New America Foundation- Arizona State Panels on Longevity and Public Policy

Last Friday,, New America Foundation, and Arizona State University hosted a series of panels discussing the implications of increasing life expectancy on public policy, retirement, and family planning.

Savings defaults, auto-enrollment, and financial literacy were hot topics. Nudges, “guardrails,” and redefining “retirement” are discussed at length.

Life Expectancy Rate and Impact on Retirement (~40 minutes)

Retirement confidence lags leading indicators

Admitting you have a problem is the first step in recovery. It’s not news that people are living longer than they used to, and it’s certainly not news that workers often underfund their retirement expectations. What is news, is workers are starting to realize in larger numbers that they likely won’t be able to afford retirement at 65 if they continue saving–or not saving– as they have in the past. The Employee Benefit Research Institute (EBRI) just released its 23rd annual Retirement Confidence Survey, and it shows worker confidence resting on last year’s record low sentiment.

The economy has shown signs of improvement in the last year–albeit not overwhelming improvement–and one would think that like the stock market, retirement confidence would take the opportunity to show some exuberance. Not the case this time. The poor economy of the past few years seems to have woken up workers to the practical uncertainties of retirement, and its mounting cost. EBRI suggests that regardless of whether the actual savings and investment rate increased or decreased, this lowered retirement confidence is likely a result of the Great Recession as workers faced prolonged periods of unemployment, reduced wages, and lower rates of return (or more likely losses) during that period.

“One reason that retirement confidence has remained low despite a brightening economic outlook may be that some workers may be waking up to a realization of just how much they may need to save. Asked how much they believe they will need to save to achieve a financially secure retirement, a striking number of workers cite large savings targets: 20 percent say they need to save between 20 and 29 percent of their income and nearly one-quarter (23 percent) indicate they need to save 30 percent or more.”

In other words, workers have been badly shaken during this economic doldrums, and the lasting affect is workers rude awakening to previous under-saving. We’ll have to wait and see whether or not the fear translates to long-term improved savings rates.


Non-Sequitors: Catching Up

The Economists‘ Buttonwood blog comments on retirement, longevity, and inherent inequity in a universal pension age.

Michael Barone of American Enterprise Institute foresees an end to the entitlement age, while his AEI colleague Andrew Biggs discussed public pension reform with former San Diego city councilman Carl DeMaio, after San Diego made some painful, but needed reforms.

Some wise words about personal responsibility in planning for retirement from the Wall Street Journal… let’s just say these resolutions are obviously sound practice, but easier said than done.

According to the Washington Post‘s Michael Fletcher the American worker is borrowing from tomorrow to pay for today–which means less leisure, retirement, what-have-you tomorrow.

The Washington Post‘s Jim Tankersley writes that the global economy has pulled American manufacturing into an age of weak labor, and thus weak unions… something to keep in mind during the Social Security and pension reform discussion.

Video with Chuck Jaffe of WSJ‘s MarketWatch in re avoiding the Personal Retirement Cliff.

NPR finds that the government isn’t only struggling with the question of homo sapien retirement as a growing population of research chimps are hanging up their lab coats for country living.


Growing Threat to Retirement: Student Loans

The rising cost of post-secondary education is not just a burden on today’s students, it is threatening wealth accumulation and retirement security for those that help finance college degrees. With all the flexibility for students and new graduates to tailor loan repayment, it should comes as a surprise that for benefactors that ease the burden on student debt by taking on some of there own have unknowingly placed Social Security benefits at risk.

Graph produced by Wall Street Journal’s SmartMoney.
In 2010, it was reported that student loan debt had surpassed credit card debt in the United States. The average debt burden for new graduates is nearing $30,000. As the broader economy struggles to motivate itself out of a sluggish recovery, these over-leveraged consumers will not be able or willing to save adequately for retirement or make down payments on home purchases early in post-graduate careers. These early hesitations to save and invest will cost this generation of debt-burdened students significantly in retirement security down the road.

