Aging Populations Demand Urgent Pension Reforms: Are We Prepared?

The world is aging at a much faster rate than we previously anticipated, even 10 years ago. Following the pandemic, life expectancies are continuing to rise around the world. That is, we are going to live longer than previously expected. On average, some of these extra years will be spent in good health while there also will be an increase in the years of poor health.

In almost all countries, fertility rates are dropping quickly. Simply put, the world is having fewer babies with several societal changes driving this outcome. The following table indicates the change in fertility rates during the last 10 years for selected countries based on data from the United Nations (UN)¹.

Given that a fertility rate of 2.1 is required to replace the population, most countries are now on track for a reducing population at some point in the future, if one ignores the impact of migration. China’s population has already begun to reduce.

However, before populations reduce, the first consequence will be a rapidly aging population with fewer workers and a higher proportion of the population above retirement age. As the Organization for Economic Co-operation Development (OECD) has noted: “The question of how to address the impact of population ageing on pension systems has moved back to centre stage.” It is no longer an option for governments to review their pension systems; it has become a necessity.

Yet, such reform is never easy as it affects the community’s expectations of the future. In particular, it may lead to lower pensions, longer working lives, and/or higher pension contributions or taxes.

My research of pension systems over more than four decades reveals that some reforms have occurred, but it has often been gradual or haphazard without a long-term objective.

The 2024 Mercer CFA Institute Global Pension Index (MCGPI) reviewed 48 retirement income systems around the world. It found only four have an A-grade system when assessed on the grounds of adequacy, sustainability, and integrity. They are the Netherlands, Iceland, Denmark, and Israel.

The MCGPI uses more than 50 indicators with more than half the value of the index using data from international agencies such as the OECD, the UN, and the World Bank. The balance of the Index scores relies on inputs from pension experts familiar with the retirement income system in each country.

The better systems within the MCGPI had most of the following features present:

• A state pension for the poor aged of at least 25% of the average wage for a full-time worker, thereby alleviating poverty amongst the aged
• A net pension replacement (including both public and private pensions) of at least 65% for a median-income earner with a full career
• Private pension coverage of at least 80% of the working age population, thereby ensuring a balance between public and private pensions for most individuals
• Pension contributions of at least 12% of wages are invested for the future
• Current pension assets of at least 100% of GDP
• A well-governed and well-regulated private pension system

The MCGPI recommended several significant reforms to ensure that future retirees receive an adequate income from systems that can continue to deliver in a manner that encourages community confidence in this changing world. The recommended reforms include:

• Increase coverage of employees and the self-employed in the private pension system which should reduce pressure on government budgets in the future.
• Gradually increase the retirement age and/or state pension age to encourage people to work a little longer and thereby reduce their retirement period.
• Encourage or require higher levels of private savings, both within and beyond the pension system, so that workers can spread their consumption across their whole life.
• Reduce leakage from the retirement savings system before retirement, thereby ensuring that the funds are preserved for retirement purposes.
• Introduce measures to reduce the gender pension gap that exists in many pension systems.
• Improve the governance and transparency within private pension plans to raise the confidence level of members.

These reforms will increase the importance of the funded private pension system. The growing aging population cannot rely heavily on future governments given the increasing costs of health, aged care, and public pensions. Naturally, increased pension fund assets will also generate new challenges and opportunities for CFA Institute members and charterholders.

For example, as the world moves away from defined benefit to defined contribution pension plans, investment and other risks will shift from the employer sponsor to the individual members. As the average age of the pension plan members also increases, there will be implications for the investment strategy of pension plans as older members tend to be more conservative.

The education of and communication with pension plan members will need to be done carefully to avoid any negative response from the older population. One should not assume that the current investment approaches should continue forever.

The aging population provides challenges and opportunities for all of us, including governments, policymakers, fund managers, pension plans, and financial advisers. Pension reform is needed in most countries but the outworking of this will vary between economies. There is no single solution. Nevertheless, there are lessons we can learn from each other to ensure that our future aged populations can have both dignity and confidence during their retirement years.