Research Paper SS

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active population to pay the retired peoples pensions. Using the current contributions to pay

pensions will be no longer possible because the elders will outnumber the young, thus,

making the schemes no longer sustainable. Working hard for entire decades will not

guarantee anyone a comfortable retirement anymore, unless something is changed. If this

problem is not addressed correctly the results might be highly risky, for the aging population

of the world will spend their elder years in poverty. At this level, countries must increase the

retirement age in order to prevent an economic disaster because the demographic changes

are reversing the pyramid, work expectancies have decreased and pension schemes will

soon not be able to support the pensioners.

The global demography is constantly changing. Davis (1945) states that

demographers have come up with an idea of the general progression of changes in fertility,

mortality, and population composition through which populations have typically passed; they

have named it the Demographic Transition Theory (Davis, 1945, p. 1-11). It is divided in 3

stages (see Appendix 1 Figure 1). Stage one begins with the most developed societies at

one time, which had high levels of both, fertility and mortality rates. Therefore they had a

greater young population with a relatively small population of ages 65 and over. The second

stage shows a significant drop in levels of mortality, while fertility rates stay high. The result

is a rapid increase in the population, especially at the younger ages. The final stage presents

a decline in the fertility rate; this causes a slowing of the rate of population growth and

eventually a more even distribution across age groups. Thus, the older age groups are much

weightier (Kinsella & He, 2009). If global population today had to be placed in one of these

three stages, it would find its place on stage three. These changes are due to the fact that

there has been a raise in life expectancy. People live longer than their ancestors did and

probably less than their grandchildren will. This is creating an imbalance in the population

pyramid; there soon will be more elders than young people. Whereas the aging of the global

population signifies a triumph of medical, social, and economic advances, it is also creating a

huge problem for social securities, pension schemes, health care systems, and existing


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models of social support (Kinsella & He, 2009).

Undoubtedly it is extremely difficult to estimate the cost of pension provision.

Furthermore, people have consistently lived longer than the actuaries have expected

(Coggan et al., 2011). To illustrate, consider the following case. Around 1956 a 60 year-old

woman retiring from a job in Britains National Health Service had a life expectancy of just

less than 20 years; by 2010 she could expect to live another 32 years (Coggan et al., 2011).

There now exist medicines that reduce the probability of having heart diseases, vaccines

against diseases that were once big killers, and so many other things that humanity did not

have in the past; factors that contribute to extending life expectancy. The decreasing death

rates of some countries over the years are graphed in the appendix 1 figure 2. Although

objectively speaking, increased life expectancy is an achievement for the world, the problem

with it is that pension schemes are based on a population that did not live as long as the

current one. Paying for a longer pension is certainly much more expensive.

Additionally, there has been an increase in the elderly percentage of the global

population as well. This increase results from high fertility levels after World War II. In the

post World War II period the GFR1 in the U.S. rose from what had been an all-time low in

1936 of 75.8 children per 100 women of child-bearing age to a high of 122.7 in 1957

(Macunovich, 2000). A lot of women got married and had children. The marriage age

dropped substantially as well; young people rushed into marriage, and a larger percent of

people married than ever before. The problem was not that people began having large

families, but that everybody, at all society levels, was having children (Tyler, 1997). In short,

all those people known as baby boomers are now elders who are either retiring or already

retired.

Besides that, fertility rates have dropped substantially, creating an imbalance in the

way pension schemes work hence; there are not enough contributors to support all the

pensioners. If the population is now living longer and having fewer children, then the elder

population ought to increase. The aging of the population of the globe is nearly a universal


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phenomenon (U.S. Census Bureau, 2004). When comparing the globes population in 2002

to a forecast of the population in 2050 (See Appendix 2, figure 1), it can be noted that the

elderly population will grow drastically. While the younger population will still seem to be

large enough globally, in most developed countries it will not (Appendix 3 figure 1). In the

light of some projections, it is easy to see that by 2018, for the first time in history, people

aged 65 and over will outnumber children under the age of 5 (Kinsella & He, 2009). This is a

worrying fact. The number of countries with an 11%, or more, population aged 65 and over

will increase greatly (See appendix 4 figure 1 and appendix 5 figure 1). In fact, since the

end of 2010, the numbers and proportions of older people, especially the oldest old, have

begun to rise rapidly in most developed and many developing countries, and the death rates

at older ages have been reduced (Kinsella & He, 2009). Furthermore, the worlds population

aged 80 and over is projected to increase 233 percent between now and 2040, compared to

160 percent for the population 65 and over, and 33 percent for the total population of all ages

(Kinsella & He, 2009).

