Ageing population and economic stagnation threaten pension systems
Pension systems are facing a far-reaching challenge due to the combined threats of the economic crisis, the ageing population and a lack of confidence in private pensions, according to the OECD’s Pensions Outlook 2014 report.
The OECD found that the current economic environment, characterised by low returns on investment, low growth and low interest rates has led to a reduction in governments’ revenues to finance retirement promises and, as a result, a loss of public confidence.
This is compounding the problems posed by the ageing population by undermining the sustainability of pay-as-you financed public pensions, creating solvency issues for defined benefit plans, and challenges the adequacy of defined contribution pensions.
The report notes that the crisis has spurred policy makers to speed up reforms to make their pension systems more sustainable while addressing adequacy concerns in ageing societies through a combination of measures, such as increasing coverage, encouraging higher contributions – especially in complementary funded private pensions, adjusting benefits, and extending contribution periods, particularly by postponing retirement.
Acknowledging the benefits of the recent reforms, the OECD warns that much work remains on the agenda. Balancing sustainability and adequacy, diversification between public and private pensions, tackling the high costs of running funded private pensions, the conflicts of interest of pension advisers, and improving the structure of the pay-out phase of defined contribution pensions by encouraging annuity products, are yet to be addressed.
Report highlights:
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The report calls for strengthening the regulatory framework to help pension funds and annuity providers deal with the uncertainty around future improvements in mortality and life expectancy. Failure to account for future improvements in life expectancy can result in a shortfall of provisions of well over 10% of the pension and annuity liabilities.
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Contributing more and for longer periods partially addresses the challenge that population ageing poses to pension systems. In addition, individuals will need to diversify the sources to finance retirement and more efforts are needed to assist older workers find and retain jobs. Public policies to reduce age discrimination, improve working conditions and increase training opportunities for older workers are essential.
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Auto-enrolment programs have been successful in raising coverage in countries that have implemented them. However, the best approach to reaching high coverage rates is to compel individuals to save for retirement.
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Capital markets could offer additional capacity for mitigating longevity risk, but the transparency, standardisation and liquidity of instruments to hedge need to be facilitated. The regulatory framework will also need to reflect the reduction of risk exposure these instruments offer, by ensuring they can be appropriately valued by accounting standards and lowering the level of required capital for entities hedging their longevity risk. Issuing a longevity bond or publishing a longevity index to serve as a benchmark for the pricing and risk assessment of hedges could facilitate their eventual liquidity.
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Rebuilding trust is also an important challenge that policy makers face, says the OECD. Young people in particular need to trust the long-term stability of the pension system and the pension promise that is made to them. In that respect, the OECD report stresses pension statements and communication campaigns as key tools to convey the need for reform and ensure that individuals make optimal choices regarding their retirement savings.
Pablo Antolin, Principal Economist and Head of the Private Pension Unit, commented:
“The compounding pressure Governments’ finances and increased longevity is undermining the sustainability of pension systems across the OECD countries. Although many members have begun in depth reforms, this is still work in progress. It will take many years to embed the changes and further measure will be required to strengthen private pensions, increase coverage and contributions, and reinstate public trust.”
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