Pension funds suffer as retirement ages have fallen whilst life expectancy has risen
on September 18, 2015

US pensions Sept15

10k Americans have been retiring every day since 2011, and 18k Europeans, as the BabyBoomer generation reaches the age of 65.  But pension schemes have not adapted to the fact that average life expectancy is now 20 years at age 65.   This is causing major problems for the economy as pensioners leave the workforce – and placing a increasingly large burden on the younger generation who have to fund their pensions for the next 20 years.

The problem is that these changes have happened within just a few generations.  It is not all that long ago, relatively speaking, that life for people even in the developed world was “nasty, brutish and short”, as author Thomas Hobbes had written in 1651.

  • No government thought to offer pensions even 200 years ago, as most had no regular sources of tax revenue
  • Average life expectancy in the West then was just 36 years, and only 24 years everywhere else
  • People relied on their children to look after them, if they were lucky enough to live longer than average
  • So parents typically had large numbers of children, to ensure some would still be alive to look after them

This situation only began to change when Germany introduced the world’s first state pension in 1889.  The UK, then the world’s wealthiest country, followed 20 years later (delaying because it was worried about the cost):

  • UK life expectancy was only 50, but pension age was set at 70 to ensure it was affordable
  • Only 600k of the UK’s 40m population received the pension, which was worth just £17 ($25) in today’s money)
  • But today, only 100 years later, it has become a universal benefit, received by 17% of the entire UK population

When we first began to write ‘Boom, Gloom and the New Normal’, we assumed policymakers fully understood the economic impact of today’s ageing populations.  It seemed just common sense – more older people, all spending less, and fewer young people inevitably meant slower growth and probably deflation.

How wrong we were!  Even today, most policymakers simply ignore this critical topic.  Instead, they continue to believe that creating ‘wealth effects’ in financial and property markets will somehow maintain growth:

  • Yet older people already own most of what they need, and their spending drops quite sharply as they move into their 70s and 80s
  • Plus, of course, there are relatively few young people in the main wealth-generating 25 – 54  age group, as fertility rates have been below replacement level for the past 45 years

Increasing life expectancy is, of course, great news for us as individuals.  But for the economy, it means that yesterday’s ‘demographic dividend’ has turned into a ‘demographic deficit’.  Now many pension funds are having to face the fact that they risk not being able to pay out the promised benefits.

As the chart shows from the Wall Street Journal, most US state pension funds are now being forced to reduce their expected annual returns on investment.  This means that local and state governments will have to increase their payments – either by raising taxes, or cutting spending.  And many analysts worry the assumed returns are still too high – which could mean more funds having to cut actual pension payments as in Detroit.

Private and personal retirement saving faces the same pressures as life expectancy keeps increasing.  As a result, the typical US corporate pension fund now has only 78% of what it needs to meet its pension promises.  And this, of course, is a vicious circle:

  • If companies pay more money into their funds, their earnings will fall, leading to pressure on their stock price
  • If they don’t pay more and default on their promises. pensioners will have less money to spend in retirement

Nor is the US alone in this problem.  In the UK, 4500 corporate pension schemes are in deficit, compared to only 1750 in surplus.  Major telecoms utility BT is in even worse shape, with its £47bn ($72bn) pension fund now 150% of its entire market capitalisation. In Switzerland, pension experts expect the national fund to be bankrupt within 10 years.

There is no easy solution to this problem.  But the longer it is ignored, the worse it is going to get.

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