement rate for a median income earner? Based on OECD research, most countries had a net replacement rate of less than 70 percent of revalued median lifetime earnings, which is considered inadequate. By contrast, the Dutch figure is 105.5 percent.

• What is the minimum pension, as a percentage of the average wage, that a single aged person will receive? This pension is equivalent to the zero pillar under the World Bank approach and, as such, represents the income available to the aged poor. There is no correct answer as to what the minimum pension should be, as it depends on a range of socioeconomic factors. However, it is suggested that a pension below 27 percent of the national average earnings would not fully meet the goal of poverty alleviation.

• What is the household savings rate in the economy? The living standards of the aged will depend on the benefits arising from the pension system as well as the level of household savings. These rates ranged from -17 percent in Chile to +20 percent in Singapore, thereby highlighting the variety in the level of savings around the world.

The main sustainability questions were:

• What proportion of the employed workforce are members of private pension plans? Private pension plans represent an important pillar within all retirement income systems. Hence, a higher proportion of coverage among the workforce increases the likelihood that the overall retirement income system is sustainable, as it reduces reliance on government expenditures in the future. The rates of coverage ranged from less than 25 percent in China to more than 90 percent in the Netherlands, Singapore and Sweden.

• What is the level of pension assets, expressed as a percentage of GDP, held in both private pension arrangements and public pension reserve funds? The level of current assets set aside for future pensions, when expressed as a percentage of a country’s GDP, represents a good indicator of an economy’s ability to meet these payments in the future. Assets ranged from 6 percent of GDP in China to almost 150 percent of GDP in the Netherlands.

• What is the current gap between life expectancy at birth and the state pension age, both now and in 2030? A retirement income system is designed to provide benefits to an individual beginning when the person leaves the workforce and continuing to his/her death. The longer the period, the larger the total benefits will need to be and thus an increased financial strain will be placed on the overall system. Although individuals retire for many reasons, the state pension age represents a useful proxy that guides many retirement decisions. As life expectancy increases, one way of reducing the strain on the overall system is to encourage later retirement.

Our research reveals that there is a range of indicators across countries and that no one country leads in all the indicators. In practice, we view this as a healthy situation. Clearly, many have already analyzed the work done in the Netherlands and Australia, but in searching for a relevant best practice, it may be wiser for some countries to emulate, say, Sweden for sustainability or the UK for integrity.

Tailoring a system to needs and circumstances

The development of the Melbourne Mercer Global Pension Index has been an exciting new milestone in the global debate about retirement incomes. It is expected that the results will, at least in part, be controversial. Of course, any comparison between systems in different countries is bound to lead to debate and discussion. There is no perfect retirement income system, as the best arrangements for a particular country will depend on its social, economic, political, cultural and historical circumstances.

The index will be published annually, and we hope to extend it to include more countries. For employers, we think the emergence of trends, best practices or convergence between countries will be extremely useful features when developing or reviewing the effectiveness of global retirement programs.

The overriding purpose of all retirement income systems should be to enable older citizens to have access to adequate financial resources in retirement and thereby to live their later years with dignity. Of course, in many countries this objective is becoming more problematic due to aging populations and increasing longevity. It is our hope that this research will lead to an improvement in retirement income systems worldwide, through a consideration by governments and policymakers of the importance and relevance of the indicators used in the Melbourne Mercer Global Pension Index.