Pension systems around the world have faced a “stress test” during the pandemic, what could be called the “pension pandemic paradox”.
On the one hand, there has been pressure to allow access to retirement savings as emergency support during a period of severe economic downturn. This was understandable, because for many people, retirement savings are their primary financial asset. But, in some countries, this has turned into unprecedented access beyond immediate emergency needs and has jeopardized the retirement savings system. The most notable case is that of Chile, a pioneer in pension reform. A colossal $50 billion – about 25% of retirement savings representing almost a fifth of Chile’s GDP – was withdrawn from the system in 2020 and 2021.
While the challenge of financing the Sustainable Development Goals and the Paris Agreement remains before the world, our pension systems, like our architectural heritage, deserve to be preserved.
On the other hand, the long-term national capital represented by our retirement savings has been used to support short-term emergency measures. For example, Dutch and European pension funds bought “COVID bonds” issued by the Nordic Investment Bank. The CDPQ, which funds pension plans in Quebec, has joined the effort to support local businesses affected by the crisis.
And these funds are needed to support longer-term structural imperatives such as the transition to a low-carbon economy. Prior to the COVID-19 crisis, it was estimated that an investment of around $2.5 trillion would be needed for developing economies to achieve a low-carbon transition and tackle the climate crisis. The Organization for Economic Co-operation and Development estimates that, after the pandemic, that amount rose to $4.2 trillion. To put that into perspective, the annual lending capacity of multilateral development banks is less than 10% of that. Patient capital from long-term investors around the world, managed in particular in pension and insurance funds, will be essential to finance this transition.
From pillars to pagodas
The pandemic has also amplified and laid bare global workforce trends, which in turn reflect ongoing demographic shifts that our traditional pension systems are struggling to adapt to. Rather than a traditional structure of spending a period of our life in education, entering employment, and then retiring at a certain age, lifespans of 100 years are becoming more and more normal, and people are adapting and taking a “staged” approach to life. This will involve periods of employment, periods of self-employment, a return to education and training, and possibly a combination of activities – paid or unpaid – until a later age. For people working in developing economies, this actually sounds familiar. This reflects the less formal labor market structures that are the norm in poorer countries.
Even in advanced economies, pension systems will need to adapt to accommodate these new structures, becoming more flexible to reflect increasingly fluid life stages. Instead of the concept of “pillars” of pension systems promoted by the World Bank since the 1990s, perhaps we should think of our pension systems more as “pagodas”..“Just as pagodas are supported by the shinbashira column at their center, a strong core of social protection should be at the center of any well-designed retirement system, providing protection whenever needed throughout our lives. This can be designed in different ways – from “universal” pensions to subsidized contributions – and could be covered by general taxation to serve the basic redistributive insurance function of any well-designed pension system. Tiers of retirement savings would then be suspended from the central structure and built around this central core, provided by employers, voluntary schemes and other arrangements.
Like a strong yet flexible pagoda that adapts to changing circumstances, these levels of savings could be designed to adapt and meet the needs of our changing lifestyles. Unlike our current, somewhat rigid pillars which are often linked to employment – with fixed parameters defining eligibility, amounts and duration – these should be designed in a more flexible way.
Greater flexibility on the “pathway” to retirement savings could involve linking contributions to consumption rather than income, while mimicking the simplicity, regularity and “hardship” elements of contributions through employers’ payroll. Contribution flexibility can mean saving different amounts throughout our lives when we have more capacity to do so, mimicking the “Save More Tomorrow” technique currently used in many corporate pension funds in the United States. Incentives to build retirement savings could be provided to people after taking breaks for training or family care.
The use of new technologies paves the way for the use of insights from behavioral economics. These include innovative mechanisms such as “recharges”, which help us save automatically, by redirecting unused funds from our bank accounts or by connecting us to regular events such as functions offered by companies such as Acorn and Qapital. Even ideas such as the “gamification of savings” are tested, for example by the Long Game team.
Exit flexibility means allowing controlled access to our savings in specific circumstances. The idea of ’side car’ accounts – combining a short-term savings account with longer-term retirement savings – has proven successful in the NEST scheme in the UK, among others. Including retirement savings in credit scores to provide access to lower-cost loans while providing an incentive to maintain balances is another potential avenue.
Add the flexibility of the East to the strength of the West
The fundamental purpose of our pension systems – first formalized in the World Bank’s report ‘Averting the Old Age Crisis’ which launched a global challenge to traditional pension systems in the early 1990s – remains always the same: to provide for the needs of the vulnerable elderly in our society and to help people smooth their income and consumption throughout their lives. What has changed is the nature of our lives and livelihoods. Like pagodas, our retreat systems will continue to come in different shapes and sizes, with thin or thick cores, and more or fewer levels.
We still have a lot to learn from the ancient Greeks. Our pillars of retirement still have a lot of strength, including the benefits that come from collective savings through employment, which keep costs down and arguably protect us from our own short-sightedness by making savings both simple and automatic. We should blend this wisdom with the teachings of Asian cultures, adding the flexibility that pagodas represent. While the challenge of financing the Sustainable Development Goals and the Paris Agreement remains before the world, our pension systems, like our architectural heritage, deserve to be preserved. For this, the time-tested Corinthian columns that inspired multi-pillared retreat systems may need to be imbued with Asian practicality, so that discipline and durability are preserved.