Debt Crisis Ravaging World’s Pension Systems?

The Globe and Mail reports, Debt crisis takes a toll on world’s pension systems:

Greece, India, China and Thailand are home to the weakest national pension systems in the world, crippled by a mix of acute sovereign debt, young retirement ages, high ratios of pensioners to workers and poor pension take-up, a study showed.

The Allianz Global Investors Pension Sustainability Index, which tracks the relative sustainability of national pension systems in 44 countries around the world, showed the number of Greek retirees to people of working age remains above the European average.

The country has committed to addressing this ratio as part of a series of pension system reforms demanded by the International Monetary Fund and European Central Bank, who are overseeing the distribution of financial aid to Greece.

In India, China and Thailand, roughly 12 per cent of the population contribute to a pension, while the weaknesses of Thailand’s pension system are compounded by an average retirement age of 55 years, compared with 65 years in most western European countries.

The ratio of retirees aged 65 and older to population aged 15-64 years is expected to top 40 per cent in China and Thailand by 2050, above the rate forecast for Cyprus, Britain, Luxembourg, Norway, Ireland and Denmark.

Comprehensive pension systems remain the exception rather than the rule across Asia, Allianz GI said. But a rapid rise in sovereign debt across more developed economies has pushed the need for pension fund reform up the national agenda in Ireland, France and Spain this year, the index shows.

Further afield, Estonia, Hungary, Latvia, Lithuania, Poland and Romania have channelled contributions to privately funded second schemes to the ‘pay as you go’ public system in order to strengthen fiscal positions. Conversely, Norway and Finland benefited from their comparatively solid public finances.

“The negative impact of the financial crisis on accumulated funds and national economies has tested the resolve of many governments,” said Renate Finke, senior economist at AllianzGI.

“In central and eastern Europe, for instance, some countries decided to put their hand into the proverbial pension-fund cookie jar in response to the dramatic rise in debt to GDP ratios,” the economist said.

The world’s strongest pension systems can be identified in Sweden, Denmark, New Zealand, the Netherlands and Australia, the study showed. All countries benefit from highly developed, privately funded systems which lessen the potential burden on public finances.

Canada also made the list of the world's strongest pension systems but I can tell you that a lot more work needs to get done to shore up our pension system. In my humble opinion, the Netherlands is way ahead of every other country in the world when it comes to bolstering their pension system.

But even Dutch pensions have sustained losses and cuts loom following the eurozone debt crisis:

Pensioners in the Netherlands could face cuts in retirement benefits because their savings are being hit by ongoing market turbulence as the euro-zone debt crisis takes its toll on one of Europe's strongest economies.

Four of the Netherlands' largest pension funds Thursday (month ago) warned that they may have to reduce pension payments in 2013 because troubled markets are knocking holes in their capital buffers. Their coverage ratio, which measures assets relative to liabilities, has over a period of a few months fallen below the legally required minimum of 105% to between 84% and 91%. This means they technically don't have enough money to meet their financial obligations.

The funds, which cover over 5.5 million active and retired workers, blamed the debt crisis in the euro zone as choppy markets resulted in lower investment returns. Low interest rates added to their problems.

"As long as European leaders shirk their responsibility for arriving at a definitive answer to the European debt crisis, it will not be possible for Dutch pension funds to start showing sufficient recovery," said PFZW, a pension fund for the healthcare sector.

European governments are expected this weekend to present a new package of measures aimed at solving the crisis.

The impact on Dutch pension funds highlights how the euro zone debt crisis is affecting the bloc's core countries. The Netherlands is considered one of Europe's healthiest economies and is one of the six triple-A-rated countries in the currency area, making it a small but important contributor to the European bailout fund. The country has one of the world's most lavish and robust pension systems, according to a recent report by the Mercer consultancy.

Still, consumers in the Netherlands are losing confidence in the economy. Fresh data showed Thursday they have never before been so pessimistic on the outlook for their personal finances. Unemployment is still relatively low, but it rose to 5.6% in September from 5.4% in August.

The prospect of lower pensions may add to the gloom. Cutting pensions is a thorny issue in the Netherlands, where many citizens expect to receive 70% of their salary when they retire. Its workers are thrifty savers and they have built up a huge capital buffer of around EUR750 billion through a quasi-mandatory system that requires them to save for retirement through their employer's pension fund. Retirees will receive this money on top of their state pensions.

The Dutch Central Bank, the sector supervisor, has given pension funds an extra year to solve their problems. But they will be forced to cut payments as of April 2013 if difficulties persist in the fourth quarter.

"Our pensioners ... are entitled to expect that we will do our utmost best to prevent that from happening. But we cannot postpone taking measures indefinitely," PFZW said.

