One of the greatest risks facing the world today is “risk management”. I put the term in quotes because what passes as risk management is in fact the low level check-box risk avoidance systems embodied in doomed regimens such as Solvency II (or Basel 3), hedge fund investment strategies and popular politics. Our world is flooded with deep-seated paradigms about what works, what is desirable and what is achievable. Institutions (state or corporate) continue along a path of selective strategies like a music store chain sticking to its core competencies – selling CDs on the high street in a world that is swapping MP3s on-line.
In the case of retirement planning the prevailing paradigm that drives thinking is that 65 is a respectable retirement age and, in the modern era, we should be able to reduce that age thus giving us more leisure time. This is linked to the ethos that society should be able to ensure a good standard of living for all, focusing on minimum levels of comfort (or consumption) rather than economic value (or production). In advanced economies this seems both affordable and noble, and in some respects it is. A different view is that it is patronising and demeaning and destructive of long-term economic value.
This alternative view seems harsh, until you understand the feelings of panic felt by a 64-year old facing imminent compulsory retirement from a role that has been his or her life for a long time. From having value in a social domain the future now plays out as a long period of inactivity apart from irritating his/her partner and some unfulfilling pastimes that are classified as leisure. Even those who cannot wait to escape the strains of working life may find feelings of inadequacy and lack of value taking hold as perceived leisure turns to real boredom.
Of course, there are many things that can be done to mitigate this – hobbies, travel, golf, or whatever is your preference. However, the key point is that allowing consumption in the absence of value-adding production is not necessarily the virtue that it is extolled to be.
The cruel economic fact is that in the long run we cannot consume what we do not produce. The modern world is producing at an unprecedented level, but there are equally unprecedented levels of lost productivity. We are also consuming at unprecedented levels with the luxuries of times past now regarded by many as basic necessities or rights.
So, let’s get back on the topic of retirement age. The retirement age of 65 was set in the 19th century, apparently by Otto Von Bismarck (see http://timkastelle.org/blog/2010/06/why-is-the-retirement-age-65/ ). This retirement age worked as many people died before reaching retirement age and those that did reach the ripe old age of 65 tended to last only a few years thereafter. Over 70 was “a good innings” and those who died in their late 70s and 80s often did so in care homes, suffering from senile dementia. Today the age at which we start work has increased significantly with longer education periods and troublesome anti-child labour laws. Today’s “geriatrics” remain active for longer and are fit enough to, if necessary, hold down demanding jobs well beyond traditional retirement ages – think Queen Elizabeth or Warren Buffett for two ready examples. Life expectancy has increased by 20% to 30% and the quality of life at all ages is improved by better diet and lifestyle information as well as more favourable economic conditions. If we are to maintain Bismarck’s balance between working life and post-work retirement then it makes sense to increase the retirement age by 20% to 30% - i.e. to somewhere in the range of 78 to 85. That is today – as our longevity continues to increase perhaps those entering the workplace in 2013 should be contemplating retirement at age 100 or beyond!
There are many reasons why we could or should modify these targets to something less extreme. Some are compelling, such as the fact that we can afford more leisure-time as a percentage of our total life-time. Others are the result of decades of short-term vision, especially in the way in which we have structured and run our corporations. Most organisations are not well equipped to handle large numbers of staff at more senior ages and most lack the vision of how to keep staff productive in a 21st century technological environment when these staff developed their own paradigms in the 1960s and 1970s.
Another practical problem is dealing with defined benefit schemes that have promised a certain level of benefit from a specified retirement age. Existing members of those schemes have accrued a level of pension promise that has a certain value. Making them wait longer for their benefit would reduce the value of the accrued benefit and some compensation is required (i.e. the accrued promised pension needs to be increased, probably quite dramatically). With a full-funded scheme there is no hurdle to overcome – the investments held against each member’s pension can now be utilised more effectively to provide a significantly enhanced benefit to the individual. Similarly the reduced funding cost of the future pension accrual could be passed on to the member in the form of enhanced benefits or, perhaps better, improved salary.
The bigger challenge is dealing with unfunded schemes, especially those of government welfare schemes where a basic level of pension is funded on a pay-as-you-go basis. A 64-year old prospective pensioner in the UK is looking forward to a basic state pension starting within a year of a little over £7,000 per annum, inflation-linked. This represents a liability of maybe £150,000, which the state has left to be covered by future on-going generations of workers. If we deferred the liability to age 80 then the liability would reduce dramatically – 15 years of investment return, a reduced probability of reaching retirement age, a shorter pension-payment term and the individual would continue to pay National Insurance Contributions in the meantime. The accrued liability would probably drop below £50,000 which means that the ordinary citizen might rightfully look for compensation worth £100,000 or more. The state does not have those funds available to pay that compensation now and therefore it would probably have to enhance future pensions according to current age (with a greater enhancement for those closest to retirement). This is a political minefield – not easily explained in five-word sound bites, not easily understood by politicians never mind their constituents. It requires an admission that the current position is unsustainable and unaffordable, this in an environment where most Western Europeans are struggling to sustain any period of austerity or cutback in unfunded consumption.
Perhaps this goes some way towards explaining why current political solutions are hopelessly inadequate small steps along the way. Current proposals go around trying to increase retirement ages a year at a time, spread over a long period. The impact on those affected is seen as small enough not to have to address the impact on value (although members of government employee pension funds have rightly expressed concern about how their rights and entitlements are being affected). The solutions proposed are therefore typically too little, too late and unfair to current and future generations alike.
Further aggravation is that retirement savings are building up to high levels, resulting in bloated investment funds under-serviced by available labour. The inevitable impact is historically low real investment returns, probably as much a cause of current sustained recession in developed countries as it is a symptom of that recession.
So, what is the solution? The answer depends a little on what you are trying to achieve and how adept you are at persuading others to walk the path with you. Politicians with short-term re-election goals are likely to continue with inadequate solutions that can be sold to enough voters to achieve re-election. The more courageous approach is to strive for a whole solution that encompasses:
1. An immediate and substantial increase in retirement age to at least 75
2. Offers of early retirement to those close to current retirement ages, but incentives to defer retirement to the new age or even beyond
3. Compensation for those within 30 years of the current retirement age, on a sliding scale, to be paid out in the form of enhanced future benefits
4. Proper funding of all pension liabilities, including state welfare pension schemes
5. …and, most importantly, a substantial re-evaluation of the way in which we work, incorporating life-long learning, changing careers paths and new incentives and ideas to keep staff fresh and engaged over a 50+ year career rather than a 40-year career.
More easily said than done, but failure to address this challenge will in all likelihood mean eventual decline of established economies and their replacement by emerging economies that do not carry the same historical burdens. The virtuous result of addressing this challenge correctly is greater productivity, longer periods of saving for retirement, shorter periods of in-retirement consumption, better living standards, and sustainable long-term real investment returns.
There are other implications of such a sea-change, including those for disability income insurance and long-term care policies, establishing challenging career and promotion paths for those stuck behind baby-boomers, and finding creative ways of extending existing employment opportunities to keep the enlarged workforce fully engaged and productive. I suggest that these are good and exciting challenges, but perhaps best left for a later discussion.
In summary, I firmly believe that an immediate and substantial increase in state retirement age to 75 and beyond is not only desirable, it is essential.
Category: Funding longer lives: Pension/retirement