The Factors That Influence Pension Funds Economics Essay
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Published: Mon, 5 Dec 2016
Pension plans not only serve to supplement Social Security earnings but also to provide retirees with a higher degree of financial security. Corporate pension funds provide an important service to both individual employees and the general public as a whole. A broad history of the corporate pension fund and its origins is shortly presented.
Gross (2000) in his examination of public employee pension funds notes that these funds were developed in response to a growing concern about family economic well being in the early twentieth century, which specifically became an integral part of labor movements by 1915. Although it was not until after the development of the New Deal that public employee pension funds became an integral part of improving conditions for workers, Gross demonstrates that this issue had long been a part of labor reform in the United States.
By the 1930’s retirement programs were scheduled for teachers, and after 1939 pensions were set up for other civil servants. This suggests that the basis for the development of corporate pension funds were the government initiatives for the improvement of financial outcomes for employees. As the adoption of pension plans by public means started to grow rapidly, private organizations joined effort to provide employees with the same benefits as those working in the public.
Presenting an opposing view, Wiatrowski (1990) reports that in 1916, a number of small pension funds which had been organized by local governments, already existed. Some private employers also had pension programs in place; however, Wiatrowski asserts that pension funds were typically found in high risk occupations such as utilities and transportation.
It is generally argued that the economic changes caused by the Great Depression served for further development of pension funds. After this event, a great focus was given on the improvement of the economic and social conditions for workers. By the end of World War II, corporate America was financially strong and able to assume some of the financial responsibility for improving the status of labor. Therefore a growing number of pension programs were developed by the government and the private organizations followed the same pattern.
As the benefits offered to private employees began to expand, they became an integral part of employment packages for new hires. In order to ensure that the tradition of pension funds and employee benefits continued over the long term, the government passed the Employee Retirement Income Security Act of 1974 (ERISA). Since the 1970s, the federal government has amended ERISA and enacted a host of new laws in an effort to protect the benefits received by employees. Thus, while many private organizations followed the lead of public institutions in developing pension funds for employees, it has been the federal government that has worked to ensure that employees are able to retain and expand their benefits. The adaptation process that took place in the 1980’s in the USA and UK started during the 1990’s in the rest of Europe, in an effort to restore the compatibility of social policies with the changing economic and demographic contexts, which in most cases is pursued by retrenching existing social programs (Gross,2000).
Total assets of the world’s 300 largest pension funds appeared to bounce back modestly in 2002 after their heavy falls of the previous year. Assets of the 300 at the end of 2002 totaled $5.5 trillion compared with $5.4 trillion in 2001, according to the annual survey by Watson Wyatt and leading US industry publication Pensions & Investments. Their peak was $6.2 trillion at the end of 2000, before global markets went into a tailspin (Finstad, 2005).
Nevertheless, US pension assets did not drop as dramatically as might have been expected, given the relatively high equity component of the US funds compared with most of their non-US peers. This may be the result of sharply increased contributions by many large US pension funds. As the majority of US pension funds have tended to stick to their equity beliefs over the past few years, any change in asset allocation may simply be because they have avoided completely rebalancing their funds to their strategic benchmarks. In January 2008, The Economist reported that Morgan Stanley estimates that pension funds worldwide hold over US$20 trillion in assets, the largest for any category of investor ahead of mutual funds, insurance companies, currency reserves, sovereign wealth funds, hedge funds, or private equity.
The factors that influence pension funds can generally be dived in two main categories: economic factors and socio-demographic factors.
The demographic structure of population affects the economic development of pension funds as a catalyst bearing in mind that insurance benefits depend on the age structure of population. The dependency ratio (i.e. the ratio of pensioners to the working population), through which we study the demographic structure
a population in most countries of the European Union has reached historically high levels. The deterioration in the dependency ratio is the result of financial, political and cultural factors that act on key demographic basic variables, but on the other hand causes the fall in birth rates and rising of life expectancy. The expected number of fewer births and the expectation of longer life leads to an increase of the dependency ratio so far in the EU, resulting requiring five active workers for every pensioner by 2040 (OECD, 2004).
To address the financial problems caused by the socio-demographic factors the adoption of economic measures is required. These include the reduction of benefits, the tightening if the conditions of pension entitlement, mainly due to old age and disability, the increase of social security contributions which will have negative effects on worker’s incomes and the competitiveness of the economy (McGill, 1975; Hickman and Montgomery, 1975).
The economic factors influencing the pension funds are as important as the socio-demographic factors. Inflation and performance reserve influence the technical interest rate for calculating the present value of revenues and expenses of pension funds. In times of inflationary boom the economic balance of fund systems is disrupted mainly due to the reduction of the reserves at constant prices, so their function is gradually based upon pay as you go systems (Arnold, 1971).
Apart from these two categories, another four categories of factors have a correlation with pension management performance. These factors which can be modified and applied to both the public sector and private firms are organizational factors, process factors, style factors and dummy variable(Finstad, 2005).
Organizational factors include the percentage of a firm owned by employees, firm age, firm size (assets under management), product age, product size, staff size, experience and personnel turnover, process factors include the percentage of a manager’s investment process described by the manager as being “top-down” as opposed to “bottom-up”, the number of company visits undertaken during a year, portfolio size (the number of stocks in a manager’s portfolio) and portfolio turnover; style factors include the value-growth approaches and the percentage of the manager’s portfolio invested in large-cap stocks and dummy variables were designed to isolate extraneous factors (Finstad, 2005).
