Over the next decades, the number of people in retirement age will increase markedly and put social security systems under severe stress
The dramatic shift in demographics is best characterized by the increase in the global old-age dependency ratio: Until 2050, it will grow by a whopping 77 percent to 25 percent, i.e., faster than in the last 70 years since 1950. In many emerging economies the ratio is going to more than double within the next three decades, that is, in less than half of the time this development took in Europe and Northern America. The most prominent example is China where the ratio is going to increase from 17 percent to 44 percent. For industrialized countries, however, the absolute level of this ratio is the main reason for concern, reaching, for example, 51 percent in Western Europe.
This development is reflected in the first pillar of the API, called the starting points, which combines demographic change and the public financial situation. Not surprisingly, many emerging countries in Africa score rather well as the population is still young and public deficits and debts are rather low. On the other hand, many European countries such as Italy or Portugal are among the worst performers: Old populations meet high debts.
“For most industrialized countries, the old Scottish joke applies: If I were to build a stable pension system, I certainly wouldn’t start from here”, said Michaela Grimm, author of the report. “And that is the situation before the coronavirus and its tsunami of new debt. One of the legacies of the current crisis will certainly be that we have to double our efforts to reform our pension systems. What had remained of financial leeway has gone for good.”Â
The second pillar of the API is sustainability, measuring how systems react to demographic change: Are there built-in stabilizers or will the system be blown apart when the number of contributors fall while that of beneficiaries keeps rising? In that context, an important lever is the retirement age. In the 1950s, an average 65-year old men, living in Asia could expect to spend around 8.9 years in retirement (women 10.3 years).
Today, the average further life expectancy of a 65-year old is 17.8 years for women and 15.2 years for men and it is set to increase to 19.9 years (women) and 17.5 years (men) respectively in 2050. As a consequence, the ratio of working life to time spent in retirement has declined markedly. Countries, which decided to adjust the legal retirement age or the increase of pension benefits to the development of further life expectancy like the Netherlands, have thus a more sustainable pension system than countries where postponing retirement further is still a taboo.
The third pillar of the API rates the adequacy of a pension system, questioning whether it provides an adequate standard of living in old age. Important levers are the coverage ratio – i.e. how big are the shares of the working age population and the age group in retirement age that are covered by the pension system? –, the benefit ratio – i.e. how much money (measured in terms of average income) does an average pensioner receive? –, and last but not least the existence of capital-funded old-age provision and other sources of income.
Overall, the average score in the adequacy pillar (3.7) is slightly better than that in the sustainability pillar (4.0), a sign that most systems still put greater weight on the well-being of the current generation of pensioners than on that of the future generation of tax and social contribution payers. The countries leading the adequacy ranking have either still rather generous state pensions, like Austria or Italy, or strong capital-funded second and third pillars, like New Zealand or the Netherlands.
However, capital-funded retirement solutions are under increasing pressure in the persisting low interest rate environment. The COVID-19 pandemic has further exacerbated this trend by further pushing down yields. “The low yield environment has forced both pension funds and life insurers to explore alternative asset classes”, said Cameron Jovanovic, head of global retirement proposition at Allianz SE.
“This push into alternatives enables benefit providers to capture the illiquidity premium that matches well with their portfolio duration. Another strategy is to offload risk rather than chasing returns as longevity swaps, pension risk transfers and creative reinsurance set-ups become means of optimizing the exposure taken on by pension funds and insurers.”
Kenya ranks 55th in this global ranking and second in Africa. Thanks to its still very young population Kenya has one of the best starting conditions of all analyzed countries, ranking 4th in this sub-index. But, Kenya’s population in retirement age is set to increase from 1.3mn today to 6.2mn in 2050. Hence, in order to guarantee the long-term sustainability of the pension system, the aging of the population should be taken into account by increasing the retirement age in line with future gains in life expectancy and by introducing a demographic factor in the pension benefit formula.
However, currently the main issue of the pension system is the insufficient adequacy: Among the 70 analyzed countries Kenya ranks only on the 61st place in this sub-index, due to the low coverage and benefit ratio of the public pension system. Furthermore, limited access to financial services hampers the build-up of sufficient private old-age savings to cushion the lack of the public pension pillar. Against this background, further pension reforms and efforts to improve the access to financial services for a broader share of the population are urgently needed.
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