Tuesday, May 30, 2017

The $400 Trillion Pension Time Bomb?

Szu PingChan of The Telegraph reports, Pensions are sitting on a global time bomb, warns WEF:
The world’s biggest economies are sitting on a $70 trillion (£54 trillion) pensions time bomb that will balloon to more than $400 trillion within four decades unless policymakers take urgent action, the World Economic Forum has warned.

Analysis by the WEF showed the six countries with biggest pensions – the US, UK, Japan, Netherlands, Canada and Australia – as well as China and India – the two most populous countries in the world – faced a retirement savings gap of $428 trillion in 2050, up from $67 trillion in 2015 (click on image).


This is based on the Organisation for Economic Co-operation and Development’s (OECD’s) recommendation that savers should aim for a retirement income of 70pc of earnings when they stop working.

The gap is expected to grow to the equivalent of $300,000 per person by 2050, adjusted for wage inflation, which is larger than the size of the global economy.

In the UK, the current shortfall of $8 trillion is forecast to rise by an average of 4pc per year to $33 trillion in 2050.

A study by the OECD in 2015 found that savers in the UK could on average expect the state to fund 38pc of their working-age income when they retired, lower than any other major advanced economy.

Across the 35 major economies in the OECD, the average was 63pc.

But while the think tank has praised the UK Government’s shake-up of the pensions system, which is now linked to life expectancy, it described the notion that it had found a “beautiful balance between affordability and sustainability [as] some sort of Panglossian fantasy”.

Many are not saving enough into private pension schemes, it warned.

The WEF said a five-point plan was needed to ensure those born today can retire and still receive a comfortable income.

Ageing populations

The WEF noted that life expectancy has been increasing “rapidly” since the middle of the last century, rising on average by one year, every five years.

This means babies born today can expect to live for more than 100 years. According to the forum, the number of people aged over 65 will increase from 600 million today to 2.1 billion in 2050 (click on image).


As population growth slows, this will mean the number of workers paying for the pensions of those in retirement will fall from eight workers today to four per retiree in 2050, putting pressure on the public purse.

All this will be against a backdrop of slower growth, lower interest rates and weaker returns on investments.

The WEF said: “Over the past 10 years, long-term investment returns have been significantly lower than historic averages.

Equities have performed between 3pc and 5pc below historic averages and bond returns have typically been around 1pc and 3pc lower.

Low rates have grown future liabilities, and at the same time investment returns have been lower than expected and unable to make up the growing pension shortfall.

Taken together, these factors have put increased strain on pension funds as well as on long-term investors that have commitments to fund and meet the benefits promised to current and future retirees.”

Saving for the future

The WEF believes working for longer is inevitable. George Osborne, the former chancellor, linked the state pension age to life expectancy in the previous parliament.

As a result, the Office for Budget Responsibility (OBR), the government’s fiscal watchdog, forecasts that workers will have to retire at 69 by 2055.

Under current plans in the UK, the state pension age will rise to 66 by 2020 for both men and women.

The OBR’s latest long-term projections suggest this move is necessary for state pensions to remain sustainable.

Official projections show 26.2pc of the UK population will be aged over 65 in 2066, compared with 18pc last year and 12pc in 1961.

The WEF believes workers need to save between 10pc and 15pc of their annual salary to support a reasonable level of income in retirement.

It warned that many workers faced a shock in later life, with current savings rates “not aligned with individuals’ expectations for retirement income – putting at risk the credibility of the whole pension system".

This means babies born today can expect to live for more than 100 years. According to the forum, the number of people aged over 65 will increase from 600 million today to 2.1 billion in 2050.
Sam Meredith of CNBC also reports, Pensions time-bomb for world's biggest economies could explode to $400 trillion, says WEF:
Future generations are on course to become enveloped in the biggest pension crisis in history, according to the World Economic Forum (WEF), unless policymakers from the world's leading economies take urgent action.

The Geneva-based organization predicted the challenges of an ageing population could result in the world's largest economies being forced to tackle a pension time-bomb.

Analysis from WEF showed six countries with the biggest pensions, including the U.S., Canada, U.K., Netherlands, Japan and Australia, as well as the two most densely populated countries in the world – China and India – would face a retirement savings gap in excess of $400 trillion in 2050, up from around $70 trillion in 2015.

'Financial equivalent of climate change'

"The anticipated increase in longevity and resulting ageing populations is the financial equivalent of climate change," Michael Drexler, head of financial and infrastructure systems at WEF, said in the report published on Friday.

The body that organizes the annual gathering of the global elite in Davos said with babies being born today having a life expectancy of more than 100, the costs of providing financial security to people in retirement could skyrocket to unprecedented levels.

According to the WEF's forward looking estimates, the retirement savings gap from all eight countries is set to inflate by 5 percent every year over the next four decades. This translates to an extra $28 billion of deficit every 24 hours.

