Pension Risk News & Analysis : Pension Governance, Inc. : Pension Risk & Investment

Mr. Mark Steyn, author of the popular paperback book, America Alone, responds to the recent post about changing demographics. Read Mark's comments:

 << Sue, the problem isn't rapid aging, it is a rapid decline in fertility. Before the "smart" ideas of pensions (Bismarck, Germany, 1870) and Social Security (FDR), people's "pensions" were productive children. When the government tried to become the safety net, the incentive to build a flexible, productive, human pension withered. Now we try to shuffle financial assets around to plug the hole, when really what we need is more human ingenuity. So we're all in this together, against the government's unfulfilled and unfulfill-able promises that it will take care of us. >>

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Mr. Bob Mitchell echoes a similar sentiment that government largesse is unsustainable. Here is what he writes:

<< Full credit to Credence Clearwater Revival – “How much should we give? They only answer more! ‘more!’”

• There is no “fair amount” of minimum benefit that we need to provide, beyond possibly food to survive.
• Whatever level you provide, you are too stingy for those who want more. So they will keep pushing.
• People don’t have a right to live in a particular area that they cannot afford.
• People don’t have a right to high paying jobs nor pensions.
• People don’t have a right to unlimited free health care.
• Some things have to be earned.
• US standards of poverty exceed the average income of much of the world population.
• You are on your own But if you work it right, you can join a group (lobbying, union, church, insurance plan, fraternity, etc.,) where someone will look out for you in exchange for your involvement. But don’t expect it to come for no cost.

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Editor's Notes: Click to read the original post entitled "World Economic Forum Report - Demographic Gaia" (October 2, 2008). Click to access the lyrics and music to "Fortunate Son" by Credence Clearwater Revival.

If you concur or have a different point of view, drop us a line.

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According to Wikipedia, the Gaia Hypothesis refers to an ecology that inextricably ties together elements of Earth and the biosphere. With respect to world population trends, the World Economic Forum embraces the notion that "We Are in This Together" as one possible scenario. Other scenarios put forth include "The Winners and the Rest" and "You Are On Your Own."

 In its new report entitled "The Future of Pensions and Healthcare in a Rapidly Ageing World - Scenarios to 2030," authors cite UN projections that, by 2050, "one-third of the populations in developed countries and one-fifth of those in developing countries will be aged 60 or older." Authors Bernd Jan Sikken, Nicholas Davis, Chiemi Hayashi and Heli Olkkonen center on the likely outcomes associated with a radical increase in retirees. Why is this important? As more people leave the workforce, fewer wage-earners remain. This in turn means that fewer dollars (Euros, yen, etc) are deposited into the employee benefits pot to fund promises made to others.  

This blog has oft-commented on the potentially dire consequences of "out of control" obligations.  World Economic Forum researchers offer that population shifts will no doubt change the political and economic landscape in many countries. Their list of challenges includes, but is not limited to:

• "Growing expectations that the private sector will come to the rescue"
• Financial illiteracy on the part of individuals
• Less than robust private-pension and health insurance mechanisms
• Mounting pressures on "pay as you go" public safety net programs
• Waning support from younger family members to care for elders
• Shortage of skilled healthcare workers
• No safety net programs for some 80% of those who live in less-developed countries.

The report is chock full of graphs and statistics and includes a comprehensive bibliography. Case studies about China and Italy are worthwhile as their problems mirror those of other countries.

I personally am a believer in the "together" theory, no matter how much we save as individuals and irregardless of employer largesse (for whom that applies).

As we've seen in the last few weeks, global capital markets are kissing cousins. Someone sneezes in one country and we all get a cold. In a similar sense, increasing numbers of impoverished persons likely affect us all in the form of (a) increased taxes on working individuals (b) drag on economic growth as monies are diverted from the business sector to support government programs and the (c) human element of not wanting to see others suffer because they cannot afford everyday basics.

Email your thoughts. Do you think we are in this together as relates to a benefits crisis?

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February 18, 2007 marks the Chinese New Year (the Year of the Boar). Also known as the Spring Festival or Lunar New Year, it is the "most important of the traditional Chinese holidays." Interestingly, Chinese New Year's Eve is known as the eve of change and indeed, China is on the verge of significant change.

