Building Better Retirement Systems

Jun 26, 2020 / Amanda Chase, Horsesmouth Assistant Editor

In the wake of the global pandemic known as COVID-19, retirees, along with those hoping to retire someday, have been shocked into a new awareness of the need for better risk management tools to handle longevity and aging. This paper offers an assessment of the status quo prior to the spread of the coronavirus, evaluates how retirement systems are faring in the wake of the shock. Next we examine insurance and financial market products that may render retirement systems more resilient for the world’s aging population. Finally, potential roles for policymakers are evaluated.

The global financial crisis of 2008-9 brought into sharp focus several factors threatening public and private pension systems. For one thing, while people were living longer, very few worked sufficiently long to offset their rising need for retirement spending. The fact that the elderly are spending more years in retirement has resulted in worsening pension funding patterns, meaning that revenues received to support payouts have fallen below those needed to maintain solvency. Indeed, the World Economic Forum estimated that “the retirement savings gap” will grow by 5% each year to ~$400 trillion by 2050. This means an additional $28 billion of deficit each day.”

Beyond hollowing out DB and DC retirement plans, the COIVD-19 pandemic has also starkly altered peoples’ retirement prospects, as workers and retirees begin to recognize their far greater susceptibility to catastrophically expensive health problems. In times past, retirees often relied on the “4 percent rule” as a heuristic to determine how much they could withdraw from their pension pots to live on. Now the pandemic has spurred some financial advisers to drop this recommendation to 2.4 percent. In the US, the “cost of retirement,” or the amount of money one would need to save in order to generate a payment of $1 per year for 25 years has risen by 14 percent, from $21 for a target retirement in 2040 in 2019, to almost $24 in March 2020. Importantly, these calculations do not generally make allowance for rising out-of-pocket healthcare costs in retirement.

Against this backdrop of substantial economic and political uncertainty, it is important to identify and facilitate the kinds of pension reforms that can enhance workers’ ability to save and invest for retirement. One lesson we have learned is that tying workers’ pensions (and in some countries, health insurance) to an employment relationship is quite risky when firms go out of business and worker mobility results. Therefore, in the wake of the pandemic, retirement and health insurance coverage are likely to be delinked from employer-provided plans in many countries, instead of continuing what was once termed “industrial feudalism” under which workers were discouraged from leaving their firms for fear of losing their benefits. The U.S. SECURE Act of 2019 now allows private sector employers to establish and operate multiple-employer pension plans; this had been infeasible in the past due to rules requiring all sponsor firms to be in the same industry.

Pension models for the future will also require new methods to share risk, beginning with enhancing financial literacy in the population, helping people to save more and invest smarter, and to better manage longevity. Plan sponsors can also do more to make pensions more flexible, for instance by linking retirement ages and contributions to funding levels. Policymakers could enhance the decisionmaking environment by providing better data to price insurance products, and by formulating better forecasts and establishing plans to respond to the aging population&rquo;s needs. Raising retirement ages, incentivizing continued work, and helping people save more are also likely to be part of the solution, though answers will vary across countries. Additionally, strengthening safety net programs is also likely to be critical in helping those who cannot work and lack private insurance. Taken together, these can strengthen not only retirement systems around the globe, but also the economic vitality of our economies more broadly.


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