Funded provision will not solve the demographic crisis facing the pensions industry, accord-ing to B...
Funded provision will not solve the demographic crisis facing the pensions industry, accord-ing to Barclays.
Its 45th Gilt-Equity study argues that while the unfunded system is unsustainable, funded provision has its own set of difficulties.
Principally the return on investment is reduced by the impact of demographic changes.
The survey suggests the sheer size of the estimated £800bn funded pension system in the UK, combined with the obligation to deliver guaranteed returns is dragging down bond yields to sub-growth levels.
Tim Bond and Kevin Adams, authors of the report, argue this means the market can only guarantee a rate of return by making it a very low one.
At the same time, they said, dependency ratios will rise, and are likely to translate into a structural shortage of gilt issuance as the Government seeks to contain the debt ratio, and that would further damage the ability of pension providers to lock in returns.
The dependency ratio currently stands at around 30%, which indicates that there are roughly three workers for each retired person. However, by 2018 it will be 35%, by 2025 rising to 40%, and by 2035 it will be 50%. This means that it may only be through an expansion in investment in corporate bonds, and a change of philosophy regarding equities that the demand imbalance may be relieved, according to Barclays.
Bond said: "It seems likely the Minimum Funding Requirement review committee due to report this spring will recommend the use of corporates rather than gilts to discount pension liabilities. Clearly this would act to encourage the further development of the corporate bond market and may reduce the supply and demand imbalance evident at present."
The survey suggests the rising dependency ratio will also bring about a downturn in savings, and that could substantially impact on future asset prices from which the retired population will take income and may wish to sell in order to maintain living standards.
Bond and Adams said the evidence indicates there may be merit in pension fund managers overturning their traditional view of risk and the assumption that bonds should be substituted for equity as a pension fund matures.
Barclays figures show the risk of equity investment relative to gilt investment is much lower than simple comparison of volatility would suggest.
Bond said: "Rather than thinking purely in terms of variability of returns on different asset classes, it is arguably more useful to think in terms of the probability of outperformance or underperformance of one asset class against another."
One possibility in the future is that the working population may refuse to pay out the full heavy burden demanded by the growing percentage of the retired. Bond said: "There is a limit to which the future generation of retirees can accumulate claims on the working population.
"Essentially the pensions problem comes down to how to organise the transfer of income from the working to the non-working population.
"The principal distinction between funded and unfunded systems simply boils down to whether this transfer is arranged via a claim on investment earnings or via the tax and social security system. Whichever method is chosen, a rising dependency ratio makes the transfer increasingly difficult to achieve."
Technology could play an important part in mitigating some of these adverse effects.
Bond said: "If an accelerated rate of technological change helps to raise the rate of trend growth in the economy the burden of supporting the future retired population will become to some degree easier. Clearly if future workers are more productive, their ability to provide for the non-productive members of the economy will be greater."
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