Wednesday 26 August 2015 8:52 pm

A pensions perfect storm is brewing – but longer lives needn’t prove a nightmare

An old friend recently confided that there is one thing he is afraid of more than death – and that is living too long.
Longer lifespans and low interest rates can combine to make retirement a potential nightmare of penury. Public finances face a related challenge. 
According to IMF research, public pension expenditure for advanced economies climbed from 3.8 per cent of GDP in 1960 to 9.1 per cent in 2010, and it is projected to rise to 11.9 per cent by 2050.
Add in current high debt levels and the rise in age-related healthcare costs, and you have a perfect storm on the horizon.
How did we get into this mess? Mainly by living longer but not retiring much later; by consuming today and not saving enough for tomorrow; and, especially in the West, by enjoying childhood but then having fewer children.
As a result, growth in pension liabilities is outstripping growth in assets in most countries, including the UK.
This impending problem begs an obvious question: is there an ideal retirement system that could provide a solution?
Given the large number of experiments around the world with various features of retirement provision, we have a much better understanding of what works.  
Applying this learning, a new paper by Mercer and CFA Institute offers some guiding principles for the design of an effective retirement system.
Happily, the current UK pension system already enjoys many of the suggested features. Recent changes related to a single-tier State Pension, auto-enrolment and limited lump-sum withdrawals add to the simplicity and flexibility of pension plans. 
New proposals for “defined ambition” pensions and collective defined contribution schemes are designed to allow better risk sharing between savers, employers and pension providers. This flurry of pension reform bodes well for pre-empting a crisis.
Yet more can be done. The share of disability benefits in the UK has been high historically, especially during hard times – such benefits are often used as a bridge to retirement. Stricter medical evaluation is the standard remedy elsewhere. 
In addition, low labour force participation and slow productivity growth both add to the pension burden. And although auto-enrolment is increasing the share of private pensions, there is still room for more growth. 
Relatedly, the funding position of corporate defined benefit schemes tends to fluctuate wildly depending on market levels, endangering corporate stability and expanding pension risk for scheme members. 
Many of the elements of the proposed ideal retirement system may seem sensible and even obvious. So why are they not adopted more widely worldwide? 
A clue to the answer was provided by Jean-Claude Juncker, president of the European Commission, who once famously quipped of economic reforms: “We all know what to do, we just don’t know how to get re-elected after we’ve done it.”  
In other words, problems that affect the political economy are often difficult to mediate and solve. The social and economic trade-offs are not easy to achieve. Yet our financial stability and prosperity depends on finding better pensions solutions. 
After all, longer lives should be a cause for celebration.