Steven Baxter, Club Vita, on the challenge of ensuring the sustainability of European pensions amid widespread protests
“Never in the history of opinion polls have French people been so convinced of social injustice,” claimed the political academic Roland Cayrol as over one million workers took to the boulevards of France in September to protest against rises in the retirement age. Strong words, but raising pension ages in response to increasing life expectancy is an emotive subject and in some parts of Europe enough to bring the country to a standstill.
But what is all the fuss about? Perhaps a good place to look is a Green Paper recently published by the European Commission (EC) which seeks to encourage debate on the challenges faced by European Union (EU) members – and identify how the EC can support members.
Unsurprisingly, concern is expressed at the migration away from defined benefit to defined contribution based systems – and in particular the way the risk is being transferred to those least well placed to face the risks. Collective risk sharing via hybrid schemes such as career average revalued earnings and cash balance along with conditional indexation are all supported.
The paper also questions the effectiveness of the “exempt-exempt-taxed” system we have in the UK and suggests that pension schemes should be subject to some form of solvency regime akin to the Solvency II standards applied to insurance companies.
However, the key focus of the paper is the challenge of ensuring EU pensions are sustainable. For many countries, including the UK, this will start with looking at the problem facing the state pension system.
Rising life expectancy has meant that state pensions are no longer affordable and so are unsustainable. Already every five people of working age in Europe are supporting three “dependants” (ie those under 16 or over 60) – and the future looks bleak. By 2040 there will be one person of working age to every “dependant”, unless state pension ages rise and working lifetimes are successfully extended.
The situation differs between individual member states though. The Figure contrasts life expectancy with state pension age (SPA) for men in 23 different EU countries. The majority of the countries fall into two groups.
The “group of opportunity” covers six of the ascension states including Latvia and Hungary. This group is characterised by relatively low SPAs and relatively low life expectancies – life expectancy exceeds state pension age by between three and seven years. Crucially these states are likely to have the opportunity to introduce state pension reforms as life expectancy rises.
In contrast the “group of pain” countries have much higher life expectancy and only slightly higher state pension ages than the “group of opportunity”. Life expectancy typically exceeds SPA by between nine and 13 years for these countries. This group contains most of the founding member states along with UK and Ireland which typically have established pensions and social welfare systems. The pain arises from the costs of having left SPA unchanged in the face of several decades of rapidly increasing life expectancy.
The inevitable response has been a rush of legislation to raise SPA. In 2007 the upper house of the German parliament ratified proposals to increase SPA from 65 to 67. Closer to home the UK state pension age is set to increase slowly to 68. However, our own analysis at Club Vita estimates that life expectancy has already increased by a year since the changes were introduced in the Pensions Act 2007. It is no surprise therefore that the Department for Work and Pensions (DWP) recently consulted on accelerating the timing of an increase to 66. The DWP has also intimated that more wide sweeping reforms may be forthcoming.
The Figure also shows five countries which do not neatly fit into our two groups.
Most prominent amongst these is France. While M. Cayrol may feel that increasing state pension age from 60 to 62 is a grave social injustice, he can expect little sympathy from his European compatriots. By the time French SPA reaches 62 in 2018, they will still have the lowest SPA age (with Slovakia and Latvia) across the EU yet one of the highest life expectancies.
At first glance Sweden also looks to have a very low SPA. However, the system in Sweden, like much of Scandinavia, already recognises the challenges posed by longevity. While state pensions can be drawn from between 61 and 67, the pension amount reflects life expectancy with a lower pension amount payable the earlier it is taken.
The Czech Republic and Slovenia both have life expectancy notably higher than other ascension countries yet similar SPAs. The Czech Republic in particular is responding to this challenge – with the SPA due to rise to 63 years and 8 months by 2020 (and ultimately to 65).
In contrast, ascension state Poland appears ahead of the game in having an SPA of 65 and relatively low life expectancy. However, it currently has no plans to increase SPA so this position may be short lived.
Will we see a convergence of SPAs across Europe? A combination of health policies and mobility of populations may lead to some convergence in life expectancies between countries. However, the EU is keen to respect national solidarity. This, along with differing political landscapes and levels of social activism between countries, means that harmonisation of SPAs across EU is a distant prospect.
So what does this mean for the UK? While the UK already has high life expectancy, it continues to increase rapidly. The life expectancy of a 65 year old is currently increasing at over two years per decade. Fiscal constraints mean increases to SPA are inevitable rather than optional. However, how should SPA increase?
Current plans for SPA increases are ad hoc – having no explicit link to emerging increases (or decreases) in life expectancy. However, Work and Pensions Secretary Iain Duncan Smith has suggested a more direct link. If a direct link is chosen, then it will need to reflect the purpose of the state pension. Is it a safety net which ensures dignity in later life? Or is it a reward for a lifetime of “socially useful” activity? The current system is a blend of these – meeting neither purpose fully.
One trap the Coalition needs to avoid is assuming it should link SPA to average life expectancy. Men with a healthy lifestyle and high income can expect to live 11 years longer than those in poor health and low income. If SPA is linked to national life expectancy then changes in SPA will have a disproportionate impact on those with shortest life expectancies, ie those who have the greatest reliance on state pension.
The Coalition also needs to be careful with how any such link works. For example, if life expectancy increases by one year, should SPA increase by one year or by some smaller amount, sharing the benefits of longer life with the individual?
Nor should we assume that increasing life expectancy automatically means people can work longer. In reality some of the increases in life expectancy will be in good health – but not all of them! We believe that trends in “healthy life expectancy” (ie lifetime in “good” health) will be more closely aligned with changes in the period an individual can reasonably be expected to be in employment. We are therefore strongly encouraging the DWP to focus on “healthy life expectancy” when reviewing the state pension age.
The issue is wider than simply pensions policy. To be effective, any increases in SPA will need to provide individuals with sufficient time to adapt. Employment policy will need to support later retirement, including phased retirement, while recognising employers’ concerns over their ability to manage their workforce. Health policy will also need to support longer working lives.
Personally I hope we do not need to share M. Cayrol’s fears of social injustice. Instead the need to increase state pension age should be a catalyst for social justice – by removing the social inequalities that drive differences in longevity and so enabling us all, regardless of social position, to be healthy enough to work longer and retire later.
Steven Baxter leads Club Vita’s longevity anaytics programme;
Author: Steven BaxterSteven Baxter leads Club Vita's longevity analytics programme.