Also the way many insurance companies calculated the pension schemes used

nowadays was based only on the ratio of cash benefits to contributions, without the least

care for the future. Nevertheless, the way pension schemes should be calculated is based on

the support ratio, also called dependency ratio (Coggan et al., 2011). This measures the

proportion of population economically dependent working population, in simple words, the

number of people on their working age or contributors that support each pensioner

Despite the fact that life expectancy has changed, the working life expectancy has

not. In fact, people work around the same time, as their ancestors did. Thus, their lives as

pensioners are extended. This means that social services will have to pay pensioners a

longer period of time while the lifetime employment of contributors is still the same. Along the

same line, if pensioners live longer, while workers keep on contributing to Social Security the

same number of years, there will come a moment in which the Social Services will not have

enough funds to pay the respective pensions.


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Simultaneously, while the global population is aging, the total population size in some

countries is declining, and this list is projected to expand. Furthermore, low fertility rates will

make it impossible to support pensioners and businesses will become insolvent. Appendix 6

figure 1 shows how the support ratios of the most developed countries have and will

decrease substantially. For instance, the most drastic change in the support ratio between

now and 2050 is found in Mexico. In 2010 the number of people of working age compared

with the number of people beyond retirement age was of 8.6; by 2050, this number will

decrease to only 2.5 if no measures are taken.

Along the same lines there has been a reduction in the proportion of life spent

working. People are retiring relatively earlier than they were 40 years ago (Kinsella & He,

2009). To exemplify, life expectancy for males aged 65 in France has increased from 9.9

years to 18.15 and retirement age has been barely reduced from 60 years old to 59.1 (See

Appendix 1 figure 1). The average retirement age in the most developed countries, which

are facing a crisis right now, is of 64.2 years. The years of contribution are approximately 45.

Thus, people are living a higher proportion of their lives in retirement, there are less years of

contribution relative to the years spent in retirement, and there is less people contributing as

well.

All in all, the way pension schemes were made years ago is not working anymore. It

is not logical to expect that more pensioners will be able to be supported by fewer

contributors. Certainly, employers who promised higher pensions in the past knew they

would not be in their posts when the bill became due (Coggan et al., 2011). That made it

tempting for them to offer higher pensions rather than better pay. So now countries are faced

with this issue: how to change the pension schemes in order for them to be sustainable and

for the population to accept them? As they are now, working hard for years will not guarantee

a comfortable retirement. Taking matters into action, in Spain, the retirement age has been

raised to 67 from 65 (Minder, 2011).

In order to provide an adequate solution, currently used pension schemes and their


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flaws must be analyzed first. In the first place, some employees are promised pensions

linked to their salaries; these are known as defined-benefit schemes. A definedbenefit plan

promises a specified monthly benefit at retirement. It may state this promised benefit as an

exact dollar amount, such as $100 per month; or, more commonly, it may calculate a benefit

through a plan formula that considers such factors as salary and service, for example 1% of

average salary for the last 5 years of employment for every year of service with an employer.

Usually, the formula used to calculate the benefits is a combination of years of service

multiplied by a percentage of the average salary over the last several years of service.

Back in the 1980s and the 1990s a long bull market in equities hid the true cost of

the promises made to the employees. Those funds have been depleted, hence,

privatesector employers have majorly ceased making these promises to new employees;

the public sector is beginning to face the same issues (Coggan, et al., 2011). Therefore, this

pension scheme is not working so well anymore. The funds to pay the pensioners are

depleted, and there are not enough contributors to support them. Namely, countries such as

Sweden, Germany and Japan use a defined-benefit contribution. They have an automatic

balancing system to deal with deteriorating pension finances, largely by making the inflation-

linking benefits less generous. The Netherlands, another country with defined-benefit

pension scheme, also limits inflation linking benefits but delivers pensions that are very close

to average earnings (Coggan, et al., 2011). The United States has also taken certain

measures, the actual retirement age ranges from 65 to 67 years, depending on the year the

person was born (U.S. Social Security Administration, n.d.).