According to a new study, co-authored by Reuters and KMPG, the demographics are compelling. "By 2050 the number of people aged 60 or over is expected to rise to more than 430 million, or 31 percent of the population, from just 147.8 million, or 11 percent today. This would put it well above the projected world average. More worryingly, the percentage of China’s population that is working is expected to peak in 2010, with the ratio of workers to retirees declining from six to one in 2000 to two to one by 2040." Click here for a copy of the study.

"The heavenly mandate: Winning a piece of China’s pensions market" describes a 401(k) look-alike known as enterprise annuities. Fixed fees and a local investment requirement are two notable features. Asset allocation constraints are another. Equity investments are limited to no more than 30 percent of assets under management, 20 percent in money market instruments, and up to one half to be invested in fixed-income securities "but at least 20 percent must be kept in government bonds."

Asset allocation is touted by many experts as THE most important of all investment decisions, leading one to ponder. Will an arguably "conservative" mix require yet additional change? People can't pay bills with rates of returns and depend instead on having sufficient cash on hand. What happens if (when) people come up short?

From the "glass is half full" camp, reform comes none too soon. As an anonymous Chinese sage suggests: "Do not fear going forward slowly; fear only to stand still."

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Some things never change. On November 27, 1994, I wrote an op-ed piece for a local newspaper entitled "A prescription for Social Security" in which I warned of the entitlement mentality and the crushing debt load soon to be foisted upon young people everywhere. According to the editor, my suggestions for funding reform were not well-received, as evidenced by a flood of letters with the same message. "Keep your hands off my federal piggybank" and let someone else pay the price. (Like many others, I am an advocate of phased-in privatization for those who prefer to save on their own.)

Recognition of big problems ahead is certainly not unique to me. In his 1993 book, Generational Accounting: Knowing Who Pays, and When, for What We Spend, Dr. Laurence J. Kotlikoff warns of the great divide between the young and old. In their 2005 book, The Coming Generational Storm: What You Need to Know about America's Economic Future, Kotlikoff and co-author Scott Burns tell a grim tale of what has been chronicled many times before. A disproportionate number of persons are retiring from the work force, leaving those who remain to bear the staggering burden of a "pay as you go" system in the form of Social Security and Medicare.

Published last May, the 2006 Social Security Trustees Report states: "Over the 75-year period, the Trust Funds require additional revenue equivalent to $4.6 trillion in today's dollars to pay all scheduled benefits. This unfunded obligation is $600 billion higher than the amount estimated last year."

New York Times reporter Steven R. Weisman writes that Federal Reserve chairman Ben S. Bernanke is worried too, asserting that "Recent positive trends on the budget were a 'calm before the storm,' to be undone by huge deficits in federal entitlement programs. In "Fed Chief Warns That Entitlement Growth Could Harm Economy" (January 19, 2007), Weisman describes Senate testimony that sounds downright gloomy. "The longer we wait, the more severe, the more draconian, the more difficult the adjustment is going to be."

Unfortunately, as we know too well, attempts at entitlement reform are political folly and so the problem festers with little hope of short-term remedy

There are plausible solutions (hard ones but they do exist) IF only people would give up the ghost of an actual retirement piggybank in Washington, emblazoned with their names. In this case, Virginia - there is no Santa Claus.

Sorry kiddo!

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Credit illustrator Mike Dowdall for this delightful figurine. Now Art Director for Westland Giftware, after stints with Dakin, Portal, Hallmark and Bradford Exchange, Dowdall has created an entire line around the idea that "old is happening." (Click here to see more of his work.) Seeing a selection of this new product line in a local gift shop, I enjoyed a few chuckles but that's not all. It's yet another indicator that we are in for a radical change with respect to all things demographic. After all, no company is willing to commit funds unless they anticipate commercial success with lots of "geezers who get it."

Consider the following facts reported in "The Profile of Older Americans - 2005," published by the U.S. federal government. (Click here for a copy of the report.)

<< The older population (65+) numbered 36.3 million in 2004, an increase of 3.1 million or 9.3% since 1994. The number of Americans aged 45-64 - who will reach 65 over the next two decades - increased by 39% during this decade. About one in every eight, or 12.4 percent, of the population is an older American. Persons reaching age 65 have an average life expectancy of an additional 18.5 years (19.8 years for females and 16.8 years for males). Older women outnumber older men at 21.1 million. >>

This seismic shift in population make-up has the potential to impact every aspect of the U.S. labor landscape, not to mention the economic well-being of Corporate America. New York Times reporter Elizabeth Olson discusses the increased number of gray-friendly job boards. In "Some Web Job Sites Put Out 'Gray Hair Welcome' Signs," she writes: "Of the estimated 76 million baby boomers reaching retirement in coming years, some will start businesses. But the majority who continue to work will seek the familiarity and security of a regular paycheck."

