Population Ageing & Pensions Flashcards
Population aging trends in the UK
Rise in life expectancy (past 50 years men+10 women+8) , but also working fewer years.
2 types of life expectancy
Cohort life expectancy -predicted changes in mortality rates in future
Period life expectancy - holds mortality rates constant
Over the last 50 years, the average length of life has increased by…
10 years for a man
8 years for a woman (but rmb female L.E>male to begin with)
Period life expectancy at 65 in 2020-22. Why important
Life expectancy at age 65 was an extra 18.3 years for males, 20.8 females. (A fall of 22 weeks from previous estimates 2017-2019)
Important for pensions because it can influence how much pensions will cost (a fall means live less long due to COVID effects, so savings to pension payments!
Cohort life expectancy findings: for babies born 2020
b) What % of boys and girls born in 2020 expected to live till 100?
87.3 for boys , 90.2 for girls
b) 13.6% boys, 19% girls
Population is ageing because of falls in child mortality and old age mortality
Why has childhood mortality and mortality at older ages improved? (2)
Gains in medical knowledge/tech
Improved lifestyle choices
What doe OADR measure
Old Age Dependency ratio formula has changed overtime, how?
OADR measurers older dependents per working age population.
OADR = no. of ppl 65+ / no. of people 16-64
now: / no. of people 20-64
OADR trend across countries (OECD ones)
Due to increase for most countries
(more old people per working age population)
(Japan OADR nearly reaching 80%!)
Why is higher OADR a concern
More pressure on PAYG pensions since intergenerational transfer: less working age per current retirees, so concerns about sustainability
i.e more people to pay for, and less to contribute!
Implications to healthcare following this trend (2)
Further strain (old more problems)
Also nature of illness - more age related e.g dementia
Implications on education upon this
Ageing population may mean less resources are needed to be diverted towards education.
Thus we need to consider net fiscal impact of population ageing (since it can reduce costs in some areas e.g ed, and increase in others e.g health)
Predicted net fiscal impact 2000-2050
(use UK vs Poland for comparison)
UK - total 3.7% increase in expenditure as % of GDP, with expected rises in pensions and health care (desp falls in education as mentioned prev FC)
(So bad, but the least severe relative to other countries e.g Poland due to rise 21%!)
Ageing & economic growth relationship
Why?
Both prospective & retrospective ageing is hindering economic growth
b) Baby boomers (born after WW2) getting older i.e large number now suddenly economically inactive!
2 types of pensions in the UK
State pension - funded by tax contribution.
Private pensions - additional provision individuals may do
Objectives of a pension system (5)
Consumption smoothing (max lifetime utility)
Acts as insurance against poverty at old/longetivity risk i.e living really long
Poverty relief (mainly S.P not private)
Redistribution (S.P only
Promote economic growth (in private pensions, money is invested!)
Pension/private expenditure as % of GDP across countries
(compare Italy and UK)
Italy - 16% on public , 1% private (mostly all public i.e we have to do less)
UK - 6% public, 5% private (government don’t contribute as much, so important to invest in private pension ourselves!)
3 types of private funded
B) 2 forms of one of the types
others, personal and occupational
2 types of occupational: Direct benefit and Direct contribution
Defined benefit - 2 types
Final salary, career average salary
Defined benefit - employers will pay a part into the pension too, multiplied by length worked there. E.g 1/50 of salary X x length worked
Final salary means salary near end of the career. (tends to be your highest wage) good, but expensive for firms so rare.
Career average salary - takes average of salary of career less expensive for firms (since will include salary when young)
Defined contribution
As a result which do FIRMS prefer DC or DB?
Employers pay in too, and gets invested (avoid inflation destroying value, and links to economic growth point) However, the risk is on the employee, as won’t get paid the shortcoming if investment comes short of salary
In DB E.g if wanted a return on investment of £20000 and get 15000, employer pays the 50000
Hence why firms prefer and offer DC rather than DB. (As risk on employee not them)
What is the pay-as-you-go pension system based on?
Inter-generational promise: that we will contribute to older peoples pensions, and younger people will contribute to our pension when we get old.
PAYG main pro and con
Pro: insurances against poverty at old age
Con: system at risk to population ageing, more people claiming relative to people paying in. (OADR increasing!!)
Sustainability figures of PAYG from 1909 to 2008
1909: approx 10 workers per pensioner paying in
2008: approx 4 workers per pensioner paying
Supports the figures of OADR increasing too
Is population aging and the OADR a concern for funded pension schemes (2)
Not directly - but indirectly
They still pay taxes toward PAYG. Aging population may mean taxes rise to accomodate, meaning they can put less aside for themselves in their private funded pension!
Also since more old, demand for annuities increase so prices increase (become less generous, more pressure on state).
PAYG age (at which they can claim pensions)
B) future expectations
B) It will rise to 67 by 2026-2028, then 68 by 2046.
(continually increasing since life expectancy is rising!)
What has happened to the default retirement age
Phased out - people can work as long as they wish.
(Aims to ease the intergenerational transfer by letting people cope for themselves for longer, delaying taking the state pension!)
(Firms used to be able to kick people out at a certain age)
New state pension:
How much is this worth?
£203.85 per week max. (Approx 10,600k p.a)
Not a lot, a huge drop from working salary! hence private pensions recommended if feasible.
How does it compare to old state pensions?
After adjusting to CPI, it is still better than previous pensions despite being way lower than working salary
Variants on PAYG and funded systems in different countries a) Chile , and why controversial
B) Sweden - what do pensions payouts consider (3)
Chile - moved from PAYG to individual funded (private) accounts. (Controversial as low earners are stuck while high earners have higher pensions since can contribute more, no more insurnace against poverty for the lower earners!)
