Around the World
August 01, 2008 | Frédéric Létourneau and Leo de Bever

In a challenging social and economic environment, plan sponsors are looking to pension and benefits consultants for enlightenment.

Finding the right balance between regulatory simplicity and responsible governance is an ongoing issue for pension authorities, and there’s more than one possible solution. Demographic changes have caused governments around the world to modify their social security programs. Many have also modified their pension legislation to fix weaknesses exposed during a recent shakeup in the pension world—the infamous “perfect storm” of 2001/2002.

The solutions implemented by the various governments were vastly different and, unfortunately, contributed to eliminating or reducing the popularity of defined benefit (DB) programs. While defined contribution (DC) plans clearly have a role in the new world of pensions, systems that inherently discourage DB plans may ultimately prove to be problematic.

However, there is a bright side. The positive effect of having such diverse strategies is that we can observe the outcome of each government’s solution in a sort of national test centre. It’s hoped that all of these efforts to modify the pension environment will point us to the optimal solution for retirement plans on the whole.

Demographic Drivers

Many governments implemented social security systems between 1950 and 1970. At that time, fertility rates were still well above the 2.1 children per family required to maintain a stable population (ignoring immigration). Most governments thought there would always be more taxpayers than pensioners; therefore, they could use a portion of the taxpayers’ contributions to cover the pension benefits due each year.

With this in mind, many countries designed generous DB social security programs and set the contribution rate well below what would be required for each person to pay for his or her own benefit entitlement. This approach created a serious intergenerational inequity, meaning that younger employees were effectively subsidizing older employees in the workforce. Even worse, most governments—with some exceptions such as Malaysia and Singapore, with their mandatory provident funds—did not create and maintain a separate fund for contributions exceeding the benefit payments due. Instead, they decided to add these contributions to their general revenues.

Governments later became aware of the impact of demographic issues due to a reduction in fertility rates over the last 30 to 40 years. These fertility rates were, and continue to be, well below what is required to maintain a stable population.

While Canada’s situation is problematic, the situation is most drastic in Japan, where a pyramid inversion is predicted by 2050. In a lesser way, other countries such as the Netherlands and Australia also face an aging population and resulting complications. This is extremely worrisome for governments, as they will have fewer taxpayers than pensioners to fund their systems. It also leads us to wonder if there will be enough people in the workforce to provide the basic goods and services needed for a growing senior population. Will housing prices go down as the population decreases? Will medical costs increase even more with a greater demand for medical services and, most likely, fewer doctors to deliver them?

2008 Fertility Rates

Country

 

Births/woman

Australia
1.8
Netherlands
1.8
Canada
1.6
Japan
1.2

Strategies and Solutions

Many governments quickly concluded that the design of their social security programs did not deal adequately with pensions. They also realized that this unbalanced situation would only get worse over time, as a decreasing workforce would lead to rapidly decreasing general taxation revenues. In addition, benefit payments would continue to increase with the aging population and longer expected lifespan.

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