The 'P' Word

Posted by Allison on 4 April 2009, 10:21

There is an 8-letter word that can strike fear into the hearts of even the sternest of souls.  Anyone operating on any financial markets or dealing with any long term financial planning, anywhere in the world, will know this word well (or its equivalent in their own language) and really will not want to hear it, since it is such a dreaded word, but it really has to be talked about.  In a sense, the nettle has to be grasped.  It has to be said….. Pensions!

Ever since the credit crunch hit the US, there has been a steady stream of interest in the media not just in the US but also in the rest of the world's media about whether or not people are saving enough for their retirement.  Partly the anxiety associated with whether or not people are saving enough, is actually to do with the volatility of company pension funds and the fact that some employers have not been meeting their requirements to pay money in.  Effectively this has resulted in a shortfall for many people in terms of their pension plans.

So, because employers have not been meeting their requirements and because governments are worried that they do not have enough money to meet any projected shortfall, the onus is placed back on the individual to be able to provide for their retirement and ensure that they are not a burden on the state.

Concern about how much money people were saving for retirement started around 2003-2004 and effectively has been with us every since.

If you live in a developed country, then it is likely that you will have some kind of pension scheme or retirement plans if you are of working age.  If you don't, then no matter how young you are, it really is something worth thinking about, because we are all living longer and because of this, people are receiving pensions for longer and the pots of money available within pension schemes, seems to be getting smaller by the minute.

Is there a crisis looming?

Given how much hysteria there is currently, in the world's media as a whole, it is relatively hard to estimate the risk of a pensions crisis.  In a sense there is such hysteria generally about anything to do with finance that it is increasingly more difficult to divide fact from fiction.

However it does seem likely, that there may well be some problems ahead for those involved in financial markets and for those who will be drawing a pension or a retirement plan.

The possibility for an impending pension crisis was made by Adair Turner's Pension Commission as long ago as 2004, when it announced, quite calmly, that the majority of people simply do not make rational decisions about any longer term savings, unless they are given advice… and encouragement.

Then in 2005, president Bush said that pensions would have to be reformed to ensure that people could be well looked after in their future.  But one very chilling aspect of his speech was that the social security system in America could potentially be insolvent as early as 2041 unless it underwent a significant overhaul.  A frightening prospect indeed.

Around this time, other voices started to be heard saying pretty much the same thing and this was just before the credit crunch really started to kick in.  Some firms started to default on paying mortgages and then there was a landmark case in 2005 when United Airlines actually had the biggest ever corporate default in terms of a pension plan.  The losers in this case were really the airline's 14,000 pilots, who may only receive some 20%  of the retirement benefits that they had been promised.  Pension funds for this one airline alone were actually under-funded by a total of $6.6 billion.

Sadly, this was not an isolated case in the United States and indeed has been replicated several times.  In the US, the Pension Benefit Guaranty Corporation is a government-funded organisation that covers any liabilities if a company cannot pay its pension plan.

During the financial year of 2002, the PBGC's balance sheet went from a staggering $7.7 billion surplus, to a very scary $3.6 billion deficit.  There were some serious problems in the US economy!

Then came the credit crunch and soon it was not just the United States that was starting to fret about its pensions but the rest of Europe as well.

Primarily this was because of the way that the sub prime lending market had been funded.  Money had been loaned from European institutions to the US lenders.  When it became clear that this money was not actually going to be recovered, then this affected stock markets throughout the world.

As a result, many pension plans that were linked to stocks and shares were suddenly seriously devalued, often overnight.

Increasingly governments throughout Europe began to talk about the effects of the ageing population, the lack of money in pension plans and the fact that many countries in Europe do not have a high birth-rate, which means that in 20 years' time, there will be fewer people of working age.

Why does nobody want to think about pensions?

Generally, the whole pensions issue is seen as something of a bore.  One of the main problems pensions face, is that when people are really young, a pension is almost the last thing that they want to think about.  People tend to think that they are invincible when they are young.  Young people tend to think that getting old is a condition that affects other people, but it certainly will not happen to them.  Then they get older, start to acquire material possessions and perhaps a house, maybe get married, perhaps have children and money is a little bit tight, so it could well be something that they will think about when they are 40.

Then they get to 40 and decide that they will look into organizing a retirement plan or a pension.  And then, panic sets in, this retirement plan is going to cost a lot of money if it is to provide for a relatively long time.  Since no one wants to die early, everyone wants to have a pension plan that will pay out a fairly good rate, for as long as possible.

In the US, UK and other countries, pension plans have now been amended (or soon will be) so that any worker who joins a company will either automatically be enrolled in the company pension or they may have a state sponsors pension scheme.  This is the seen as the only way to increase people's contributions and make sure that people plan adequately for their retirement.

In the United Kingdom, Prime Minister Brown has even indicated that he may introduce a tax to make people pay for their retirement, a kind of elderly tax that you pay whilst you are in work.  This was widely opposed and he does not seem to have repeated it, but it may well happen at some stage.

So is there a crisis?

