Most western countries face a looming demographic challenge as their populations age and the ratio of workers to retirees shrinks. Britain has come up with a compelling plan for dealing with its problem, one that could provide some ideas for Canada to ponder.

The recommendations came in a massive 472-page report by Britain’s Pension Commission, a committee headed by Lord Turner, who is also vice chairman of Merrill Lynch Europe PLC. Chief proposals of the report, handed down at the end of November, include boosting the retirement age for receiving a state pension, beefing up the size of the state pension and introducing automatic, but not compulsory, self-directed investment accounts.

Many of the weaknesses in Britain’s pension system are the same as those that threaten to beleaguer the Canadian system. For one, the population is aging and the proportion of workers to dependents is shifting toward a much greater portion of dependents. State pension systems are inadequate on their own to provide for a comfortable retirement, yet relatively few people seem to be saving enough to provide for themselves.

There’s no magic bullet for dealing with the growing issues, and no two countries face exactly the same set of problems, but the basic issues are similar, and the strategies for addressing them in one country can still be instructive for the government of another.

The latest data from Statistics Canada show the aging of the Canadian population has already begun and it will accelerate in 2011, when the leading edge of the baby boomers (those born in 1946) hit age 65. The rapid aging is expected to continue until 2031, when between 23% and 25% of the population is projected to be more than 65 years old. Currently, seniors represent 13% of the population.

Afterwards, the aging will slow, but the proportion of seniors will continue to grow, and is projected to reach between 25% and 30% by 2056. As a result, over the next 30 years, the ratio of working-aged people to retirement-aged people is expected to halve.

The large shift in the ratio is what has policymakers fretting. Indeed, Sen. Jerahmiel Grafstein, chairman of the Senate standing committee on banking, trade and commerce, noted that some see demographic change as a “potential ticking time bomb” in Canada. The committee was to have delivered a report on the issue by the end of June 2005, but the report is now scheduled for release by the end of December (after Investment Executive’s deadline).

In the meantime, Britain’s Turner Report provides some guidance on the kind of solutions that may be required. Raising the retirement age is an obvious step in any reform that hopes to accommodate a significantly aging population. Life expectancy has increased substantially in the past few decades, but prevailing retirement ages haven’t kept pace, the report notes.

The simple fact is that in many countries, too many people retire far too early for current trends to remain sustainable over the long term. In Canada, the appeal of early retirement is even stronger than it may otherwise be because the Canada Pension Plan’s payouts are structured in a way that doesn’t appropriately reduce benefits for those who choose early retirement.

Hiking retirement ages is a logical step for any country contemplating how to deal with its own demographic challenges, but it can be politically dicey. Retirees can be a large and loud political force. Witness how quickly they helped force the government to climb down from plans to tax income trusts.

Although tinkering with the age limits for public pension eligibility is a straightforward way of dealing with the issue, it’s not the only way. The true goal is to keep more people working longer.

Extended working lives

Bank of Canada Governor David Dodge has suggested as much in his public remarks about the prospects for demographic change, indicating that people must extend their working lives. When he appeared before the Senate banking committee in October, Dodge noted that increased labour force participation among older Canadians would “help a lot” in dealing with the aging population problem. “It is important that there be no barriers to that participation,“ he stressed.

Existing barriers include disincentives to work that are in the pension rules, the age limit on RRSP contributions and barriers of omission, such as the lack of services to retrain older workers or otherwise help them find appropriate work after the typical retirement age. As Dodge noted in a speech earlier in 2005, future retirees will be better equipped to work longer than they have in the past. The reasons: older people are healthier now; jobs tend to be less physically demanding; technology allows more flexible work arrangements; and future retirees will be better educated than in past generations, enabling them to adapt to new work environments.

@page_break@There is plenty that can be done to make working longer more attractive to older people. Overall productivity improvements could also help ease the economic burden of an aging population. It will be interesting for Canadian policymakers to see how the British government deals with the recommendation to raise the retirement age — and how the public responds if it follows through.

In the past, the Canadian government has shown a willingness to take a politically tough decision for a long-term payoff — such as when it tackled the financial solvency of the government pension system by hiking CPP contribution rates several years ago. The reform shored up the CPP financially, which is one less thing to worry about, but it doesn’t alter the fundamental realities of demographic change.

The other obvious way to accommodate an aging population is to get more people to do more saving for retirement. This has proven a challenge throughout the world, as people often seem to underestimate vastly their post-retirement needs and chronically save too little.

Some countries have introduced compulsory retirement savings schemes, albeit with mixed results. The Turner Report proposes an intriguing system of automatic but voluntary retirement savings. It calls for “the creation of a low-cost, national-funded pension savings scheme into which individuals will be automatically enrolled, but with the right to opt out, with a modest level of compulsory matching employer contributions, and delivering the opportunity to save for a pension at a low annual management charge.”

It recommends that, as a minimum, total default level contributions should be around 8% of earnings, comprised of 5% in contributions from employees and 3% from matching employer contributions. Additional voluntary contributions would be allowed up to about twice the default amount.

The report also envisions that such accounts could be administered for less than 0.3% a year, with workers having the option of investing in very low-cost funds bought in bulk from the fund management industry. It recommends limiting the choices to between six and 10 mandates for the sake of efficiency and easy understanding.

Although the recommended national pension scheme is voluntary, there’s evidence that making enrolment automatic means participation rates will be very high — pushing people to save, without actually forcing them to do so. The idea of automatic enrolment has its intellectual roots in the notion of “libertarian paternalism,” advanced by economists such as University of Chicago professor Richard Thaler.

The default option

The theory is that people can be induced to do things that are good for them simply by making this the default option. In other words, if you want to encourage people to save more for retirement, you require employers to deduct some portion of employees’ pay and direct that to retirement savings accounts. Employees can opt out, but the academic literature suggests many will save much more than they would have if they were left to their own devices.

If its recommendations are adopted, the Turner Report estimates that public pensions would provide pensioners with about 30% of the median income in retirement, and that this new national scheme could provide a further 15%-35% (depending on the size of voluntary contributions), pushing most people well toward that oft-quoted ideal of having about 70% of their pre-retirement income available to finance a comfortable retirement.

The changes, however, could also have a significant impact on British industry, not least of all its financial services industry. In its comment on the recommendations, Deloitte & Touche LLP suggests that the fund management industry could benefit from an estimated additional £5 billion a year in added pension contributions, but there would probably be pressure on fees.

The big loser would probably be the insurance industry, as it administers many of the existing group pensions that may be curtailed in the presence of a new national scheme. It could see a significant drop in revenue and, ultimately, job cuts and consolidation, says Deloitte.

Employers could also take a significant hit from the introduction of mandatory contribution matching. Deloitte notes that although some of this could be recouped through lower salaries in the future, some industries may have a harder time doing so than others.

Therefore, it remains to be seen whether any of the ideas will become reality. There will surely be furious lobbying of the British government from various quarters, for and against, and any effort at ratcheting up the retirement age will undoubtedly prove controversial.

Nevertheless, such hard choices are required to face down the huge demographic problems. Canadian policymakers should take note, because their turn to face the issue is fast approaching. IE