• The World Can’t Afford to Retire
  • Cash Is No Longer King
  • Don’t Get Too Concerned About Consumer Debt

Nine months after I started my first banking job, I got an official-looking letter from an insurance company I had never heard of. It informed me that I would be provided with a monthly annuity of about $60 upon my retirement, the result of the bank’s decision to close its pension plan. I filed the letter away without giving it much heed, since retirement seemed a long way off.

I didn’t realize it at the time, but that event was significant at a micro and at a macro level. The gradual fade of private pension plans has shifted responsibility for retirement preparedness to employees, a responsibility that some have not borne well. For the pensions that remain, the secular decline in global interest rates that began in the early 1980s has created new challenges to solvency. Today, with populations aging, the challenge of fulfilling retirement expectations is an immensely expensive problem.

Pensions are centuries old. Post-retirement payments were often offered as an incentive to military enlistees to fill out the ranks. Governments gradually offered these schemes to the general population as a means of combatting indigence among the elderly. Today, government pensions provide more than 60% of retirement income in the United States and Western Europe.

Corporations began providing pensions to augment compensation packages. In the United States, wage controls implemented after World War II led firms to compete for talent using other means. (Corporate health plans began gaining popularity at around the same time.)

When beneficiaries are young and asset returns are ample, pension systems enjoy robust health. Given long time horizons, programs are free to invest aggressively, without much regard to the timing of prospective liabilities. Under these circumstances, funded ratios (which compare the values of plan assets to the value of benefit commitments) are easy to sustain.

But today, pension systems in the public and private sector are grappling with a perfect storm. With the ranks of retirees growing rapidly, plans have had to shift to fixed income investments just as interest rates are at generational lows. Pensioners are living longer, extending the annuity of benefits owed to them. Funded ratios are consequently slipping.

Well managed programs thought ahead, taking risk off the table by setting terms carefully and matching their prospective liabilities. Others weren’t so fortunate. Private sector pension backstops, like the Pension Benefit Guarantee Corporation in the United States and the Pension Protection Fund in the United Kingdom, have seen their caseloads grow and their financial positions tested.

Pensions in the public sector are a particular problem. In this arena, pension contributions compete with other fiscal priorities, and often are limited to keep budgets in balance. (This is a fundamental design flaw.) Proposed benefit reforms meet significant resistance and create a political furor. Aggressive investment strategies, aimed at digging out of the deep hole, haven’t been successful.

As a result, retirement obligations threaten the solvency of U.S. states and some national governments. Pensions remain a point of stress in negotiations over Greece’s debt restructuring, and Brazil must soon enact changes to its national pension plan to avoid a painful reckoning. These are not isolated incidents: a series of governments will need to think creatively to avoid seeing pensions bankrupt their economies.

The consequences of underfunded retirement systems will be wide-spread. Keeping pension promises will require significant amounts of revenue from taxpayers. The monies channeled in this direction will not be available for public investment, and high tax rates can be a deterrent to businesses and residents. Certain areas are already in a demographic death spiral, and others may join them.