One can conclude that entrepreneurial firms which are characterized as employee-owned, newer, and smaller, as opposed to “institutional” firms – tend to display the characteristics which have a demonstrated correlation to the generation of outperformance by a manager over time.
Lastly a short analysis will be presented for the major factors that influence pension funds (Lee, 1979; Arnold, 1971; Insley, 2010).
Income is positively related to savings. Higher income implies higher savings. Therefore, higher income might result to higher wage reservations for retirement purposes or higher saving which will be invested for a retirement program.
Demographics also influence saving behavior. Saving is higher due to the working age period, while during retirement prior savings are consumed. To the extent that most pension funds have not reached a payout phase, one could expect a high stock of accumulated retirement savings in aging societies, implying a positive relationship.
Alternative retirement sources imply that there is no need for pension savings. The expected income from the public pension determines the need or not for a private pension program (Feldstein, 1980).
The reform of the pension systems across the world generally determines private pension funds. The negative effect of this reform to the citizens has turned them to the adoption of private pension programs.
The growing number of populations around the world which are ageing rapidly, both in the advanced economies but also in the emerging and developing economies is one major factor that will influence the future of pension funds. This phenomenon will have significant impacts on societal, economic and political structures. As far as societal structures are concerned, the ageing population implies a larger proportion of it will be less economically active and more dependent on others, economic structures are affected since naturally smaller proportional labour forces exist, while politically, the power balance will shift towards older citizens and this change may result to the appearance of intergenerational conflicts (WEF, 2008).
Nowadays the world faces the challenge of financial sustainability and the achievement of minimum standards of adequacy and quality. While demographic trends themselves are predictable, in the case where no major pandemics or global conflicts occur, economic factors are highly uncertain. As mentioned above economic factors can influence the ability of governments, corporations and individuals to finance both lifestyle and pension needs. Attitudes by both governments and individuals towards social welfare, retirement and well-being will drive critical social and political outcomes that could dramatically alter the future of pension services. Based on these facts one could argue it is very challenging to predict the future of pension funds. However an effort will be made bearing in mind the trends of the pension funds influencing factors.
In 2007 Europe had the highest old-age dependency ratio (24%) while it is expected to be the oldest region in 2050 according to the UN. However, the same dramatic increases in the dependency ratio are expected to occur to all counties. This will result to the increase of the elder population as well as the decline of the working-age populations in the high-income countries (WEF, 2008). According to the World Bank (2007) it is expected that in high-income countries the labor force will begin to shrink from here on.
Bearing in mind the global economic recession, one can safely presume that the economic turmoil will be prolonged and will therefore force rapid and radical reforms which will result to painful changes (Walker and Lefort, 2002; Roldos, 2004). Every individual will stand alone in this situation, but ultimately the changes may prove constructive. The prolonged recession and stagflation we are globally going through has already hit public finances and it is not believed that the situation will change in the near future. Growth will thus be held down due to the financial crisis and the natural resource constraints. Furthermore, in order to confront this rising problem, governments are obliged to act aggressively and therefore move towards the reduction of public spending and adopt a “social security provider of the last resort” approach. At the same time, people are being resentful towards liberalizing reforms and young people who are influenced from the negative environment adopt an aggressive mindset and take strong individual responsibility for finance, since the government only focuses on the most needy citizens. These social circumstances have resulted to the replacement of the retirement concept with the “lifestyle planning” paradigm, according to which people remain active even after the retirement age, or plan ahead for the retirement they might want to receive by joining a private company pension plan. These attitudes of the public will exist during the preceding years, as long as the results of the recession continue.
Positive results however may emerge from this prolonged depression. Although the transition from social welfare to individual responsibility is difficult and generally resented, the focus on educating people for financial planning may result to young people taking responsibility over their finances. This turn to lifestyle activity management and planning will probably cause in the next years a shift from wage-linked pensions to minimum payments which will be supplemented by private capitalized pensions. The retirement age will probably be raised even more before being replaced by the lifestyle planning model. Further changes will be introduced to the whole socio-political system, as organizations will be forced to accept both younger and older workers and governments might need to enforce plans for co-operation between the public sector and private fund management firms. The increased taxation and increasing rate of inflation will lead the public pensions to reduction and therefore citizens will be forced to plan ahead for their retirement and join a private pension plan.
Nowadays and even more in the preceding years household savings for retirement in pension funds will be growing rapidly. Accumulating pension fund savings depends on various factors. Some of these factors include the introduction of pension reform and fund performance. Furthermore, Pension savings are determined by a variety of macroeconomic and structural factors such as income growth and the unemployment rate.
Pension savings could be encouraged by a series of policy implications which will be determined according to the aforementioned factors. These implications may include the facilitation of support to old-aged incomes through mandatory forms of saving, the reduction of costs through the harnessing of economies of scale and the reduction of burdens and the promotion of education concerning savings and financial planning.
In general, the future of pension funds until 2016 could be described as uncertain. The financial crisis and global recession has caused a general climate of turmoil and has thus affected people’s predisposition towards saving. Citizens will now be educated for their alternatives, and their contribution for private pension funds in comparison with public funds will be increased. Lastly, the world will move towards a model of self-organization and lifestyle planning, since the negative effects of the recession have led to the decrease of people’s trust to public institutions.
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