Why Outsourcing Your Retirement Pension is a Really Bad Idea

The Germans are up to their old tricks again. They’re sending undesirables off to Eastern Europe by the thousands. Only this time, it’s not racially or religiously motivated. Nor is it a matter of Lebensraum. It’s a matter of cost. Old people are expensive, and Eastern Europe is cheap.

All you have to do is give companies like ‘Seniorpalace’ a call and an ambulance comes and takes your aged person off to Hungary, the Czech Republic or Slovakia. Monthly care costs there are about a third as much as in Germany.

God only knows what the locals think about their former invaders returning to retire. Let’s not dwell on that. We’ve been politically incorrect enough for the minute.

All this is very depressing. Our German grandmother is fit and well, by the way. Our biological grandfather was less lucky. He picked the wrong retirement haven and got himself killed by terrorists.

Anyway, if a place as prosperous as Germany can’t afford its retirees, who can?

Perhaps the Germans are just being honest about what they can afford. You can’t say the same for the UK, or the US. There, pension problems are something you shouldn’t talk about.

But the numbers speak for themselves. The problem is, there aren’t any Australian numbers for comparison. We don’t really know how much trouble we’re in down under. Back to that in a moment.

The UK figures are straight forward. Here are the numbers from the Office for National Statistics:

‘In summary, the estimates in the new supplementary table indicate a total Government pension obligation, at the end of December 2010, of £5.01 trillion, or 342 per cent of GDP, of which around £4.7 trillion relates to unfunded obligations.’

It’s a number so big it’s probably meaningless. You can’t even count it on all the fingers and toes of the world. Not even all the human fingers and toes that have ever existed. We’ll get to what the figures mean for retirees below. First, how do the Americans compare?

At the federal level, unfunded liabilities are around $US 61 trillion, with $US 5.3 trillion added in 2010 alone. That’s half a million dollars per American household in payments that will have to be made for things like healthcare, pensions and the like. Remember, these are unfunded liabilities, so nobody has set money aside for them.

Imagine what will happen to the world’s economy when the American consumer figures out that they can’t afford to consume. The money they were promised isn’t there.

Here’s an interesting summary from Stanford Professor Joshua Rauh on the state of the individual American states themselves. He was interviewed by Econtalk’s Russ Roberts:

Joshua: ‘The actual unfunded liability is $4.4 trillion, as of the end of 2011.’

Russ: ‘And that would be about $36,000 per American household? Is that correct?’

Joshua: ‘Yeah. $38,000 per U.S. household…’

The interesting thing here is that American states can’t print money like the federal government can. Many states have to balance their budgets each year. But there’s no way these payments are affordable.

So what will the world look like when people in Europe, the UK and America realise the cash they were promised in retirement simply isn’t there? Russ and Joshua explain:

Russ: ‘These are thousands of people who are expecting large sums of money, and they are going to fall very unpleasantly on another group of people. I don’t know how that’s going to turn out.’

Joshua: ‘Exactly. I think the breakdown of civilization over these things, the breakdown of a functioning government that can provide these services that we rely on, is unfortunately going to become increasingly likely.’

Russ: ‘Yeah, but I think the strike is the least. That would be a great outcome. Then you negotiate some settlement. But that’s a settlement you’d usually negotiate with current employees over future benefits. We’re talking about trying to renegotiate past promises to current retirees.’

Joshua: ‘Right.’

Russ: ‘It’s going to get nasty.’

Russ Roberts, who is the least likely person in the world to exaggerate something, then says this:

Russ: ‘But I think it’s worse than that, actually. It seems to me that the real risk is the breakdown of civilization which we saw a little bit of in Greece…’

Australia’s Slice of the Pension Cake That Was Had but Will Never Be Eaten

If you think this is only a foreign problem, think again. We haven’t had a recession in more than two decades and we’re still in trouble, according to two articles in the Australian:

‘A budget blowout of up to $107 billion in public servants’ pension costs risks swamping the value of the Future Fund and potentially undermining the Gillard government’s AAA credit rating.’


‘Taxpayers facing a super-sized problem

‘PITY the poor future taxpayers who must meet the superannuation bill of commonwealth public servants, defence personnel and others.

‘Lurking in the federal government’s recently released final budget outcome statement for the 2011-12 year is a considerable $90 billion increase in superannuation liabilities.

‘The Future Fund is falling behind in its capacity to meet these liabilities. The superannuation liability has increased from $145.1bn at June 30 last year to $235.4bn at June 30 this year, an increase of 62 per cent.’

The interesting thing here is what makes the black hole a whole lot worse than it seems.

‘The government estimated public service superannuation liabilities at $139bn in May; these were partly offset by $77bn of assets in the Future Fund. But the government is assuming a 6 per cent rate of return on safe assets, a far cry from yields of 3 per cent observed on commonwealth government bonds this week.

‘Analysis from Rice Warner Actuaries shows that using a 3 per cent discount rate leads to federal pension liabilities surging by between $46bn and $107bn; the more retiring public servants choose indexed life pensions over lump sums, which they typically do, the greater the cost.

‘That equates to an increase in unfunded pension liabilities of between 78 per cent and 181 per cent.’

Did you notice the figures weren’t as dramatic as the UK’s £4.7 trillion and the US’ $60 trillion? Maybe our hundred billion or two isn’t so bad after all, right? What’s really worrying is that Australian statistics seem to be calculated a little differently to the US and UK.

There, all obligations of the government are considered ‘unfunded liabilities’. Here in Australia, only public sector employee obligations get counted. The rest of us don’t get an accounting entry. Promises like the old age pension and the disability pension aren’t factored into projections. At least not any we could find.

If you know of any ‘unfunded liability’ calculations for pensions that don’t just mention the public sector, let us know at letters@marketsandmoney.com.au.

As far as we can tell, nobody seems to have bothered figuring out just how much money we’ve promised to hand out to the retirees of the future. But if we can’t even provision for the government’s employees, paying for the rest of us will be real fun.

We did find this comment on the matter in the Treasury’s 2009 Tax Review:

‘… demographic change will impose increasing costs on government budgets, not only for retirement incomes but also for health and aged care services. Across governments, these increases are likely to exceed four per cent of GDP by the 2040s. Four per cent of GDP is equivalent to the revenue currently raised by the GST or the entire Australian Government health budget.’

Do you think the Australian economy could sustain a second GST, or healthcare system?

If the percent of Australia’s tax revenue stays the same, at 20% of GDP, an additional 4% of GDP going to retirement incomes means that cost will eat up an additional 20% of government tax revenue. Would you like your taxes to go up 20%?

The report puts the conclusion mildly:

‘Future taxpayers may therefore have to carry a higher taxation burden to support the funding of pensions, and other services, for a much larger population of retirees.’

Or, maybe the taxpayer will refuse to pay for past promises. In countries that went through the process of discovering they couldn’t keep their welfare promises (the Scandinavian countries in the 90s), and in countries going though that experience now (Greece), the taxpayer simply defaulted on those promises.

Pensioners didn’t get paid then. And they won’t get paid in the future. At least not what they were promised.

Australians might discover the problem of unfunded liabilities later than their friends in Europe and America. But they will discover that outsourcing their retirement to the government and its cronies in the funds management industry was a bad idea.

So now what?

We spent 20 minutes answering that question in an interview that you can watch here.

Until next week,

Nickolai Hubble.
Markets and Money Weekend Edition

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, Markets and Money is published in 7 countries with a worldwide readership of almost 1 million people.

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