At roughly twenty-five percent of total U.S. population, workers over 55 years could exert some serious bargaining power. Companies in desperate need of skilled workers will likely rethink their HR policies, including benefits that appeal to the "seasoned" set. That's on top of the oft-discussed cost of funding benefits for individuals whose lifespans are outpacing that of the trademarked Energizer Bunny.

Parenthetically, this pattern is not unique to the U.S. and arguaby more pronounced in countries such as Italy and Japan. Former U.S. Census Bureau Director Martha Farnsworth Riche describes "expensive housing, inflexible work practices, and persistence of traditional gender roles" as reasons for a reduction in new births, making seniors a large cohort in both an absolute and relative sense. (See "Population Aging: National Differences Make a Difference" - January 2004.)

Email us if you'd like some help in quantifying the relationship between demographics and your company's bottom line.

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According to the Census Bureau, U.S. population now exceeds three hundred million people. In contrast, the headcount was roughly two hundred million in 1968.

Additional numbers are noteworthy. With one birth every seven seconds, a death every thirteen seconds and one net international migration occurring every thirty-one seconds, it's easy to see that population will continue to grow.

Shades of Thomas Malthus, the English economist who warned that more mouths would deplete the available food supply, or an opportunity for innovation due to additional brainpower?

It likely depends on whether you see the glass as half full or half empty. However, one thing is clear. The population is graying at a rapid rate and there is real concern about the economic well-being of seniors who exit the workforce and younger persons who will be called upon to support them.

According to William Poole, president of the Federal Reserve Bank of St. Louis, "Changing demographics make it impossible both to maintain that traditional retirement age, with the level of benefits defined in current law, and to maintain the current level of taxation on the working population to support the retirement system." Global Action on Aging provides a vast collection of country reports about pensions. The message is the same sobering sentiment. Fewer and fewer people are going to have sufficient funds for their later years.

News from the federal front is equally grim. In "Status of the Social Security and Medicare Programs, A Summary of the 2006 Annual Reports", the Social Security and Medicare Boards of Trustees report that "The fundamentals of the financial status of Social Security and Medicare remain problematic under the intermediate economic and demographic assumptions. Social Security's current annual surpluses of tax income over expenditures will soon begin to decline, and will be followed by deficits that begin to grow rapidly toward the end of the next decade as the baby-boom generation retires."

My friends and I have this discussion often. Our conclusions?

1. We will work for a long time, perhaps well beyond the "typical" retirement age.

2. An increasing number of people will move into poverty as national benefits are cut, taxes are raised and private pensions are reduced or terminated altogether.

3. Taxpayers will struggle to fund troubled municipal plans while trying to save for themselves.

4. Fewer companies will offer benefits to new employees, forcing a lifestyle change that requires diminished spending, increased use of debt or both.

5. Health care problems will soon dwarf the pension crisis.

6. There is a perverse incentive for politicians to ignore making unpopular changes that might help in the long-run but hurt voters now. (Besides which, when is the last time a legislator had to worry about his or her retirement account?)

7. Individuals must get smarter and better about taking responsibility for their financial well-being.

8. Effective financial education is paramount.

9. Many individuals favor immediate consumption in lieu of systematic saving.

10. No particular individual or organization seems to "own" the issue.

You get the picture. It's a veritable challenge to be upbeat about what is fast becoming a global retirement crisis.

Is there a sunny side?

Yes but only if one is receptive to making changes. There will be winners and clever investors who identify them early on will do well. Some industries are already showing continued robust growth as our population ages in both absolute and relative terms. Health care is an example. Some see the forced move towards economic individualism as a return to the "get up and go" attitude of our forefathers. (Self-employed persons are already familiar with paying for their own benefits.)

According to an ancient Chinese proverb, "Many grains of sand piled up will make a pagoda."

It's time to get started on a serious savings plan.

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Talking about defined benefit plans is a little like listening to the Beatles.

You say yes, I say no.
You say stop and I say go go go, oh no.
You say goodbye and I say hello
Hello hello
I don't know why you say goodbye, I say hello
Hello hello
I don't know why you say goodbye, I say hello.

While some advocate their use as a means to attract and retain employees, others intimate their inevitable demise. Either way, one thing is certain. More and more companies seem to favor plan freezes in order to cut costs.

