How best to measure pension adequacy (2013)
Aaron G Grech
Abstract
Though the main benchmark used to assess pension reforms continues to be the expected resulting fall in future government spending, the impact of policy changes on pension adequacy is increasingly coming to the fore. As yet, there does not seem to be a broad consensus in policymaking circles and academic literature on what constitutes the best measure of pension adequacy. While various indicators have been developed and utilised, no single measure appears to offer a clear indication of the extent to which reforms will impact on the achievement of pension system goals. Many indicators appear ill-suited to study the effective impact of reforms, particularly those that change the nature of the pension system from defined benefit to defined contribution.
Existing measures are frequently hard to interpret as they do not have an underlying benchmark which allows their current or projected value to be assessed as adequate of inadequate. Currently used pension adequacy indicators tend to be point-in-time measures which ignore the impact of benefit indexation rules. They also are unaffected by very important factors, such as changes in the pension age and in life expectancy. This tends to make existing indicators minimise the impact of systemic reforms on the poverty alleviation and income replacement functions of pension systems. The emphasis on assumptions which are very unrepresentative of real-life labour market conditions also makes current indicators deceptive, particularly in relation to outcomes for women and those on low incomes.
This paper posits that these defects can be remedied by using adequacy indicators based on estimates of pension wealth (i.e. the total projected flow of pension benefits through retirement) calculated using more realistic labour market assumptions. These measures are used to give a better indication of the effective impact of pension reforms enacted since the 1990s in ten major European countries. They suggest that these reforms have decreased generosity significantly, but that the poverty alleviation function remains strong in those countries where minimum pensions were improved. However, moves to link benefits to contributions have raised clear adequacy concerns for women and for those on low incomes which policymakers should consider and tackle.
LSE CASE Paper 172