Pension Sustainability is perhaps the most important subject to most expats and rightfully so as we see many companies, states and countries facing large shortfalls in the future.

As reported on expatbriefing.com on April 7, 2014, the degree to which public pension systems are sustainable in the long-term now varies significantly from country to country according to a report by Allianz, the Munich-based financial services firm. Given that pension provision is such an important topic for expat retirees, expats approaching retirement, and those actively making plans to retire overseas, we delve a little deeper into this issue and the findings of Allianz’s report.

Introduction

Few expats are likely to rely solely on state pension payments from their country of origin when they retire abroad, and most will have a least a reasonable level of income as a result of saving into an occupational pension scheme, or some other type of pension arrangement. However, given that the majority of pensioners will have paid into public social security systems for all or nearly all of their working lives and are therefore entitled to get something back out of it, the issue of pension sustainability remains a relevant one (particularly for expat Britons angry at having their state pensions frozen). This is especially so for younger people who have aspirations of spending their old age in warmer climes, but have some way to go in years before they get to retirement age. Despite all the recent warnings about saving enough for old age, there is still a significant minority of people who think that state pension payments will be sufficient to sustain them in their old age, whether at home or on foreign soil. However, they had better think again!

The Demographic Time Bomb

Most developed countries are ageing societies; that is, people are living longer so that pensioners are accounting for an increasing proportion of a country’s overall population. In many respects, this is something to be celebrated as it is a sign of levels of wealth and health that our ancestors could only have dreamed of. Indeed, last year, the United Kingdom’s Office for National Statistics estimated that 1 in 3 babies born in the UK would live to 100, and the UN expects that by 2050 a quarter of the total population of all the advanced economies will be over 65 years of age. However, this trend has severe fiscal implications for governments as they need to pay out more than is being put into the public pension pot by a shrinking pool of workers to cover public pension liabilities.

The so-called demographic time bomb is closer to exploding in some countries than it is in others, although most governments are thinking about how they can defuse it because it has major implications for the level of taxation and economic growth.

In 2012, the United Kingdom budget watchdog, the Office for Budget Responsibility (OBR), warned that the costs of the UK’s ageing population could widen budget deficits over time unless offset by tax hikes or spending cuts. The OBR concluded that were government policy to remain unchanged, more money would need to be spent as a share of national income on age-related items such as pensions and health care. This could eventually cause public sector net debt to rise on an unsustainable upward trajectory, leading to lower long-term economic growth and higher interest rates. The OBR forecasts that spending other than on debt interest will rise from 35.6% of GDP at the end of 2016-17 to 40.8% by 2061-62. Health spending will increase from 6.8% of GDP in 2016-17 to 9.1% in 2061-62 as the population ages, while state pension costs will rise from 5.6% to 8.3% over the same period. Social care costs will go up from 1.1% to 2%.

Ageing societies were also the subject of a speech by Australian Finance Minister Joe Hockey last week, in which he warned that between 2010 and 2050 the number of people in Australia aged 65 to 84 is expected to double, and the number of people 85 and older is expected to quadruple. “Between 2010 and 2050 the number of people of working age to support people over the age of 65 in Australia will almost halve,” he said. “This will inevitably have an impact on the affordability of health care, aged care, pensions and discounted services for older communities.” To pay for the growth in health and pension expenditure, the Australian Government would need to raise the equivalent of the existing company tax, according to Hockey.

To some extent, Japan is already feeling the effects of the demographic time bomb. The Japanese Government projected in 2009 that, all things being equal, 40% of the population would be over age 65 by 2025. However, the Government is also massively in debt, to the tune of USD10.5 trillion, or more than 200% of the value of the Japanese economy, and the country is facing some unpalatable truths: either taxes will have to rise substantially, or social security and other forms of public spending slashed, or a combination of the two. Given the controversy surrounding the long overdue decision to raise consumption tax, it is not a challenge that Japan is meeting terribly well.

The Pension Sustainability Index

Allianz observes in its Pension Sustainability Index that: “First-pillar pension reforms introduced over the last two decades have brought about drastic changes in the global retirement landscape driven by unfavourable demographics and unsustainable, outdated or fragmented systems. The reform process differs considerably from country to country though.”

The Allianz Pension Sustainability Index analyses countries according to a range of parameters in order to arrive at a country ranking that reflects the long-term sustainability of the pension system in aging societies. Dr. Renate Finke, author of the study, says of the results: “A good ranking in the index does not equate to generous pension payments in a country, but it shows that a country’s pension system will be able to cope with its underlying demographics. In contrast to that you have to take into account that the countries at the low end of the ranking are there for different reasons.”

In the current study, the pension systems of Thailand, Brazil and Japan were found to be the least sustainable.

Thailand has an extremely low retirement age, only sporadic coverage, and is aging rapidly. However, disastrous flooding and political turmoil have seen the problem of an ageing society fall down the political agenda.

Brazil is also ageing quickly, and the report notes that its pension system has a high replacement rate which, combined with early retirement options, will be unsustainable in the long run.

Unsurprisingly, Japan comes in at the low end of the ranking because of its very old population and very high sovereign debt level. Exacerbating the problem, the pension system remains expensive, making the need for reform an ongoing concern.

Despite Hockey’s concerns, the PSI places Australia at the other end of the spectrum. With the amount of burden a country’s pension expenditures place on public finances being a core sub-indicator in the PSI, Australia’s two-tier system combining a lean public with highly developed funded pensions is under the least pressure to reform.

Australia’s success is followed in order by Sweden, New Zealand, Norway and the Netherlands. The western European countries benefit from their comprehensive pension systems based on strong, funded pillars. Sweden and Norway benefited from their comparatively solid public finance situation. Norway has surpassed the Netherlands due to its better fiscal position. Norway’s high legal retirement age and moderate aging demographic also assisted in awarding the country its high index ranking.

Surprisingly given the country’s dire economic situation, Greece has improved its pension sustainability substantially, mostly as a result of the drastic reforms stipulated by the International Monetary Fund and European Union austerity packages. According to the report, Greece has succeeded in cutting back on pension expenditures “with lasting effect”. However, the high debt level and an old-age dependency ratio well above the European average remain a challenge for the Greek system. “Greece still needs to keep an eye on its pension system as though it were watching an upper expenditure level. Surpassing this will trigger calls for further reform”, Dr. Finke says.

The report also describes a “broad middle” of pension sustainability consisting of countries with very differing systems and pre-conditions. These include “young” countries with fragmented pension systems challenged by a rapidly aging population; and “old” countries with developed pension systems, which have initiated reforms and are aware of their challenge to monitor the financial sustainability of their old-age provisioning systems.

However, two very different approaches to this challenge have emerged. Countries such as the US, Australia, the UK and Ireland have developed a type of “bottom-draw” pension system whereby the public pillars cover only the most basic requirements in order to prevent old-age poverty. Any additional income needed to maintain a certain standard of living must be generated through funded sources. The public pillars in continental Europe – particularly in Italy, Spain, France and Greece – take a much more generous approach.

According to the PSI, the burden of Europe’s public pension systems on public finances is expected to increase over the next few decades, although perhaps not as fast as many would expect. In 2010, it was 11.3 percent of GDP and in Western Europe it is projected to rise to 12.8 percent of GDP by 2050. Similar future liabilities can be observed in Japan and Brazil.

However, whatever the solution is to the problem of public pension funding, there is no quick fix. Indeed, on current trends, it is likely to be with us for generations to come. As far as expats are concerned, it is incumbent on the individual to ensure that they have adequate financial provision for their old age to increase the chances of a happy retirement.