In many ways, it is difficult to disagree. The Melbourne Mercer Global Pensions Index ranks 20 countries’ retirement income systems against more than 50 questions covering benefits, tax support, scheme design, contributions, regulation and governance among others.
The last index, published in October 2013, ranked Denmark as the top performer overall. It was the only country to receive an “A” grade. The Netherlands and Australia received a B+ (see table), while the UK received a score of 65.4, which meant that it was ranked below Chile on the border of a B and C+ — a disappointing result for a country renowned for its financial services industry.
| Grade | Index Value | Countries | Description |
| A | >80 | Denmark | A first class and robust retirement income system that delivers good benefits is sustainable and has a high level of integrity |
| B+ | 75-80 | Netherlands, Australia | A system that has a sound structure with many good features, but has some room for improvement that differentiates it from an A-grade system |
| B | 65-75 | Switzerland, Sweden, Canada, Singapore, Chile, UK | |
| C+ | 60-65 | Nil | |
| C | 50-60 | Germany, USA, Poland, France, Brazil, Mexico | A system that has some good features, but also has major risks and/or shortcomings that should be addressed. Without these improvements, its efficacy and/or long-term sustainability can be questioned |
| D | 35-50 | China, Japan, South Korea, India, Indonesia | A system that has some desirable features, but also major weaknesses and/or omissions that need to be addressed. Without these improvements, its efficacy and sustainability are in doubt |
| E | <35 | Nil | A poor system that may be in the early stages of development or a non-existent system |
One of the commonalities of the best-performing countries is that they all offer some form of collective pension arrangement.
In the Queen’s speech on 5 June, changes in legislation were announced to allow “innovation in the private pensions market”, with collective DC outlined by the pensions minister as the centrepiece of the reforms.
But is collective DC the silver bullet it is made out to be? Mr Pitt-Watson said that if a typical Dutch person saves the same amount, has the same life expectancy and retires on the same day, they will get up to a 50 per cent higher pension than their British counterpart.
With numbers like this, it is not surprising that CDC schemes are being viewed so favourably. But will they work in the UK market?
The idea behind collective defined contribution schemes is that they offer a halfway house between DB and DC.
Members pool their assets to collectively share investment risk and mortality risk, and receive a smoothed return rather than a return on their individual DC account, as is the case with traditional DC pensions.
CDC plans do not require members to make any investment choice or decisions at retirement, as the CDC plan trustee board sets the investment strategy and pays out benefits direct from the fund.
A target benefit is calculated but not promised, as the actual pension benefit to be paid is based on the funding level of the scheme — so the pension in retirement is not certain.
Because it has a longer time horizon than a single individual, advocates have said that a CDC plan can take more investment risk. And as the cliff edge of annuity purchase does not exist, money can be invested longer and members do not suffer large capital losses if growth assets perform poorly, because the returns are smoothed from year to year.
Why does it work in Denmark and The Netherlands? Denmark, Holland and Australia are all highly unionised markets and have had mandatory or quasi-mandatory pension saving for many years, enabling large-scale funds to develop.
The populations are relatively homogenous and the collective DC schemes operate on an occupational basis with people from similar professions sharing risk with one another. This is a much fairer approach than manual workers sharing risk with white collar workers, as the life expectancy of these groups is markedly different.
While average outcomes in the Netherlands have typically been better than standard DC schemes, the Dutch Central Bank has said that around a quarter of CDC vehicles have had to cut benefits by 1.9 per cent, on average, because of funding deficits.
There is also dissatisfaction among the younger population, who are effectively cross-subsidising older members.
At the centre of all the reforms being introduced by the government is a desire to improve value for money for pension savers.
But is CDC the answer? The UK is much more fragmented than Denmark, Holland and Australia, and the scale necessary for these schemes does not exist at the moment.
From a consumer perspective, the prospect of a target income in retirement is understandably appealing. Research conducted with 2000 people with workplace pensions in September 2013 found that the most important thing workers look for in a pension scheme is high employer contributions. But the second most important thing was certainty over what they will get when they retire, which cited by nearly a fifth (18 per cent).
While consumers might like the fact that CDCs offer a target pension, it is unclear whether they will want to lock themselves up in risk sharing arrangements where there are no guarantees and there is a risk of being on the wrong side of the inter-generational cross subsidy.
If CDC schemes are to work effectively in the UK, establishing industry-wide funds is a must otherwise employees could find themselves being buffeted from a CDC scheme to a DC scheme and back again.
But convincing employers of the benefits of these schemes will be tough. Adding greater pensions complexity when firms across the country are grappling with implementing auto enrolment is far from ideal timing.
It is also uncertain how CDCs will work alongside the new pensions freedoms announced in this year’s Budget. If members of collective schemes are granted the same rights to take all of their pension as cash, then the pool will shrink and become riskier for those who are still working. This could see the pension income of younger generations significantly reduced.
Another complicating factor is that the UK has a well-developed, enhanced and impaired annuity market, which can significantly boost a saver’s retirement income. But in a CDC scheme, all members are treated the same, which could result in some members losing out.
With more than 8m people set to start saving into a pension as a result of auto-enrolment, ensuring that their pension delivers on its promises is a must.
The government’s priority should therefore be to address the things we know for certain have an impact on savers’ pension pots; namely, the level of contributions made, the charges imposed and the design and performance of the default fund.
Get these fundamental things right and savers will see a signifi-cant uplift in their income in retirement, without the need for more scheme design complexity.
While collective DC is proven in other markets, in the UK it feels as though we are trying to run before we can walk.
Changing the legislative framework to accommodate greater innovation and flexibility in the pensions industry makes sense, but for now the focus needs to remain firmly on delivering value in DC schemes, as this is where the most employees will find their money invested for the foreseeable future.
Morten Nilsson is chief executive of NOW: Pensions
Key points
The British pension system has been described as being “the poor man of Europe” .
One commonality of the best-performing countries is that they all offer some form of collective pension arrangement .
Introducing a CDC scheme to the UK now might be poor timing.