Sweden - consider length of employment, age at retirement & life expectancy. Also provides incentives to keep working
Typical private pensions age
55
Normal minimum pension age (NMPA) will soon rise to 57.
(So earlier than state pension)
Private funded schemes can fall into deficit (not enough money to make promised payouts),
Give 3 examples of times
Stock market boomed during 1990s (NICE period!) so gov allowed companies to not contribute to individuals pensions since there was a surplus, and spend money elsewhere e.g invest rather than force them to contribute to pensions)
Stock market declined 2000/01 (dot-com crash) ,2008/09 GFC, 2020/21 (Covid) all created deficits
Low government bond yields after GFC.
Intertemporal rational choice model for pensions set up
We consider private pensions first!
2 time periods: work and retirement
Economic agents have perfect foresight
Endowment income (Yw for work, Yr for retirement and Yw>Yr)
No tax initially
Budget constraints for each period?
Work:
Cw = Yw - S
(Consumption = Working income - Savings we put aside)
E.g if S=0, means we consume all our income!
Retirement:
Cr = Yr + S(1+r)
Our endowment + our savings which have been accumulating interest.
Lifetime budget constraint
Lifetime Wealth (L) ≡ Cw + Cr/(1+r) = Yw + Yr/(1+r)
I.e lifetime consumption = lifetime income since we are rational. Die having spent all money.
Consider extreme levels of consumption (2 situations)
Cr = 0 (consume nothing in retirement) , meaning Cw = L (consume lifetime income just when working)
Or Cw=0 (consume nothing while working) means Cr= L(1+r) (consume everything when retired)
EXTREME OF COURSE
But instead of those extremes, what actually do we assume for our indifference curves (more realistic
Convex indifference curves: smooth consumption (since we prefer averages are preferred to extremes)
Consumption smoothing equation
Cw = Cr = C*
But remember Yw > Yr ,
So to have smooth consumption, what is required
As the criteria is C* = Cw = Cr , but Yw>Yr, we need to save while working! So..
S>0 to perfectly smooth consumption and tide us over while old
Indifference curve diagram showing smooth consumption
What is the slope
Explain diagram
-(1+r)
Cr Y axis
Cw X axis
E is endowment where Yw>Yr as more income when working. Move upwards (and reduce Cw in order to save) to reach consumption smoothing point C*
Evaluation of these private contribution schemes
Doesn’t address poverty relief or redistribution (as mentioned earlier).
One must have means to actually pay in (hence why Chile got backlash when changing from PAYG to funded!)
What happens if r represents a return to a stock market index in 2006/07
We have assumed savings earn a constant return of r.
Stock market crashes in the GFC, returns may not be as big as expected, and so may not be able to perfectly smooth consumption.
(Applying to context of DB vs DC schemes - DB: the risk is on employer who has to pay the difference, while DC risk on employee! Hence why DC preferred and offered by most firms)
That was model for private funded pensions.
Now PAYG state pension model, budget constraints for the 2 periods
Model as a lump-sum transfer from current workers to current retirees. (So no priv savings accumulating at interest r now)
Cw = Yw - T₁ (consumption while working is income - tax)
Cr = Yr + T₂ (consumption of retired is income+pension payout from the next generation!)
T₂ is paid by next generation of workers.
Indifference curve for PAYG state funded pensions
Budget constraint stops vertically at point L-T₁ since max consumption we can consume while working is limited since paying T₁ e.g NI tax
Then we assume government saves on our behalf and allows us to replicate the same consumption smoothing.
Is PAYG pension sustainable?
B) what would need to happen if not sustainable (2)
Feasible with a stable OADR but not with an ageing population (WHICH IS HAPPENING WITH OECD COUNTRIES AS MENTIONED BEFORE)
B) tax would need to rise, or payout to pensioners would need to fall.
Should the UK move to a funded state pension
Pro and con
Yes - It would help with the ageing population problem in the long run as not directly impacted. (Since no intergenerational transfer)
The transition: who pays for pensions of those working now? they currently pay for older people, but if move to funded they also have to save/contribute for themselves! (younger generation won’t pay for them anymore!)
What does this transition problem cause
Higher taxation on those who currently work,
and/or higher borrowing from government to pay for the pensions of current workers (since current workers were currently paying for older people, so haven’t got much saving for their own)
So, solutions to maintain state pension (cope with population aging (4) (Blake & Mayhew)
Reduce size of pension payout
Increase taxes - Higher NIC contributions to pay for the increased older people (eval: solution, doesnt address underlying issues!)
Work for longer
Immigration (less unappealing)
1st alternative solution to address transition to funded pension system: reduce payouts
Eval:
Reduce payouts indivually to spread across more pensioners
Eval : Payouts are already small - do we want to be even less generous?
3rd solution to population ageing: Work for longer pro (1)and con (2)
Pros: Not unreasonable given people are living longer. Work longer, thus less reliant on state pension.
Cons:
Social/politcal unrest - although living longer, working less. less willing to accept this?
Distributional issues. People who earn lower incomes often start work earlier and are often less able to retire early.
4th (better) solution to population ageing: immigration
And eval:
Migrants tend to be young and more likely to be employed (EEA make £4.7bn positive net fiscal contribution!)
Eval: However get old too. Those paying taxes will expect state pensions in future. (Also recall 3 cons in previous topic, use public services, claim benefits , private sector implications e.g housing too)
So state pension is vulnerable to our aging population. What needs to be encouraged.
(EXAMPLE!)
Encourage private pension savings e.g Singapore & Australia! mandatory legislation to force workers and employers to pay into private pension schemes (reduce reliance on state pension)
