Experts at the OECD said that given the extraordinary nature of the current inflation surge, governments and pension providers could justifiably tweak pensions indexation rules by uprating poorer peoples’ pensions by more than those of the better off.
In the 2023 edition of the Paris-based organisation’s Pensions at a Glance report, which comes out every two years, the OECD said: “The ongoing episode of high inflation reverses the standard way of thinking about pension indexation.”
“In normal circumstances, wages grow faster than prices due to productivity gains, and in the past many countries shifted from wage to price indexation to limit pension expenditures,” it said.
But in the short term, due to falling real wages, price indexation has become more favourable for pensioners – but is more costly than initially anticipated for public finance or pension providers more generally, the OECD said.
It warned that applying indexation rules consistently was key to building confidence in pension promises, but added: “It may be fair in exceptional times of economic and fiscal pressure that pensioners with retirement income above a certain threshold share some of the pain with the working-age population in terms of reduced benefit adjustments.”
Wouter De Tavernier, economist at the OECD’s Directorate for Employment, Labour and Social Affairs, told IPE that since people on low incomes had felt the surge in inflation more because energy and food expenditures made up a higher share of their budgets, it was important to protect their purchasing power.
Asked whether there was a danger that governments as well as pension providers may not get indexation right in the current circumstances, and that confidence in pensions could be lost, he said people’s trust in the system seemed less affected by replacement rates produced than by its ability to deliver on promises.
“Hence, consistency in applying the rules governing the pension system over time is crucial to build or maintain trust in the pension system,” De Tavernier said.
It was not uncommon for countries to temporarily deviate from indexation rules, he said.
“If the deviation is temporary and clearly justified given truly exceptional economic circumstances, the impact on trust in the pension system’s ability to deliver in the future may be limited,” said De Tavernier.
Most OECD countries had been able to keep pensions up with inflation in the current situation, he said, though he added that the longer the inflation surge lasted, the more costly it would be to hold on to full price indexation, and the more this would weigh on the solvency of pension providers.
“But the last years have been truly exceptional, so we are hopeful that real wages will catch up soon and the impact remains temporary,” he said.
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