Will the World be ever able to bridge funding gap in pension systems? The answer with “Yes” is near to Impossible

Ebrahim K Ebrahim

Pension Researcher & Chairman of the Annual MENA Pensions Conference

The world’s six largest pension saving systems – the US, UK, Japan, Netherlands, Canada and Australia – are expected to reach a $224 trillion gap by 2050. Adding in China and India, which have the world’s largest populations, the combined savings gap for the eight countries reaches a total of $400 trillion by 2050, a sum five times the size of the current global economy. Here in the GCC, the aggregate funding gap, actuarially, in public pension systems for the six countries already stand horrifically at US$400 billion, exactly 25% of the region’s total GDP. And surely if current trends continue (i.e., the dynamics responsible for the creation of such deficits), it’s expected to easily exceed its total GDP.

The magnitude of such funding gap is practically close to economic infinity and very difficult to cover; and because it directly impacts vital social benefits and rights of societies, economists and political commentators in recent years have increasingly called it “a social time-bomb”. In the words of a middle eastern finance minister of a populous country with little financial reserves in a recent pension conference: "We’re already weathering this time-bomb and all that we’re hastily doing with these continuous sovereign bonds and international loans is clearly firefighting”.

Since the middle of the 20th century, life expectancy has been increasing rapidly. On average, it has been increasing by one year, every five years. Your kids that are born this year can expect to live to over 100, or in other words, they will live to see the year 2117. While this is great news for individual and societal health and productivity, this change has a profound impact on the traditional make-up of our societies and structures of social support, especially for people in old age. In many advanced countries, retirement can begin at 60; in the GCC people can go on early retirement after 15 and 20 years of work for women and men respectively. This could result in a retirement of 40 to 60 years in line with improving life expectancy. Thus, the big question all governments need to address is: how do we economically and socially rethink our retirement systems which were designed to support a retirement of 10-15 years?

Think-tank institutions and actuaries have for the last three decades advocated a series of parametric reforms on the design of pension systems – the extension of retirement age, increasing contribution rates, changing annual accrual rates, pension salary cap, etc. which have financially and actuarially improved funding levels– however, these still remain far from solving the funding issues, being socially popular or meeting people’s pension outcomes! 

One thing, and one thing only, could make a significant difference in this terrain– it’s the way we make access to pension easy, and make the whole experience of arranging one’s own pension simple and low-cost as much as possible. In many cases there are options available, but take-up is low. The lack of opportunity to begin saving, and encouragement to make putting money aside a habit, is severely limiting many people’s ability to accumulate savings.

One more prerequisite for a successful retirement saving market is financial literacy. Levels of financial literacy are very low worldwide. This represents a hindrance to new pension systems which are more self-directed and which rely more on private savings in addition to employer- or government-provided savings. The lack of awareness of the basics on how interest and returns will compound over time, how inflation will impact savings, proper savings rates, and the benefits of holding a broad selection of assets to diversify risks means that many individuals are ill-equipped to manage their own pension savings.

Hence, both creating a savings culture with enhanced financial literacy/ motivation community-wide and making access to pension easy and low-cost are the real hope to turnaround the current acute deficits in global pension systems over the coming three to five decades. However, like all revolutionary social changes, this could be easier said than done. I will be shedding some light on these two angles in the next article.