Insights for the US from the UK

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Insights for the US from the UK

• John Turner
• AARP
• February 24, 2006

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Disclaimer

• My comments do not necessarily represent the
  position of AARP.

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UK Policy Innovations

• The UK is a major innovator in retirement income
  policy.
• It has tried three major policies in the
  retirement income area that have been discussed
  to varying extents in the US.

4
Overview of Presentation

• Privatizing Social Security using voluntary carve
  out individual accounts
• Extending pension coverage with greater degrees
  of compulsion
• 3. Raising the Social Security early retirement
  age to 65 or higher

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1. Social Security Privatization

• The UK is the only high-income countries
  having
• voluntary carve-out (VCO) individual accounts
  as
• a part of social security.
• With a VCO, participation in the
  earnings-related part of social security is not
  compulsorybut workers who opt out must
  participate in an alternative arrangement.

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Myth of Free Choice

• Myth Because VCOs are freely chosen, the
  option can only make people better off.
• Due to a lack of financial sophistication,
  many UK workers have been made worse off by
  taking the VCO accounts. Behavioral economics
  has shown that choice is not always a good thing.
• The mis-selling magnitude 13 billion have
  been paid to the victims (26 billion dollars, in
  an economy a sixth the size of the USs)

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The Key VCO Parameter

• Determining the offset between a VCO and social
  securityhow much will social security benefits
  be reduced, or how much will be paid into the
  individual accounts-- is a difficult technical
  problem, involving expectations of future
  interests rates, and is a key issue of
  practicability with VCOs.
• If this tradeoff is too generous, it will be
  expensive to the government. If it is not
  sufficiently generous, people taking the VCO will
  be made worse off.

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Problems with the Offset

• The rebate paid into private accounts for workers
  taking the VCO are reset every 5 years.
• 2 large life insurance companies have advised
  their clients to return fully to social security
  because they feel the government made a mistake
  in setting the level of the rebate rate when it
  assumed that the low interest rates would rise.

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Rejected in the UK

• The participation rate in VCOs has declined.
  Since the early 1990s, there has been little
  growth in the number of people choosing the carve
  out individual account, despite the growth of the
  labor force.

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UKs Proposed Reform

• The Pensions Commission recommends phasing out
  the system of voluntary carve outs as part of
  social security.

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2. Greater Degrees of Compulsion in Extending
Pension Coverage

• UK employers are not required to provide a
  pension plan
• but for employers with 5 or more employees who do
  not offer a plan, the employer is required to
  designate a pension provider to whom employees
  can contribute (like a universal IRA)

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Problems

• Widespread non-compliance many employers are
  not offering plans
• Low take-up the majority of plans offered have
  no participants
• Most plans without employer matching
  contributions have no participants

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UKs Proposed Reform

• Proposed reform would require employers to offer
  a pension AND contribute to it, with employees
  having the right to opt out
• This is one step short of mandating that
  employees participate in a plan

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3. Raising the Social Security Pensionable Age

• Currently, the UK pensionable age (earliest age
  for benefit receipt) is 65 for men
• It will be raised from 60 to 65 for women over
  the years 2010-2020

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How It Works

• With the current pensionable age of 65, many men
  find alternative ways to retire earlier
• Disability benefits
• Employer-provided pension benefits
• Contracted out benefits
• The labor force participation rate for persons
  aged 55-64 is actually slightly lower in the UK
  than the US (58 vs 62).

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The Policy Options

• With increased longevity, a country has the
  following undesirable options
• Reduce old age benefits
• Raise taxes to support old age benefits
• Raise (in a nonactuarial way) the age at which
  benefits can first be received (the pensionable
  age)

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The Central Problem

• Nicholas Barr (2006) of the LSE has stated,
• the central problem of pension finance the
  age at which people are first eligible to claim
  their pensions.

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UKs Proposed Reform

• To limit the increase in tax rates to support old
  age benefits, the Pensions Commission proposed
  that pensionable age would be indexed to life
  expectancy, so that a constant proportion of
  adult life would be spent in retirement.
• The pensionable age could rise to 67 or 68 by
  2050, depending on the rise in life expectancy.

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Conclusion (1)

• The UK has tried three major retirement income
  policy innovations.
• It has had problems with voluntary carve out
  individual accounts, and is considering phasing
  them out.

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Conclusion (2)

• The UK has had a short, but largely unsuccessful
  experience, with a mandatory IRA. It has proposed
  moving to greater compulsion by requiring
  employers to offer a matching contribution and
  having automatic enrollment.

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Conclusion (3)

• The UK has had a relatively high pensionable age
  of 65 for men, and is raising the pensionable age
  for women to 65
• It is proposing indexing that age to improvements
  in life expectancy.