Posted on December 19, 2014 by Tom Healy
Economics may be viewed as a dismal science but what do you make of the following biblical passage: ‘Our days may come to seventy years, or eighty, if our strength endures; yet the best of them are but trouble and sorrow, for they quickly pass, and we fly away’ (Psalm 90:10). Economists might sense some affinity with the psalmist!
The topic of ageing exercises the minds of economists, actuarial analysts and pension fund managers. When the German Chancellor Otto Von Bismark introduced a state pension scheme for persons over 70 life expectancy was much shorter than what it is today. And, in 1908, records of the number of persons over the age of 70 probably took a bit of a jump in Ireland and Great Britain when the Liberal Government of Lloyd George introduced a state pension for the first time (there is a Scottish saying that sheep gain in weight with weighing). A baby born today might expect to live until they are 90 (whereas a baby born in the 1950s would have expected, on average, to live into their 60’s). In other words, it might be expected – barring an epidemic of obesity or some other natural or human-made catastrophe – babies born today will survive to the 22nd century.
A sobering and challenging thought!
Most of us, hopefully, will live to see a period of retirement (or reduced paid work) when we can turn our time to a variety of interests and commitments more than we were previously able to do and when we can continue to enjoy our lives on an adequate level of income and savings. As people live longer and as expectations and management of health change new challenges arise in the funding of pensions, health care and accommodation in the final part of our lives.
Significant changes have occurred in patterns of fertility, family formation, work as well as life expectancy over recent decades. In short, we can expect, ‘on average’, to live longer, to work beyond what was the traditional post-Bismarkian retirement age and to have access to health services. Notwithstanding the inequalities in access to health services as well as access to pension rights (especially in the case of women who are more likely to have had broken records of employment and pension contributions during their middle-years), the absolute and relative improvement in the value of the state pension in the decade prior to 2008 was a welcome development. It made a dramatic difference to rates of poverty among older people at a time when the economy in the Republic of Ireland was growing at a rapid rate.
Providing adequate incomes for those in retirement is a fundamental human right and a mark of a civilised society. Broadly there are a number of ways of providing for retirement income:
- Personal savings over a lifetime while working.
- Social insurance schemes that pay out from a social fund into which one contributes as a worker over a lifetime of paying taxes (e.g. Pay-Related Social Insurance in the Republic of Ireland or National Insurance Contributions in Northern Ireland/UK).
- Private occupational pension schemes into which employers and employees contribute and from which retirees draw incomes upon retirement.
- The basic state pension which is means tested.
- .. or, when all else fails, assistance from family members or other benefactor sources to top-up income or assist in meeting various expenses.
What implications will changing population structure in the Republic of Ireland have on age-related spending? It would be useful, first, to consider what might evolve in terms of total population and its distribution by age-group. One possible scenario based on the assumption of a return to significant net inward migration in the long-run coupled with a constant fertility rate of 2.1 would see total population rise from 4.6 million, currently, to 6.7 million in the year 2046.
Chart 1: Projected Population (M1F1) – with ratio of ‘working-age’ persons (25-64) to others
Chart 1 indicates a significant drop in the ratio of ‘working age’ persons to others from just over 1.1, currently, to 0.9 in the year 2046. In other words, it is expected on the basis of this scenario for each person in 'paid work' there will be very nearly one person who is 'dependent' (includes the very young, those outside the labour market including those who are retired). The projecrted change betweeen 2011 and 2046 is not that dramatic due to what might be described as favourable demographics resulting from rising births in the 1990s and up to around 2010. However, behind these figures is the sharp rise in the proportion of persons aged 65 and over over the whole projections period (see light blue component in Chart 1). This latter age-group will continue to experience significant health and retirement income needs and it is likely that this component of the overall 'age dependency' ratio will place significant challenges on public finances in a very difficult context where, up to now, Governments have a stated commitment to cutting taxes further and reducing the size of the state and public expenditure to levels well below the European average - all within very tight EU fiscal rules on the absolute size of public spending, the ratio of the Government deficit and the overall ratio of public debt to GDP.
An alternative demographic scenario based on continuing (but declining) net outward migration coupled with a decline in the fertility rate to 1.8 by 2026 would see population reach a level just short of 5 million in 2046. Under the latter scenario the ratio of ‘working age’ persons to others would go from 1.1 to 0.8. While there is a sizeable shift in the ratio from 2011 to 2021 (reflecting, in part, demographic shifts in the 1980s) the ratio is projected to be fairly stable from 2021 until the late 2030s. This reflects a surge in the number of births in the period 1994-2010. The cost implications of this for both Governments and households are not without consequence. The main point to grasp is that whatever assumed underlying demographic scenario is adopted for the future the structure of population is sure to change in ways that will drive age-related spending upwards.
Ireland differs from most countries in the European Union where, on average, the proportion of persons aged 65 and over is significantly higher, at 18%, compared to 12% in the Republic of Ireland. The ratio of 25-64 year olds to others in the EU28 is projected to fall from 1.2 to 0.9 between 2013 and 2046 while the proportion of 65 and over is projected to increase from 18 to 28% of the overall total by the 2040s. The projections of population by age-group for the entire 28 Member States of the EU is based on the main projections scenario concerning fertility, mortality and migration used by Eurostat.
