By Rebecca Christie and Peter Woodifield
Even before the euro crisis, people were worried about Europe’s pension
bomb.
State-funded pension obligations in 19 of the European Union nations
were about five times higher than their combined gross debt, according to a
study commissioned by the European Central Bank. The countries in the report
compiled by the Research Center for Generational Contracts at Freiburg
University in 2009 had almost 30 trillion euros ($39.3 trillion) of projected obligations
to their existing populations.
Germany accounted for 7.6 trillion euros and France 6.7 trillion euros
of the liabilities, authors Christoph Mueller, Bernd Raffelhueschen and Olaf
Weddige said in the report.
“This is a totally unsustainable situation that quite clearly has to be reversed,” Jacob Funk Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington, said in a telephone interview.
A recession threatening the world’s second-biggest economic bloc, along
with efforts to reduce debt across Europe, is exacerbating the financial risks.
Stable or falling birthrates, plus rising life expectancies, are adding to
pressures, with the proportion of economic output devoted to spending on
retirement benefits projected to rise by a quarter to 14 percent by 2060,
according to the ECB report.
Ageing Populations
Increased retirement ages and lower benefits must be part of any package
to hold the 17-nation euro area together, according to analysts, including
Fergal McGuinness, the Zurich- based head of Marsh & McLennan Cos.’s
Mercer’s pensions consulting unit for central and eastern Europe.
Europe has the highest proportion of people aged over 60 of any region
in the world, and that is forecast to rise to almost 35 percent by 2050 from 22
percent in 2009, according to a report from the United Nations. That compares with
a global estimate of 22 percent by 2050, up from 11 percent in 2009.
The number of people aged over 65 in the 34 countries in the
Organization for Economic Cooperation and Development is forecast to more than
quadruple to 350 million in 2050 from 85 million in 1970. Life expectancy in
Europe is increasing at the rate of five hours a day, according to Charles
Cowling, managing director of JLT Pension Capital Strategies Ltd. In London.
In so-called developed countries, the average lifespan will reach almost
83 by 2050, up from about 75 in 2009, the UN said.
Cutting Costs
Governments and companies have taken steps to reduce future costs with
policy makers having increased retirement ages in countries, including France,
Germany, Greece, Italy and the U.K.
“Irrespective of whether you’re inside or outside the euro or anything
else, raising retirement ages is one of the structural reforms that all of
Europe has to do,” Kirkegaard said. “The crisis has forced them to address
this. This is actually a positive thing in many ways.”
By 2060, the average French pension benefit will be 48 percent of the
national average wage, compared with 63 percent now, said Stefan Moog, a
researcher at Freiburg University in Freiburg, Germany.
Pension managers and governments are relying on economic growth to
safeguard the promises they make. If the euro zone grows too slowly to bolster
public and private coffers, the retirement plans may become unaffordable,
according to Mercer’s McGuinness.
Benefits’ Squeeze
“The amount of money countries are going to spend on social security and
long-term care is going to go up,” McGuinness said in an interview.
“Governments with more generous social-security systems will have difficulty
affording them. They will have to recognize these costs will impact their
ability to reduce borrowings.”
State pension obligations in France and Germany are three times the size
of their economies, according to data compiled by Mercer. It’s more sustainable
in France than Germany because of France’s higher birthrate.
Last year, there were 4.2 people of working age for every pensioner in
France. The ratio will fall to 1.9 by 2050, according to a report by Economist
magazine in March. In Germany, the proportion will decline to 1.6 from 4.1 in
the same period.
“That is going to put a lot of pressure on Germany’s ability to meet
their promises,” McGuinness said. “What they are more likely to do is cut back
benefits. Governments face a lot of longevity risks.”
Add to Risks
Private pension funds are under pressure too with benchmark euro-area
interest rates at the lowest level since the 13-year- old currency was
introduced. Low rates mean pension plans have to hold more assets to back their
long-term payout projections.
Unless growth returns, fund managers will effectively be forced to take
on more risk, said Phil Suttle, chief economist of the Washington-based
Institute of International Finance.
“That creates problems because they all head into sectors that seem a
great idea now, and then they blow up, whether it’s commodities or equities or
whatever,” Suttle said. “You’re going to intensify the boom-bust cycle.”
The growing doubts facing the euro area is another planning hurdle as
companies reconsider investment strategies amid concerns that Greece may
default on its debt and spark a broader euro breakup.
The implied probability of one country leaving the euro by the end of
2013 fell to 49 percent on Jan. 10 from 51 percent a week earlier, based on
wagers at InTrade.com, an Internet betting market. The probability of one country
departing by the end of 2014 is 59 percent.
Rates Benefit
Pension plans in countries such as Greece or Portugal may benefit from
exiting the euro as higher interest rates that would likely accompany a return
to their national currencies would cut the cost of liabilities, while assets
invested abroad would almost certainly gain in value, according to Mercer, a
unit of Marsh & McLennan Cos.
PensionDanmark, Denmark’s seventh-largest pension fund by assets, sold
all its German government bonds last year, Chief Executive Officer Torben Mogen
Pedersen told reporters in Copenhagen yesterday.
“Our government debt investments are all in Scandinavian non-euro
countries,” Pedersen said. “We think 2012 will be a very hard year for European
investors.”
In Britain, which has refused to join the euro, occupational pension
funds have moved the risk of ensuring adequate retirement income to the
employee from the employer in the past decade to curb pension-fund shortfalls.
Funding Gap
Unfunded public-sector U.K. pension obligations across 1,500 public
bodies totaled 1 trillion pounds ($1.57 trillion) in March 2010, the Treasury
said Nov. 29 in the first set of audited Whole of Government Accounts. That
compares with a total of 808 billion pounds of outstanding U.K. government
bonds and accounts for 90 percent of all public-sector pension liabilities.
Royal Dutch Shell Plc (RDSA), Europe’s largest oil company, was the last
member of the benchmark FTSE 100 Index to close its defined-benefit pension
plan to new entrants when it made the decision last month to do so. The company
plans to introduce a fund for new employees next year that makes them
responsible for ensuring they have enough to live on in old age.
Governments may have to follow the same path for their own employees as
well as increasing the retirement age to at least 70 and possibly 75 to make
the pensions affordable, Cowling wrote in an article published in July by
Public Service Europe.
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