The rise in national pension reserve funds is one of the responses from governments, which are becoming increasingly aware of the financial problems that many of their citizens will face in retirement as funding pensions from pay-as-you-go schemes becomes more impractical. There are various ways that governments can reform their pensions systems, including improving the regulatory environment to reassure savers that their money will be safe and creating a tax regime to incentivize saving. Governments have also introduced policies to encourage people to stay in the workforce longer, and age discrimination in employment is now outlawed across the European Union. Many of these policies are new, and it will take many years to see an impact on the official statistics. As it stands, average retirement ages in Europe range from sixty-three in Sweden to fifty-six in Slovenia. The gap between life expectancy and the average exit age from the labour force varies between twenty-one years in France and eight years in Latvia, with over half of the countries bunched between fifteen and eighteen years.
The trends strongly suggest that many – perhaps a majority of – people in developed countries are unlikely to have a financially comfortable retirement as they are either choosing not to save or are on incomes so low that saving is not a realistic option. It is no surprise that governments find it very difficult to introduce mandatory savings schemes on a scale that would be likely to have a material impact on future pensions provision. Company pension schemes, upon which many employees are depending, are also unlikely to be the solution. One Scottish newspaper article, ‘Pensions crisis is much worse than firms say’, quoted the president of the Faculty of Actuaries, Scotland’s most senior actuary, as saying: ‘We are kidding ourselves over the security of pensions.’ He predicted that more pension schemes will collapse and pensions be lost, because companies rely upon ‘wholly inadequate’ yardsticks to measure solvency.1
AON Consulting, part of the insurance and risk management company, produces an annual benchmarking study of the European pensions systems, assessing which country is likely to find itself under the greatest pressure to make material changes to its pension system in the medium to long term. The study analyses each country according to its demography, adequacy of the state pension, affordability and sustainability of the state pension, and the availability of company pensions. The 2006 study put Denmark in the most favourable position and Belgium in the least favourable. The top countries, including Denmark, Estonia, Ireland, Latvia, Netherlands and the UK, combined favourable demographics with reasonable private pensions. The state pensions might be poor but at least they are affordable. France, among the lowest-performing countries, combines a high life expectancy, one of the lowest retirement ages, decent state pensions and low private provision, similar to the situation in Belgium.2
The UK is one country that has at least conducted an analysis of the problem and identified the solutions, even if the appropriate policies have not yet been fully adopted. The Pensions Commission was an independent body set up following the Pensions Green Paper published in December 2002 to keep under review the regime for UK private pensions and long-term savings. It produced three reports between 2004 and 2006 and concluded that there was almost universal acceptance that the combination of the present state pension system and voluntary system of private pensions ‘is not fit for purpose and will result in pension provision which is increasingly inadequate and unequal’. It concluded that the solution should entail some combination of higher private pension saving, higher average retirement ages and an increased percentage of national income spent on state pensions. The option of pensioners’ incomes falling relative to average earnings was viewed as unattractive.
The contents of the Pensions Commission’s reports have been widely welcomed, and leave the government facing a difficult challenge of deciding how far and how fast state pension reform can be afforded. The government introduced pensions legislation in 2007 which included measures to restore the link between earnings and state pensions (currently state pensions are uprated in line with inflation), an increase in the state pension age to sixty-eight and provision of access to workplace schemes, but these were small changes spread over many years.
The re-establishment of the link with earnings growth was popular but is not an easy option. The Pensions Commission estimated that the percentage of GDP devoted to pensions might need to rise by about 1.5 percentage points by the year 2050, from about 6¼ per cent today. Such an increase carries significant implications either for tax rates or other categories of public expenditure.
These measures are at least a step in the right direction, which is more than can be said for some of the government’s other policy decisions. The then Chancellor of the Exchequer Gordon Brown was widely criticized when he removed the tax relief on the dividends earned by pension funds’ equity holdings in his first budget statement in 1997. One report in the Daily Telegraph said that the ‘raid on pensions’ cost Britons £100 billion and created ‘the crisis that has left huge shortfalls in pension pots and forced hundreds of firms to wind up final salary schemes’.3 The Treasury’s view was that the change removed a distortion in the tax system that encouraged companies to pay out their profits in dividends, rather than reinvest them. The government also failed to equalize public- and private-sector retirement ages at sixty-five and amend the civil servants’ final salary scheme when it reviewed pension policy.
A cynic might think that there was little incentive for reform at the heart of government given the size of senior public-sector employees’ pensions. Pensions are hard to understand and essentially dull, so if the senior policymakers are sitting pretty, they perhaps do not understand the predicament faced by the majority. One report by the Taxpayers’ Alliance, a lobby group, discovered that nine senior civil servants had pension pots worth more than £1 million and claimed that ‘the public sector elite is seemingly immune from the pensions crisis hitting ordinary workers across the country’.4 The Cabinet Secretary had an accrued sum equivalent to a guaranteed annual index-linked income of £75,000.
