This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 4 - 10, 2016.

Governments have made commitments that stretch years into the future, but have largely been unable to meet those commitments, according to Citigroup Inc’s report, The Coming Pensions Crisis, released on March 17. 

The total amount of retirement underfunding in 20 Organisation for Economic Cooperation and Development (OECD) member countries stand at US$78 trillion — almost double their total national debt of US$44 trillion. When comparing these liabilities as a percentage of the country’s gross domestic product, the numbers are just as staggering, the report says.

“[In terms of] government pension liabilities for public sector workers and social security, our own analysis of 20 OECD countries indicates an average level of unfunded government pension liabilities of about 190% of GDP. For that same cohort of countries, the reported amount of all government debt totals only 109% of GDP,” says the report. 

“European countries with significant state pension systems appear to be facing the greatest challenge. France, Germany, Italy, the UK, Portugal and Spain have estimated public sector pension liabilities of more than 300% of their GDP, according to these calculations.”

With the exception of Japan, the US, Canada and Australia, the level of contingent public pension liability in most countries is about two to three times the size of “conventional” public debt-to-GDP ratios. 

The report says the pension crisis has showed itself in different ways around the world. In Asia, there is a lack of retirement provision for a population that is rapidly ageing. There is an issue of underfunding in public-defined benefit schemes and a large corporate-defined benefit deficit problem in the US. In Europe, however, it is a government and public sector issue in unfunded and mainly social security schemes.

The changing demographics around the world, such as an increase in the retirement age population, accompanied by a decrease in the working age population, may not just be putting a strain on pay-as-you-go government pension schemes but also private pension schemes run by corporations. 

“Corporations have also not consistently met their pension obligations, and most US and UK corporate pension plans remain underfunded, with an aggregate fund status in the US of just 82%,” says the report.

Citi researchers say S&P 500 companies were estimated to have pension deficits totalling US$403 billion at end-2015, with total pension obligations amounting to about US$2 trillion. In the UK, FTSE 350 companies were estimated to have deficits of £84 billion and gross liabilities of £686 billion.

Also contributing to the issue are individuals in defined contribution plans who fail to have enough savings for a secure retirement. 

To address the crisis, the report recommends several solutions, including “publishing the amount of underfunded government pension obligations so that everyone can see them”.

“Governments must make data on the size of government and other public retirement commitments public. They must be clear about their assumptions and their size. This is the only way policymakers stand a chance of addressing the pension problem. 

“Governments and international bodies (for example, the European Union, International Monetary Fund and OECD) must agree on how to value these liabilities — with realistic discount rates and other assumptions — and introduce consistent reporting standards in published national accounts. Our calculations indicate that for a basket of OECD countries, there are US$78 trillion of unfunded or underfunded liabilities currently not being shown on government balance sheets.”

Another recommendation is for all countries to change their approach to retirement by linking retirement age with expected longevity. “Many countries (for example, the UK, France and Italy) are already in the process of gradually raising retirement ages to reflect this, but there is no explicit link with mortality tables. Not only could this have a substantial positive impact on liabilities (for example, raising the national retirement age by just two years could reduce liabilities by between 4% and 8%), but linking retirement to an independently monitored variable removes some of the politics from making this decision and also helps to ‘future proof’ the national retirement system. 

“As an anecdotal example to show the power of linking retirement age to longevity, if the retirement age were adjusted so that retirees received 12 years of retirement benefits (the retirement benefit that was originally forecast when instituting the US social security system), the new retirement age would be 73 and this would save about US$4 trillion.” 

Due to the unsustainable reliance on government pensions, there will be an inevitable move towards private pension savings. 

The report says the largest private pensions savings pool globally is currently in the US, with about 55% of the global US$26 trillion of pension assets invested in US pension plans. “Many other countries (such as the Netherlands, Iceland, Switzerland, Australia, the UK and Canada) also have very significant private pension savings schemes,” it adds.

These crises present opportunities for insurance and asset management companies to address this global challenge. “This is in line with a strong growth forecast in insurance pension buyouts, private pension schemes, and asset and guaranteed retirement income solutions.”

The report notes that private pension assets are forecast to grow between US$5 trillion and US$11 trillion over the next 10 to 30 years. In line with that, insurers and asset managers will have to be prepared for this shift, “making sure they have the right systems, right level of scale and an ability to generate adequate margins in what could be quite a highly regulated market”.

“Asset managers and insurers should also recognise the huge ‘decumulation opportunity’ in more mature markets where established private pension schemes and customers are coming to retirement. These individuals in defined contribution plans will need products to manage the risk of living too long: some downside investment protection, real returns to keep pace with inflation and some protection against longevity risk. We think both insurers and asset managers could be well placed to design products to manage retirement income.”

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