1 Department for Work and Pensions, UK Replacement Rates in Pensim2 Stewart Butler Pensim2 Team Model Development Unit Department for Work and Pensions
Mar 31, 2015
1 Department for Work and Pensions, UK
Replacement Rates in Pensim2
Stewart Butler
Pensim2 Team
Model Development Unit
Department for Work and Pensions
2 Department for Work and Pensions, UK
Introduction
• Background: UK Pension System
• What are replacement rates?
• Previous UK work
• What Pensim2 offers us
• What matters?
– Income
– Relativity
– Adequacy
• Features specific to Pensim2 analysis
• Summary
3 Department for Work and Pensions, UK
UK Pension System
4 Department for Work and Pensions, UK
Replacement Rates
Replacement rate = Retirement Income
Work Income
Undersaving:
If replacement rate < threshold then undersaving = 1
5 Department for Work and Pensions, UK
Previous UK work
• Pensions Commission 2004/5
Assumed everyone started contributing at age 30 and continued until retirement
• Institute for Fiscal Studies 2005
Survey dataset of individuals aged 50
Limiting assumptions on how people continued in work and contributed to pension schemes
6 Department for Work and Pensions, UK
What Pensim2 offers…
• Has a representative sample of the UK population fusing both administrative and survey data
• Rich set of assumptions and estimations
• Simulation of life courses until 2100
Assumptions
- Policy framework - Pensions parameters - Macroeconomic parameters - Structural trends
n iterations
Base data
Pensions: accrual or in payment depending on age.
- State pensions - Private pensions
Mortality
Education
- Labour market status - Job characteristics - Earnings
Other processes
- Housing - Saving - Tax and benefit
Output data
Family change
- Partnership - Fertility - Marital
7 Department for Work and Pensions, UK
Pensim2 Methodology
Benefit Unit Dataset Individual Dataset
25<=Age< State Pension Age
Benefit Unit DatasetWith Person Identifiers Appended
Pay Information
Retirement Information
2 Person Benefit Unit:∑ (Pension1, Pension)
∑ (Pay1, Pay2)
1 Person Benefit Unit:Pension
Pay
8 Department for Work and Pensions, UK
What Matters? Income
• But what income?– Average lifetime income– Last year of work income– ‘Best of’ last X years– Average of ‘peak’ earning years
Evolution of Mean Replacement Rates
0
0.2
0.4
0.6
0.8
1
1.2
1.4
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
Lifetime Work Income Last Year Positive Income
Best of Last 10 50-SPA
9 Department for Work and Pensions, UK
What Matters? Income
Evolution of the Proportion of Undersavers under different Work Income Definitions
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
Lifetime Income Last Year of Positive Work Income
Best of Last 10 Years 50-SPA
Here we will chart the corresponding ‘undersavers’
Thresholds (of gross income):
80% Poorest
70%
67% Median Income
60%
50% Richest
10 Department for Work and Pensions, UK
What Matters? Income
And not just working age income….
Mean Replacement Rates Under Different Pension Income Specifications
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
1st Year Lifetime Pension
11 Department for Work and Pensions, UK
What Matters? (Pension) IncomeAnd the corresponding number of undersavers….Evolution of Undersavers under different Pension Income Definitions
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
Lifetime 1st Year
12 Department for Work and Pensions, UK
My old car My son’s car
What Matters? Relativity
Earnings IndexationPrice
Inde
xatio
n
Hmm, I think I’d like a new car for my retirement…
Undersavers
Threshold adjusted for inflation:
2006 1002012 94
Difference -6%
Undersavers
Threshold adjusted for earnings: 2006 196
2012 200Difference 2%
Results are presented relative to the number of undersavers under the price threshold in 2006
13 Department for Work and Pensions, UK
The Effects of Spreads in Economic Assumptions
0
0.2
0.4
0.6
0.8
1
1.2
1.4
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
Standard Economic Assumptions Low RPI and Earnings High RPI and Earnings
What Matters? Relativity• The Effect of Spreads in Economic Assumptions
Equates to a difference in undersavers of around 16% in 2040
14 Department for Work and Pensions, UK
What Matters? Adequacy• How do we define what is an adequate retirement income?Different Thresholds for Adequacy
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
60% 2006 Median Income
Pen Comm
15 Department for Work and Pensions, UK
Features specific to Pensim2 analysis
• Units of Observation
– We are looking at a point in time estimation but using modelled outputs from future periods
• Non-Pensions Wealth
– At present we do not include wealth in Pensim2 modelling• Likely to bias results especially further up the income scale
– We are working wealth into our analysis by applying a distribution estimated from a survey dataset
– Planned wealth module in Pensim2 to incorporate accumulation and decumulation of wealth
16 Department for Work and Pensions, UK
Summary
• Pensim2 offers us the ability to comprehensively model replacement rates, using a much richer set of assumptions than was previously available. Important when looking at pensions policy with long time horizons.
• Especially important to define the assumptions and definitions for analysis before you start to avoid trying to pick a number that you like best.
• Can be difficult to unpick the effect of individual assumptions due to number of life events estimated and the interaction between these.
17 Department for Work and Pensions, UK
Contact
Stewart Butler
Pensim2 Team
Model Development Unit, Department for Work and Pensions, UK
+44 207340 4097
18 Department for Work and Pensions, UK
References
• Pensions: Challenges and Choices, The First Report of the Pensions Commission, 2004
• A New Pension Settlement for the Twenty-First Century, The Second Report of the Pensions Commission, 2005
• Prepared for Retirement? The Adequacy and Distribution of Retirement Resources in England, Banks et al., Institute for Fiscal Studies, 2005