Pensions crisis

The pensions crisis or pensions timebomb is the predicted difficulty in paying for corporate or government employment retirement pensions in various countries, due to a difference between pension obligations and the resources set aside to fund them. The basic difficulty of the pension problem is that institutions must be sustained over far longer than the political planning horizon. Shifting demographics are causing a lower ratio of workers per retiree; contributing factors include retirees living longer, and lower birth rates. An international comparison of pension institution by countries is important to solve the pension crisis problem. There is significant debate regarding the magnitude and importance of the problem, as well as the solutions. One aspect and challenge of the "Pension timebomb" is that several countries' governments have a constitutional obligation to provide public services to its citizens, but the funding of these programs, such as healthcare are at a lack of funding, especially after the 2008 recession and the strain caused on the dependency ratio by an ageing population and a shrinking workforce, which increases costs of elderly care.
For example, as of 2008, the estimates for the underfunding of the United States state pension programs ranged from $1 trillion using a discount rate of 8% to $3.23 trillion using U.S. Treasury bond yields as the discount rate. The present value of unfunded obligations under Social Security as of August 2010 was approximately $5.4 trillion. In other words, this amount would have to be set aside today so that the principal and interest would cover the program's shortfall between tax revenues and payouts over the next 75 years.

Background

The ratio of workers to pensioners, the "support ratio", is declining in much of the developed world. This is due to two demographic factors: increased life expectancy coupled with a fixed retirement age, and a decrease in the fertility rate. Increased life expectancy increases the number of retirees at any time, since individuals are retired for a longer fraction of their lives, while decreases in the fertility rate decrease the number of workers.
In 1950 there were 7.2 people aged 20–64 for every person of 65 or over in the OECD countries. By 1980, the support ratio dropped to 5.1 and by 2010 it was 4.1. It is projected to reach just 2.1 by 2050. The average ratio for the EU was 3.5 in 2010 and is projected to reach 1.8 by 2050. Examples of support ratios for selected countries and regions in 1970, 2010, and projected for 2050 using the medium variant:

Country or Region	1970	2010	2050
United States	5.2	4.6	2.5
Japan	8.7	2.6	1.3
United Kingdom	4.3	3.6	2.1
Germany	4.1	3.0	1.7
France	4.2	3.5	1.9
World	8.9	7.4	3.5
Africa	13.6	13.2	8.8
Asia	12.0	8.6	3.3
Europe	5.4	3.8	1.9
Latin America & Caribbean	10.8	8.3	3.0
Northern America	5.3	4.6	2.4
Oceania	7.2	5.3	3.0

Key terms

Support ratio: The number of people of working age compared with the number of people beyond retirement age
Participation rate: The proportion of the population that is in the labor force
Defined benefit: A pension linked to the employee's salary, where the risk falls on the employer to pay a contractual amount
Defined contribution: A pension dependent on the amount contributed and related investment performance, where the risk falls mainly on the employee
Pension computations

Pension computations are often performed by actuaries using assumptions regarding current and future demographics, life expectancy, investment returns, levels of contributions or taxation, and payouts to beneficiaries, among other variables. One area of contention relates to the assumed annual rate of investment return. If a higher investment return is assumed, relatively lower contributions are demanded of those paying into the system. Critics have argued that investment return assumptions are artificially inflated, to reduce the required contribution amounts by individuals and governments paying into the pension system. For example, bond yields, the return on guaranteed investments, in the US and elsewhere are low. The U.S.and other stock markets did not consistently beat inflation between 2000 and 2010.
But multiple pensions have annual investment return assumptions in the 7–8% p.a. range, which are closer to the pre-2000 average return. If these rates were lowered by 1–2 percentage points, the required pension contributions taken from salaries or via taxation would increase dramatically. By one estimate, each 1% reduction means 10% more in contributions. For example, if a pension program reduced its investment return rate assumption from 8% pa to 7% pa, a person contributing $100 per month to their pension would be required to contribute $110. Attempting to sustain better-than-market returns can also cause portfolio managers to take on more risk.
The International Monetary Fund reported in April 2012 that developed countries may be underestimating the impact of longevity on their public and private pension calculations. The IMF estimated that if individuals live three years longer than expected, the incremental costs could approach 50% of 2010 GDP in advanced economies and 25% in emerging economies. In the United States, this would represent a 9% increase in pension obligations. The IMF recommendations included raising the retirement age commensurate with life expectancy.

