Many companies and their employees have begun to realise over the last few years that pensions have become increasingly expensive to provide. The answer of most corporate employers has either been to increase contributions and/or to reduce benefits. But there is another solution which really requires action from governments and that is to increase retirement age. If you increase retirement age you increase the working life over which contributions can accrue and reduce the period over which benefits have to be paid. Hey presto, benefits suddenly become more affordable.
How to provide for old age is a question that people are finding increasingly difficult to answer. Many people have recently realised that the dream of a happy retirement is becoming the nightmare of an inadequate pension. Final salary schemes are closing, leaving people to ponder what benefits a poorly funded money purchase scheme will provide. In addition, governments realise that an increasing elderly population supported by a shrinking workforce will eventually pose an insuperable economic problem.
So if the answer looks so obvious why is there so little action? When state-based pension schemes were established, they were essentially funded on a pay-as-you-go basis. This meant that pensioners’ benefits were paid out of general or specific taxation. At the time, this was not seen as a problem because life expectancy was limited and working populations were growing.
Now that times have changed, governments have attempted to restrict the generosity of state pensions (for example by indexing them to prices rather than average earnings) and to encourage the growth of private provision. In the UK, the Netherlands and a few other countries this has gone as far as it can go. Privately funded pensions have become mature but costs are continuing to increase. Pension provision, both state and private, is taking up an increasingly large slice of a country’s wealth. Left unchanged, this would mean less wealth for the working population - not an attractive option.
There are few ways round this problem. Unless productivity increases by an unprecedented amount, governments could either increase size of their workforces by accepting significant immigration or by increasing the pool of domestic labour. In theory, the latter option could be achieved by raising the rate of participation by women but there is little scope for this in Europe. The only sensible remaining option is an increase in the retirement age. As people are all living longer it seems strange that such an eminently sensible move should be regarded as so radical. Raising the retirement age would enable an increase in a country’s wealth without the social upheaval that immigration might produce. It would also give people more time to build up their pensions.
If governments do not act, can companies do anything on their own? Obviously, unilateral action is difficult but certain things would help. First, companies could consider reducing the incentive towards early retirement. It really makes little sense with increasing longevity to encourage people to think that they can or should retire from age 50. Second, companies should do more to make people realise how expensive it is to provide pension benefits. For too long members of final salary pension schemes, especially in the UK, have been shielded from the real cost of benefit provision.
In the UK in particular, abnormally high equity returns exaggerated by excessively high equity exposure brought what have proved to be unsustainably high actual returns. Pension schemes have lived off those returns for some years and built up expectations that such returns would continue for ever. While the good times rolled, companies felt that they did not need to explain to their employees that the true cost of benefit provision. This was because many companies used the good times to subsidise the contribution they paid.
Now that the true cost is becoming apparent, companies within the UK, in particular, are deciding that they can no longer afford to provide such high levels of benefit and and are closing final salary schemes. Instead they are establishing money purchase pension schemes. All too often these are not funded sufficiently to provide reasonable benefits at their nominated retirement age. I would much rather see a better explanation of the benefits that such schemes can provide with a greater flexibility of retirement age. This means encouragement towards later retirement rather than merely the option of early retirement.
Explanation is the key. Companies owe a duty to their employees and governments owe a duty to their electorate to explain how much should be set aside to properly provide for retirement at all ages. Without such explanation, people will discover late in their working lives that those working lives will have to be even longer than they had planned.