An Analysis of the US Savings Rate

Gross Domestic Product (GDP) grew by 1.9 percent in the first quarter 2012, down from a 3 percent increase in the fourth quarter 2011.  Since the end of the recession—a span of eleven quarters—the growth rate of GDP has averaged 2.4 percent.  Over the same eleven quarter period after the end of the 1981-82 recession, GDP growth averaged 5.5 percent.  What accounts for the slow recovery of the most recent economic downturn?  One possibility is the country is entering into a period of less than robust growth due to the anemic savings rate over the past thirty years.

According to the Solow Growth-Model, long-term economic growth comes from a country’s willingness to forego current consumption (i.e. save) in order to enjoy higher future consumption.  The increased savings is used to invest in education, technology, and capital-deepening.  Over the past thirty years the United States—and much of the industrial world—has done the opposite.  Americans have increased their current consumption at the expense of future consumption.

The chart above shows the US savings rate as a percent of income.  Since 1970 the trend-line for the savings rate has fallen—though it has increased somewhat since the past recession.  Between 1970 and 1989 the annual savings rate averaged 9.1 percent; compared to an average of 4.5 percent between 1990 and 2011.

Why has the savings rate fallen over this time?  Two suggestions:  (1) defined benefit pension plans, which became standard after the Second World War; and (2) the two asset price bubbles of the past twenty years—tech stocks and housing—created by the loose monetary policy of the Federal Reserve.

In theory, defined benefit and defined contribution pension plans are equal.  The former plan provides high rewards, but at high costs; while the latter provides lower costs but with fewer guarantees.  One downside of defined pension plans is it reduces the incentive for workers to save for their own retirement—especially when someone else is responsible for making the contributions.

The problem in the United States is most workers want the rewards of the defined benefit plan but pay the costs of a defined contribution one.  The US economy in the 1950s and 1960s allowed workers and employers this option.  Back then a GM or Ford employed hundreds of thousands of workers and had to finance relatively few retirees.  In addition, these firms didn’t face global competition.  As a result, firms put up limited resistance to labor demands for generous retirement plans.  GM and Ford could charge a few extra dollars for a car to finance those workers who were retired.  As well, to guarantee a dollar in future pension didn’t mean they had to put a dollar in an account right then.  They could contribute, say only eighty cents, because pension plans could invest that contribution and earn interest, which would be available in the future.  Another factor was life-expectancy.  In the post-war period, it was around sixty-five years of age.  Thus workers who retired at sixty could be expected to receive on average benefits for only a few years.

Times are different today.  Now a GM and Ford have four or five times as many retirees as workers.  A fully finance pension plans adds thousands of dollars to the cost of every car.  With global competition, it is difficult for the carmakers to pass these costs on to the buyer.  Secondly, life-expectancy has risen to near eighty years of age.  This means the average retiree will receive benefits for twenty or more years, putting additional pressure on pension funds.  What has happened is the money put into pension funds today are not being invested, they are being used to cover the pensions of current retirees.

The second possibility lies with the Federal Reserve’s monetary policy over the past couple of decades, one which created two asset bubbles.  Americans saved less during this period because they assumed (wrongly as it turned out) that prices would continue to rise and would make up for any deficiency in their savings accounts.  The chart which plots the savings rates also does the same the federal funds rate.  As it is with the savings rate, there is a downward slope in the fed funds trend-line.

This in a way contradicts basic economic theory, which suggests a negative correlation between the savings rate and interest rates.  When savings is low—i.e. the supply of loanable funds is limited—the price of money (interest rate) should rise.  If savings is high, the price should fall.  It should be pointed out that the federal funds rates used are in in nominal and not real rates.  Nominal rates equal the real interest rate plus expected inflation.  The growth rate of the price level since the late 1980s has diminished greatly from the high rates of the 1970s.

