Drop in Asset Prices Pressuring U.S., European Pension Plans

by: Research Recap

A pair of reports from Oxford Analytica highlight the challenges facing pension systems in the US and Europe following the plunge in asset prices.

The collapse in equity prices means that many Americans approaching retirement will have to change their plans to overcome the financial losses suffered by their 401(k) and Individual Retirement Accounts (IRAs).

Data from the Center for Retirement Research suggest that the income replacement rate for the median worker who claims Social Security benefits at 65 will decrease from 39% in 2002 to 28% in 2030.

In recent Testimony before the Committee on Education and Labor, Alicia Munnell, Director of the Center for Retirement Research at Boston College suggested that a possible solution could involve:

  • 401(k)s resuming their old status as a third-tier pension “top-up” institution;
  • Social Security remaining the primary pillar of the pensions system and;
  • creating a new ’second-pillar’ retirement institution.

“Building a new ’second-pillar’ institution that ensures retirement income security has emerged on the policy agenda, and is increasingly likely to occur before the end of President Barack Obama’s first term,” OxAn says.

UNITED STATES: Retirement institutions are inadequate

Pension reform in Europe has aimed at decreasing the internal rate of return from public pay-as-you-go (PAYG) systems, making private pre-funding more necessary and attractive (see EUROPE: Shift to pre-funded pensions sustains finance - October 22, 2008):

  • Italy and Sweden have made deep reforms, moving from defined-benefit (DB) to notional defined-contribution (NDC) pensions, encouraging private pre-funding to complement lower public benefits, with Sweden’s PAYG income replacement rate just 53%.
  • In Germany, France and Italy, PAYG systems still assure replacement rates above 60%.
  • In the Netherlands and the United Kingdom, the PAYG rates are below 30% and 20% respectively.

“A general trend towards the equalisation of expected rewards from public and private schemes may hamper the development of private provision, which is under financial strain. PAYG reform mechanisms correcting only for macroeconomic and demographic risk would avoid accumulating market risk on both pillars,” OxAn says.

EUROPE: Market exposure is rising for pensioners