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:
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:
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 in 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:
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.
Click HERE to read more.