The global ageing population is considered as one of the main issues to be addressed by most governments. Its impact is not only on the budget but also on pension policies. FAIZAL AHMAD MANJOO briefly analyzes the pension changes that took place in 2014/15 and what can be expected for 2016.
Helping the greying population to maintain a sustainable consumption smoothing is becoming a challenge both for funded and unfunded pension schemes. Much legislation has been enacted, mainly in western countries, in order to address this malaise. Failure to do so might lead to a chronic social problem for at least another 50 years when the dependency ratio will decrease again with an increase in a younger working population in some countries.
Review of 2015
The various Organization for Economic Cooperation and Development (OECD) reports on pensions provide a deep insight into the pension market trajectory on OECD member states and also the G20. The statistics reveal that pension funds’ assets exceeded US$25 trillion in the OECD countries with US$21.7 trillion or more than 85% of OECD pension funds’ assets emanating from the US, Australia, Canada and the Netherlands. This skewed distribution of pension funds is a clear indication that the pension industry situation in the OECD is alarming in sustaining the ageing and retiring population. Despite the weighted average asset-to-GDP ratio reaching 86% for these countries, the majority of them witnessed the market value of assets accumulated in pension funds relative to the size of their economies at below 10%.
Legal reforms have been accelerated in almost 34 member states of the OECD, mainly to improve pension coverage and safety net benefits as part of their efforts to fight poverty in old age more effectively. Unfortunately, due to the global financial downturn, some countries such as Greece, Italy and Portugal are still facing economic difficulties. The ongoing areas for pension reforms are:
- Pension system coverage in both mandatory and voluntary schemes
- Adequacy of retirement benefits
- The financial sustainability and affordability of pension promises to taxpayers and contributors
- Incentives that encourage people to work for longer parts of their lifetimes and to save more while in employment
- Administrative efficiency to minimize running costs of the pension system
- The diversification of retirement income sources across providers (public and private), the three pillars (public, industry-wide and personal), and financing forms (pay-as-you-go and funded), and
- The need for the residual category to cover other types of change, such as temporary measures and those designed to stimulate economic recovery.
Other countries like India and Chile are making efforts to improve their systems while others are really lagging behind.
Preview and forecast of 2016
The main challenges for the industry are not only to provide cash annuities but also to develop products in kind. This is due to a shortage of energy, health products, housing, etc. The British National Employment Saving Trust is a practical model for other countries to simulate as it will encourage more people from lower-income groups to access a portable pension scheme via the auto-enrolment mechanism. Another product to be considered in order to mitigate the longevity risk is the issuance of a longevity bond by the states to cushion the aggregate longevity risk. The UK and Chile have worked in this area but without the support of the insurance industry it might be problematic.
A major change in UK pension industry is the introduction of pension freedom effective from April 2016, i.e. people can opt for a drawdown from their pension pot without the need to buy annuities. This approach is a bone of contention because it has been argued by the government that people are intelligent enough to look after their wealth, but this needs to be proved over time. This approach has attracted lot of criticism and has dictated industry readjustment with new products. A product which might attract the attention of some firms is the Swiss model of book reserve pension. This new product has many advantages but the main issue is the employer’s bankruptcy. So, massive insurance support will be needed to mitigate the bankruptcy risk. Interestingly, the regulators have not imposed a capital adequacy regime on the pension industry yet. Should this happen, it will create more liquidity problems. The EU directives have been drafted however.
As far as the Muslim world is concerned, the demographic physiognomy is relatively young compared to many western countries; however, the ageing population is catching up. Muslim countries can be divided into three groups: the under-developed, the developing and the oil-rich countries. Unfortunately, very few countries have adopted a stance to develop the funded pension industry. The focus is mainly on unfunded state pension. This precarious situation is difficult to manage and demands immediate remedial actions. The average purchasing power parity of OIC countries is US$10,825 which is relatively low compared to OECD countries. The low human development index in most Muslim countries also explains why the disposable income to purchase pension plans are limited. The drastic drop in oil prices is a signal that Gulf states cannot rely on oil only.
However, there are opportunities in the Muslim world in terms of having Islamic pension due to the social construction and awareness. Some countries like Turkey and Indonesia are becoming emerging economies with a young population which has the potential for disposable income to buy pension products. In other countries like Egypt and Pakistan, though they are facing political unrest, the potential market should not be discarded. Malaysia has set the pace in developing Islamic pension though there is still work to be done to bring it to a mature level.
2016 might not appear promising for the pension industry in general; however, more stability is warranted to meet the longevity risk hovering over the ageing population. Efficient legal reform is needed not only to encourage more product innovation with appropriate returns, but also to guarantee pensioners a good income smoothing. For the Muslim world, a more concerted effort is required before it is too late.
Faizal Ahmad Manjoo is CEO of Minarah Consulting in the UK. He can be contacted at [email protected].