At the IQPC conference last week, Norman Ehrentreich of RBC Global Asset Management discussed how the Dutch are way ahead of everyone else when it comes to managing pensions because they're proactive and have a legal requirement of an 105% coverage ratio. Under this legal threshold, they're considered insolvent and have to present a plan with a specific timetable as to how they will close the gap. This is quite outstanding as most US pension funds would salivate at the thought of a 105% funded status.

At the opposite end of the spectrum are Greek pensions, which not surprisingly, ranked last in the new global study:

The Greek pension system was ranked the worst in a new study because of its acute sovereign debt and overly generous promises, while Australia was found to have the most sustainable system.

The Pensions Sustainability Index (PSI) produced by Allianz Global Investors (AllianzGI) analyses the current and future prospects of national pension systems in 44 countries around the world. The index examines relevant elements of pension systems such as demographic developments, public finances and pension system design to capture in one figure the need for further pension reform.

Greece was found to be under the most pressure to reform, with a pension system that is "buckling under its sovereign debt crisis." Greece was ranked the worst despite pension reforms initiated as conditions of austerity packages issued by the International Monetary Fund (IMF) and the European Central Bank (ECB). Greek's old age dependency ratio (the ratio of elderly people to people of working age) is also well above European average.

AllianzGI head of international pensions, Brigitte Miksa said: "While pension reform has been at the top of the political agenda across the globe for many years now, the progress of reform itself differs considerably from country to country, hence the need for an Index to show at a glance how countries compare."

"In this current study, Greece, India, China and Thailand show the greatest need for pension reform, although not due to a common cause."

Extremely low coverage is the main challenge to India's pension policy, with only 12% of the population is covered by any type of formal pension arrangement. China and Thailand are also under pressure to reform due to low coverage. Thailand's pension system is also suffering from an extremely low legal retirement age (55 years).

Emerging markets in Asia were also found to be facing major structural changes. Strong economic growth has led to a prosperous middle-class in the region, however increased urbanisation and a breakdown in traditional family structures have caused extreme socio-economic changes which the report said is altering the retirement landscape.

Comprehensive pension systems are the exception and not the rule in most of Asia according to the report and increasing the coverage of the public pension system is a challenge. Many Asian governments are beginning to implement a multi-pillar system by introducing a variety of funded pensions.

Australia's two-tier system of lean public and highly developed funded pensions puts it under the least pressure to reform, the report said. Australia is followed in order by Sweden, Denmark, New Zealand and the Netherlands.

Other trends included an ongoing shift from pay as you go systems to funded systems, a move from defined benefit to defined contribution systems and a rise in more formalised public systems over family support structures worldwide.

As I stated above, the Dutch are way ahead of everyone else, including Australia whose pensions are way overexposed to their domestic equities (much worse than Canadian pensions).

As for meaningful pension reforms in Greece, I'm not holding my breath. After visiting with Petros Christodoulou last year, Greece's 300 billion euro man (now 350 billion +), I realized that Greece has a bunch of civil servant political cronies running their pension schemes. If Greece wants to get serious reforming their public sector pensions, they should hire the world's best pension and investment consultant. The problem is that I'm too ethical and will demand transparency and accountability. I'd start by immediately firing all the corrupt clowns running Greek pensions. I'd do the same here in Canada with certain individuals, which is why they're petrified of me and still not hitting my bid. -:)

***Feedback on Dutch Pension System***

Norman Ehrentreich of RBC Global Asset Management sent me some interesting feedback on changes to the Dutch pension system:

As it happens, the very same day when I praised the Dutch pension system at the IQPC conference, I became aware of a detail of the Dutch Pension Agreement that has escaped my attention so far. As a reaction to some of the same problems that plague DB pensions worldwide – a combination of the ageing population, faster-than-expected longevity increases and market volatility – the Dutch social partners agreed in June to wide ranging pension reforms.

In addition to raising the pension age from 65 to 66 and linking it to future increases in life expectancy, one important detail that slipped by me is a change in the discount rate: Previously, Dutch pension obligations were valued by market-based swap rates. It will be replaced by an expected rate of return. After listening to my presentation at the conference you are probably not surprised that I consider that change to be a terrible mistake.

Depending on the type of investment portfolio, expected returns don't have to be terrible estimates of future pension costs. But for most pension portfolios with a high allocation to risky assets, expected returns systematically underestimate future pension costs. It looks like the Dutch too, wanted to solve their pension problems with a combination of real pension reform and accounting gimmicks.

Here are two links to some IPE articles that discuss this change and its possible implications.

I may have to rethink whether I can still point out to the Netherlands as a beacon in a troubled pension world. I am afraid that this change may become the beginning of a slippery road on which the Dutch are tempted to make the same mistakes that their peers in most other countries have already done.

Are the Dutch capitulating on their pension promises? It sure looks that way. The world's pension systems are a lot weaker than we've been led to believe.