This is the year of the 70th birthday. According to David Willets, executive chairman of think tank the Resolution Foundation, this year will see more people reach 70 years of age in Britain than ever before in our history.
As Willetts points out, that’s cause for celebration. But it’s also a reason to be concerned. The year of the 70th birthday is an indicator of a demographic transformation underway in Britain as the baby boomer generation heads into retirement. But that is only part of a wider story of major demographic changes across the world. According to Willetts, in a documentary on the effects of demographic change for BBC Radio Four, population bulges around the globe are a mixed blessing.
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“Each stage of this process can be a fanstastic opportunity to change a country for the better. But it can also bring real strains for any society,” says Willetts
This provocative thought not only brings with it big questions about how we will look after the expanding population of older people but also how it will effect pension funds, the area of most concern for those working in the Local Government Pensions Scheme.
And there are real demographic challenges coming down the line. Hans Rosling, the late Swedish physician and statistician, has pointed out that the world population is expected to grow from its current seven billion to around 11 billion in the next 50 years.
But that comes along with news that birth rates have plateaued. Indeed, the United Nations estimates that the world reached “peak children” — around 1.9 billion — in 2011. So, much of the underlying reason for population expansion stems from people living longer into retirement while at the same time there are proportionally fewer people of working age to pay for their care.
The UK’s issue is that the baby boomers — those born as part of the spike in births after the second world war — are now retiring, while the number of new births is at just about replacement rate: two per woman.
Elsewhere in the world populations are at different stages, some that cause concern for the future — especially in emerging markets.
In under developed economies birth rates tend to be high. As they develop these economies capitalise on an expanded workforce to drive growth and provide support for elderly populations. But as markets mature birth rates fall — sometimes dramatically — and the ratio of working age people to retired citizens changes, putting pressure on services.
Nigeria and China are two cases in point. Nigeria has been through high fertility rates and currently has youth unemployment at around 40%, while at the same time becoming the biggest economy in Africa. Its population however, is expected to double by 2050, illustrating Africa’s fertility issues. Hans Rosling believed the birth rate will fall as society and the economy develops. “If they get people out of extreme poverty, they get child survival working, child labour not needed, rights for women, contraceptives available, they’ll get two child families.”
China is at different stage with its population and, as the engine of global growth, raises worrying strategic issues. The worry, as David Willetts points out for the BBC, is that it “grows old before it grows rich”.
Currently around 10% of China’s population is aged 65 plus. But that is expected to rise to 30% by 2050. Helped along by the country’s one-child policy, observers worry that a demographic burden is coming that has far reaching consequences: as China’s median age rises the country will find itself with a declining number of workers supporting a growing number of old people.
Liabilities
But should a shift in global demographics cause concerns in LGPS?
According to Graeme Muir, head of public sector at actuaries Barnett Waddingham, LGPS pensions are in some way shielded from rising liabilities as people live longer because they are “funded” schemes. Muir suggests unfunded schemes, face a much bigger problem.
But Muir also points out that LGPS has done well in managing the effects of people living longer on pension liabilities. Recent improvements in the assumptions made about longevity means funds are already adjusted to account for bigger liabilities.
There is another positive sign, according to Muir, because there appears to be changes underway in mortality. In March a report from the Continuous Mortality Investigations said: “Recent population data has highlighted that, since 2011, the rate at which mortality is improving has been slower than in previous years.”
According to Muir, actuaries have been making prudent assumptions so LGPS funds have been saving more than they need. A slow down in mortality improvement could offer an extra level of security when it comes to liabilities.
That’s good news for those managing pension liabilities and raises a question about whether there are limits on longevity. That said, CMI is at pains to stress “mortality is expected to continue to improve and there is significant uncertainty as to whether this will be at a slower rate compared with the higher rate improvements seen in the first decade of this century.” Pension liabilities are not out of the woods yet.
Open and shut
While being “funded” will provide some strategic protection, according to Andy Todd, head of UK pensions and banks at investment advisers State Street, LGPS has another great advantage.
He says the “demographic challenge” is most keenly felt in defined benefit schemes closed to new members. The LGPS functions differently: its funds are open to new members and as long they keep recruiting members, they are relatively secure.
“Having that open ended approach is hugely beneficial to managing any demographic peaks and troughs over time,” says Todd.
However, Todd also notes that it is difficult to generalise about LGPS and the effect of demographics because of its complexity. “It’s not possible to draw a broad-brush conclusion across LGPS,” he says, and adds: “Some schemes are immature where the bulk of membership is still working or deferred. Others may be highly mature where there may be few working or deferred members.” Liability profiles can therefore differ significantly.
According to William Bourne, director of Linchpin pension advisers: “There is a problem but panic is always the wrong reaction.” He says the important step in addressing demographic challenges is to begin the planning process. Bourne says demographic pressures and a fall in the number of local government employees, means some funds are already thinking about the prospect of becoming “cash negative”.
This has resulted in some funds asking how much income they will need from their assets in the future. “That’s kind of the approach people are taking: how much do we need, where are we going to take it from, should we divide the portfolio into an income portion and growth portion,” says Bourne.
One reaction to the demographic pressures will be for funds to consider moving more money into income generating assets. Funds could start by considering fixed income and income generating equities. Recent research from State Street revealed that LGPS increased its asset allocation to fixed income by 31% from 2013 to 2016, and the allocation to alternative assets by 61%. The downside with equity is that dividends might generate income but, warns Bourne, it’s possible to take a capital loss at the same time.
But Bourne also adds that the big question will be figuring out where alternative assets —private equity, credit and infrastructure — fit in to the allocation equation.
Elsewhere, Andy Todd sees part of the answer to allocation question coming from the LGPS pooling project currently underway and due for completion in 2018.
This will enable small funds to join with others to access investments, like infrastructure, that would otherwise require much larger pots of money. This also reduces the cost of the investment. “This will give investment committees additional levers to pull,” says Todd.
Timebomb
There are those though that see the greatest challenge for pensions funds and LGPS coming not from home but from global demographic changes, such as those in China. According to Mike Jensen, co-chief investment officer with Local Pensions Partnership, the demographic “timebomb” is a global problem that could scupper any hope of getting back to economic growth in emerging countries, the very markets that have provided the engine for world-wide growth.
“I still feel that from a pension fund perspective,” Jensen told a recent Room151 LGPS investment roundtable, “the overriding risk, which trumps everything else is global demographics.
“Maybe we’ve got a handle on the UK, but global demographics, especially emerging markets, I think, will change the whole footprint of global trade and the whole footprint of global returns.”
According to Andy Todd, emerging markets are only one asset class “out of an increasing number” open to pension funds and that it remains hard to foresee how demographic changes in those territories will impact the developed world.
“As emerging markets mature they may be seen as more mainstream while some frontier markets are also likely to mature and stabilise, and be reclassified as ‘emerging’. Any consequential impact this will then have on pension funds is therefore even harder to predict,” he says.
William Bourne agrees demographics trends in emerging markets, especially China, will undoubtedly cause a problem in the future. But he also adds that it is “probably too early to see it as a major concern”. According to Bourne, there is still plenty of growth left in emerging markets. Plus an ageing population brings its own investment upside.
“On the asset side while there may be less wealth generated by an older demographic, there will eventually be fewer people to spread it over.
“And at the corporate level, which is where the money to pay pensions is ultimately generated, there will be plenty of opportunities for companies serving older populations.”