"We must address it now or accept that its adverse consequences will haunt future generations, putting an impossible strain on our children and grandchildren," Drexler added.

The report based its pensions saving gap projections on the amount of money required in order to allow people to retire with a relatively unaffected standard of living. The Organization of Economic Co-operation and Development (OECD) recommend a target of 70 percent of one's pre-retirement income. The OECD argues this should give people enough financial security post-retirement as people generally save less and pay less tax when they stop working.

The WEF proposed a five-point checklist that policymakers should adopt to help curtail the impact of a pension crisis for future generations.

The high priority actions included reviewing the national retirement age, embracing technology assistance where needed, supporting financial literacy efforts for vulnerable people, providing clear communication to all and standardizing pension data to give citizens a full picture on their respective financial positions as they get older.

"While the challenge can seem overwhelming it is important to continuously evolve the systems in place to start to put positive changes in motion," the report said, before adding, "If we continuously review, assess and take small steps over time we will more likely be able to meet the needs of today's retirees and afford the promises we are making to today's workers."
You can read the World Economic Forum (WEF) report, We’ll Live to 100 – How Can We Afford It? by clicking here. The WEF put out a brief comment, 5 things you need to know about the global pension crisis:
At what age are you planning to retire? Do you have enough saved up to do so?

Two simple questions, but the answers are not so simple.

Depending on where you live, you could have a pension waiting for you – either from the government, or your job, or your personal savings.

But is it enough?

A new report from the World Economic Forum, We’ll Live to 100 – How Can We Afford It? takes a closer look at the global pension crisis. Here are five key findings.

1. We are living much longer than what pension systems were designed for

The chart below illustrates the retirement ages for the six countries with the largest pension systems.

Retirement age for most of these countries is 65 (with Japan the exception, at age 60).

The bottom bar represents the number of years of payments expected using life expectancy in 1960. This ranged from five to eight years of payments on average.

Looking at life expectancy in 2015, we can see that pensioners are now living eight to 11 years longer – and in the case of Japan, a whopping 16 years longer.

That means that pension systems are now having to pay benefits for two to three times longer than what they were designed for.

The top bar represents the expected increase in life expectancy by 2050 (click on image).


2. We currently have a pension gap between what is needed for retirement and what is saved

It is difficult to define what is considered adequate income for retirement.

One common assumption is that we will need less money in retirement than we do while we are working (during wealth accumulation).

There are three main sources of income during retirement: government sponsored pensions, work or occupational pension plans, and personal savings.

Because we are living so much longer these days, there is a gap between what we need during retirement and what we have available, even among countries with developed pension systems.

Add the two most populous countries (China and India), and one can see why this is truly a global pension crisis (click on image).


 3. The problem is worse for women

As if the wage gap wasn't enough of a problem, women have it worse with the pension gap as well.

Globally, retirement balances for women are typically 30-40% lower than that of men.

Lower wages account for some of this imbalance, but coupled with longer life expectancies for women, these smaller balances then need to be stretched over a longer period of time as well (click on image).


4. The gap is growing at an alarming rate

This problem is getting worse.

In the chart below, we have illustrated both the gap in 2015 as well as the gap by 2050.

For all countries, this is being driven by continued increases in life expectancy.

For some countries, there is also a demographic challenge of an ageing population with fewer workers to support them.

For economies that are still developing, the increase in the gap is also being driven by rising wage growth as these countries continue to industrialize. By 2050, the total gap is a predicted to be a staggering sum of $400 trillion – roughly five times the size of the global economy today (click on image).


5. We need to act now

This is a difficult problem for policy-makers to address.

Politically, it is easy to ignore the future. But, as we have shown, this will lead to us paying a massive economic price.

We have proposed a series of measures for policy-makers to look at today (click on image):

I'm glad the World Economic Forum is finally paying attention to the global pension crisis, almost ten years after I began this blog. Welcome to the club!

