As longevity becomes an increasing problem in developed nations, governments have moved to increase retirement ages, with some either considering or legislating for an automatic link to longevity. Despite its popularity among both national parliaments and the European Union, however, the OECD has warned that any such link could be very difficult to implement.
As part of the organisation’s inaugural Pensions Outlook report, examining issues ranging from the ideal construction of a defined contribution scheme to the viability of automatic stabilisers, it concluded that, despite the impact of longevity on public finances, the automatic link under consideration in countries such as the UK and Sweden and implemented in Denmark, Greece and Italy might not be the best solution.
Edward Whitehouse, head of pension policy analysis within the social policy division, conceded that automatic mechanisms were theoretically “very, very attractive” for taking control of retirement ages and pension income away from politicians. But he said it remained just that - a theory.
Speaking at the report’s launch event, Whitehouse cited Germany and Sweden as examples of where such de-politicised mechanisms had failed. He pointed out that, in Germany, legislation meant to link state pension payments to the ratio of contributors to those drawing payments had been overruled five out of six times.
“In Sweden, they not only ignored the rules but changed the rules,” he continued, saying the government initiated the change when faced with a 3.5% nominal cut to pensions at the beginning of the most recent financial crisis - also, coincidentally, an election year.
Whitehouse acknowledged that parliament pledged to claw back the above-average increases in both cases. “In Germany, that probably will happen,” he said, “but it doesn’t particularly bode well.”
Indeed, it does not. Denmark, one of the few countries to already link pension age to retirement - therefore predicted to reach a retirement age of 69 by 2050 - nonetheless requires the increase to be signed off by the government.
The OECD report goes on to stress that other issues have to be taken into consideration, such as the viability of any such changes and how these may impact benefit levels.
“It is important that the question of the adequacy of benefits, and thus of the social sustainability of pension systems, will not be left out of the debate,” it says.
“Maintaining financial and actuarial balance might be pursued together with a set of rules or principles to ensure benefit levels would remain adequate.”
Whitehouse is more frank, saying that if countries do not have adequate social safety nets, these techniques could lead to a “resurgence” of old-age poverty, likely to undo what he deems the successes of post-World War II social policy.
The OECD also highlights that while automatic mechanisms could de-politicise the thorny issue of retirement ages, that does not mean people would necessarily start working longer.
This is the problem facing Ireland. Under the terms of the IMF/EU bailout, it is obliged to increase the retirement age drastically while doing away with payments that would have served to dampen the impact of the sudden increase for those already on their way out of the active workforce.
Despite all the concerns, Whitehouse nonetheless insists that change is needed, saying that the fiscal impact of longevity will otherwise be much larger than the impact of the “horrid” post-Lehman Bros crisis. However, despite its tacit support, the OECD seemed to view automatic mechanisms as the lesser of policy evils, rather than the solution to all of them.