Other countries have introduced a variety of initiatives that are likely to help: Turkey has raised its retirement age; Finland has changed the formula used to calculate benefits so that they are based on earnings throughout the working life rather than a specific shorter period of relatively high earnings; Mexican legislation has increased competition among pension fund managers and cut the costs of running such schemes; and Italy has legislated to boost the growth of private pensions. In all bar a few developed countries, the proportion of defined benefit plans, where the pension payable is related to income earned, is decreasing while the proportion of defined contribution plans, where the pension is related to the value of savings and investments made, is increasing. Schemes of the former type are generally more generous.
Despite several years of scare stories in the British media, the population does not seem to have changed its habits. It seems that paying off a mortgage, repaying a student loan or just spending money are far more appealing options than making a decent provision for retirement. Perhaps people have been frightened off the idea of saving by the stories of individual pension fund scandals. A report in 2006 on the City of San Diego’s pension fund scandal told of ‘years of reckless and wrongful mismanagement’ and ‘non transparency, obfuscation, and denial of fiscal reality’.5 The report drew analogies with what happened at Enron and HealthSouth in the US. Such stories go back many years including the plundering of the Mirror Group pension fund by Robert Maxwell, which was discovered after his death in 1991. The pensions mis-selling crisis in the UK in the late 1980s is also fresh in the memory.
The gradual decline in the percentage of the British workforce that has any current pension provision above that provided by the state has continued, with the decline in participation rates among private-sector workers continuing at a significant pace – from 10½ million to 9 million in the last eight years. The percentage of employers making any pension provision for their employees declined from 52
per cent in 2003 to 44 per cent in 2005. Some people will no doubt be bailed out by their investment in property, but that will only save a minority, and many of those who have done well in the property market have probably also made some provision for a private pension.
The prospect of poverty in old age remains very real for many people. Most countries have to face up to significant policy changes or come to terms with the consequent growing inequalities in society.
Never Never Finances
‘Britons piling up Europe’s worst debts’ Metro
Britons are the big borrowers of Europe, and the figures are frightening. By the end of 2006, the country’s adults had racked up over £1,250 billion in personal debt – that equated to £27,000 for each adult. The amount of debt increased by over 10 per cent during the year, growing at the equivalent of £225 per adult per month. The average amount borrowed on credit cards, finance deals and bank overdrafts stood at £4,500 per person, and the total personal debt is increasing by £1 million every four minutes. This might have dire outcomes for the feckless families involved, but if enough are affected the problem could push the economy into recession.
Given these sums, the headlines are perhaps unsurprising. ‘Banks are warned to stop tempting families into debt’ followed the publication of the annual report from Britain’s financial regulator, the Financial Services Authority. Its 2006 Financial Risk Outlook warned of ‘signs of growing distress among consumers, including more insolvencies, more late payments on credit cards and a rise in mortgage repossession orders’.1 The FSA was particularly scathing of credit card companies encouraging customers to borrow when their debts are already out of control – it is said that lenders send out at least 100 million unsolicited but pre-approved credit card application forms between September and November each year to tempt us with Christmas spending – and the offering of so-called ‘mega-mortgages’, which allow homebuyers to borrow up to 125 per cent of the property price.
The young Britons, who are doing more than their fair share of the nation’s borrowing, have been described as the iPod generation – insecure, pressured, over-taxed and debt-ridden.2 Traditionally the young take out debt to buy their first property and the middle-aged repay the mortgage and save for old age. The elderly run down their savings and sell their assets. But that life cycle is being distorted by several factors that are encouraging the young and middle-aged to borrow more than they have in the past. The large increases in house prices in recent years mean that proportionately more now has to be borrowed to get on the property ladder. Today’s twenty-somethings in England are the first generation of graduates to start their working life in debt, owing on average £15,000 from student loans. The ‘buy now, pay later’ culture has taken a firm grip on consumers in many countries. And all the evidence suggests that those who want to have children are having to deal with costs increasing rapidly in real (inflation-adjusted) terms. One survey suggested that seven out of ten young people fear for their financial future.
This love of credit is not evenly spread across all countries. An Organization for Economic Co-operation and Development study of fifteen industrialized countries showed that only Britain, the Netherlands and Denmark had total household debt that was greater than national income.3 Italy and Finland were at the other end of the scale, with debt levels less than 50 per cent of GDP. Except in Japan debt has increased, in most cases significantly, over the last decade, but Britain is the dominant borrower in western Europe.
