How emerging markets can address the retirement challenge

Pension wordcloud © Borislav Marinic /123 RF Stock PhotosEmerging markets are facing a retirement crisis that arguably far outweighs that of the countries comprising the Organization for Economic Co-operation and Development, according to a research paper by Nadeem Ahmed Jeddy, executive director of Pakistan-based Magnus Investment Advisors Ltd.

The number of people 65 and older in emerging markets is nearly double those in OECD countries and major issues with current retirement frameworks are becoming clear, especially in Latin America, the research found.

Bearing in mind that speaking about emerging markets as a whole leaves room for serious generalization, Jeddy said the sociopolitical context of these countries differs vastly from what he referred to as the west. Key factors he pointed out were the solidified nature of OECD countries’ legal and judicial systems, property rights, a robust media capable of standing up to corrupt leaders and a higher degree of overall transparency.

He also noted that where retirement expertise is concerned, there is a deeper pool of talented professionals for OECD countries to rely upon in the investment management and actuarial spheres.

Jeddy argued that emerging markets should not take on the burden of developing investment organizations in the public domain, given the context of countries that have been preoccupied with spending money to establish fundamental public institutions and resources, from highways to hospitals. Simply copying systems from the west, where retirement planning is concerned, is not the best way for these economies to move forward, he said.

“The retirement systems in the West evolved piecemeal to address specific needs at different points in their history,” the paper read. “They were not built on a systematic study of all costs and benefits where at the end of the process best trade-offs were chosen. As a result, the retirement systems in many Western countries today are based on a patchwork of solutions that were designed to address visible problems one at a time but that collectively fail to deliver the pension promise.”

While Jeddy noted there was no historical precedent for western leaders to learn from, current emerging markets do have the advantage of being able to learn from the mistakes of existing systems.

Indeed, when the pension systems in what are now more developed countries were just beginning to take shape, they were being built for populations that are not the same today, says Hervé Boulhol, senior economist at the OECD.

Since their inception, the population has shifted and a larger portion of the overall population is seniors, he says. Historically, the old-age dependency ratio has worked because there were fewer retirees relying on contributions of younger workers, he says. In a pay-as-you-go system, benefits are paid by current workers out of contributions, which is easier to sustain when there are more current workers than retirees, he adds.

Today, emerging markets are at the early stage of that same shift in demographic structure, so the proportion of those close to retirement, or in it, is growing, Boulhol says.

However, the shift has not happened to the extent that pay-as-you-go systems are clearly unfavourable yet, he says. However, the pace of aging in emerging markets is fast enough that these systems would have to be put in place quickly or it will essentially be too late.

Looking forward, emerging markets should not view defined contribution and defined benefit pensions as the only options to implement, according to Jeddy. DC plans suffer from behavioural biases of their members and while the hope has been the general population can become financially literate enough to overcome that issue, that hasn’t happened yet, he said. As for DB, he says companies, broadly speaking, are no longer willing to underwrite the investment and longevity risks involved.

Jeddy focused his recommendations for emerging economies on plan design, costs, regulations and sustainability.

Where costs were concerned, he noted this must be examined alongside governance and scale. “The pre-requisite for achieving lower total costs is to build scale,” the paper read. “This requires facilitation and promotion of institutional investing arrangements over retail accounts.”

On regulation, Jeddy argued for consolidation, touting the benefits of consolidating oversight of investment management, labour law, trusts, life insurance, capital markets, pension funds and brokerage houses in a single regulator.

And on sustainability, he suggested savings for retirement should be made mandatory, with withdrawals both limited and penalized during the accumulation phase. He argued that employer and industry groups should take the lead in scaling up investment vehicles, lowering costs and maintaining governance, rather than public stakeholders. “A higher-level aggregation under public sector is not feasible given a different sociopolitical context for the emerging markets,” the paper said.