How Is Covid-19 Affecting Global Pension Systems?

To critically analyse the issues surrounding pension systems, we must first have an underlying framework to evaluate these systems. Given that pension systems vary significantly from market to market, the World Bank categorises them into the following five “pillars”:

• Pillar 0 is the most basic public pension, providing only a minimal level of protection
• Pillar 1 is a mandatory public system based on contributions from earnings
• Pillar 2 is a mandatory, private, and fully funded system
• Pillar 3 is a voluntary and fully funded system
• Pillar 4 is anything that lies outside formal pension arrangements

Notably, Pillars 2 and 3 are considered fully funded because they are assumed to be defined-contribution plans, which, by definition, cannot be underfunded. In contrast, defined-benefit plans can (and often do) face funding pressures.

These categorisations are helpful, but they still do not provide criteria for rating each system. For the Global Pension Index, Mercer ranked pension systems across three aspects:

• Adequacy: The relevant question is: what do you get? Salient data points include benefits, government support, household savings versus debt, and the net replacement rate (a measure of how much of a worker’s preretirement income can be “replaced” by their pension benefits).
• Sustainability: The question is: can it keep delivering? Plan coverage, pension assets versus GDP, demographics, economic growth, labour force participation, and public pension costs are some of the primary data points used for this metric.
• Integrity: This is the governance question: can it be trusted? Factors such as regulation, governance requirements, member protection, and communication, as well as system costs, affect this metric.

As Knox points out, “There is an underlying tension between adequacy and sustainability. The more adequate a system is, the less sustainable it may be.” While a system can score highly in both of these areas, the underlying trade-off will still exist.

As in past years, the rankings were done on a weighted-average basis, with the adequacy, sustainability, and integrity metrics receiving a 40/35/25 weightage. Although international data (such as those from the OECD) were used to tabulate these scores, Knox noted that “they were supplemented by ‘on the ground’ data points from Mercer staff in each market.”

On the adequacy front, the top three markets were all European. The same was seen for integrity, for which the leading scorers were even more focused: all Northern European territories. Unsurprisingly, the lowest scorers on the integrity metric were in the developing world , highlighting the additional challenges (beyond broader macro pressures) that these systems face.

The sustainability rankings were a bit more interesting. While Denmark and the Netherlands took the top two spots (as they did for the overall ranking), two of the lowest scorers were also European, namely Austria and Italy. In Asia, Singapore came out on top overall, followed by Hong Kong SAR and Malaysia.

Some may argue that these rankings are somewhat arbitrary, but Knox pointed out that they had found a 63.3% correlation between a territory’s Global Pension Index ranking and their GDP. While not definitive, this finding may indicate that underlying economic development may be one of the most important factors influencing a pension system.

The pandemic’s impact on pension systems focused on one area — sustainability. First, the immediate impact on economic growth, on average, resulted in a 1.2-point reduction in 2020’s sustainability scores. Second, employment is a factor. Because pensions are funded mainly from employees’ wages, a rise in unemployment means a fall in pension funding, detracting from the system’s sustainability.

Furthermore, as Li noted, “Governments, such as that of Malaysia, had also permitted citizens to make early withdrawals from the pension system and reduce mandatory contributions to alleviate near-term financial pressures. But in doing so, they are borrowing from the future to meet the needs of the present. This tension between long-term and short-term interests is a fine line that governments must tread.”

The same applies to increased government debt, especially from massive stimulus programmes, which also could reduce pensions in the longer term. Interestingly, a lot of this stimulus supports employers to prevent them from needing to lay off employees, thus preserving some pension contributions.

The pandemic may have heightened demographic pressures. Knox observed that it might cause reduced migration, which would increase the proportion of senior citizens in the population and affect the old-age dependency ratio. This could be a particular cause of concern for the advanced nations, as they tend to be the fastest-ageing societies.

Given the long-term nature of pensions, it is understandable that the bulk of the concern surrounds the long-term impact of the pandemic. The panellists were unanimous, however, on one point — in most cases, it is still far too early to state with any confidence what the definitive long-term impacts would be.

For instance, Knox notes, “The higher household savings rate could offset some of the more negative impacts.” Dong also brought up the point of sustained low interest rates depressing expected returns. He stated that “while this was true, it could also cause inflation to fall as well, which would effectively preserve real expected returns.”

The same holds for extrapolating the health of the pension system with the health of the market. Sane observed that assets under management for its pension systems had significantly increased during the pandemic in India. Because the pension coverage is still low, this does not necessarily reflect the state of the overall economy and populace.

Even without the pandemic, many pension systems were already in need of reform. Many of these challenges are structural, and there are no easy answers to solve them. The desired outcomes are easy to pinpoint, such as increasing private saving levels, promoting higher labour force participation, and improving governance. Identifying and executing the specific action steps are more difficult.

The panellists all agreed on the need for a more flexible pension system that reflects today’s global workforce. The “40-year workforce” may be a thing of the past, with many people entering and exiting the labour force multiple times according to stages and events in their lives. In advanced territories, there is also an ongoing transition into the “gig economy” (while in emerging economies, there is a concerted effort to bring workers from the informal to formal sectors).

The private sector will need to get more involved — something that Dong notes is already happening in China, which traditionally has relied only on the public pillar. The panellists also brought up the need for retirement products to support both the accumulation and decumulation phases. As life expectancies increase, it is essential that retirees can draw down on their nest egg in a controlled and sustainable manner.