The US, the Netherlands and the UK are three countries where over four out of ten households have mortgage debt – in Italy, Germany and Spain the proportion is below one-quarter. There were five countries in the OECD study where at least four out of ten households have debts other than their mortgage – New Zealand, the US, Canada, Sweden and the UK. Italy, Germany and Spain were again the countries where the proportion of households with debt was the lowest. (Debt can also be measured in relation to annual disposable income and net wealth. While the pecking order of countries will change under different measures, the main differences between countries tend to be maintained.)
One report claimed that overspending Britons were responsible for a third of all unsecured debt, namely that excluding mortgage debt, in western Europe. The £3,000 per person owed is roughly double the average elsewhere in Europe. Some experts suggested that Britain was approaching its debt ‘saturation point’ and that lenders would have to focus on other markets to seek high returns.
Although the British are leading the way, America’s young are not far behind. A survey of students showed that, while one in eight most feared a terrorist attack, one-third most feared going deeply into debt and another third feared unemployment.4 Nearly a half of those surveyed expected to graduate with $10,000 or more in college loans, with one in five saying they would have more than $20,000 to pay off.
There is nothing wrong with borrowing in itself. Indeed the redistribution of capital from those who wish to save, and earn interest on, their surpluses to those who are willing to pay to use the money is a driver for economic growth. Borrowing, repaying debt and then saving is a common life-cycle activity for most people in developed countries. And the increase in borrowing should be expected following the progressive removal of credit rationing with the financial deregulation that started two decades ago in Britain and is now spreading to many other countries. Lower interest rates, both in nominal and real (inflation-adjusted) terms, have also boosted demand for credit. That said, the size of the total personal debt mountain looks worryingly large.
The high debt figures are already a matter of concern for a significant minority of the population. The figures are striking: Citizens Advice dealt with 1.4 million debt problems in the last year (equating to over 5,000 people a day seeking advice, and up 11 per cent over the year); personal insolvencies are over 100,000 a year and rising, similar to the number of mortgage repossession actions initiated by lenders; one in five adults have unsecured debts of over £10,000; and on it goes. Mortgage delinquency, or default, rates have edged up in most countries from recent low points. The survey evidence makes grim reading too – nearly 4 million people admit that money worries have caused them to take time off work and over 10 million claim to suffer relationship problems because of money worries.5
And this started happening when there was a benign economic environment of low interest rates and high employment. Those in debt become particularly vulnerable when the economy weakens, at which point many more households could be pushed over the edge into financial crisis. The OECD believes that households in aggregate have become more vulnerable to adverse shifts in the economy.6 The FSA has warned of various risk events that could affect financial markets and the ability of people to service their debts, namely a global pandemic, terrorism, financial system crisis, a significant fall in house prices or major corporate bankruptcy. The ‘credit crunch’ of 2007 led to higher interest rates for borrowers with lower credit ratings and could trigger further problems. Although the British government is convinced that it has put an end to what it calls ‘boom and bust’, itself the type of rhetoric that over-encourages borrowing, history suggests that some sort of economic crisis will come along sooner or later.
For all the doom and gloom, however, the situation might not be as bad as it seems. Households’ net wealth has increased, mostly reflecting a sharp appreciation of property values and an increase in home ownership rates, and incomes have risen. It also seems to be the case that most indebtedness across the household sector is held by higher-income households that are generally better able to manage it. This needs to be taken with a pinch of salt, however, as it might be those on lower to middle incomes who have difficulty meeting their repayments in a crisis even though their debt levels are lower – those on lower incomes generally have less in the way of reserves to draw on in a time of crisis and, with inferior credit ratings, might well have access to less flexible borrowing schemes and be subjected to higher interest rates.
There is little sign to date that enough households are having difficulties meeting their financial obligations to lenders to harm the broader economy, but economists are trimming their growth forecasts. It does seem, however, that an increasing number of families are engaging in what has been described as ‘revolving arrears’, that is, shifting debt to where it can be most easily and most cheaply handled, for example the utility companies. Over 8 million letters were sent last year to British household water customers warning that they could face legal action because of the non-payment of bills, and around 2 million households are struggling to pay their council tax.
In the short term, the risks associated with the high levels of borrowing would seem to be modest for most families and most economies. Home-owners, who have generally seen the value of their properties rise, are also able to shift any unsecured loans, typically on high interest rates, to their mortgage, on a lower rate. Even so there will be a potentially large minority of families who fall into financial difficulties as a result of higher interest rates on high debt levels.
But even if a crisis is averted, borrowing has other consequences. Higher debt coupled with rapidly rising property prices does serve to shift financial obligations between generations. More borrowing and less saving now by today’s workers will leave them with lower pensions and less equity than they expect in the future, and quite probably a more financially stretching retirement. It will also mean that there is less money to pass on to the next generation – properties might have risen in value but so have the debts set against them.
Panicology Page 12