So what are my thoughts on this report? There is definitely an alarmist tone to it which is meant to "shock and awe" policymakers and citizens reading it, and while I agree with the thrust of its arguments, I disagree with some points:
  • Longevity risk: No doubt about it, we are projected to live longer and this will put pressure on pensions as they need more money to pay future liabilities over a longer period. A sensible proposal is to raise the retirement age gradually to 70 years old over the next decade (easier for some jobs, not for others). In the case of Japan, I was shocked to read Japanese can retire at 60 and yet their pensioners are living a whopping 16 years longer. Do the math, this isn't sustainable, placing huge pressure on Japan's pension system.
  • The pension gap: The report says it is difficult to define what is considered adequate income for retirement but goes on to ascribe an arbitrary figure of 70% pre-retirement income. Can I be honest with you? Very few people will retire with a 70% pre-retirement income. I can assure you most people will retire with little to no savings and end up relying on some measly government pension which is why I've been very vocal on enhancing the Canada Pension Plan (the study found Canadians are among those most at risk) and enhancing US Social Security, provided they get the governance right (like we did in Canada with CPPIB managing assets of the CPP). But the fundamental issue behind the rising pension gap is lower wages, an ongoing global jobs crisis, and rising inequality, ensuring that most people cannot save enough for retirement. By the time people are done paying the mortgage, food and other needed expenses, they cannot afford to save five percent, let alone 15 percent of their income. And even when they do manage to save, they're left at the mercy of "the market", meaning if they're lucky, saved enough and don't retire before a major bear market, they might be able to squeeze enough out of their savings to retire in dignity and security. This is yet another reason why I'm a big proponent of enhancing the CPP, because unlike a defined-contribution plan which is just brutal during market downturns, a large, well-governed defined-benefit plan will pool longevity and investment risk and invest across public and private market assets. Moreover, there are plenty of other benefits to large well-governed DB plans that help improve the economy over the long run.
  • Pension crisis isn't gender neutral: No doubt, unless you are a female teacher or nurse working in Ontario where you're a member of two of the best defined-benefit plans in the world (OTPP and HOOPP), you're definitely not in better shape than your male counterparts when it comes to retirement because you are earning less and living longer. Women need to think about their retirement a lot more carefully than men, which is another reason why I'm for enhancing the CPP and US Social Security (provided they get the governance right).
  • On the $400 trillion projected gap: Here is where I want to tone things down because as I stated above this figure is based on an arbitrary 70% pre-retirement income figure which to be quite truthful, isn't needed. The older people get, the less they spend, so I don't know where they get this 70% pre-retirement income figure. Still, the pension gap is growing as people live longer and save less. I would have liked to have seen a range of figures starting from 40% pre-retirement income to 70% to see just how much this gap will grow in the coming decades.
  • On the five recommendations: I agree with the WEF recommendations but I find them timid. As I stated above, we need to bolster large, well-governed defined benefit plans that lower costs, pool investment and longevity risk, and invest across public and private markets all over the world either directly or through top funds. We also need to introduce proper risk-sharing into these plans to make them sustainable over the long run. 
On that last point, go back to read my previous comment on the pension prescription and those of you who can, forward it and this comment to the World Economic Forum.

In short here are my recommendations:
  1. Enhance large, well-governed defined-benefit plans, preferably ones that invest on behalf of all citizens (ie. state pension plans) and back them up by the full faith and credit of the state.
  2. Get the governance right like we did in Canada so you can hire experienced professionals that invest directly across global public and private markets and co-invest with top partners.
  3.  Get the risk-sharing right because from time to time pensions will experience shortfalls and you need to have a relief valve to restore fully funded status. In a low inflation world, I recommend pension plans introduce Conditional Inflation Protection. 
Those are my thoughts on the $400 trillion pension time bomb. If you have anything to add, feel free to contact me at LKolivakis@gmail.com.

One last thing which is worth noting here. When I discuss global deflation, one of the six structural factors I allude to is the global pension crisis. It's highly deflationary and exacerbates global wealth inequality which is itself deflationary. 

Policymakers really need to think about pensions a lot more carefully. As I stated in my previous comment on the pension prescription, everyone needs to play a role in solving a looming crisis that is only going to get worse. There are no easy solutions but in my mind, we absolutely need to bolster defined-benefit plans (and avoid defined-contribution plans) and make sure we get the governance and risk-sharing right.

And to do this, everyone needs to be committed to the best interests of the plan, including unions with unreasonable demands, governments who shirk their responsibilities in topping up pensions, public pensions with unrealistic return targets, and large alternative investment managers charging insanely high fees for mediocre returns in a low growth, deflationary world.

Below, discussing the geopolitical and economic effects on global markets with Michael Gapen, Barclays chief US economist and managing director, and Kevin Caron, Washington Crossing Advisors senior portfolio manager.

Geopolitical risks are the least of my concerns over the long term. Read this comment carefully and send it to your kids and friends. The global pension crisis should be one of our main concerns but in an age of Twitter, Facebook, Snapchat and Instagram, we are continuously distracted and ignoring the forest for the trees. The pension storm cometh, be prepared or risk a miserable retirement.

Second, Japan and Germany may be sitting on a ticking demographic time bomb where aging populations begin to drag down economic growth. Good thing they’re also prime candidates for robot revolutions. Bloomberg reports on how robots may help defuse this time bomb.

Lastly, one of my blog readers sent me Erik Townsend's interview with Professor Russell Napier on MacroVoices where they discuss the US dollar, the secular bond bull market, and the pension crisis (minute 28). Take the time to listen to this podcast, it's excellent.



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