Europe's Pension Time Bomb?

Francesco Guerrera of Politico reports, European pension schemes ‘vulnerable to big market downturn’(h/t, Suzanne Bishopric):

Many work pension schemes are vulnerable to a major market and economic shock, the first Europe-wide stress tests of the sector found.

The tests, carried out by the European Insurance and Occupational Pensions Authority (EIOPA), found that dramatic falls in equity prices and other adverse economic occurrences would dramatically reduce the amount of money held by pension funds to pay for the retirement of current and past workers.

Pension funds suffer when markets fall because they invest in equities, bonds and other asset classes. Any reduction in interest rates is also detrimental because it reduces pension funds’ returns.

The results, released Tuesday, showed that “defined benefit” schemes — ones where the pension payout is based on the number of years worked and the level of salary attained — would find themselves with a deficit of more than €750 billion almost overnight under two different adverse scenarios.

That equates to a funding ratio — the amount of money available to pay for pensions — of between 59 percent and 61 percent of future liabilities. Such a low level would put pressure on pension funds to find other ways to fund the gap, such as reducing benefits or forcing the financial groups or companies that run the schemes to inject capital into the funds.

“While pension plan liabilities have a very long-term nature, it is important that supervisory regimes are prepared to deal with these stresses in a transparent way, be it through appropriate recovery periods, the role of pension protection schemes, increased sponsors’ contributions and/or benefit adjustment mechanisms,” said Gabriel Bernardino, chairman of EIOPA.

You can read the entire IORPs Stress Test  Report 2015 to get a better understanding of the serious challenges many European pensions face.

I strongly recommend you read the report as it discusses various investment, interest rate and longevity risk stress tests that impact defined-contribution (DC) plans and defined-benefit (DB) plans.

The key points worth noting are the following (click on image):

Basically, historic low rates, record stock market volatility and the increase in lifespans are driving the costs of defined-benefit pensions up which explains the inexorable global shift to DC pensions.

And I've got some bad news for you. That deflation tsunami I've been warning you about is going to decimate all pensions, especially ones taking increasingly more risk to achieve their target rate-of-return.

But as I've repeatedly argued, the solution isn't to shift out of defined-benefit plans into defined-contribution plans. The brutal truth on DC plans is they will exacerbate pension poverty. The more we understand the benefits of well-governed DB plans, the better off we'll be over the long run.

I just finished writing a comment on Ontario's new pension plan going over these points. My former colleague, Brian Romanchuk, just wrote a comment on the difficulty of extending universal state pension which you all need to read. I sent that comment to Bernard Dussault, Canada's former Chief Actuary, to get his thoughts and will follow-up with a comment of my own in the near future.

My views are firmly entrenched in what I believe a well-functioning social democracy requires to thrive: free healthcare as a fundamental right for all, free education for all especially the poor and working poor, and a universal pension plan which covers the retirement needs of a huge subset of the population no matter what happens in the bloody stock market!

In short, I believe the entire world needs to go Dutch on pensions and even improve on its retirement system. But while the Dutch and Danes got it right on pensions, most European countries are struggling with chronic deficits that threaten their pension system.

Nowhere is this more acute than in Greece, the epicenter of Europe's deflation crisis. The Greek economy cannot escape a deep debt deflation crisis and its pension system has been teetering on collapse for a long time.

Not surprisingly, protests over Greek pension reforms are escalating, the country is a mess, and the FT reports Alexis Tsipras and Kyriakos Mitsotakis are clashing over Greek pensions:

Alexis Tsipras has fended off attacks from Kyriakos Mitsotakis, Greece’s newly elected opposition leader, by insisting that his Syriza government can rescue the country’s underfunded pension system without cutting benefits to retirees.

The prime minister and his rival went head-to-head on Tuesday night in a heated parliamentary debate, their first confrontation since Mr Mitsotakis, a pro-European reformer, was voted in to lead the centre-right New Democracy party this month.

“There will be no reductions in main pensions,” a defiant Mr Tsipras said. “One pension is a whole household’s income in the present [recessionary] circumstances.”

Syriza has resisted pressure from creditors — the EU and IMF — to impose hefty pension cuts by March. The move, postponed from last year, has become an urgent priority with bailout monitors due to return to Athens next week to assessing progress on the reforms agreed in return for a €86bn third international bailout.

Taking aim at Mr Mitsotakis, the son of a former conservative premier, Mr Tsipras asserted that state pension funds were poised to collapse because of “sustained looting” over decades by previous governments.

