A pensions time bomb

In our last article (The Sunday Times, September 10) we looked at the demographic time bomb, explaining how, as a global nation, we are getting older and living longer. The rate at which we are aging is unprecedented in our history and has some serious implications for society.

So why does it matter that we are all living longer? Apart from the pensions situation, we should think about the economics of a society in which up to 40 per cent of the population will be aged over 60.

It can be argued that consumers save more during their working life in order to pay for their expenditure during retirement. In a society where the proportion of the retired population is increasing it therefore follows that the savings ratio will fall.

This will lead to higher interest rates, which in turn would lead to less investment and consequently a slowdown in economic growth.

Financial markets could also suffer if less money is being saved by individuals and existing accumulated investments are being sold to fund expenditure. This in turn would lead to asset depreciation, which would mean a reduction in household expenditure, again leading to a stalling of the economy.

As less people continue to be born, the labour supply will shrink, which would in turn lead to increases in wages and inflation.

Family life will change and we will spend more time caring for elderly grandparents and great-grandparents.

But perhaps the biggest impact is seen in the provision of pensions. The simple truth is that, as people live longer, pensions have to be paid for longer and therefore they cost more money to provide.

Traditional state pensions operate on a Pay As You Go (PAYG) system, which means money received by the Government today is used to pay the pensions today. Really it makes you think that the system should be called You Pay As They Go, because your National Insurance contributions are being used to pay the pensions of today's retired.

Your contributions are not held by the Government and invested for your future retirement; instead, your future state pension is dependent on future workers (your children, grandchildren and even great-grandchildren) paying sufficient contributions to cover the cost of your pension.

At the moment there are five workers covering every pensioner, but by 2050 it will be just two. Because less people are being born, the percentage of the population paying National Insurance contributions is lower, meaning there is less money being received by Government but an ever increasing amount to be paid out.

The World Bank's Report estimated that in 2003 the pension system in Malta was running at a deficit equal to 1.2 per cent of GDP. This means that the amount of pension money being paid out was greater than the employee and employer National Insurance contributions being received.

The Government also allocates a 10 per cent contribution to the pool, which at present covers the pension shortfall; however, this money is also required to pay for other social services, such as health, housing, long-term care and income support payments.

Based on the World Bank's conservative estimates, the pensions deficit in Malta will increase to 3.5 per cent of GDP by 2015 and 4.7 per cent of GDP by 2030. It is stated that by 2011 the full 10 per cent Government contribution will be insufficient to cover the whole pensions deficit, leaving nothing left for the other important social services.

This form of pension provision cannot be sustainable without huge increases to taxation and/or large reductions in the benefits paid.

So what can be done about it? The main problem seems to be that the population is getting older, so we could look at ways of reducing the age of the population. However, encouraging higher birth rates or allowing more immigration seems unpopular in the current political climate, and mass genocide of the over 70s would surely not be a vote winner.

All we are left with really is to change the current pension system radically and make individuals responsible for their retirement. We will consider the pension reform options in our next article.

The stark truth is that if we simply rely on state provision then we will find that we have to work longer and pay more in order to receive less when we retire. We have to be realistic and appreciate that the State will provide for our needs, while we will have to provide for our wants.

That means if we want anything other than the minimum wage in retirement then we have to take responsibility and do something about it ourselves, by saving hard for us and our families' futures.

If you have a pensions related question please e-mail us at: pensions@middlesea.com

Mr Fairbairn is a pensions consultant with Middlesea Valletta Life Assurance Company Ltd (MSV), which is authorised to carry on long-term business under the Insurance Business Act 1998 and licensed to provide investment services in terms of the Investment Services Act, 1994, in relation to linked, long-term contracts of insurance.

In a series of fortnightly articles we will explain everything you need to know about pensions. Starting with the demographic influences on future pension provision, we will then investigate the global and local pension time bomb, focusing on different solutions and experiences from other countries. Specifically, we will then focus on the situation here in Malta, looking at current pension levels and the proposed changes to state, personal and corporate pensions. Full explanations will be given of the technical terms you will hear along with an analysis of how the changes will affect different sectors of society. Finally, we will look at some general holistic retirement strategies and focus on building suitable investment portfolios for medium to long-term savings. A 'question and answer' section will also be published with future articles to help unravel the world of pensions. Anyone with questions should e-mail: pensions@middlesea.com.

Middlesea Valletta Life Assurance Company Ltd is authorised to carry on long-term business under the Insurance Business Act 1998 and is licensed to provide investment services in terms of the Investment Services Act, 1994 in relation to linked long-term contracts of insurance.