Population Ageing & Pensions

Question 1

Population aging trends in the UK

Answer 1

Rise in life expectancy (past 50 years men+10 women+8) , but also working fewer years.

Question 2

2 types of life expectancy

Answer 2

Cohort life expectancy -predicted changes in mortality rates in future

Period life expectancy - holds mortality rates constant

Question 3

Over the last 50 years, the average length of life has increased by…

Answer 3

10 years for a man

8 years for a woman (but rmb female L.E>male to begin with)

Question 4

Period life expectancy at 65 in 2020-22. Why important

Answer 4

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!

Question 5

Cohort life expectancy findings: for babies born 2020

b) What % of boys and girls born in 2020 expected to live till 100?

Answer 5

87.3 for boys , 90.2 for girls

b) 13.6% boys, 19% girls

Question 6

Population is ageing because of falls in child mortality and old age mortality

Why has childhood mortality and mortality at older ages improved? (2)

Answer 6

Gains in medical knowledge/tech

Improved lifestyle choices

Question 7

What doe OADR measure

Old Age Dependency ratio formula has changed overtime, how?

Answer 7

OADR measurers older dependents per working age population.

OADR = no. of ppl 65+ / no. of people 16-64

now: / no. of people 20-64

Question 8

OADR trend across countries (OECD ones)

Answer 8

Due to increase for most countries
(more old people per working age population)

(Japan OADR nearly reaching 80%!)

Question 9

Why is higher OADR a concern

Answer 9

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!

Question 10

Implications to healthcare following this trend (2)

Answer 10

Further strain (old more problems)

Also nature of illness - more age related e.g dementia

Question 11

Implications on education upon this

Answer 11

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)

Question 12

Predicted net fiscal impact 2000-2050

(use UK vs Poland for comparison)

Answer 12

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%!)

Question 13

Ageing & economic growth relationship

Why?

Answer 13

Both prospective & retrospective ageing is hindering economic growth

b) Baby boomers (born after WW2) getting older i.e large number now suddenly economically inactive!

Question 14

2 types of pensions in the UK

Answer 14

State pension - funded by tax contribution.

Private pensions - additional provision individuals may do

Question 15

Objectives of a pension system (5)

Answer 15

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!)

Question 16

Pension/private expenditure as % of GDP across countries

(compare Italy and UK)

Answer 16

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!)

Question 17

3 types of private funded

B) 2 forms of one of the types

Answer 17

others, personal and occupational

2 types of occupational: Direct benefit and Direct contribution

Question 18

Defined benefit - 2 types

Final salary, career average salary

Answer 18

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)

Question 19

Defined contribution

As a result which do FIRMS prefer DC or DB?

Answer 19

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)

Question 20

What is the pay-as-you-go pension system based on?

Answer 20

Inter-generational promise: that we will contribute to older peoples pensions, and younger people will contribute to our pension when we get old.

Question 21

PAYG main pro and con

Answer 21

Pro: insurances against poverty at old age

Con: system at risk to population ageing, more people claiming relative to people paying in. (OADR increasing!!)

Question 22

Sustainability figures of PAYG from 1909 to 2008

Answer 22

1909: approx 10 workers per pensioner paying in

2008: approx 4 workers per pensioner paying

Supports the figures of OADR increasing too

Question 23

Is population aging and the OADR a concern for funded pension schemes (2)

Answer 23

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).

Question 24

PAYG age (at which they can claim pensions)

B) future expectations

Answer 24

B) It will rise to 67 by 2026-2028, then 68 by 2046.
(continually increasing since life expectancy is rising!)

Question 25

What has happened to the default retirement age

Answer 25

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)

Question 26

New state pension:

How much is this worth?

Answer 26

£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.

Question 27

How does it compare to old state pensions?

Answer 27

After adjusting to CPI, it is still better than previous pensions despite being way lower than working salary

Question 28

Variants on PAYG and funded systems in different countries a) Chile , and why controversial

B) Sweden - what do pensions payouts consider (3)

Answer 28

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

Question 29

Typical private pensions age

Answer 29

55

Normal minimum pension age (NMPA) will soon rise to 57.

(So earlier than state pension)

Question 30

Private funded schemes can fall into deficit (not enough money to make promised payouts),

Give 3 examples of times

Answer 30

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.

Question 31

Intertemporal rational choice model for pensions set up

We consider private pensions first!

Answer 31

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

Question 32

Budget constraints for each period?

Answer 32

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.

Question 33

Lifetime budget constraint

Answer 33

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.

Question 34

Consider extreme levels of consumption (2 situations)

Answer 34

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

Question 35

But instead of those extremes, what actually do we assume for our indifference curves (more realistic

Answer 35

Convex indifference curves: smooth consumption (since we prefer averages are preferred to extremes)

Question 36

Consumption smoothing equation

Answer 36

Cw = Cr = C*

But remember Yw > Yr ,

Question 37

So to have smooth consumption, what is required

Answer 37

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

Question 38

Indifference curve diagram showing smooth consumption

What is the slope
Explain diagram

Answer 38

-(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*

Question 39

Evaluation of these private contribution schemes

Answer 39

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!)

Question 40

What happens if r represents a return to a stock market index in 2006/07

Answer 40

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)

Question 41

That was model for private funded pensions.

Now PAYG state pension model, budget constraints for the 2 periods

Answer 41

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.

Question 42

Indifference curve for PAYG state funded pensions

Answer 42

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.

Question 43

Is PAYG pension sustainable?

B) what would need to happen if not sustainable (2)

Answer 43

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.

Question 44

Should the UK move to a funded state pension

Pro and con

Answer 44

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!)

Question 45

What does this transition problem cause

Answer 45

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)

Question 46

So, solutions to maintain state pension (cope with population aging (4) (Blake & Mayhew)

Answer 46

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)

Question 47

1st alternative solution to address transition to funded pension system: reduce payouts

Eval:

Answer 47

Reduce payouts indivually to spread across more pensioners

Eval : Payouts are already small - do we want to be even less generous?

Question 48

3rd solution to population ageing: Work for longer pro (1)and con (2)

Answer 48

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.

Question 49

4th (better) solution to population ageing: immigration

And eval:

Answer 49

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)

Question 50

So state pension is vulnerable to our aging population. What needs to be encouraged.

(EXAMPLE!)

Answer 50

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)