Ben Bernanke and Alan Greenspan argue that the reason for the low rates—despite the equally low US savings rate—was the world-wide savings glut.  In a global economy, the Fed rightly needs to take into account more than just domestic economic conditions.  One such condition should be how the global savings is being invested.  A large portion of the money saved by the Chinese is going into US Treasuries.  This would be okay if the federal government was running deficits to finance projects designed to promote long-term economic growth.  Rather it is a situation where a growing part of the budget is going into transfer payments.  The graph below charts the size of the federal debt since 1990—which has increased by 360 percent over the past twenty-one years.

A large portion of the increase in federal spending was for outlays to Social Security and Medicare, which increased 250 percent since 1990.  Like with the private sector, the federal government has promised retirees a defined benefit retirement program in the form of Social Security and Medicare.  The problem is politicians have tried to finance it as if it was a defined contribution plan.  In addition to guaranteed lifetime monthly checks, the federal government provides generous cost-of-living raises.  At the same time they are unwilling to require current workers to pay the full cost of such future promises.  The federal government made things even worse when it reduced employee contributions to Social Security a couple of years ago as a short-term solution to stimulate consumption.  When interest on the debt and other income security payments are included, a large portion of the federal budget goes to transfer payment designed to help consumption—not savings.  In 2011 these outlays represented 62.9 percent of total federal government outlays.

This is not to say that the lack of savings is the only reason for the lackluster economic growth over past few years, just that it is a factor.  The US has enjoyed a two decade reprieve from reality, one which permitted them to consume like drunken sailors.  The thinking was they didn’t need to worry about the future because the rising stock market and housing prices would provide for their retirement.  There is an old saying that one reaps what he sows.  The US may now be realizing the consequences of their unwillingness to adequately save for the future.

Savings and Longevity

Jordan’s last post poses an interesting question: How should longevity risk be split between the retiree and the government?

People who reach retirement these days are living longer than ever. My favorite statistic du jour is that longevity for people aged 65 increased by an ENTIRE YEAR between 2000-2007. That pace may be unsustainable but I’m not qualified to speculate as to that—and I’m not sure if anyone else is either, frankly.

People are starting to discern that once they hit 65 they have a lot more living left to do. The only age cohort working more now than they were five years ago are people 60 and over, and a recent survey suggested that people in their fifties have radically increased their anticipated retirement age in the last five years. That’s no doubt in part due to the shock of the 50 percent stock market decline in 2007-2008 still being fresh in everyone’s mind, so that people are starting to think long and hard about how long they will live and whether they have the resources to sustain themselves over that time.  As more and more people reach retirement age with one or more parents still alive (a development that was simply inconceivable even a generation or two ago) the prospect of living to one’s 90s doesn’t seem so implausible after all to a whole host of people.

A natural question to ask is whether people will simply insure against running out of money by buying annuities. Thus far it doesn’t seem like it: to many people they still feel very opaque and besides, they have something akin to an annuity in their Social Security benefits. For 30 percent of retired U.S. households Social Security benefits constitute nearly their entire income.   “People don’t buy annuities: they are sold is a common refrain in the industry. In that state of affairs it’s hard to see people flocking to them no matter what kinds of tax breaks come with annuities.

For the top forty or fifty percent of society the current calculus goes like this: they have social security, a private pension worth something, a house more or less paid for, and some other savings. They have a general goal of leaving something to their heirs but it wouldn’t crush them (or their children) if they stuck around long enough to spend down their wealth.

As people start coming to grips with their ever-increasing longevity, they’re increasing how much money they want to have set aside before they retire, and they are working longer—and saving a bit more as well.

Is there a need for a vigilant public policy response? I’m not so sure. It would help if we made Social Security solvent and addressed the rising cost of health care, and in general we should end the punitive taxation of capital income for a whole host of reasons, but beyond that I’m hesitant to call this a crisis. Maybe because the prospect of people living longer and healthier lives is nothing short of miraculous and something we should all be grateful for.