The other type of pension scheme has to do with private-sector employers providing

pensions in which the payouts are linked to the investment performance of the funds

concerned. These are called defined-contribution schemes; they transfer nearly all the risk to

the employees, a defined contribution plan, does not promise a specific amount of benefits at

retirement. In these plans, the employee, the employer, or both, contribute to the employee's

individual account under the plan sometimes at a set rate, such as 5% of earnings annually.


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These contributions are generally invested on the employee's behalf. The employee will

ultimately receive the balance in his account, which is based on contributions plus or minus

investment gains or losses. The value of the account will fluctuate due to the changes in the

value of the investments.

In theory, these plans can provide an adequate retirement income as long as enough

money is paid in, but employees and employers are contributing too little (Coggan, et al.,

2011). For example France is a country with a defined-contribution pension scheme. As

mentioned before, the retirement age in France was increased; this was accompanied by a

phased increase in the minimum level of contribution from 40.5 to 41.5 years. Italy, which

also has a defined-contribution pension scheme, increased the retirement age but has gone

further: from 2015 on, future changes in the retirement age will be indexed to the rise of life

expectancy (Coggan, et al., 2011).

Moreover, both pension schemes, defined-benefit and -contribution, essentially face

the same problem: the aggregate amount of pension savings is inadequate (as cited in

Towers Watsons, 2011). Additionally, the contributions are not insured in either pension

scheme. That is, the contributions of the economically active population are used to pay the

pensions of the retired people. This would signify no problem if new generations were

providing enough contributors to continue sustaining this. Since the demographic pyramid is

changing, as it was mentioned before, Social Services are faced with a problem, because

they are retiring more money from the common fund than they are receiving, and, when

current economically active generations begin to retire, they will not have money to pay their

promised pensions.

As of now, retirement age must be delayed in order to prevent an economical chaos.

People live longer than they did 40 years ago; additionally the fertility rates have dropped.

Consequently, the pyramid is in the process of reversing itself. That is, there are not enough

people in the economically active population, while the percentage of elders or pensioners is


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increasing rapidly. This has caused an economical imbalance, which has led to the crisis of

social services. In final analysis, the circumstances under which the pension schemes used

today were created were very different to the ones today, ergo they are not as effective.

Increasing the retirement age is the best immediate solution to the problem. People should

work for a longer period of their lives; one that equals the proportion of life spent working

from people years ago. Then, the economically active population would increase

automatically as well. Also, social services would have higher incomes enabling them to pay

for the pensions they promised.

Indeed, global population is constantly changing; it is an erratic characteristic of the

world that depends on a lot of different factors, many of which cannot be inferred. Population

projections can and will always be made, but they are limited by unpredictable factors that

define population, such as human preferences; thus, these projections are not infallible. To

conclude, the investigation made for the development of this thesis makes it clear that there

is no perfect formula for the measurement of benefits and contributions in a pension scheme,

no one could have predicted the changes the world population is currently undergoing, nor

can someone today predict that of the future global population. Social services worldwide

must take these changes as they come, making adjustments accordingly to the time and

place, hoping they make the right choices.


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APPENDIX 1

Appendix 1 - Figure 1: Demographic Transitions

(Kinsella & He, 2009)

Appendix 1 - Figure 2: Decreasing Death Rates

(Global Change, 2006)


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APPENDIX 2

Appendix 1 - Figure 1: Global Population Pyramid (2002 and 2050)

(U.S. Census Bureau, 2004)


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APPENDIX 3

Appendix 3 - Figure 1: Developed World Population Pyramid (2001 & 2050)

(U.S. Census Bureau, 2004)


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APPENDIX 4

Appendix 4 - Figure 1: Percent Population Aged 65 and Over (2008)


APPENDIX 5


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Appendix 5 - Figure 1: Percent Population Aged 65 and Over (2040)


APPENDIX 6

Appendix 6 - Figure 1: Some Countries Support Ratios

(Coggan, et al., 2011)


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(Coggan, et al., 2011)

Research Paper SS

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