Retirement income systems perform a critical role for both individuals and societies around the world as most countries grapple with the social and economic effects of an aging population. To date, there has never been a comparison of national superannuation and pension systems worldwide to determine how well they meet the retirement needs of each country’s population. Uncovering best practices in the pension arena means having a yardstick against which different options can be measured. Yet comparing retirement income systems is difficult and bound to be controversial, as every system is different and each has arisen from specific economic, social, cultural, political and historical circumstances. Nevertheless, there are certain common features and characteristics of retirement income systems that are likely to lead to the positive outcomes needed: improved benefits, future sustainability of the system, and a greater level of confidence and trust within the community. 

With these objectives in mind, Mercer, in conjunction with the Melbourne Centre for Financial Studies, has undertaken a comparison of national retirement income systems around the world to develop an index value for each country’s system. Such a comparison is also likely to help policymakers and governments that are planning to establish, review or reform their pension systems.

The overall index value represents the weighted average of the three sub-indexes, as indicated in the following diagram, which also shows some of the indicators that are being used in each sub-index.

The different weightings used reflect the primary importance of the adequacy sub-index, which represents the benefits that are currently being provided together with some important benefit design issues. The sustainability sub-index focuses on the future and measures various indicators that will influence the likelihood that the current system will be maintained in the future. The integrity sub-index focuses on a private sector system and, therefore, has a more restrictive scope than do the other two sub-indexes. In total, more than 40 indicators are being used.

The final index value for each country enables us to grade each country’s system based on its index value, according to the following table.

A pilot study of 11 countries has confirmed that no system is perfect. Indeed, no country’s system has an index value above 80, which we would consider represents an A- grade retirement income system. However, several countries have an index value between 65 and 80, which represents a B-grade system that, with some improvements or changes in particular areas, has the potential to be classified as an A-grade system. Further details of each country’s results will be discussed in the next edition of Mercer’s Global Retirement Risk & Finance Perspective.

About the Index

The variety of pension systems around the world is considerable, with a wide range of programs representing great diversity. Data are not always readily available, but the Organisation for Economic Development and Co-Operation (OECD), in particular, has made significant progress in preparing comparable data for many countries in recent years. Nevertheless, having reliable data with respect to some key indicators remains a significant issue. For these reasons, the index uses a wide variety of data sources.

Notwithstanding the data challenge, this is a vital topic in an aging world, and there is no doubt that studies on policies and practices being conducted in some countries provide valuable insight and information for the development or reform of pension systems in other countries. The Melbourne Mercer pilot study highlights both the considerable diversity and the positive features that are present in many systems. The study also confirms that no pension system is perfect and that every system has some shortcomings. Our objective for this study is that it will act as a stimulus and prompt each country in the study (and in other countries as well) to review its retirement income system against the indicators used within the index and to consider making improvements, so that the future retirement incomes for its citizens can be improved.

Defining a good retirement system

In its influential report Averting the Old Age Crisis, the World Bank (1994)⁽¹⁾ recommended a multi-pillar system for the provision of old-age income security comprising:

Pillar 1: A mandatory publicly managed, tax-financed public pension
Pillar 2: A mandatory privately managed, fully funded pension
Pillar 3: A voluntary privately managed, fully funded personal savings pension

More recently, the World Bank (2005)⁽²⁾  has extended this three-pillar system, adding Pillar 0 (or safety net), which represents a basic or social pension, and a new Pillar 4, which includes personal savings, home ownership and other assets that are held outside the pension system but which, nevertheless, can play an important role in financially supporting an individual in retirement.

Donghyun Park (2009)⁽³⁾, in a recent Asian Development Bank paper, suggests that a well-designed pension system is:

• Broad-based in terms of both coverage and the range of risks covered
• Sustainable over time in terms of its actuarial and financial soundness
• Robust so that it can withstand macroeconomic and other shocks
• Affordable from individual, business, fiscal and macroeconomic perspectives
• Able to provide reasonable levels of post-retirement income
• Able to provide a safety net for the elderly poor

These features suggest a multiple set of objectives for any pension system, and as Park correctly notes, different societies will need to decide on the relative importance of each objective at a particular time. Furthermore, these priorities are likely to change over time as a society’s economic and demographic circumstances change. Nevertheless, they provide a useful checklist.

