Seeking a Global Pension Fix

By Mark Vickers, Human Resource Institute (HRI)

Everyone knows it’s coming. It’s so large that it looms over huge swaths of the world, stretching from North America to Europe and then onwards toward China. It gives many a board member and politician the cold sweats at night, and it worries workers so much that they often try not to think about it.

The “it,” of course, is the coming wave of retirements that will affect most developed countries making up the membership of the Organization for Economic Cooperation and Development (OECD). Among OECD member nations as a whole, the so-called dependence ratio – that is, people ages 65 and older as a percentage of people ages 20 to 64 – will rise from 22% today to 46% by the middle of the century (OECD, 2004). One of the most worrisome aspects of these changes is that they will make it hard if not impossible for many countries to fund their pension plans unless serious reforms are put into place.

The pension shortfalls are particularly acute in various Western European nations. BBCNews reports that the public pension systems in Spain, France, Germany and Italy could be seriously underfunded by 2050 (Schifferes, 2004). Already, state-funded pensions represent, on average, a little more than a fifth of government spending in the European Union. By comparison, Social Security spending is only 4.8% of U.S. GDP (Fairlamb, 2004).

This isn’t just a government problem, of course. In much of Europe, corporations pay out huge amounts to the state pension systems. For example, corporate contributions represent 19.5% of gross pay in Germany. These are the kind of costs that tend to reduce operating profits while raising unemployment rates (Fairlamb, 2004).

Then there’s the funding of corporate-based pension plans. Global Finance magazine reports, “In Europe and the U.S. a large number of corporate employers, both large and small, have fallen behind on the level of funds needed to fund the retirement plans of their employees” (Sheehan, 2004). A recent Towers Perrin poll of multinational companies found that “global pension liabilities represent almost a quarter (23%) of total market capitalisation for the companies surveyed.”

In the U.S. alone, corporate defined-benefit retirement plans cover about a fifth of workers and yet are underfunded by $450 billion. Meanwhile, the Pension Benefit Guaranty Corporation (PBGC), the entity that insures pension funds in the U.S., recently reported a record deficit of $23 billion (“Finance,” 2005). And the situation could get a lot worse. In recent weeks, the PBGC took over the responsibility for unfunded pension plans from United Airlines and U.S. Airways. Analysts worry this is just the start of an unhealthy trend, as embattled firms try to shift their pension liabilities to the PBGC in order to gain price advantages (Clark, 2005).

So what are the answers to these funding crises? From a global perspective, according to OECD’s chief economist Jean-Philippe Cotis, the problem can only be addressed by some combination of strategies, including getting people to work longer, reducing their benefits and raising taxes. (In the case of the unfunded pensions in the U.S., a massive government bailout is being discussed.) Italy already plans to raise the retirement age by five years in 2007, and Germany plans to reduce government pensions as a proportion of the average worker’s salary (Cowell, 2004).

But the movement toward reform has been slow because such strategies cause so much political pain. Moreover, their ultimate effectiveness remains in doubt. It’s much easier, for example, to withhold pensions from older people than it is to actually find them work. Even in today’s economy, older Germans have a hard time locating jobs.

Another strategy being pursued in Europe is putting more of the responsibility for retirement savings on employees, often through vehicles similar to the defined-contribution plans common in the U.S. But such plans have their own set of problems. In the U.S., many companies don’t provide them and, even when they do, employees often wind up ignoring or underfunding them (Sheehan, 2004). In fact, the retirement savings rate in the U.S. remains alarmingly low, which may be one reason some experts in the UK think the government may someday make retirement savings compulsory rather than voluntary (Stern, 2004).

At the multinational corporation level, companies are trying to get serious about global pension funding. Towers Perrin (2004) reports that “pension plans are now a board-level issue in 90% of major U.S. companies and in 92% of leading European companies.” Firms recognize that their pension funds have got to be carefully managed so they can avoid “unwelcome surprises” during periods of capital market volatility.

One way of coping is through centralization. Over two thirds of the Towers Perrin survey respondents have already created central committees or management teams that, on a global level, supervise pension plans and other benefit programs. In addition, companies are striving toward a greater global coordination of funding, investment strategies and actuarial valuations.

Companies as well as governments are slowly coming to grips with the pension realities, but no one is quite sure whether the solutions will come fast enough to avoid the impending crisis.

Documents used in the preparation of this TrendWatcher include:

“Controlling Benefit Costs and Financial Risks Top Concern for Multinationals, Survey Finds.” Human Resources Report, December 13, 2004, pp. 1339-1340.

Cowell, Alan. “Demographic Time Bomb Threatens Pensions in Europe.” New York Times, November 26, 2004.

Clark, Kim. “Pension Tension; Workers Can No Longer Count on Company-Funded Retirements.” U.S. News and World Report, ProQuest. January 24, 2005.

Fairlamb, David. “Europe’s Pension Problem: Too Few Cradles, Too Few Graves.” BusinessWeek Online, March 29, 2004.

“Finance and Economics: Red and Redder; America’s Pension Holes.” The Economist. January 15, 2005, p. 72.

Organization for Economic Cooperation and Development. Ageing Societies and the Looming Pension Crisis.

Schifferes, Steve. “Employees ‘Should Work Until 70.’” BBCNews, May 14, 2004.

Sheehan, Brendan. “The Looming Pensions Crisis.” Global Finance. Mid-Year 2004, pp. 12-15.

Stern, Stefan. “It Is Time to Force People to Pay into Pension Schemes?” Human Resources, November 2004.

Towers Perrin. Managing Employee Benefits Globally: Today’s Increasingly Disciplined Approach, November 2004.

For more information about this article, contact Jay J. Jamrog of HRI at 727-345-2226 or jamrog@HRInstitute.info.

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