The economic downturn sparked by the coronavirus pandemic (COVID-19) is having a major impact on global labor and financial markets – which in turn will have significant effects on pension systems. Crucially, policy responses will need to strike a balance between the immediate protection of vulnerable groups and ensuring that our pension systems remain able to deliver retirement income in the future as the global population ages. Here, we propose four important policy questions to be considered as governments grapple with this challenge:
First, how can we alleviate the impact of a sharp drop in returns on financial assets? The level of impact differs according to the type of pension system. Declining investment returns have an immediate effect on defined contribution systems. For example, the OECD estimated that the 2008 financial crisis reduced global pension assets by 23%. Investment returns also lower the funding ratios of defined benefit schemes – the OECD estimates a $1 trillion impact from the last crisis on the funding levels of U.S. public pension plans alone. While the magnitude of the pandemic is expected to be higher, lessons from the 2008 financial crisis showed the importance of regulatory flexibility in times of market volatility – such as allowing some flexibility in timing to purchase an annuity or allowing defined benefit schemes longer recovery times to rebuild their funding ratios. The importance of moving into more secure assets closer to retirement age, such a via life-cycle funds, has been reinforced in the current situation – a lesson that Latin American countries have learned since the previous downturn. The rapid expansion of social pensions and non-contributory minimum pensions in several countries in recent years will also reduce the impact of the crisis on pensioners, especially those in the lowest income brackets.
Second, how do we support pensioners? The crisis has dramatically demonstrated that it’s urgent to improve financial inclusion, especially for the elderly and persons with disabilities, who are the most vulnerable population groups. Possible increases in health care needs and costs can be mitigated with temporary pension increases, either selectively targeted to those affected by COVID, or generalized to all pensioners. COVID-19 is also prompting governments to rethink how they make payments to pensioners – who make up the largest number of social protection payment recipients in many countries. With the elderly receiving payments in cash, social distancing is difficult to achieve, heightening the risk of infection. There are several immediate steps that can be taken to counter this, including the staggering of payments, introducing new queueing protocols, reducing payment frequency, or allowing collection by proxy. Waiving inter-bank fees is also an option where pensions can be paid electronically. Rwanda and India provide good examples of countries which are moving towards digital pension payments.
Third, should pension contributions be maintained in the immediate term? The impact of the coronavirus pandemic on the economy, jobs, and workers’ incomes is a primary concern to governments. Given the seismic economic implications of COVID-19, governments are looking for measures that can provide immediate relief to businesses. Suspending or reducing contributions to pension schemes from employees and/or employers can help reduce labor costs and provide an incentive to retain workers. However, contribution holidays need to be done in combination with long-term reforms to make pension systems more robust and able to meet the needs of a growing global elderly population. This means reversing and increasing contributions once economic stability returns – as Estonia did, for example, following the 2008 crisis. Behavioral economic techniques, such as the Save More Tomorrow method used by some U.S. employers, can be used to gradually increase contributions as wages rise in the future.
Fourth, should pension savings be used to support younger workers? Whether to allow working-age people to access their pension savings early is another policy choice facing governments. In most low- and middle-income countries, unemployment insurance programs are either small or do not exist at all – and scaling up would require significant government resources. The temptation for countries with pension assets is to borrow funds across programs and allow access to pension savings without tax penalties to cover short-term needs – as has recently been allowed, to some extent, in countries such as Australia, Malaysia, and Peru. However, it should be recognized that pensions are a poor substitute for unemployment insurance, and withdrawals must be limited, time-bound, and only for emergency needs – otherwise delivering adequate incomes in retirement will be difficult. To give a stylized example, making a withdrawal of 25% from pension savings after 15 years of contributions can result in 15% less pension income for life once the worker retires. In addition, we risk seriously depleting these important sources of long-term domestic capital, which we will need to rebuild as our economies come out of the downturn. In some emerging markets, pension savings can represent a significant percentage of GDP – almost 100% in South Africa, for example. Governments should also resist the temptation to relax eligibility conditions for early retirement or disability benefits – as was done in some European countries after the 2008 downturn – since this compromises the long-term financing conditions of pension systems.
The bottom line. Balancing payments today with tomorrow’s needs is a challenge when designing pension systems at any time – but especially in conditions like we’re experiencing globally today. To ensure our pension systems provide the payouts needed to fund the retirement income of an aging global population, we must ensure that their assets are preserved as much as possible and that they are invested in long-term, secure, and sustainable investments – taking into account broader concepts of risk, which have been growing with climate change and which the COVID-19 pandemic has displayed in force.