Over the past six years,
I've repeatedly blogged on what I call the pension Ponzi scheme. As the
financial world is rapidly figuring out, the pension plans of the past
generation(s) are simply not sustainable. People are living longer and,
thanks in large part to the Great Recession, central bankers have pushed returns
on safe investments to near zero or, in some cases, into negative territory.
Those who are currently retired may find themselves with their
gold-plated defined benefit pension plans in jeopardy and those who are
planning to retire in the future may find that there simply isn't enough
funding to cover their pension expectations. A report by Citi,
"The Coming Pensions Crisis", looks at the
massive growth in unfunded government pension liabilities and the accompanying
underfunding in corporate pension plans. In the report, the authors also provide
possible solutions to a problem that will grow over time if it is left
unattended. Since this is a rather important subject, I will address it
in two parts; part one will look at the size and causes of the pension problem
in both the government and private sectors and part two will look at some
suggested solutions that may mitigate the size of the crisis.
Let's start by looking at
the scope of the problem in three parts, beginning with demographics and
longevity, followed by government pension issues and the private sector pension
issues.
1.) Demographics and
Longevity: A century ago, an urban dweller in the developed world could
anticipate a life expectancy of 51 years. In the United States in 1935
when the Social Security Administration was founded, a 65 year old man could
expect to live an additional 12.7 years. Now, the life expectancy of a
man has risen from 77.7 years to 85 years, which means that the social safety
net has to provide for him for 7.3 years longer than the system was designed
for. In addition, the drop in fertility rates, particularly in developed
nations, means that fewer individuals will be contributing to the pension
system. This will result in a shift in the median age; in 2015, people
aged 65+ accounted for 8 percent of the global population, a level that will
increase to over 15 percent of the global population by 2050 as shown in these
two population pyramids:
Some regions will have a
far greater problem with 65+ year olds by 2050; China's older population will
comprise 24 percent of its total, Japan will have more than one-third of its
total and Europe will have 27 percent of its total population among the
elderly. This will push down the dependency ratio of workers (aged 15 to
64) to retired (65+) as shown here:
In the case of China, the dependency ratio will fall from its current level of 7 to 2.2 by 2050 and in Japan, the dependency ratio will fall from its current very low level of 2.1 to 1.1. Globally, the dependency ratio will drop by half over the next three and a half decades. As you can quite clearly
imagine, any "pay-as-you-go" pension plans will (or already are)
unsustainable in the face of dropping dependency ratios. This will result
in one of two things; a cut in benefits or a complete collapse of the pension
system.
2.) Government Pension
Issues: Here is a look at pension obligations and deficits liabilities in
the private sector in the United Kingdom and the United States:
In the U.S., current
unfunded corporate defined benefit pension plan commitments total $425 billion.
Individuals in defined contribution plans or who are without retirement
savings are a whopping $7 trillion short of the ability to provide for
themselves after retirement.
Here is a graphic showing how important
government pensions (including Social Security) are to the citizens of many nations when
compared to the income from private pension plans:
Obviously, as the decades
pass and Baby Boomers retire, government pension payments as a percentage of
GDP will rise as shown on this figure:
The average government
pension costs to GDP rises from 9.5 percent in 2015 to 12 percent of GDP by
2050, a very significant increase. This will put additional stress on
already stressed balance sheets, particularly as debt levels rise along with
interest owing on that debt.
Lastly in this section,
here is a graphic showing how the total estimates for all forms of government
pension liabilities add up as a percentage of GDP compared to current conventional
public debt-to-GDP ratios:
The weighted average
contingent liability to GDP from public sector pension liabilities is roughly
190 percent of GDP compared to average sovereign/public debt-to-GDP levels of
190 percent. For the twenty OECD nations in the graphic, the public debt
totals of $44 trillion, slightly over half of the size of the $78 trillion of
unfunded and underfunded government pension liabilities. The biggest
pension problem (as a percentage of GDP) lies with European nations that have
state pension systems; France, Germany, Italy, the United Kingdom, Portugal and
Spain have estimated public sector pension liabilities in excess of 300 percent
of GDP. Interestingly, most of this unfunded liability does not appear
on government balance sheets. In the United States, the pension problem
is not just federal; state and local government employee defined benefit plans
have between $1 trillion and $3 trillion (the level varies with the discount
rate in use) in unfunded pension commitments. While these numbers seem
large, they are dwarfed by the liability in the U.S. social security system
which has more than $10 trillion in unfunded liabilities. The biggest
problem with government pension plans in the United States is the fact that
government plan sponsors (i.e. Congress and state legislatures) have not made
contributions to these plans that come close to meeting their funding
requirements and, ultimately, their pension payment levels to individuals.
3.) Private Sector
Pension Issues: At the end of 2015, America's S&P 500 companies had pension
liabilities of $403 billion compared to total obligations of $2.027 trillion as
shown on this graphic:
As well, in the United
Kingdom, FTSE 350 companies were expected to have deficits of £84 billion
compared to total obligations of £686 billion as shown on this graphic:
These figures greatly
understate the private pension problem because they include only the largest
companies in both nations. As well, many publicly traded companies have
already taken action by transferring funding from defined benefit to defined
contribution pension plans, reducing their future obligations to whatever their
employees have managed to set aside.
The biggest factor that
has created the current pension funding deficit problem is the discount rate
used by the plan, with much lower interest rates resulting in higher deficits.
As shown on this graphic, AA discount rates have declined markedly since
the end of the Great Recession with each 10 basis point reduction in the
discount rate increasing the pension liability by approximately 1.7 percent:
Additionally, increased
life expectancies have impacted pension liabilities with each 1 year of
additional life adding about 3 percent to gross liabilities. Given the
significant increase in life expectancy over recent decades, this is having a
marked impact on the viabilities of many pension plans. In my own case,
my mother received a pension from her decades of service as a teacher. In
reading through the pension plan literature, it was interesting to note the
large number of teachers who were living to 100 years of age and the high
percentage of teachers who took early retirement and collected their pensions
for significantly longer than their years of teaching service. This is
obviously an unsustainable business model.
Now that you have some
idea of the massive scope of the pension problem that looms over the world's
advanced economies, I'll close this posting. In part two, I'll look at
some recommended solutions by the authors of the report that may help mitigate
the pension crisis.
Marvelous article, it has become clear the number of pension defaults will soar in coming years. This is especially true in the public sector where the 25 largest U.S. public pensions face about $2 trillion in unfunded liabilities. In recent years pension funds have not been able to generate the earnings and high returns that they had predicted because interest rates have fallen and growth has slowed so expect things to get worse.
ReplyDeleteWhile it could be said that several ways exist to cheat or rob those who paid into pensions for years it would be an understatement, more ways exist than you could imagine. One reader on another site compared pensions to a Ponzi scheme where benefits are paid out to its investors from new capital paid in by new investors. More on this growing problem below.
http://brucewilds.blogspot.com/2016/05/pension-benefits-will-be-cut.html