The main trend in worldwide pension reform is the shift from pay-as-you-go defined benefit to funded defined contribution, according to the World Bank. Addressing the World Pension Association conference in Dublin last month, Richard Hinz said this involves moves from “large first-pillar public systems to multi-pillar models. From single assets to a diversified portfolio.”
“This is something the World Bank has been a strong advocate of,” Hinz said. “Many current pensions systems are unsustainable at the level of demographic change we are now facing.”
An increase in life expectancy of 25% after the age of 60 had occurred since 1970. Such changes bring a disproportionate change in the pension cost of perhaps 50–60%. The more that is invested in health care the greater the impact in pension cost provision, he said. “There are some difficult tradeoffs here.” Even the lower income countries are seeing significant increases in life expectancy. “Birth rates are converging around the world to replacement rate,” he said.
The typical PAYG system was not designed to cope with such demographic trends. “Most countries would require more than double their contribution rate. As currently these are in the range of 15–30% of payroll, they could go to 50%. This is not just sustainable.” Unless retirement ages could be increased by 10 years there could be an “apocalyptic reaction”.
One of the key features of population ageing is the effect on the labour and capital markets, Hinz said, adding that one of the future problems for growing the economy will be future labour shortages. And the greater the tax disincentive to work, the greater the proportion of unused labour capacity.
Some innovative work was being undertaken in public systems, he said. “Latvia and Poland are moving to the so-called ‘notional defined contribution systems’, a hybrid of DC and DB. Hinz described this move as “somewhat controversial” adding they have been dubbed ‘virtual pensions’. The jury was still out about this development, he said.
There also had been interesting developments in Europe on the administration of pension, with the use of centralised clearing-house administration for the collection of contributions. He said that the Swedish use of a clearing house is one of the more fascinating reforms that used the concept of managed competition. This meant private management of the assets, with distribution to the market controlled by a clearing-house approach.
We are seeing “interesting developments” in payroll deduction and use of employers to collect contributions. This is probably the most efficient way to collect them, he said.
The role of employers throughout the world “in the places with strong occupational schemes employers are withdrawing from their role and taking less responsibility for guaranteeing benefits. They are acting more as financial intermediaries.”
The benefits to be expected from pan-European pension funds were outlined by MEP Piia-Noora Kauppi. The Finnish MEP is a member of the European Parliament’s economic and monetary committee.
The economies of scale that the new directive on pan-European pension funds will allow pension funds would create benefits, she said. “Investors would see better returns,” she added.
There would be a positive effect on Europe’s capital markets, she pointed out. The amount to be invested in pension fund arrangements in Europe could come to e2.5trn, equivalent to 25% of European gross domestic product. “This is a huge amount of capital.”
The bigger multinational companies would certainly benefit from the proposed directive, she said. “They may stand to gain the most,” she said. But she also saw that smaller and medium sized businesses involved in cross-border activities could benefit.
She believed that companies with activities in just three or four countries could benefit, especially if they were operating on a regional basis. “If you can pool your assets in one investment portfolio and in one administration there are huge advantages.”
Strong positive news about pension developments came from Latin America, when Guillermo Arthur, president of FIAP, one of the driving organisations behind the WPA, addressed the conference. Altogether 55m people in Latin America were in the reformed mandatory pension systems, with a further 20m in eastern Europe, using Latin American type models. Together these accounted for $101bn in assets in 2002. Apart from Argentina, where assets dived, the eight other LA reforming countries showed continuing growth in assets up to last year, with still high rates of inflation-adjusted returns. “Actual pension fund investment returns have been higher than the level estimated at the inception of pension reform,” he said.
But the weakness of the world economy is having a negative impact on pension fund returns. “This situation could strengthen opposition to pension reform,” he warned.