The World’s Largest Risk

Pension systems around the world are in total crisis. It is not a question whether the systems can fulfill any of their promises. There is not a real possibility that systems that exist can continue to pay the benefits that are now being paid to retirees over the next 40 years.

A loss that you know is coming is not a risk.

The risk is how the governments of the world will respond to this problem. Poor handling of this problem can bankrupt governments and throw an entire economy into a long term decline.

The fundamental issue is to find a way to balance the ability of an economy to pay retirement benefits with the needs of the bulge of retirees that the entire world will experience over the next 40 years. If governments try to pay out more than the economy can afford, then there will be very serious problems for those governments and their economies.

One very large problem is that in many countries, the pension benefits are not even set to be a reasonable self supporting system over time even without the age bulge.

Those issues should be tackled first. Those issues include:

Setting the basic benefit to be approximately 1.5% of wages per year of employment.
Full benefit for no less than 40 years of employment. Results in benefit of 60% of wages.
Full actuarial reduction of benefits for early retirement. Eliminate other subsidies where they exist.
Index pensions to wages, not to prices. Keeps link of benefits to revenues.

To work towards resolution of the age bulge requires benefit changes. Increases to taxes are likely to be counterproductive with the levels of government debt and changes to government spending and taxes that will be required to resolve those imbalances leave little leeway for pensions. The main change that will be needed will be to raise the retirement age. The above basic benefit of 1.5% for 40 years of employment needs to be shifted to a minimum of 45 years of employment. In some countries, the retirement age needs to be higher still. Needs of individuals who are not able to work because of physical problems of age will need to be handled under a disability system. That system will need to be policed to avoid overuse of the disability benefits.

This risk should be of high, though not immediate concern for all firms. How the governments resolve this issue will have massive impact on employment, taxes and the financial markets of each country. All firms should include this issue on their list of emerging risks and should do scenario analysis of the potential impact on their firms business, employees and investments.

This post was inspired by a World Bank presentation.  To learn of their positions on these issues and to get the facts and projections that they present on this topic see worldbank.org.

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2 Comments on “The World’s Largest Risk”


  1. […] the average 8 times as large as the debt incurred fighting the financial crisis!  This was called The World’s Largest Risk on that […]

  2. Robert Arvanitis Says:

    The fundamental issue is “self-supporting.”

    Should people provide for themselves or rely on government?
    There is a range of response:
    1 Self
    2 “Nudge” (tax incentives, employer-based, default with opt-out…)
    3 Mandatory (but actuarially fair)
    4 Some degree of transfer/subsidy

    Politicians dive right into (4), with moderate subsidy for all voters, and large subsidies for government employees. This is because the feedback mechanisms are terribly wrong: votes today for benefits tomorrow.

    No question of balance, welfare or demographics makes any sense until we fix the feedback mechanisms. In free markets that is done with price.
    In political markets, that is done with votes.


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