From the TUC

Inadequate pensions are a bigger problem than unaffordable ones

21 Sep 2011, by Guest in Pensions & Investment

We are as a society living longer. We are asked to believe that this makes pensions unaffordable and unsustainable in both the public and private sectors. It is simply untrue. There is a tendency for analysts to suggest that demographics and population dynamics are undeniable, absolute truths. The fact is that over history we have made many such forecasts which have missed their mark by miles – Schumpeter’s 1943 observation that “Forecasts of future populations, from those of the seventeenth century on, were practically always wrong” remains as valid today.

It is true that society is ageing, but the rate of increase of longevity is far lower than the rate of growth of output, GDP. We have, with the exception of occasional periods of recession, grown steadily wealthier, and as we grow wealthier so, by choice, we spend more, both absolutely and proportionally, on education, healthcare and retirement. If we had, in their infancy, told today’s ninety year-old that their consumption at this age would be some eight times more in real terms than a ninety year-old at that time, we would have been summarily dismissed as over-optimistic to the point of certifiable madness.

It is also worth considering the medical advances and societal changes which have contributed so much to increased longevity: the defeat of tuberculosis, antibiotics, statins and the decline of smoking are obvious examples. But, though they operate on the scale of a human lifetime, it is important to realise that these are one-off events. In just the same manner as raising the rate of VAT causes retail prices to rise, to sustain the rate of increase requires further rises in the VAT rate, so it is with longevity. To sustain the rate of increase, further medical breakthroughs will be needed. To expect such breakthroughs seems folly as it, in effect, requires suspension of the law of diminishing returns; that the easiest, low-hanging fruit is picked first and ever greater effort needed thereafter. Certainly the financial markets do not value pharmaceuticals companies as if this is possible, let alone likely.

Simple dependency ratios (the ratio of retired to working age populations) are often cited in support of the unsustainability hypothesis – they omit such elementary corrections as the labour market participation rate, or the per capita capital employed, which has been growing markedly for many decades, or the increasing quality of employees, or the number of dependent children. In short, they, in essence, deny any role for increasing productivity. They also omit to notice that since the mid 1990s, throughout the developed world, we are retiring much later – in 1995 the average age of retirement from the UK labour force was 63.1 years and most recently 64.5 years – over this period estimated life expectations have increased by approximately 3 years.

This is not to say that simple increases in the normal retirement age are the answer. The low-paid and socially-deprived have far shorter lifetimes than the well-paid and wealthy. Raising the retirement age by one year for a poor man with a ten year life expectation at age 65 is very different in equity from that of a rich man with a twenty five year life expectation at that age.

Increasing inequality among its population is not the role of government, though it has been the reality of the past thirty years across the developed world, notably in the UK. Indeed, it is counter-productive as is now becoming widely held; it appears that there is a strong relationship between less inequality and sustained growth. Rather than being the outcome of a simple race between technology and education, it appears that technological progress, institutional change, globalisation and changing social norms all contributed to the rising inequality of recent times in the developed world.

The trend from defined benefit pensions to defined contribution to evade the problems of longevity can only end in tears. Many commentators have begun to notice how poor and unequal the outcomes from DC will be (see Morris & Palmer, “You’re on your own” Civitas, September 2011). Yet the not-yet finalised government response is NEST, a scheme of precisely this form. The power and efficiency of collective DB, with its risk-sharing and risk-pooling among employers and employees, is remarkable – to achieve the same pension DC will cost at least 50% more in contributions than DB. The low contribution rates to DC relative to historic DB contribution rates will ensure that these arrangements are only minor additions to retirement income. Indeed, they begin to look as if they are little more than devices to reduce the costs of means-tested retirement benefits.

In just one blog post (download the full report for more), I’ve had to omit much on this – the role of misguided regulation in destroying the private sector funded occupational DB market is particularly relevant as many are now foolishly citing the demise of that as if it were relevant to public sector unfunded schemes.

It is about time that our government recognised that inadequate pensions are as unsustainable as the unaffordable.

NOTE: This short blog is based upon research conducted for a recent and much longer paper on UK occupational pensions entitled “Don’t stop believing”, which itself is a sequel to an earlier [2010] paper, “Don’t stop thinking about tomorrow.” Both are freely available at:  A short synopsis of some of the salient points of the 2011 paper, which debunks many of the pension myths which have found currency, is also available there.
GUEST POST: Con Keating is a member of the steering committee of the financial econometrics research centre at the University of Warwick and of the Societe Universitaire Europeene de Recherche en Finance. As a research fellow of the Finance Development Centre he published widely on the regulation of financial institutions and pension systems. He has been Chairman of the committee on methods and measures of the European Federation of Financial Analysts Societies and is currently a member of their Market Structure Commission. Con has also served as an advisor and consultant to the OECD’s private pensions committee and a number of other international institutions, including the boards of a number of educational and charitable foundations and as a trustee of several pension schemes. He is currently Head of Research for the BrightonRock insurance group.

One Response to Inadequate pensions are a bigger problem than unaffordable ones

  1. Web links for 20th September 2011 | ToUChstone blog: A public policy blog from the TUC
    Sep 21st 2011, 9:04 pm

    […] The state and future of UK occupational pensions If you’ve been reading Con Keating’s guest post for us today, and want to hear more about his major research into the state of the UK’s occupational […]