Dow Jones Newswire reporter Steven D. Jones points out that the newly enacted Pension Protection Act of 2006 encourages freezes by compelling companies to fully fund their obligations within a prescribed period of time.

Whether a freeze is "soft" and shuts out new entrants or "hard" and also halts benefits from further accruing, current retirees are not typically impacted. On the other hand, people in the system could end up with less money when benefits are tied to time in the plan.

Even when companies are flush with cash, freezing may make sense. Retiree longevity comes with a hefty pricetag in terms of funded benefits. Moreover, forthcoming accounting rules will force disclosure of pension obligations onto the balance sheet, an unwelcome event for some, especially if it leads to loan covenant breach.

Even writing from a few sunny vacation days in Arizona, this author has to admit that the pension climate sometimes seems downright Arctic.

Jacket anyone?

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Low birth rates, combined with large pension obligations, could spell trouble. That's why, according to several recent articles, many countries are now offering incentives to encourage natural parenting. Immigration reform is another approach.

Without change, countries such as Japan expect to cut pension benefits precipitously. Companies are worried too. A labor shortage could erode profitability in a big way.

There are so many questions. It's hard to know where to start.

1. Is it an invasion of privacy for national policy-makers to encourage individual lifestyle choices in order to preserve social benefits and promote "the greater good"?

2. Will working women respond to financial incentives to give birth or fret that it could deter them from climbing the corporate ladder?

3. Will child-free adults feel like social miscasts for not having children?

4. What should companies spend to create a "child friendly" work space and how will it impact shareholder value?

5. What is the nature of optimal immigration reform?

6. Should companies reach out to already retired workers and how could that affect the workplace dynamic between Generation X and Baby Boomers?

These, and a host of other queries, will keep politicians, sociologists and business professionals busy for months to come.

For background reading, try these articles.

1. "Cash Incentives Aren't Enough To Lift Fertility" by Mark Fritz, The Wall Street Journal, August 17, 2006

2. "Retiree benefits grow into 'monster'" by Dennis Cauchon, USA Today, May 24, 2006

3. "Low Japan birth rate may force pension cuts-report", Reuters, July 2, 2006

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Do you have happy workers? Productive workers? Loyal workers? So many news stories address the financial dimensions of THE pension issue. While important, ultimately the story is about the employees, isn't it? Ignoring tax considerations, companies provide benefits to protect human capital. Though this asset shows up nowhere on a company's balance sheet, it is nonetheless vital to profitability and growth. This is especially true for countries and industries where intellectual prowess determines success or failure.

According to a recent article in FORTUNE, the new paradigm urges managers to "hire passionate people". Citing research done by Christopher Bartlett of Harvard Business School, employees "want a sense of purpose". (See "Tearing Up the Jack Welch playbook" by Betsy Morris.)

In their best-selling book, First, Break All the Rules: What the World's Greatest Managers Do Differently, Marcus Buckingham and Curt Coffman regale the reader with countless suggestions as to how to manage people more effectively, including the need to keep people motivated.

Ironically, at a time when identifying and cultivating human potential is paramount, some leaders are still missing the mark. In today's Wall Street Journal, Erin White describes the disconnect between what companies say their performance reviews are supposed to measure versus what employees describe as their perceived opportunity set to advance and contribute. (See "For Relevance, Firms Revamp Worker Reviews".)

With so many companies shifting away from defined benefit plans, will there be a concomitant change in worker happiness? Do employees really choose a work situation based on benefits? Could plan sponsors be taking a short-term view without acknowledging long-term consequences? Do employees favor a parental approach or is individual empowerment the touchstone (in which case 401K and other choice-focused plans make perfect sense)?

There are no easy answers. People genuinely disagree about the role that benefits (quality, quantity, form) play in attracting and keeping good people.

One thing is certain, however. Corporations everywhere (U.S. and abroad) will be affected by changing demographics (recently described elsewhere in this blog). An oft-discussed dearth of skilled workers compels companies to think long and hard about the link between benefits and the bottom line.

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Many experts agree with Betty Friedan that "Aging is not 'lost youth' but a new stage of opportunity and strength." Unprecendented advances in healthcare technology and amassed wealth make life a happy lot for countless seniors.

Gray power is here to stay.

According to a report from the National Institute of Aging, "the U.S. population age 65 and over is expected to double in size within the next 25 years. By 2030, almost 1-out-of-5 Americans - some 72 million people - will be 65 years or older. The age group 85 and older is now the fastest growing segment of the U.S. population."