Mr Mitsotakis responded that the social security system was a victim of the Syriza government’s “incompetence” during a political roller-coaster last year that ended with Greece agreeing to a third bailout after defaulting on a sovereign debt repayment.

“It was accepted that the pension system was viable until 2060 — until Syriza came to power,” he said.

The debate came as thousands of farmers across Greece used tractors to block border crossings and main roads in protest at plans by the government to increase pension contributions and income tax for farmers. The farmers on Tuesday rejected Mr Tsipras’s call for dialogue, demanding immediate cancellation of the increases.

The premier argues that cuts to cover a projected €1.8bn pension deficit in this year’s budget can be avoided through a 1 per cent increase in contributions already agreed with employers and another 0.5 per cent raised from workers.

Syriza has dismissed criticism by creditors that increasing contributions will slow a return to economic growth by dissuading businesses from hiring and will also encourage small companies to employ workers without paying social insurance.

Mr Mitsotakis, who launched an overhaul of the civil service while serving as administrative reform minister in 2013 and 2014, said there were resources available to fund social security without resorting to increased contributions “if the public sector undergoes a restructuring”.

Lawyers, engineers and doctors have staged protests against large projected increases in contributions to a pension fund for self-employed professionals running an annual deficit exceeding €500m

New Democracy has proposed the fragmented social security system be streamlined into three funds covering employees, self-employed professionals and farmers with a basic pension guaranteed at the age of 67 after at least 20 years of employment.

“As a new political leader, I have recognised the mistakes of the past and I am committed not to repeat them,” Mr Mitsotakis said.

Greek journalists have now joined the strike against the pension reforms. The country is a mess and I foresee another Greek crisis in the not too distant future.

And Kyriakos Mitsotakis is right, it's high time Greeks wake up and stop the charade of public sector profligacy run amok. The Greek public sector is unsustainable and so are Greek pensions (I disagree with Mitsotakis's assertion that they were ever sustainable).

But what is going on in Greece can easily happen in Italy, Spain and even France. The entire eurozone system is built on unsustainable promises and unlike Canada, you'd be hard pressed to find websites on many large European pensions plans to understand how they invest and what governance models they use to manage pensions (with a few exceptions).

In fact, in Greece, there is no accountability, no transparency, no governance whatsoever on pensions and pretty much anything the government is involved with. It makes me sick and until Mitsotakis wins the next elections by knocking some sense into stubbornly foolish Greeks who think they can have their cake and eat it too, the situation will only get worse.

Let me leave it there. Greek pensions are teetering on collapse but this comment demonstrates that Europe's pensions aren't that much better and there's a very real risk that a prolonged deflation crisis will negatively impact them for years to come.

Below, a panel discussion at Davos on the future of Europe where Greek Prime Minister Alexis Tsipras sparred with German Finance Minister Wolfgang Schäuble on solidarity. Of course, Europe's pension time bomb wasn't discussed because that topic is kept strictly confidential. As far as the future, I agree with George Soros, Europe is on the verge of collapse.

And former Greek Finance Minister Yanis Varoufakis spoke on Bloomberg recently stating "God and his angels can't fix Greece."

What Varoufakis fails to mention is that "God and his angels can't fix Greece" because no Greek government ever had the courage to implement tough reforms and drastically cut the disgustingly bloated Greek public sector down to size. Instead, successive PASOK and New Democracy governments kept buying votes by expanding the public sector beast and even now with the economy teetering on collapse, SYRIZA refuses to make much needed drastic cuts to the public sector.

I also embedded an interesting TED talk Varoufakis gave in December on how capitalism will eat democracy unless we speak up. Whether or not you like him, take the time to listen to this speech as he raises some good points on rising inequality and the glut of unproductive global savings that can be put to good use.

Of course, here too, Varoufakis speaks of half truths and conveniently ignores his gravest mistake as the former finance minister, namely, when he underestimated the resolve of his European counterparts and went home to his wife triumphantly stating: "Honey, I closed the banks."

Yes he did which is why Greeks now despise him and why he's hitting the lecture circuit and getting ready to release a "tell all book" to make him look like he was the virtuous one and everyone else was stupid (for a Marxist, Varoufakis sure knows how to capitalize on capitalism!).

I stated this before and will state it again, despite his somewhat intelligent but hopelessly pompous rhetoric, Yanis Varoufakis will go down in Greek history as the worst finance minister ever. And despite his capitulation, Alexis Tsipras will go down in history as the worst Greek prime minister, surpassing his childhood hero, Andreas Papandreou who began this Greek culture of entitlement that has literally crippled the country till this day.