Chart 2: Projected Population (main Eurostat scenario) – with ratio of ‘working-age’ persons (25-64) to others
Source: Online Eurostat Database (accessed on 20 Dec 2014)
In analysing age-dependency there are two measures to focus on:
- The ratio of ‘working age’ persons (25-64 year olds) to others (in practice the actual working population spans a wider age group and many in the 25-64 do not work).
- The proportion of persons aged 65 and over (% of total population).
Both ratios are important to policy makers but in different ways. The overall dependency ratio has implications for a wide range of public services (e.g. education) and income supports. The proportion of 65 year olds and over impacts more especially on health and pensions.
In one analytical exercise undertaken by the Department of Finance in Dublin and published in the Stability Programme Update, 2014, the estimated exchequer cost of pensions (both retired public servants and the state pension) is projected to rise significantly right up to the year 2040. The assumption made by the Department appears to be consonant with M1F1 (fast population growth) and envisages a doubling in the proportion of persons aged 65 and over in total population (up from 11% in 2010 to around 22% in the mid-2040s. However, under an alternative scenario (M3F2) the ratio goes to 28% - with the implication of much higher public pension cost. Policies to gradually increase the retirement age for eligibility for the state pension have already been enshrined in legislation with the qualifying age rising to 68 by the year 2028. The real value of state pensions has declined since 2009 as nominal rates have not kept pace with inflation.
To pensions must be added the cost of long-term care and health which are also set to rise over the coming decades.
Defined benefit schemes
The situation in regards to ‘defined benefit’ (DB) pension schemes is extremely troubling. These schemes entail greater employer liability for future pension payments unlike ‘defined contribution’ schemes were the employee or member takes the risk. The onset of the Great Recession in 2008 has contributed to the demise of DB schemes. The Pensions Board (2012) has estimated that 80% of such schemes are in deficit. Many companies have closed DB schemes to new members. Changes in Minimum Funding Standards have also exacerbated problems.
The total value of Irish Pension Fund assets has fallen from a peak of €88 billion in 2006 to around €70 billion, currently.
The Central Statistics Office published, in 2011, data on pension coverage for the year 2009. It showed that 51% of workers aged 20-69 had a pension of some sort with the self-employed having only 36% coverage and young people (aged between 20-24) having 19%. Nor surprisingly, workers in low-paid sectors such as hospitality, food, agriculture and retail had the lowest coverage.
Looking to the next 30 years it is clear that the current policy approach to pensions is neither fair, sustainable or secure. Over-reliance on market forces to determine the value of pension funds given the variation in share and real estate prices is a recipe for instability. At the same time the non-contributory state pension, while improved over recent decades, is not adequate for some pensioners and is, in any case, subject to means testing. A basic, secure and adequate level of pension income is required which could be topped up by other means including a universal social pay-related insurance fund or by occupational pension schemes that are adequately funded. Ultimate, as seen in recent court judgements on pensions, the State is left to pick up the costs when schemes or companies or both go bust – either directly or indirectly through social spending related to low income.
Some regard the traditional retirement age of 65 (or 68 from 2028 in the case of the state pension) as too young. People are living longer and stay more healthy than was the case formerly. While some increase in standard retirement age is to be expected over coming decades caution is needed in how this is done. Some occupations are, by their nature, physically onerous and not suitable for change. In many situations there is merit in allowing persons the option of continuing to work on a part-time basis either because of their valued skills and experience or because they wish to. However, there is merit in encouraging people to retire and make way for new blood. A balance needs to be struck between various considerations and societies need to agree on arrangements that are sensible and affordable.
Readers may be interested in a number of seminar papers relating to pensions presented at the most recent NERI Annual Labour Market Conference:
Maureen Maloney (NUIG/PPRG) ‘Achieving Pension Adequacy through DC-type Schemes: Problems for Employers’
Jasmina Behan (SOLAS) ‘The Occupational Employment Projections 2020’
Michelle Maher (NUIM/PPRG) 'Gender and Pensions. The Missing Element in the Pensions Debate.’
James Stewart (TCD/PPRG)and Bridget McNally(NUIM) 'Pension Funds and Governance'
In a paper presented at one our monthly NERI seminars earlier this year Eamon Murphy presented on Pension Policy in Ireland: an Evaluation. His key finding was the pension system could be made more financially equitable and less discriminatory by bringing universal pension coverage to everyone while reducing the extent to which the Exchequer supports private pension arrangements via tax reliefs that are inequitable in the way they favour higher-income earners.
One could conjecture that movement towards a universal pension provision funded from a removal of inefficient and inequitable tax reliefs poses a chicken and egg challenge – which part of the policy agenda moves first? The Republic of Ireland is relatively unique in Europe to the extent that employer and employee social security contributions are a small fraction of what they need to be to fund a 'social wage' that includes income protection throughout people's working lives and beyond into retirement.
The one constant in life is change. And age offers a perfect example. But like all good things in life it must be paid for. This blogger wishes all readers a healthy, prosperous and happy Christmas and new year!