As many commentators have noted, the “best” system for a particular country at a particular point in time must take into account that country’s economic, social, cultural, political and historical contexts. In addition, regulatory philosophies vary over time and between countries. There is no perfect pension system that can be applied to all countries in the world at a particular time. It is not that simple.

However, there are some characteristics of all pension systems that can be tested or compared so that we can gain a better understanding of how each country is tackling the provision of retirement income.

The Melbourne Mercer Global Pension Index has grouped these desirable characteristics under the terms adequacy, sustainability and integrity. The study represents the first time that each country’s retirement income system has been considered from these three distinctive, but complementary, perspectives. 

Adequacy

The adequacy of benefits is perhaps the most obvious way to compare different systems. After all, the objective of any pension system must be to produce retirement income to its citizens. Thus, this sub-index considers both the minimum level of income provided (that is, Pillar 0 in the World Bank model) as well as the net replacement rate for a median income earner. However, savings for retirement are not carried out only through the formal pension programs, and as the World Bank notes, Pillar 4 can play an important role, so we have also allowed for the net household savings rate.

Critical parts of delivering adequate benefits are the design features of the private pension system (or Pillars 2 and 3 of the World Bank classification). While there are many features that could be assessed, we have considered the following four, each of which represents a feature that will improve the likelihood that adequate retirement benefits are provided:

• Are there taxation incentives for the median-income earner to make additional voluntary contributions to the system?
• Is there a minimum age at which members can access their benefits, thereby limiting the leakage of benefits before retirement?
• Can a member’s entitlement be easily transferred or maintain its real value, should the member’s circumstances change (for example, a change of employment)?
• Is part (or all) of the retirement benefit required to be taken as an income stream (or product) during the retirement years?

Sustainability

The long-term sustainability of the current retirement income system in many countries has been raised as a concern, particularly in light of the aging population and the increasing old-age dependency ratio. This sub-index, therefore, brings together several measures that will affect the sustainability of the current programs. While some of the demographic measures, such as the old-age dependency ratio (both now and in the future), are difficult to change, others, such as the state pension age, the opportunity for phased retirement and the labor force participation rate among older workers, can be influenced, either directly or indirectly, by government policy.

An important feature of sustainability is that the long-term risks are shared or, to put it another way, involve all the relevant stakeholders. Hence, this sub-index also considers the sharing of mandatory contributions between employers and employees and the importance of the private sector system through measuring coverage rates and the level of assets. Finally, given the key role that the public provision of a pension plays in most countries, the existing level of government debt represents an important factor affecting the system’s long-term sustainability.

Integrity

The third sub-index considers the integrity of the private sector pension system. After all, as most countries are relying on the private system to play an increasingly important role in the provision of the retirement income over the longer term, it is critical that the community has confidence in the ability of these private sector pension providers to deliver the retirement benefits in future years. This sub-index, therefore, considers the role of the prudential regulator, the required governance, the level of protection available to members from a range of risks, and the level of communication required to be provided to members.

Countries included in the Melbourne Mercer Global Pension Index

The Melbourne Mercer study includes countries from the Americas, Europe and the Asia Pacific region with a diversity of experience and pension systems, to reflect the considerable range of approaches adopted around the world. The availability of comparable and reliable data from international sources (for example, from the OECD) and the presence of a Mercer office in each country (to collect information and to confirm our findings) represented additional criteria in the country selection. 

Health, wealth and comparisons

Living standards in retirement are affected by a number of factors, including the provision and costs of health services (through both the public and private sectors), the provision of aged care and the level of home ownership. However, some of these factors can be difficult to measure within different systems and, in particular, difficult to compare between countries. It was therefore decided, within this pilot study, to concentrate on indicators that directly affect the provision of retirement income, both now and in the future. Therefore, the Index at this point does not claim to be a comprehensive measure of living standards in retirement; rather, it represents a helpful measure to use in reviewing the provision of retirement income in each country.

As noted previously, we will outline the pilot results in a subsequent article, and will continue to develop the coverage of other countries. In today’s changing but aging world, this measure will act as a stimulus to all stakeholders, including governments, enabling them to clearly identify what is accepted best practice, aspire to it and then take progressive action to achieve it.

Notes:

1. World Bank (1994). Averting the Old Age Crisis, Oxford University Pres
2. Holzmann and Hinz (2005). Old Age Income Support in the 21st Century, The World Bank
3. Donghyun Park (2009). Ageing Asia’s Looming Pension Crisis, ADB Economics Working Paper Series No. 165