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UK pensions system maintains adequacy, sustainability and integrity, according to Mercer

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The UK pension system has maintained its sixth place ranking for the third year running in a global comparison of national pension systems, according to HR consultancy Mercer.

The static ranking masks improvements in the UK's overall index score which have resulted from increases (relative to pay) in people's projected pensions, improved population coverage of pension schemes and increased savings rates.

According to the 2011 Melbourne Mercer Global Pension Index, however, further reform is still required to ensure that the UK can withstand the pressures of its ageing population and ensure sufficient retirement savings for its population.

The report outlines that many of the world's retirement systems are under "significant stress" with even the world's most advanced systems requiring ongoing reform to ensure they're robust enough to support a rapidly ageing population.

The index also highlights that currently there is no perfect national retirement income system. No country received an A grade, but six countries received a B (sound structure with many good features but room for improvement) including the UK.

Ten countries received either a C (major risks or shortcomings) or a D (major weaknesses and omissions). The index also provides valuable lessons and insights into how countries are grappling with the economic and social challenges of an ageing population.

Mercer senior partner and author of the report, David Knox, said: "Given the current economic situation, the risk of governments not being able to financially support their ageing population is becoming more of a reality. Significant pension reform needs to be made now. The best pension systems adopt a multi-pillar approach to spread these long term risks between governments, employers and individuals," he continued.

"Such an approach is also particularly relevant in periods of economic uncertainty such as we now face. Each country has to consider its own social, economic, political, cultural and historical circumstances, but despite the differences in the history and development of each country's system there are some common challenges around the world."

According to the report, the UK's index value rose from 63.7 in 2010 to 66.0 in 2011. The UK's position has improved due to developments in three key areas.

Firstly, according to the Economist Intelligence Unit, the net household saving rate for the UK rose from 0.5% to 2.7% in response to a more uncertain job market. Secondly, the OECD has changed the way it calculates pension scheme coverage and, as a result, the percentage of people in the UK with pension provision has changed from 59.1% of the employed workforce to an estimated 58.2% of the working age population (i.e aged 16-64). The change in definition encompasses more people and provides a more appropriate measure of the numbers with access to pension schemes, dramatically increasing the UK's score relative to other countries. Finally, according to the OECD, the target net pension replacement rate for a median income earner in the UK increased from 44.3% to 48.0% of their pre-retirement take-home pay, largely due to an expected greater than prices linked indexation of the Basic State Pension.

More broadly, the report points out that there are several areas where countries can make an active difference to the challenges facing their national pension systems. The UK has already taken, or is considering, action in many of the areas.

The report suggests that governments should consider increasing the state pension age and/or retirement age to reflect increasing life expectancy and thereby reduce the level of costs of the publicly financed pension pillar. It also suggests promoting higher labour force participation at older ages including the provision of phased retirement. In the UK, the Government has abolished the default retirement age from 1 October ensuring that workers able and willing to do so can continue in employment beyond the age of 65.

The report also suggests encouraging or requiring higher levels of private saving, both within and beyond the pension system, to reduce the future dependence on means tested support. The report also suggests that governments should consider increasing the coverage of employees and/or the self-employed in the private pension system, recognising that many individuals will not save for the future without an element of compulsion or automatic enrolment. Auto-enrolment is due to begin in the UK and will dramatically increase the number of people saving for retirement. Furthermore, the Government is considering improving access to the state pension for the self-employed.

Finally, the report suggest states should reduce the leakage of funds from the retirement savings system prior to retirement thereby ensuring the funds saved, often with the associated taxation support, are used for the provision of retirement income. Earlier in the year the UK's Treasury conducted a consultation on allowing people 'early access' to pensions but was concerned it would have a negative effect on retirement savings and decided not to press on with the initiative. Raising the general minimum age for pension access from 55 to 60 would also improve the UK's score.

Deborah Ralston, director of the Australian Centre for Financial Studies said: "One again, this third edition of the Melbourne Mercer Global Pension Index highlights the areas of policy debate in pensions around the world. The on-going difficulty of developing systems that provide an adequate level of retirement income and yet maintain sustainability, especially in countries with an ageing population, warrants further research and discussion world wide. We hope the Index will make a contribution to that end."

The Index is in its third year and has grown from 11 to 16 countries, now covering over half of the world's population. It objectively looks at both the publicly funded and private funded components of each retirement system as well as personal assets and savings outside the pension system. It is produced by Mercer and the Australian Centre for Financial Studies and funded by the Victorian State Government. It is based on more than 40 indicators grouped into three sub-indices: adequacy, sustainability and integrity.