Britons Govern Their Own Retirements

Shelagh Wellbelove, a retired secretary from just outside London, lives on about $1,000 a month. That is enough, she said, to take vacations, pay for a car and generally live comfortably, especially since she paid off her mortgage. And it seems perfectly fair to her that most of the money comes from her own savings and investment, with Britain's version of Social Security kicking in less than half. "If you're in a decent job," she said, "why don't you save for your own future?"

Alone among the biggest industrialized nations, Britain has taken aggressive steps over the last two decades to shift responsibility for retirement income from government to individuals, a change very much in line with the market-oriented ideology of the Conservative governments that imposed it. As a result, the financial burden of providing pensions to an aging population will decrease in Britain relative to the size of the economy. For governments in France, Germany, Japan and to a lesser extent the United States, it will increase sharply if their social security systems are not changed.

Most European countries have hardly begun to grapple with this, one of the biggest long-term economic challenges facing them, and one of the most politically delicate, given their welfare-state traditions. The United States is just now plunging into a debate about what can be done to prepare Social Security for the baby-boom generation's retirement. Britain's economy is much more similar to the United States' than those of other countries often held up as examples of successful pension privatization, including Chile and Australia. So American economists and lawmakers are looking to Britain for lessons. Among the options being seriously considered in the United States is partly privatizing Social Security much in the way Britain has overhauled its system. The idea would be to allow individuals to use a portion of the payroll taxes that finance the system to set up private retirement accounts.

"The United Kingdom stands out by the absence of a significant financing problem in its public pension system," Barry Bosworth and Gary Burtless of the Brookings Institution in Washington wrote in a recent study of the economic challenges created by aging populations. "Through a series of legislative changes, it has already moved to scale back its public pension system, choosing to rely increasingly on a basically private system of providing retirement income."

Britain's public system is divided into two parts. The first is a basic state pension -- currently about $100 a week -- that is paid to all retirees. The second part pays a benefit based on the retiree's earnings history. But under the Conservative Government of Prime Minister Margaret Thatcher in the mid-1980's, workers were urged through tax breaks and educational campaigns to "opt out" of the system's earnings-based component and instead invest a portion of their payroll taxes in a private investment account or a company-sponsored retirement plan. Nearly three-quarters have done so.

The lure for people was the chance to amass more retirement savings than the Government plan would provide by investing in stocks, bonds and lower-risk plans sold by insurance companies. The Government also made the state benefit less attractive by reducing the annual cost-of-living increase. For the Government, the attraction was to address a fundamental problem shared by most big countries: the traditional "pay as you go" system, under which taxes levied on the current generation of workers pay for the state pension benefits of current retirees, will begin to buckle in coming decades as the baby boomers retire. At that point there will be proportionally fewer workers paying the taxes that finance the benefits. Workers' taking responsibility for themselves will reduce the gap between the benefits due future generations and the money that governments will be able to raise through taxes on a shrinking work force.

In many ways the changes in Britain work just as intended. But they have also been criticized as moving the country closer to abandoning collective commitment to one of its most vulnerable populations. Moreover, high-pressure sales of individual pension programs by insurance companies and other financial services groups in the early 1990's caused heavy losses for many people and cast a shadow over the entire process. Indeed, the British experience has raised warning flags for the United States about the perils of transforming guaranteed government pension programs into investment-oriented plans that force people to make their own financial judgments.

Britain's main regulators, the Pension Investment Authority and the Financial Services Authority, have reviewed hundreds of thousands of cases, estimating that the cost of bailing out the investors could top $15 billion. Most of this would be picked up by the insurance companies that were the primary sellers of the plans.

"In my view it's gone way too far," said Mike Reddin, an authority on pension policy at the London School of Economics. "I don't believe people realize that we've almost entirely privatized income maintenance in Britain." But Mr. Reddin acknowledged that there is little public pressure to reverse the changes, and as Mrs. Wellbelove's attitude suggests, the shift has left many retired people feeling relatively well off at a time when the economy is booming.

As a result, there has been only muted political opposition to the shift. The Labor Government that swept into power last year under Prime Minister Tony Blair has left intact the system put in place by the Conservatives, and has even flirted with expanding it. "For individuals, it is a tradeoff between political and economic risk," said Roderick Nye, the director of the Social Market Foundation, a conservative research organization in London. "Which do you trust more, politicians or markets? If you look at a country like Germany, the politicians are going to have to default on the promises they have made to provide a certain level of publicly financed pensions. Here, people are investing in the performance of the economy."

In shifting to individuals most of the burden of saving for retirement, Britain will be keeping the lid on its bill from financing pensions. By 2030, when most of the postwar generation will have retired, the British Government's pension costs are projected to be 6.2 percent of gross domestic product, compared with 6.8 percent in the United States, 14.2 percent in Germany and 17.2 percent in France.

At the same time, the flood of money into a variety of investment products has generated returns in recent years well above those produced by government pension payments. The system has helped create a large pool of private pension fund assets -- third in size only to the United States and Japan. Economists say this has helped Britain remain more vibrant and competitive than many other European countries by providing plentiful capital for British companies through the financial markets.

"If you believe as I do that private savings and consumption is better than public savings and consumption," said Mr. Nye, "then this system has to have put us in better shape."