When I really want to make myself depressed about the drab state of the global economy and why we are all struggling so hard to hoist ourselves out of the quagmire created in 2008, there is one reliable theme: pensions. Or perhaps I should say the coming pension crisis.
As all those clever people in global financial and banking institutions that are gathered this week in Jackson Hole scratch their heads over why seven years of record-low interest rates – basically free borrowing – has failed to tempt either companies or consumers to borrow or spend, it is the state of the world’s pension schemes that they should think about.
In short, in strict terms, the world’s pension fund managers are in crisis. In the US, the 1,500 company pension schemes that make up the SP index are underfunded to the sum of US$560 billion. The country’s state and municipal pension schemes are even deeper in debt, with aggregate deficits estimated at US$3.4 trillion. Detroit’s pension scheme went belly-up two years ago, with Alaska, Illinois, California and Connecticut all carrying debts above US$70,000 for every household in the state. The Illinois state pension fund had unfunded liabilities of US$111bn at the turn of the year.
In the UK, the country’s 350 largest companies have assets equivalent to US$950bn, but have payment obligations of US$1.15 trillion. The UK Pension Protection Fund, which was created to bail out the country’s 5,945 pension schemes if they collapse, says 5,020 of its schemes are in deficit and just 925 are in surplus. It says their aggregate deficit is equivalent to US$538bn – but outside experts say the deficit is twice as large.
Other economies are facing a similar crisis. In France, the government’s pension fund liabilities amount to 350 per cent of GDP, while in Germany and the UK they are over 320 per cent. Japan’s public pension liabilities amount to 165 per cent of GDP. Australia is a rarity with liabilities at just 10 per cent of GDP.
Remember that this is the crisis facing the privileged part of the world. And it is the crisis as it has unfolded so far. It is going to get worse, even ignoring the billions of people across the developing world who have yet to discover the luxury of a pension. Various factors make deterioration a certainty:
• Rapidly ageing populations across the world are radically altering the balance between those in work (who pay for our pensions) and those in retirement. In 1950, in the world’s rich economies, those aged 65 or older amounted to 10 per cent of the working population. Today they account for 25 per cent, and by 2050 they will account for 50 per cent.
• As people live longer, so they rely on pensions for many more years. When Count Otto von Bismarck created the first pension scheme in Germany in 1883, he set the pensionable age at 70, and average life expectancy was just 64. Most people died before they had the chance to draw on a pension. Today in Hong Kong (the world’s most long-lived society) a man who retires at 65 can confidently expect to live at least 16 more years – and his wife a further 22 years. Pension pools have never been so stretched, and it is going to get worse as we move towards “the 100-year life”.
• Quantitative easing has meant flat-lining interest rates for pension funds for the past seven years, with no respite expected. Most pension schemes have for the past half century assumed they could earn annual returns of 6 per cent, and based their annual payouts on that income. Today, with returns around 3 per cent at best, their liabilities are exploding while revenues shrink.
• As the arithmetic of defined-benefit pension schemes – in which an employer or the government guarantees a pension equivalent to around 75 per cent of final salary – has gone so alarmingly awry, so more and more pensions are defined-contribution schemes – US$35.4 trillion worth in the world’s richest 19 economies. This eliminates the funding crisis facing companies, but only by shifting the crisis firmly onto the shoulders of the pension savers themselves.
For most of the past half century, by saving 8 per cent of your salary for a working life of 40 years, and assuming an annual investment return of 5.5 per cent, you could retire confident of a pension equivalent to 75 per cent of your final salary. But with investment returns now averaging less than 3.5 per cent, you would need to save 15 per cent a year to match the 75 per cent pension.
In the US, the average direct-contribution scheme account (the 401K schemes created in 1974) holds US$104,000. On government guidelines that pensioners should not draw down more than 4 per cent a year, that means a pension of US$4,000 a year.
The net message is grim: many pension schemes will go belly-up in the next four to five years. And if we are to avoid mass poverty in old age for a majority of our population, we face three difficult facts: we must save more, we must work longer and we must lower our expectations.
For Hong Kong’s MPF savers, the message is similarly depressing. If you earn HK$35,000 a month (which puts you firmly among Hong Kong’s upper-middle class), then your MPF savings would amount to HK$36,000 a year, or HK$1.4m over a 40-year working career. Real investment returns of 3 per cent a year would give you around HK$4.6m – enough to last for about 17 years if you can live on 75 per cent of your final salary. But MPF investment returns have been negative for five of the last 15 years. Contributions of HK$500,000 since the year 2000 would have earned just HK$100,000.
This is a tsunami approaching our shores far faster than we think, and it is no wonder that companies and workers alike are squirreling away every penny they can. The aftershocks of the 2008 crash still have potential to inflict great suffering, and there are many who argue that the weird global experiment with zero and negative interest rates may today be doing more harm than good.
David Dodwell is executive director of the Hong Kong-APEC Trade Policy Group