Elizabeth Corley: A pension crisis is looming

Saving for retirement has never been more challenging than today

As it quietly eats away at accumulated assets, financial repression is becoming a real existential threat to people saving for retirement. It makes the difficult task that employees face building an adequate pension nest egg in the new world of defined contribution (DC) pension schemes even harder and, ultimately, could be setting the scene for a future pension crisis.

With DC pension schemes having come to dominate the retirement landscape, individuals must now assume a greater share of the investment risk involved in preparing for retirement. But this challenge is even more fraught with difficulties than in the past as interest rates are set to extremely low levels in most developed economies – and are likely to stay there for some years.

Currently, with central banks continuing to keep interest levels artificially low, pension institutions are struggling to earn the returns they need to fulfill their mandates. Add an aging population and a lack of political will on further retirement reforms, and you understand why considerable pressure is mounting on systems in many countries.

Future pensioners, particularly in Europe, could be in for a horrible surprise in terms of the reduced size of their final pension pot. Partly this is due to the fact that many have not yet realized how dramatically public pension benefits have been cut in their countries. In Germany, for example, according to the European Union’s Pension Adequacy Report, public pension benefits will be reduced from 53% of a retiree’s final wage (assuming they have worked 40 years) to an estimated 44%.

Nor have future retirees realized that with the shift from defined benefit (DB) pension schemes to DC systems, occupational pensions are no longer calculated as a percentage of earlier income, but on contributions paid in and the returns they yield. In an era of financial repression, it is difficult to generate the returns on capital markets that are needed to support an individual for up to three decades of retirement.

MIXED MESSAGES FROM THE FED

The Federal Reserve in the United States finally made an interest rate hike last December – the first in nearly a decade. Although modest, it could have provided some certainty after years of contradictory comments by Fed representatives. Alas, this has not proved to be the case. Investors are still left trying to interpret how high this may go even as they try to factor in the negative interest rate policies of other central banks.

Such an approach has discredited one of the central bank’s most important tools – the ability to stabilize markets via comments. This leaves central banks in a tight spot at least in terms of monetary policy. It is now time to consider other levers apart from financial repression to resuscitate economic growth.

In Europe, political initiatives, such as the planned Capital Markets Union of the European Commission, offer a ray of hope. Indeed, the proposals outlined in the Capital Markets Union would improve aspects of capital market efficiency and contribute to more and better market financing of infrastructure, investment and job creation, thus diversifying funding sources and long-term projects.

If the Capital Market Union is ever realized, its benefits will come well into the future. We are dealing with the here and now. While it is unlikely that any national pension systems will collapse – despite the pressure mounting on them – the consequences of the current low yield environment will become more visible as time moves on.

As people age and retire, state reductions in social security will be reflected in increasing levels of old-age poverty within society, unless individuals are made aware of the full extent of the retirement challenge ahead of them and begin to seriously save. However, as the absolute number of retirees increases, even if the amounts to each of them is smaller than in the past, the overall cost imposed on the dwindling number of active workers to fund social security could lead to increased tension between generations.

This is also one of the dangers inherent in the present situation. The longer financial repression continues, the longer we have near or even negative interest rates, the greater will be the detrimental effects on people hoping to save for retirement.

For a global overview of the shift from DB to DC, download the PROJECT M Global Pension Atlas

Elizabeth Corley: A pension crisis is looming

Saving for retirement has never been more challenging than today

Elizabeth Corley: A pension crisis is looming

Saving for retirement has never been more challenging than today

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