Global Pension Crisis

CHAPTER 2

Dimensioning the Problem

If you read the paper, watch the news, or even if your sole source of current events is derived from snippets captured on late night political satire, you have probably heard of or read stories warning of the "pension crisis," "pension underfunding," or "pension tsunami." However, unless the story directly affects your firm's pension, or your state's pension, it may seem irrelevant to you.

For instance, why should a person from New York care that;

These are all pieces of a much larger puzzle. In this chapter, we tell the pension story, because in order to understand why every single American will be affected by the pension crisis, we need to dimension the crisis and quantify each of the components. Broadly characterized, every issue will come back to managing four things: people, wealth, obligations, and expectations.

In this chapter, we attack the following questions:

• What is a pension?
• What is the pension crisis?
• How much of the world's wealth is committed to retirement?
• How wealthy is the world?
• How will demographic trends affect the way we look at a four-generation world?
• Will developed nations maintain their statuses as world leaders?
• And, most importantly, how will the crisis affect you?

The answers to these questions help explain why everyone across the globe, whether very wealthy or less affluent, will have to prepare for the imminent pension crisis.

CALCULATING THE SUFFICIENCY OF SAVINGS

When talking about pensions, one is mostly concerned about sufficiency of the wealth set aside for retirement. If we start with the simple premise that one of the main reasons to save is to provide for the "winter" of our lives, when we are not productive for the most part and must decumulate (defined as the spend-down of assets in retirement) our assets to live upon, then we can go about calculating the sufficiency of our savings to perform such a function.

The things we must understand in order to properly assess that sufficiency include answering the following five questions:

Most of these are factual and not projection-based estimates. There is, of course, some longevity estimation, but if we simply use the current retirement age and national longevity averages, we get a fair estimate of the full average retirement period.

As for the number of people in the retirement pool, this is a constantly changing and, unfortunately, constantly growing number that has a great deal of impact on the retirement burden.

As for the retirement earnings rate, it is said that the impact of the earnings rate on retirement funds during the decumulation stage (that is, after retirement has commenced) impacts the total amount available for retiree income to the tune of 50 to 60 percent. This is logical based on the scale of funds to be invested at that point in the cycle and the overall compounding impact in the later years of any investment cycle.

Probably the easiest estimate to make of all is retirement need percentage, which has proven fairly steady and universal at 60 percent of final income. What is perhaps less clear is whether this absolute number must rise to match average national income numbers for the higher growth countries in question. Luckily, the "problem" situations are generally lower-growth countries, so it should present less of an issue. Inflation indexation of pensions is a politically charged issue and is particularly so in European countries, where this has become the norm. This probably lines up with many other entitlement issues, which are likely to be thrown into serious challenge as the full extent of the pension crisis problems unfolds.

We delve into these five areas in the remainder of this chapter.

Worldwide Wealth and Retirement Assets

We should start gathering information by estimating the amount of wealth that exists in the world and what proportions of it are dedicated or set aside specifically to fund the retirement of existing and future pensioners. That alone is already a challenging concept because it is unclear exactly how to measure wealth and then delineate its intended use.

We can certainly start by understanding several key generic "buckets" of wealth:

• Private wealth
• Pension funds
• Mutual funds
• Insurance companies
• Sovereign wealth funds

I believe this list captures the bulk of the world's recorded wealth with minimal overlap. One might argue that private wealth encompasses mutual funds, since most of those assets are, indeed, held in private hands, but the category has become so big as to justify its own bucket, and it is uniquely important as the vehicle of choice for the past 30 years for housing the bulk of the defined contribution pension obligations.

New, alternative buckets such as hedge funds, private equity funds, and real estate funds do not seem to make this list. Why is that? Well, to begin with, they are all pretty much imbedded in the other categories. They all began as high-net-worth investment vehicles and have now gravitated more and more toward being institutional investment vehicles, which means they can be found as parts of private wealth (also encompassing endowments and foundations), pension funds, insurance funds, and sovereign wealth funds. Despite being thus subsumed, they will be very important to delineate eventually since they drive a disproportionate amount of the activity and price movement of the major and most emerging markets (especially due to the extraordinary use of leverage that acts as a multiplier effect, not to mention their high turnover, which also magnifies their impact).

Let us also remember that there are substantial natural and even intangible resources that constitute "wealth" that is not being captured by this approach to tallying assets. A perfect example I always use in the United States is Yosemite National Park. Nowhere does its value, either as a unique natural wonder or simply as a big chunk of valuable real estate, appear on a balance sheet with a value assigned to it. Some have tried to postulate a balance sheet for the United States (usually to make some balancing argument or assessment of the impact of our national debt levels), but nowhere is the full value of our resources officially or formally captured in terms of the fullest complement of wealth. And then there are even more challenging asset valuations like satellite spectrum. We now certainly understand the value of satellite spectrum for global telecommunications. Not too long ago someone might ignore the small pie slices of the sky as embodying value, but today, private companies pay a great deal for spectrum as a scarce resource, which enables current technology to operate and gives these companies an ability to charge for the voice and data that flow through satellites. Once the value of such a resource is recognized and paid for, it constitutes an asset on company balance sheets that gets reflected in our buckets above in any number of places. However, nowhere do we capture the vast natural resources that constitute the perhaps unknown or certainly unrecorded patrimony of the world's nations or, for that matter, for the universe as a whole. If we add to those resources the vast amount of human and intellectual capital that exists in the mind of man (whether we consider the historically accumulated wisdom, the current intellectual property, or the future brainwaves of countless generations), we can easily conclude that, although this value is actually quite real, it is infinite and therefore not able to be captured. But what can be captured are the existing recorded assets that constitute the balance sheet of the world as we know it, and that is what concerns us for now.

So if we go back to our generic buckets, our best estimate of the sizes of those asset buckets today (that is, global recorded wealth) are as follows:

I am therefore prepared to...