October 18, 2011 12:17 am

Pensions: Age concern

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Next month, up to 3m European public-sector workers plan to take to the streets again – becoming the latest, and among the largest, groups to protest against government austerity measures. This time, however, they will be British, boast the most generous pensions in their country and – according to the rationale of the reforms they oppose – be largely railing against their own life expectancy.

This “day of action” over pensions, called by the trade unions, is set to mirror recent demonstrations in Greece, France, Spain, and Italy – but it is likely to be the first to see school dinner ladies join forces with civil servants and fire-fighters to demand the retention of entitlements dating back to the 1940s. It follows attempts by the government to raise the public-sector pension age from 60 to the private-sector norm of 65, and link pension payments to average career earnings, rather than final salary.

At the heart of the matter is life expectancy. In the 1980s, UK health service workers retiring at 60 could expect to spend one-third of their adult lives drawing a pension. Now, retirement is nearer 45 per cent of their life-spans. Increases in funding have not kept pace, leaving higher retirement ages and lower incomes the only obvious alternatives to higher contributions.

In Europe, measures have been introduced in an attempt to break – or loosen – the link between demographic change and government debt. Italy and Denmark have introduced rules that peg retirement age to life expectancy, while in Hungary and Portugal, pension benefits are linked to gross domestic product growth. France has introduced an increase in the state retirement age to 62, and the EU average is already 65.

Looking out over the continent from her headquarters in Folkestone, on England’s south coast, Ros Altmann, director-general of Saga, the travel and financial services group built on the spending power of the so-called “grey pound”, paints a worrying picture.

What she sees on the horizon is not the potential for more cruise bookings – rather an income squeeze that will turn retirement into a period of heightened anxiety for many.

“We are on course for increasing numbers of pensioners living in penury,” she warns. “So far, people have been in denial and have just been frantically crossing their fingers hoping things will improve. We have to wake up to reality and help people realise that the costs of decent pensions are much higher than previously admitted.”

But while demonstrations against cuts may reignite the debate, analysts point out that the “pensions time-bomb” has been ticking for decades.

Dexia Asset Management projects that the ratio of older non-working people to workers is set to double by 2050. It directly attributes this shift to a combination of longer life expectancy and declining fertility rates in developed countries.

In the UK, the number of younger taxpayers as a proportion of the total has been steadily shrinking. Forecasts from the Office for National Statistics show that the percentage of people over 70 will rise by more than 50 per cent, from 6.2m today to 9.6m by 2030. As a result, the ratio of people of working age to people over 70 will fall from 5.3:1 today to 3.7:1 by 2030.

Swelling the ranks of the retirees in the next few years will be those “baby boomers” who were conceived in the immediate aftermath of the second world war. Steve Groves, chief executive of Partnership, a specialist pension provider, suggests these people now have much to celebrate. “They can look forward to living for nearly twice as long in retirement as the 65-year-olds who were celebrating the end of the war in 1945,” he says. “Many have also enjoyed record house price inflation, company pension schemes and free education for themselves and their families.” But they are distorting the traditional age pyramid.

This is not just a developed-world problem. Dexia’s report concludes that the same longevity and fertility trends have caused China’s population to age at one of the fastest rates ever recorded. Elderly people in China are projected to triple from 8 per cent to 24 per cent of the population between 2006 and 2050, to a total of 322m.

For all pension schemes, this creates a mismatch not just between the levels of contribution and liability, but also their duration.

Retirement can now last significantly longer than the time spent paying into a scheme. Mortality models run in 2007 by Paternoster, a pension buy-out group now owned by Goldman Sachs, the US investment bank, suggested that half of all current 30-year-olds in the UK would live to the age of 100. For defined-benefit pension schemes – which pay a salary-linked pension for life – that creates the prospect of four decades of retirement, funded by proportionately fewer years of contributions.

Paternoster estimated the longevity funding gap for UK private-sector pension schemes to be £170bn ($269bn) above the amount of reserves held. A recent report commissioned by the UK government estimated that the short-term gap between the amount contributed to public-sector schemes and the amount the taxpayer must make up would rise from £4bn this year to £10bn by 2015.

But simply raising the state pension age, as European governments propose, may not have the desired knock-on effect in the private sector. Fraser Smart, managing director of Buck Consultants, a human resources specialist, fears reforms could actually make the situation worse. “This is just the tip of the iceberg,” he says. “The dramatic increase in projected life expectancy should demonstrate that people will need even more income to sustain a longer retirement. However, as retirement ages are pushed back, the danger is that the opposite occurs, and people use it as an excuse to further delay the process of pension saving.”

One alternative that has been taken up in both the public and private sectors, is buying an insurance hedge against demographic risk.

Two years ago, Swiss Re, the insurer, entered into the first longevity swap transaction with an English local authority pension fund, to provide protection against the risk that members live longer than expected.

Under the swap contract, the pension scheme pays regular premiums to Swiss Re, which insures the cost of paying benefits to members. Any future positive or negative deviation due to uncertain longevity is absorbed by the insurer.

This year, ITV, the UK broadcaster, became the first private-sector company to seek similar cover, but from an investment bank rather than an insurer. This protection comes at a price – ITV said the contract will increase the deficit of its pension scheme by £50m – but is set to catch on.

The idea that untried financial innovation can clear the streets of angry savers seems optimistic, however. “If the under-pensioned become a powerful voting lobby this will make it harder for governments to balance the books,” says David Robbins of Towers Watson, the pension advisers.

They may even become a belligerent voice, suggests John Lawson, head of pensions policy at Standard Life, the life assurer. “Failure to address this issue could cause the next generation [of retirees] to rebel. Why should they pay excessive taxes to fund the self-awarded generosity of their parents’ generation?”

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