Undoubtedly much of the angst surrounding pensions has actually got worse after people realised that pension schemes they had bought in to and pension promises that had been made by governments, were not worth as much money as they had believed.  Some of the media coverage has also not helped because people have been whipped up into frenzy by the media and many people have had such a crisis of confidence about the state of their economy and the effects of the credit crunch that they are now fearful about anything relating to finances or investments.

Economists generally reckon that people ought to save enough for retirement, so that they are able to consume roughly as much after they have retired, than they did before they retired.  Naturally, when people are going out to work they tend to spend more on clothes and perhaps their daily travelling costs are higher.  But when these figures are taken off someone's income, the figures should be comparable i.e. how much money somebody has before they retire and how much they have afterwards.

Nobody does actually know how much everybody is saving and whilst media coverage in the US and Europe would have us all believe that everybody lives on credit and nobody saves, undoubtedly some people do save and many may save sufficient means to ensure that they have a comfortable retirement.

Yet a spin-off from the credit crunch is actually that it is more difficult to save, because if the money is invested in stocks and shares then these may have been affected by the credit crunch and so the value of the stocks and shares may have declined.  Also, in the US the Federal Reserve Bank has cut interest rates seven times recently and this has led to less being paid out in terms of interest, which makes it difficult for people to be able to accumulate a reasonable amount of savings.

However, in 2006 an analysis of retirement saving was undertaken by John Scholz.  His analysis found that 80% or more of Americans seemed to have taken adequate steps to ensure that they could retire with sufficient sums of money in the bank.  Of the other 20% not many were facing a really desperate future.

One economist, Laurence Kotlikoff, who has gained quite a reputation in the US for his criticism of the way that the US government has run up a serious amount of implicit debt in terms of social security promises, is actually fairly relaxed about personal savings.  He believes that savings plans and pension plans may actually be over sold.  His theory is that the retirement calculators which you can find on any investment company website, will oversell you a product.  This means that you log on to the website, enter your details into the retirement calculator and it is supposed to work out how much you actually need to save in a pension plan and how much you will need for your retirement.  He says that generally these calculators will recommend that you actually save too much money and they will try to get you to buy too much insurance.

He also asserts that this is a general problem with retirement calculators, not just one that is limited to the US.

So it could well be that many people who are currently fretting about whether or not they have saved up enough money to see them through their retirement, may actually be more secure than they thought.

However, unless somebody is retiring tomorrow, it is very difficult to know just what the effects of retirement will be.  Nobody is really able to predict the state of the economy tomorrow or next week, let alone 20 or 30 years in the future.

There are however, some particular issues that may affect how much pension people receive.  Unfortunately these are the usual issues that seem to be the curse of humankind in the 21st Century, namely global warming and the effect that this may have on financial markets, the increased price of oil and the increased demands for fuel worldwide.
Added to the pension issue is also the fact that we are living longer but as we do live past 70 or 75, we find that we have increased needs for healthcare and that at times these needs are quite expensive to meet.

So, in some ways there would appear to be significant risks associated with pensions.  For those living in the US the weak dollar will also impact on how much the stocks and shares in their pension plan can buy.  Conversely for those who are living in Europe, or anywhere with a particularly strong currency, they can possibly look forward to a brighter future due to the fact that their currency will be able to buy more stocks and shares, particularly those that may be of good value due to the dollar being so weak.  Thus as with so many cases where money is involved there are winners, but there are also losers.

One way to solve the potential pensions problem, is to extend the working age.  In the UK over the next 30 years, the pensionable age will gradually be increased.  This means that people will have to work longer, up until the age of 68 until they can qualify for the state pension.  This may well happen throughout Europe.  In Germany for example people tend to retire currently at around the age of 63, but this is likely to be increased over the next few years.  Some surveys that have been carried out recently indicate that although Germany has an incredibly high level of public spending, by the year 2031, one in three pensioners will not be able to survive financially if they only have their normal state pension to rely on.

Clearly then, if you are going to be a pensioner in Germany after the year 2031, you will have to start saving now to ensure that your retirement will be comfortable.

In Italy, the situation is little better for its prospective pensioners.  Within the next 10 years Italy's pension fund, which is administered by the state will actually have to pay out more than it receives in income.  Currently around 42% of the Italian population is over 60 and this figure is set to rise and will be in the region of 53% by as soon as 2020.  This figure means that there will be a significantly higher number of people who are relying on assistance from the state, than there will be people in work.  Consequently those people in work will have to save for their own pensions, but also contribute to the pensions of the 53% of the population that is over 60.  It is likely that as a result, the pensionable age will be raised significantly over the next few years.

So there may not be a definite crisis at the moment and pensions are not being withheld, but when we look to the future, it is certainly a far from rosy picture and people need to be aware that all kinds of factors do affect pension funds.  These factors range from how much demand for energy and oil there is in China and India, to whether or not the OPEC countries are able to stabilise the price of oil.

Thus pension schemes can seem a little like a tiny ship being buffeted on quite a tumultuous ocean.  Ultimately, because they are such a long-term investment, any pension scheme will have times when it is more successful than others.  Such is the nature of long-term investments and it is likely that there may be some turbulent times ahead for pension schemes, not just in the US but also in the rest of the world, as markets and economies are relatively shaky and are awaiting the end of the credit crunch and a return to some kind of normality.