Pensions not an ageing crisis, but a policy crisis
Our golden years will lose their lustre if governments continue to make promises that taxpayers can't afford to keep
Ensuring adequate income for people in retirement has become a major policy challenge for European governments. At the heart of this pensions crisis is the viability of the defined benefit model of pension provision. Under this model the retiree is promised a pre-set level of pension benefit, regardless of the performance of the scheme's invested assets or indeed of whether the scheme has any assets at all. Some guarantor (the government or a business firm) promises to meet payments to pensioners well into the future. But some of the guarantors, including governments which typically do not pre-fund their pension promises, face financial distress and cannot be relied upon to deliver. Schemes which are pre-funded through employer and employee contributions rely on the survival and solvency of companies to make up shortfalls if the promises exceed the capacity of the fund. But companies which look solid today could be struggling, or have disappeared, 20 or 30 years from now. Governments which appear to enjoy sound public finances can end up in a budget crunch.
Europe's pension promises have lost credibility for several reasons. The main one is that people are living longer: with fixed retirement ages this means that the liabilities of pension schemes escalate. The government's off-balance-sheet liability to public service pensioners becomes an ever greater burden on future revenues the longer people survive. Many company schemes in Ireland have predicted liabilities which exceed the scheme assets for the same reason: the annual contributions from employers and employees were not set at a high enough level to pay the promised pensions to retirees who are living longer. The government schemes are unfunded, which means that they do not have any assets; they are called, rather quaintly, pay-as-you-go schemes, so greater longevity means higher bills for future taxpayers. Adding to the list of worries, the funded schemes have seen poor investment returns in many cases.
Planning a system to deliver income in retirement exposes all concerned, employees and their trade unions, employers and politicians, to a fundamental temptation. Everyone agrees on generous benefits but nobody wants to face the upfront pain of the necessary contributions. Unfunded schemes are particularly exposed, since there are no contributions and the promises look like a free lunch. Some trade unions have learnt about the perils of the defined benefit model the hard way: their own in-house schemes for trade union staff have big funding gaps.