Pensions

Where to look now?

©Dylan Martinez/Reuters

Pension funds suffered a blow in the financial crisis. So did public confidence. How can pensions be made more secure?

 

 

Old age, said Leon Trotsky, is the most unexpected of all the things that can happen to a man. Lifetimes do indeed fly, but if there is one event that even quite young people in OECD countries need to prepare for nowadays, it is their retirement. But with many pension funds in trouble from the 2008 collapse in financial markets, even some of the best laid retirement plans have had to be put off. No wonder trust is so low and the question of public versus private schemes has become such a hot debate.

In recent years, we have increasingly had to save for our retirement ourselves. We are all living longer-which is a good thing-but this has made it increasingly expensive for governments and employers to cover pension costs.

Unfortunately, this meant that the financial turmoil and ensuing economic crisis has had a major impact on private pension assets-OECD estimates that these have plummeted by US$5.4 trillion globally, 20% of their value. Countries where pension funds were heavily invested in equities, such as Ireland and the US, faced the heaviest blows. No wonder confidence in private savings is being sorely tested and there are calls to return to what is seen as the "safe haven" of government pensions.

Yet there are many problems and dangers with making such a reverse turn. First it should be noted that pensions are long- term investments, and we should not make decisions affecting decades based on one year's results. Unlike the problems in the banking and insurance sectors, the decline in pension assets does not have short-term implications for most of us, and should recover over time. Indeed, despite recessions and bursting bubbles, over the last few decades balanced portfolios in OECD countries have earned an average 7% per year in real terms.

Even if we do find it hard to trust markets again, huddling back under the shelter of public pensions is not an option. For one thing, public pensions have also been impacted by the crisis, as unemployment rises and tax takes decline, reducing contributions to the system and adding to already stretched government deficits.

Another key reason is the cost pressures arising from an ageing society, as the disproportionate ratio of retirees to workers will continue to strain government budgets. When most of these pension systems were introduced the retirement age was 65. But then, life expectancy was also 65. Now we might work for 30 years and be retired for 30 years. Public pensions alone are no longer the answer, and for most countries a mix of both public and private pension schemes is probably where the future lies-security through diversity is the key.

Still, it is important that public pensions do offer all citizens a proper degree of security. One way to ensure that market falls such as the latest one do not have such a devastating impact is to have a proper social security safety net in place.

These have become uncomfortably weak in some OECD countries, and governments have been introducing measures, such as minimum pensions, to ensure that no one falls through the gaps. But what else can be done to safeguard our hard-earned pensions?

For a start, employers should be encouraged to continue providing pensions to their workers. Assets of defined benefit pensions declined precipitously in the last year, requiring companies sponsoring these schemes to drastically increase their contributions to plug the funding gap needed to pay promised benefits. Yet these companies themselves are struggling in the current difficult financial conditions. Demanding too high pension payments and driving a company into bankruptcy is clearly not the solution-hence OECD governments have been granting welcome flexibility with their funding rules and allowing more time for companies to repair their pension balance sheets.

Defined contribution pension funds-where we individuals bear the impact of the market declines-also need to be fixed. Like other investors, pension fund managers had every incentive to maximise returns through investments in such products as commodities and hedge funds, as well as more innovative financial instruments.

The fact that pension managers were allowed to venture into this territory with people's life savings says quite a lot about the managers, but also about the negligence of their trustees and company boards. Short-term thinking and weak governance jeopardised long-term investments. Quick winnings rather than modest, stable returns were the goal. Clearly the governance of pension funds needs to be improved, with training and expertise required to make sure managers really understand what they are investing in.

Yet we, too, must take a closer, more responsible, interest in our investments, which will require an improvement in financial literacy; the OECD would like to see this area addressed in future reforms.

Individuals close to retirement-these were the worst hit by the financial crisis-can also be protected by automatically switching into less risky investments as they get older. Likewise, forcing people to buy an annuity at specific times risks locking in very low retirement income-as was the case with people unfortunate enough to retire at the bottom of the cycle this last year.

A better approach would be to combine "phased" withdrawals, where a defined part of the fund is withdrawn each year with a "deferred" annuity paid out when an individual reaches a more advanced age. 

Is the news all bad? Most pension funds suffered very limited exposure to "toxic" assets, less than 3% being badly affected. As long-term investments, most pensions will recover as long as confidence comes back. That depends on visible, welltargeted action. If we need public and private pension systems to help face the retirement challenges ahead, then governments have a role to play in making sure private systems stand the stress tests of future expectations.

A degree of risk is unavoidable, but greater vigilance and better stewardship, along with a wider diversity of investment options and a full disclosure of where those investments had been made, would go some way to restoring pension strength and giving future pensioners more than a hard chair to sit on. Trotsky may have been right about old age, but that is no excuse for denying people the pensions they earned and deserve. FS/RJC/LT

 

©OECD Observer No. 273, June 2009

 

References

 OECD (2009), Pensions at a Glance, ISBN 978-92-64-06071-5; see also 2007 edition. Available at www.oecd.org/bookshop

Antolín Pablo and Fiona Stewart (2009), "Private Pensions and Policy Responses to the Financial and Economic Crisis", OECD

Working Papers on Insurance and Private Pensions No 36, Paris. Available at www.oecd.org/daf/pensions

For more information on pension work at the OECD, contact Fiona.Stewart@oecd.org and Edward.Whitehouse@oecd.org

See also www.oecd.org/pensions

 

 

 




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