Pension sums don’t add up
THE problem with pensions is that they are easy to promise but hard to fund. Politicians have in the past offered fat benefits and low retirement ages to voters. Bosses have offered similar goodies to workers. Without proper accounting, the full cost of those promises does not become clear for decades, by which time the politicians and bosses are long gone. Now the bill is coming due, as the new Pensions Outlook from the OECD, an international think-tank, shows.
The private sector woke up to the problem years ago. The bull markets of the 1980s and 1990s encouraged companies to assume that soaring share prices would pay for generous pensions. Unlike the biblical Joseph, they did not store the surplus harvest. Instead, they cut or suspended contributions and used funds to finance redundancy schemes, pay off senior executives and boost benefits for ordinary workers.
But as the chart shows, investment returns have been very poor in the current millennium, particularly in America. In the private sector, thanks to a change in accounting rules, the problem was swiftly recognised. Final-salary schemes were closed to new members, who were switched into defined contribution (DC) schemes, in which employees bear the investment risk.
In a DC scheme, the economics of pension provision become crystal clear. Lower contributions and poor investment returns mean a smaller pension pot. Low interest rates mean that any given pot delivers a smaller income. Workers will need to save more if they are to have an ample income after retirement. Since many do not save at all, the OECD favours mandatory plans, or at least automatic enrolment for all who do not explicitly opt out. The New Zealand Kiwisaver scheme has increased the share of workers enrolled from less than 10% to 55%.
Because of laxer accounting rules, public-sector pension schemes, particularly in America, have not faced the same pressures. Many state funds are allowed to assume an investment return of 8% a year, which is barmy when government bonds yield less than 2% and dividends only a little more. By assuming a higher return, states can limit their annual contributions, thereby storing up an even bigger problem for a later date. Many shamelessly do.
In some countries, funded pensions barely exist; today’s retirees are supported by current taxpayers and, via public borrowing, by future ones. In continental Europe, governments provide nearly 80% of old-age incomes. This is not an insuperable problem if pension promises are properly accounted for. But typically they are not. So long as this year’s contributions exceeded this year’s benefits paid out, all is deemed well.
This only works, however, when employees greatly outnumber retirees. As rich countries age, this is less and less the case. According to the OECD, the average proportion of public-pension expenditures that is financed by contributions is expected to fall from 88% to 64% by 2060. In four countries, the gap between contributions and revenues is expected to be 10% or more of GDP.
The obvious answer is that people will have to work longer. Where will the jobs come from? America shows what can happen: the number of workers aged 55 and over has increased by 3.2m since June 2009, points out Paul Marson of Lombard Odier, a private bank.
People used to retire later. Back in 1950, the average retirement ages for men and women in the OECD were 64.5 years and 63 years respectively. By 1993 these had edged down to 62.7 years for men and 60.9 years for women, even as people were living longer. As a result, between 1960 and 2010, the average time men and women can expect to enjoy retirement rose by five and six years respectively.
Most OECD countries have announced increases in the retirement age (although the new French president, who seems to think the rules of maths don’t apply to France, has done the opposite). But change will be slow; the OECD reckons it will be 2030 before the average male retirement age is back to its 1950 level. And life expectancy is rising even faster. On current trends, men in 2050 will be enjoying another 1.2 years of retirement.
It all adds to the fiscal burden on overstretched governments and suggests that some subtle culling of benefits will occur (for example, by not fully upgrading benefits for inflation). As the OECD remarks, “today’s retirees are living through what might prove to have been a golden age for pensions and pensioners.” Tomorrow’s pensioners will not be so lucky.
Jun 16th 2012
Link : Promise now, bill your children