The Gathering Pensions Storm

Boomers will soon find their retirement kitty has been underfunded. Making up the shortfall will buffet corporations -- and the economy

The baby boom generation has been described as a pig going through a python. The problem is that the pig is getting close to the end of the python. Many baby boomers are facing retirement without adequate savings of their own. Together with Medicare trust funds that will be exhausted and inadequately funded corporate and government pensions, you have the makings of a potential crisis.

The problem for financial markets is twofold: First, the underfunding in corporate and other pension funds will cause individual firms great hardship, making those with high legacy costs uncompetitive. Second, the underfunding at the state and federal government levels will cause tax hikes, which will alter regional and international competitiveness. We currently estimate that U.S. corporate pensions are underfunded by about $140 billion. Add the cost of other postemployment benefits and the deficit doubles. State pensions are underfunded by $284 billion.

Disturbing as those numbers are, the federal underfunding situation dwarfs the state and private ones. Social Security has a $4.6 trillion shortfall (based on present discounted value of the next 75 years), and the federal civilian and military employee programs are underfunded by $4.5 trillion.


  The underlying problem is demographics. The postwar baby boom was a phenomenon throughout the industrial world, and those babies born in the late 1940s and 1950s are approaching retirement. The leading edge of the baby boom is now turning 60, and we can expect the ratio of retirees to workers to rise. Those who are now paying into pensions will start collecting benefits, and there isn't enough money in the pot to pay the pensions promised.

The problem arose because companies, and especially governments, were willing to use pensions as part of employee compensation but discovered that they could get away with underfunding those pensions. In the corporate sector, legal changes (primarily the Employee Retirement Income Security Act of 1974) forced them to fund pension programs (though not always fully). Retiree health care and other postemployment benefits don't have to be funded at all, and as a result are virtually unfunded at many companies and by most states.

The fact of life, however, is that everything retirees consume in retirement must come out of current consumption. An increased ratio of retirees to workers requires that an increased share of production go to nonworking adults. This must be done either through taxation, asset sales, or interpersonal transfers. That means retirees have to be supported by the government, using the wealth they built up over their working lives, or their families.


  This situation exists throughout the industrial world and in those developing countries that have managed to cut back on birth rates. People are living longer and having fewer children. It is mild in the U.S. compared with Europe and Japan, whose birth rates have been lower and where immigration is not increasing the working-age population.

European and Japanese fertility rates (number of children born per woman over her lifetime) are all well below 2, implying long-term population decline. The U.S. birth rate is just above 2, implying essential stability (excluding immigration). High fertility rates in Latin America, Africa, and the Middle East are still keeping world population growing at an unsustainable level, but developing Asia is approaching zero population growth.

The other side of the shifting demographics is that we are living longer. Average life expectancy in the U.S. is now 77.9 years, up from 77.2 years in 2003. The U.S. has one of the lowest life expectancies of the major industrial countries; Japan, at 81.8 years, has the highest.

And not only are we living longer, but we are retiring earlier. The average retirement age in the U.S. is just below 62, up a little over the last 15 years but well below levels of a generation ago. European retirement ages are generally earlier, with France near 58 years. Longer life expectancy, extended education, and earlier retirement mean that most Americans will work barely half of their lives, and Europeans even less.


  A lot of nonsense is written about "the good old days" when everybody supposedly retired with a gold watch and a livable pension. The old days were never that good. When Social Security was proposed in the U.S. in 1933, the retirement age was set at 65 -- and average life expectancy was 63. Most people were not expected to live to collect, and historically most people worked until very near their death. Extended retirements are an invention of the last 50 years, and since life expectancy has increased and retirement ages have crept lower, people expect to spend more and more of their life in retirement (see BW Online, 6/1/06, "The Golden Years -- At Work?"").

Moreover, in "the good old days" most people never had a private pension. Even firms that had pension programs based them on seniority at retirement, so individuals who changed jobs frequently found themselves with little or no pension accrued. It was not unusual to see workers fired in their late 50s or even early 60s so that firms could avoid paying their pensions.

Today's system deals with some of these issues by allowing everyone to plan for their own retirement and by making pensions vest early. However, it creates a problem by forcing everyone to plan for their own retirement. Today's preretirement cohort -- the people now in the 55-64 age bracket -- have more assets than at any previous time, both in absolute terms and relative to their annual income. However, they also have more years to live in retirement, and thus often need more money than they have.

(Note: This article was condensed from Standard & Poor's CreditWeek, June 7, 2006, and is also available on

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