Proposed reforms

Reform ideas can be divided into several primary categories:

The worker-retiree ratio and old-age dependency ratio can be addressed by raising the retirement age, part-time work by the aged, and changing employment and fertility policy.
The pension obligations can be reduced by reducing future payment amounts
Resources to fund pensions can be increased by increasing contribution rates or raising taxes. In the United States, since 1979 there has been a significant shift away from defined benefit plans with a corresponding increase in defined contribution plans, like the 401. In 1979, 62% of private sector employees with pension plans of some type were covered by defined benefit plans, with about 17% covered by defined contribution plans. By 2009, these had reversed to approximately 7% and 68%, respectively., governments were beginning to follow the private sector in this regard. Recently there have been some proposals for confiscation of private pension plans and merging them into government run plans.
Pension systems can be reformed to be intrinsically balanced. In his book titled The Pension Fund Revolution, Peter Drucker point out the theoretical difficulty of a solution, and proposed a second best policy that may be enable to enforce.
Auto-Enrollment

Research proves that employees save more if they are mandatorily or automatically enrolled in savings plans. Laws compelling mandatory contributions are often politically difficult to implement. Auto-Enrolment schemes are easier to implement because employees are enrolled but have the option to drop out, as opposed to being required to take action to opt into the plan or being legally compelled to participate. Most countries that launched mandatory or auto-enrolment schemes did so with the intention of employees saving into defined contribution plans.
Whilst mandatory & auto-enrolment schemes have been incredibly successful overall, a major problem was created by the fact that they were launched as DC plans with no real consideration given to what happens when plan members reach retirement and need to begin decumulating their savings.
As an example, Singapore & Malaysia both launched mandatory enrolment schemes Central Provident Fund or CPF in 1955 and the Employees Provident Fund or EPF in 1951.
After the first generation of employees retired, they typically withdrew their pension balances and spent it. The Singapore Government responded by launching CPF Life which mandatorily annuitised a large portion of the CPF savings with the theory being that 'the government tells you and me, "The reason why I must take $161,000 away from you is because if I don't, if I give you the full $200,000 to take out at age 55, some of you, you will take the money and you will go Batam. Some of you will go Tanjung Pinang. Some of you suddenly got a lot of relatives popped up then you don't know how to say no because you're so nice. Then after a while, we have no money left."'.
As a result, Singaporean employees now automatically receive a pension income for life in retirement from CPF life. The EPF on the other hand has never been able to successfully introduce a decumulation solution. Reports produced by the EPF show that 90% of EPF savers have spent all of their savings within 18 months of reaching retirement age.
Following the UK's successful by introducing Automatic enrolment in 2012 based upon behavioural economic theory the Department for Work & Pensions has now proposed new legislation which enables the creation of risk-sharing decumulation solutions such as Collective Defined Contribution schemes and Tontine pension schemes the latter of which also benefits from behavioural economic effects according to Adam Smith in his book The Wealth of Nations.

By country

United States

The Pension Benefit Guaranty Corporation's financial future is uncertain because of long-term challenges related to its funding and
governance structure. PBGC's liabilities exceeded its assets by about $51 billion as of the end of fiscal year 2018—an increase of about $16
billion from the end of fiscal year 2013. In addition, PBGC estimated that its exposure to potential additional future losses for underfunded plans in both the single and multiemployer programs was nearly $185 billion, of which the single-employer program accounts for $175 billion of this amount. PBGC projected that there is more than a 90 percent likelihood that the multiemployer program will be insolvent by the year 2025 and a 99
percent likelihood by 2026.