Britain's pension cloud has silver lining

But is it sustainable - or could it lead to our own downfall?

Britain has a more favourable pension position than many other European countries. How has the UK got into this position? And is it sustainable or does it contain the seeds of its own downfall?

Everywhere in Europe, populations are ageing and the so-called support ratio - the number of working-age people creating the income out of which the living standards of each retiree has to be financed - is falling. But it is not falling as fast in Britain as in many European countries. The World Bank's World Population Projections suggest that the UK will have the highest support ratio by 2025. We have a relatively small proportion of the population in the 35-49 age range.

So while there are fewer middle-aged earners to support the retired in the UK now than there are on the Continent, the balance will shift as this group comes to retirement. That is the demographic silver lining in Britain's pension cloud.

There are two other points that work to Britain's advantage. One is that its pension commitments are much lower than elsewhere. State pensions take 6.4 per cent of the UK's GDP, a smaller share than in most other countries.

Since state pensions have to be met out of annual revenues - they are not supported by a fund - the lower the level of commitments the less tax needs to be raised to pay the bill. Indexing to prices has had a large cumulative effect: real gross weekly earnings have risen 32 per cent since 1980, and the share of the basic state pension in GDP has fallen accordingly. The result is a state pension that in relative terms is less generous than it used to be, and less generous than in other European countries.

Secondly, the UK has accumulated large stock of private pension assets - over 70 per cent of GDP - out of which future pensions can be paid. The EU countries largely lack such assets. The existence of private pension schemes is one of the reasons the UK has been able to cut state pensions so much.

Since the UK scores well on all three counts, it is not surprising that it has much lower future pension commitments than most of continental Europe. IMF research suggests that average contributions of just 6.4 per cent of earnings are required to keep the UK system in actuarial balance, compared with 43 per cent in Italy*.

These differences will increase. By the middle of the next century, if present trends continue, the UK's required level of contributions will have fallen to 5 per cent of earnings over 70 per cent in Italy.

But will present trends continue? Demography can change in unexpected ways. Moreover, these extrapolations are based on the assumption of a fixed retirement age that is already breaking down in the USA, and may do so in the UK and the rest of Europe. Demographic and retirement age pressures could thus mitigate the crisis for Europe but carry no necessary threat for the UK. It would be illogical to take comfort from comparisons that depend on the basic British state pension falling further and further behind the incomes of those in work.

Flemings Investment Trust Management's 1997 "Pension Map" suggests that over a third of the UK's 24 million households would retire in financial hardship (defined as less than 40 per cent of final earnings).

If the basic pension were to be raised in line with earnings instead of prices, OECD figures show that UK public pension liabilities would be similar to those of Germany, though still well below those of France or Italy. Hence the search for alternatives schemes, such as the Government's Pension Plus, which offer to deliver higher retirement incomes at no additional cost to the taxpayer.

But do private pensions in their present form offer a viable way forward?

The UK's private pension assets have grown almost exclusively on the back of occupational pension schemes. These have roots stretching back to the 1920s and 1930s, and grew enormously from the 1950s to the 1980s as more and more employees came within their scope.

Structural changes in labour markets, in particular towards more part- time and contract work, the growth of small companies and self-employment, and the development of personal pensions have all contributed.

Personal pensions, however, do not yet constitute a complete answer. So the UK's present and prospective pension position, attractive though it may be by European standards, does not give grounds for complacency.

* Chand & Jaeger "Ageing Populations and Public Pension Schemes", December 1996

Robert Laslett, London Economics

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