 Excerpt from the Executive Summary from Mr Patrick M Liedtke and Dr Kai-Uwe Schanz.
The notion of formal retirement is relatively young. In 1881 Chancellor Otto von Bismarck introduced the world’s first pension scheme in Germany. Prior to that, people generally worked “until they dropped”. However, when von Bismarck introduced his revolutionary scheme of protecting workers in their old age, it was only a very small minority of the population that ever reached the official retirement age of 65 years—then a full 20 years higher than the average life expectancy of a German worker. The scheme was never meant to become a social achievement that would allow almost all of its contributors to spend an increasing period of their lives in (relatively) good health while drawing a pension. Nevertheless, due to the extraordinary increase in life expectancy during the 20th century, it became one of the key components of the social contract and is often regarded as one of the great achievements of modern civilisation.
Following the Second World War, pension schemes in the developed world became ever more generous on the back of economic prosperity and relatively contained dependency ratios, i.e. the ratio of beneficiaries of the system to its contributors (usually approximated by the ratio of the over 65-year-olds to the 15-64-year-olds). From the 1990s, however, the awareness of a massive demographic shift has started to grow with the retirement of the post-war baby boomers looming. Average dependency ratios in the developed world have halved from their post-war high of around seven people. Governments in advanced economies generally acknowledge that their pension and healthcare schemes are becoming increasingly unaffordable and unsustainable. Some have started responding by raising retirement ages, lowering payouts and encouraging more private old-age provisioning through higher savings. The need for individuals to take their post-retirement destiny in their own hands has also been heightened by an inexorable shift from defined corporate pension benefits to defined contributions.
The current debate about sustainable pension systems is all about spreading the burden over several pillars. There should be (1) a state pension to meet basic needs in old age and avoid people falling into poverty, (2) a private occupational pillar, funded by employers and employees that tops up the first to keep living standards on a higher level, (3) a voluntary individual savings pillar that contributes additional income and risk diversity and (4), as conceptualised by The Geneva Association as early as 1987, a fourth pillar based on part-time post-retirement work. But it is also clear that the balance between the various pillars is set to change: state pensions are being reined back and occupational schemes are getting not only less generous but also less predictable. In order to offset the accelerating erosion of Pillars I and II, the two remaining pillars, i.e. private savingsand insurance solutions as well as working beyond formal retirement ages, will need to be strengthened markedly. And this is precisely where insurers have a much bigger role to play going forward.
They are in a unique position to enhance Pillar III savings by a transfer of longevity risk, the risk of pensioners outliving their savings, as well as the assumption of a sizeable part of associated asset risks. Insurers also have the skills and experience to design (innovative) products specifically catering to those who opt to work beyond the formal retirement age.
The current environment makes this crucial contribution from the insurance industry both socially more desirable and economically more challenging: in the wake of the financial crisis, the fiscal positions of rich-world governments have deteriorated dramatically within just a few years, leaving even less room for coping with the inevitable long-term challenges of spiralling public pension and healthcare expenditures. At the same time, employers are confronted with the prospect of protracted subdued economic growth in their core markets. As a consequence, they face an uninspiring outlook for revenue and profitability while the pension obligations to their (former) employees continue to grow. These developments are set to accelerate governments’ and employers’ gradual withdrawal from their traditional role as major and predictable sources of retirement income. Helping to fill this gap is not simply a business opportunity for the insurance industry. It arguably is also its most relevant long-term contribution to economic and social stability. A simple example: a key social benefit of annuities is that those who have bought them are much less likely to fall back on state benefits or suffer the fate of old age poverty.
Having said this, insurers face unprecedented challenges in their quest to capture these business opportunities and to meet the accompanying social obligations: returns on investments, a core pillar of life insurers’ business model, have reached record-lows. Government efforts to boost ailing economies and prop up struggling banks have left interest rates at rock-bottom levels, making it challenging for insurers to help strengthenthe third pillar of retirement.
Against this multi-faceted and intriguing backdrop, The Geneva Association has initiated a comprehensive research effort focusing on the future of retirement systems and insurers’ contribution to their long-term sustainability. This effort builds on The Geneva Association’s multi-decade record of researching into and publishing on the subject matter.
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