The U.S. is not alone. The AARP website includes an Associated Press story that ranks Japan as the "most elderly" country, pushing Italy to second place, with the elderly making up "almost 27 million of Japan's total population of nearly 128 million". Brandchannel.com reports that UK seniors account for eighty percent of the nation's wealth and forty percent of consumer spending. The financial services industry is gearing up for the nearby demographic tidal wave of seniors in need of estate planning and retirement services.

On the jobs front, countless numbers of seniors are taking suits and briefcases out of the closet and returning to work. To help combat the ill-effects of the silver ceiling, the AARP has created a National Employer Team to bring together various companies and older workers in search of work.

It's easy to understand why hiring the 65-plus set has appeal. A company enjoys ready access to well-trained workers, offsetting an otherwise scarce supply of labor. Rehiring employees might also mean that millions of dollars of retirement benefit payments are deferred until a later date. State and federal governments realize higher tax revenues. Seniors who want to work avoid the pressure of being forced into an unwanted, premature retirement.

All in all, a good thing!

As writer Lisa Belkin aptly states in the July 2, 2006 New York Times: "The Best Part Comes in the Third Act".

So does this mean that sixty is the new thirty and that being fifty makes one a veritable youngster?



Note: The photo, taken by Jud Burkett with the Spectrum, accompanies a story about Senior Olympics.

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According to economist John Maynard Keynes, "In the long run, we're all dead." That may be but the long run is getting longer. The Centers for Disease Control and Prevention report that "life expectancy for Americans has reached an all-time high" with women expected to live to 79.9 years and men giving way around 74.5 years. The good news is not unique to the U.S. More than a dozen countries have a life expectancy at birth of more than 80 years. What accounts for the female factor? Researchers Daniel Kruger and Randolph Nesse offer that men take more risks than women, exposing themselves to danger, especially in their twenties. (The gap seems to narrow over time.)

Living longer could be a blessing or a curse. Liz Pulliam Weston makes a compelling case that women are in retirement crisis mode. She warns that the fairer sex is likely to experience job discontinuity (and related income diminuition), earn less on average, outlive a spouse and save too little. Then there's a marriage penalty since "Single women are four times more likely than couples to live in poverty."

In pension land, longevity spells trouble. Plan sponsors find themselves in the unhappy position of having to fund benefits for an additional period. A KPMG study estimates a 2005 pricetag for British companies of "an additional 20 billion pounds in pension liabilities".

Longevity derivatives offer some hope. One form, annuity bonds, pay coupons that are linked to a pre-specfied survivorship index. From an investor's perspective, a low correlation with traditional offerings has appeal. Mortality bonds are another possibility. According to Kevin Dowd, one bond paid principal based on an international mortality index with a "generous floating coupon payment in return for accepting the risk of a reduced principal payment in the event of a catastrohic mortality deterioration". Yet another variation, still in its infancy, is the longevity swap. The outlook is mixed. In "The Grave Problem with Longevity Risk", professor Dowd describes advantages and disadvantages of this emerging market.

If actuarial predictions prevail, financial engineers could be extremely busy. Companies and governments will need help in managing pension and post-retirement healthcare benefits that are growing with kudzu-like speed.

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People are living longer, requiring even more in the bank to pay bills once they quit working. Studies consistently show that most people are saving very little and are not financially prepared to retire any time soon. Social Security trustees project costs to exceed tax revenues as early as 2017 and are urging reform. This is particularly compelling now that only three workers pay taxes into the system to support each existing beneficiary, compared to the original sixteen persons at inception.

Last summer, the U.S. Government Accountability Office released a study citing the largest ever deficit of $23.3 billion for the Pension Benefit Guaranty Corporation, a single-employer insurer that protects the retirement incomes of more than 40 million American workers in excess of 30,000 defined benefit pension plans. Executive director, Bradley Belt, stated that "financially troubled companies have shortchanged their pension promises by nearly $100 billion, putting workers, responsible companies and taxpayers at risk." In July, Standard & Poor's reported that defined benefit plans for 364 of the S&P 500 Index member companies remain under-funded by $165 billion. Public pension plans are struggling too. National Association of State Retirement Administrators statistics indicate a $300 billion aggregate pension shortfall for the largest state and city plans.

What do you think about the current retirement situation? Choppy waters or calm seas?

Take our five question survey and see what others think too.

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