Thursday, April 20, 2006

No pension. No social security.

The fifth and final critical assumption is that no reliance should be placed on either a company pension or any form of social security.

As for company pensions, participation in defined benefit pension plans is being phased out as employers (and investors) wake up to the fact that many companies which offered these schemes have seriously under funded them over extended periods of time. We are starting to see two consequences of the under funding. The first is a bankruptcy risk. When companies get into financial difficulties, the rights of current and former employees to their promised benefits comes under threat. The second is that employers who are now having to deal with the under funding issue are looking for ways to reduce the cost - and the only way to do that is to reduce the benefits to members of the scheme. I would not want to be in a position where my former employer decided to unilaterally reduce my standard of living because it had not made adequate provision in the past. Both of these developments are happening now.

Social security suffers from a similar problem. The social security schemes offered by governments to retired people in many countries are in the process of becoming fiscally unsustainable in their present form due to a combination of demographic factors (an aging population resulting in the ratio of retirees to taxpayers increasing) and historic under funding. The reality is that the governments concerned will need to deal with the problem through a combination of (i) inflation which will effectively reduce the real value of benefits, (ii) making eligibility more difficult (e.g. raising the minimum retirement age, harsher means testing), (iii) reducing the availability of some benefits and (iv) raising taxes generally. The only reason why measures have not been taken to address the problem since it was first recognised (at least in the early 1980s) is the the ballot box. The politicians who have the power to do something will not do anything because they want to get re-elected - a situation which the ranks of aging baby-boomers are likely to perpetuate because they make up such a large percentage of the electorate.

All in all, it does not seem to be an attractive proposition to rely on a system which is financially unsustainable.

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