Hundreds of thousands took to the streets of Santiago last week to protest at a system of private pensions many Chileans would like to see dismantled. The clamour for security in old age was just the latest sign of a global problem, of retirement schemes which threaten disappointment, even poverty, for millions.
Chile stands out, however, because the programme introduced in 1981 by dictator Augusto Pinochet had long been lauded and imitated. Bolivia, El Salvador and Mexico all replicated the system of individual pension accounts wholesale, and even Kazakhstan saw aspects to copy.
Disillusionment has set in due to challenges familiar the world over: people live longer and save less than expected, some have no pension, while those who do have seen investments disappoint or face a future of meagre income from stocks and bonds.
It also highlights how pension stress is not limited to public and corporate schemes which lack the money to meet promised payments, and how even well regarded systems have flaws which have prompted calls for reform: is there a better way?
Olivia Mitchell, a professor at the Wharton Business School who served on the recent Chilean Pension Reform Commission, says greater education would help. Those who complain their pensions are low forget the public or “solidarity” part of the system, she says, and “if they did not contribute their entire work lives, they won’t get much from the system”.
Formal Chilean employees are supposed to contribute a tenth of their gross salary to their pension accounts. A more successful form of compulsion might be Australia’s, which demands employers pay at least 9.5 per cent of all salaries into a superannuation scheme.
A weakness, however, is that compulsion ends at retirement, leaving the elderly able to fritter nest eggs. “Australia did the wrong thing, by not giving the right incentives when people get to retirement,” says John Ralfe, an independent pensions consultant.
In the UK retirees used to be effectively forced to buy an annuity, swapping a lump sum for a lifetime income. Longer lives and falling bond yields have progressively reduced the income such lump sums can buy, making what is effectively an insurance policy against living longer than you can afford unpopular.
The expense of providing such lifetime retirement income is also at the heart of challenges for schemes offering so-called defined benefits. Highlighted by BHS — a high street retailer which controversially collapsed and so left the Pension Protection Fund to take over a scheme with a £571m deficit — attention has returned to the ability of these funds to provide promised income.
Most private sector companies have closed final salary pensions to new members, leaving an estimated 11m people reliant on funds Hymans Robertson estimate have a combined £1tn deficit, thanks to a combination of rising life expectancy and record low returns from financial markets.
The pressure has intensified since the UK voted to leave the EU, prompting a further collapse in bond yields. As income from bonds shrinks, it means more money must be set aside to meet future payments.
Few can. “We need a complete review into the sustainability of pensions,” says Ros Altmann, the UK’s pensions minister under David Cameron. “Funding defined benefit schemes in an era of low rates is a bottomless pit — and liabilities have mushroomed beyond what anyone expected.”
Not all defined benefit systems have seen big gaps open up between assets and estimates of liabilities, however.
Canadian schemes are well regarded, and largely well funded, thanks to changes made in the 1990s to the way they invest. Professional in-house investment teams have built up holdings of property and infrastructure assets including pipelines, roads and bridges as a source of secure, long-term, inflation-linked income streams.
The great majority of private sector workers are not members, however, so the thrust of recent reform efforts has been to expand access to the Canada Pension Plan.
In the Netherlands, by comparison, most employees are required to make significant contributions to defined benefit schemes, typically organised on an industry-wide basis. Regulators have imposed conservative funding assumptions, but there is also flexibility to cut benefits, as many did after the 2008 financial crisis, to reflect losses.
Such safety valves provide a different tension, between the young and the old. “The big problem is, having this collective set up it’s unclear who owns the fund,” says Ilja Boelaars, an economist who has campaigned for reform. Young members are pitted against old when it comes to questions about risky investments, or whether to raise benefits now, creating danger of a future shortfall.
Such funds can also be a poor fit for those who work on projects, regularly change jobs, or the self-employed. Some, like Mr Boelaars, have pushed for savers to have individual accounts within large schemes that they can identify and move, a shift towards an approach where the individual takes the risk.
Designing a system from scratch, the challenge would be to balance the better characteristics of those above: compulsion, flexibility, individual ownership, some sharing of risk.
It suggests a need for well managed, diversified and long-term orientated funds on the Canadian model, but open to individual savers prepared to commit funds for months or years, rather than the days it takes to withdraw money from mutual funds.
The year by which all UK employers will have to provide defined contribution schemes to eligible staff
There are also more outlandish ideas, such as ways other than annuities to spread longevity risk. Outlined in one 2014 paper: for those who opt in, the remaining retirement accounts of those who die each month are shared out across the group.
In the UK, reforms have focused on expansion of defined contribution schemes, which all employers will have to provide to eligible staff by 2018, when employees, employers and the government will collectively kick in 8 per cent of earnings.
The Department for Work and Pensions has also considered “Defined Ambition” pensions, where employers provide workers with a greater level of certainty about their retirement income, but are allowed to walk away from their promise if it became too expensive.
Yet for Mr Ralfe, the solution to pension stress can be reduced to a blunt message: “People have to work longer, spend less while they’re working and save more.”
More from the FT pensions series:
Podcast: The dark future A dramatic decline in bond yields has added to the pressures of longer lifespans and falling birth rates to create a looming social and political pensions crisis. John Authers and Robin Wigglesworth discuss the looming crisis
Pensions: Low yields, high stress In the first article of a series, the Financial Times examines a creeping social and political crisis
Target-dated funds need an overhaul TDFs help pension plans but face challenges of fees, asset allocation and benchmarks
Canada quietly treads radical path on pensions Retirement funds push beyond bonds and stocks in search of better returns
Pensions and bonds: the problem explained Bond mathematics and the scale of pension deficits
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