Global pension system has seen better days

Canadian Treasury Board president Stockwell Day hinted on Monday that the federal government has plans for a two-tier pension system for civil servants, explaining to a House of Commons committee that the benefits of “existing” federal employees will not be reduced.

“We’ve been clear. We’re not reducing existing pension benefits,” he told reporters.

The government is attempting to execute an austerity program to reduce its $53.8 billion deficit without raising taxes. Previous comments by Day and federal finance minister Jim Flaherty have hinted that federal pensions are a likely source of savings.

In the U.K., Towers Watson’s latest report suggests that the cost of “gold-plated” pensions for public sector workers has soared to almost £1.2 trillion, or 80% of the country’s GDP. The consulting company explains that, were the Chancellor of the Exchequer to include the pension system’s liabilities in Britain’s upcoming budget, they would more than double the new estimate of the national debt.

“The government has been borrowing off its own employees by promising them pensions in the future in return for work carried out in the past,” says John Ball, head of defined benefit pension consulting with Towers Watson. “Members of public sector pension schemes have a bigger claim on future taxpayers than the investors holding government bonds do.”

“The taxpayer must be the only employer in the country [that] provides expensive pension benefits but tells its employees their retirement benefits come cheap,” adds Ball. “When taxes go up and spending is cut, it will be harder to justify letting public sector employees build up extra pension benefits that can be taken in full from the age of 60.”

In Germany, the president of Bundesbank Axel Weber told Bloomberg that pension entitlements will probably need to decline in future due to Germany’s aging population and low birth rates.

“In future, pensions will probably decline simply because we have to have a balance,” said Weber. “We cannot live beyond our means.”

And in the Wall Street Journal, Andrew Biggs of the American Enterprise Institute sounds the alarm over U.S. public pension deficits. He says that while pension plans for state government employees report being underfunded by US$450 billion, the true cost is vastly understated, as public pension accounting wrongly assumes that plans can earn high investment returns without risk. His research suggests that overall underfunding tops $3 trillion.

“The problem is fundamental,” he says. “According to accounting rules adopted by the states, a public sector pension plan may call itself ‘fully funded’ even if there is a better-than-even chance it will be unable to meet its obligations. When that happens, the taxpayer is on the hook. Yet public pension plans ignore market risk even as they shift into risky foreign investments, hedge funds and private equity.”

Delusional
Biggs believes that public pension plans are hiding behind unrealistically low deficit figures, allowing policy-makers to defer tough choices today at the cost of a much heavier burden on taxpayers in the future.

“There is no question in my mind that public pension funds are deluding themselves if they think they will make up the shortfall by investing more in hedge funds and private equity, or by leveraging up their bond portfolio,” he says.

Biggs points to the American political system as a major factor in the chronic underfunding of public pension plans, as it is much easier—and politically expedient—to withhold pension contributions during times of budget shortfalls. In fact, there’s a strong political incentive to increase benefits and virtually no upside to tackling the burgeoning costs.

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