Technological Changes, the Reversal of Age Pyramids and the Future of Retirement Systems

Figure 13: Life expectancy at birth and at 65 yeras of age by sex: United States, 1901-2001

Source: Center for Disease Control and Prevention, National Center for Health Statistics. Health, United States, 2004.

One possible way to mitigate the increased longevity problem is by deferring the retirement age (Giarini, 1980). When retirement ages were first determined by Bismarck’s government more than 130 years ago, less than 40% of the people survived to the age of 65, whereas today 80-85% of the males and more than 90% of the females in developed countries live beyond that age. People reaching the age of 65 today are often in good physical and mental shape, and are often willing to continue working. (It is noteworthy that the common retirement age of 60 for women, was determined in the 1940s, based on the notion that both spouses should retire more or less at the same time. In those days the wives at time of marriage were about five years younger than the husbands, on average.)
Some countries are acting towards the deferment of the retirement age, and some are already gradually moving toward a retirement age of 67. However, this trend conflicts with another major force of the post-industrial revolution: the declining demand for labour (Giarini and Liedtke 1997). As pointed out earlier, the present production capacity of developed countries is large, and it can be achieved with only part of the potential labour force. Moreover, the developed countries are facing competing imports from the countries that have recently joined the industrial revolution. In order to mitigate the effects of the resulting growth of unemployment, some European countries are reducing the monthly working hours of employees. There is an inevitable clash between the enormous forces driving toward a higher retirement age and the pressures of young populations that have to join the labour force.

4.2 Interest Rate Considerations in Retirement Planning

The rough retirement model that has been discussed above ignores the interest rate, changes in the purchasing power of money and changes in the general standard of living, and should be corrected to deal with these factors. This can be done in an accurate actuarial manner, but the following less accurate way gives a better general picture.
A retirement plan has the advantage that its financing can be spread over a relatively long period: the employment period and the retirement period. Over such a long period, the interest rates should not be ignored. Let us examine some simple interest rate calculations. Assume a person who saves $1 per year over 45 years. The amount saved by the end of the period depends on the interest rate (the first dollar gained interest for 45 years, the second for 44 years, etc.). If the money is saved at 0% interest, the person will accumulate $45. At 2% interest the amount saved by the end of the period will be $72. In other words the total is the principal and an additional 60% financed by the accumulated interest. At 4% per annum the amount jumps to $121, meaning that for each dollar saved, the (compounded) interest contributes approximately another $2 ! At 6% the interest effect is even more impressive: each dollar saved brings in close to $4 in interest. At such high interest the total amount of the savings at the end of the period is about $212.
This simple illustration shows that the interest rate should not be ignored in long-range planning. The person has to make a decision: “who should work for my retirement — myself or the interest rate?”. And the answer is obvious. Being able to finance retirement throughout 45 years, at an interest rate of 6%, means that the financial burden that we discussed earlier could be five times smaller!
There are a number of caveats to the above discussion:
a) Compounding has a strong effect when the saving period is long. The person must start the retirement planning at a young age, in order to leave enough time for compounding to have a significant effect. It can be seen in the table that a shorter saving period drastically cuts the part of the interest in the saved fund. Unfortunately, most young people joining the labour force do not think about their retirement, and by the time they start thinking about it, they have to do most of the saving by themselves without too much support from the interest rate.
b) Significant effects are reached only with high interest rates. Factors like inflation or a continuous increase in the standard of living operate in the opposite direction to the incoming interest rate. Deducting such factors from the interest rate and accumulating the savings at the lower real (net) effective interest rate results in lower real savings at the end of the period.

Table 2: The effect of interest rate on accumulation of savings at retirement (Future Value of an Annuity)
From the individual’s point of view, the interest rate is an exogenous parameter. However, there is a very strong connection between retirement savings and the market interest rates. The above discussion demonstrates that people are expected to save a substantial part of their income just to finance their retirement. These savings are a major component of the aggregated national savings, which in turn affect the economy’s growth and the market interest rate (Feldstein 1974).
It is hard to predict future interest rates in the world markets without a reliable complex econometric model. One thing, though, seems to be quite certain: most post-industrial countries are going to suffer from a decline of the working-age population, and therefore, with a concomitant decline in the growth potential in these countries. The developing countries, on the other hand, will have substantial population and industrial growth, but they will probably soon be facing limits to their growth due to market limitations. This may indicate that the real interest rates will not exceed, say, 3% in the long run, and that the risk factor resulting from interest rate uncertainties is significant.
Low interest rates mean that on the average, the retirement of most people will be mainly financed by the direct contribution (by the employers, employees and the government), and only a relatively small part will be financed by the interest accumulation. And the result will be that the burden of financing the retirement system will remain quite heavy.

4.3 Health and Age-Related Processes

On the average, some of the life-time health-related costs are concentrated around the very young ages, but most are concentrated around the last years. Thus, due to the increased life expectancy in the post-industrial countries and the fact that older people often suffer from all kinds of medical problems, health costs are becoming associated more and more with the retirement problems.
WHO statistics show a positive correlation between the developmental level of the economy and the percentage of GDP spent on health-related costs. Typically, health-related expenditures reach 6-13% of GDP in post-industrial nations, compared to 2-9% in the less developed countries. In terms of per capita figures the gap is very noticeable: an average annual per capita expenditure of $20-200 in the less developed countries, compared to $1,800-4,000 in post-industrial nations (the dollar values were calculated by WHO by conversion of the local currencies at international dollar rates rather than the actual average exchange rates).
The World Bank and the WHO have suggested a new index to measure the global burden of disease. Named DALY (Disability Adjusted Life Years), it combines weighted information about morbidity and mortality, and is expressed in term of the numbers of healthy years lost. Each state of health is assigned a disability weighting on a scale from zero (perfect health) to one (death) by an expert panel. To calculate the burden of a certain disease, the disability weighting is multiplied by the number of years lived in that health state and is added to the number of years lost due to that disease. Years of life in childhood and old age are assigned lower values in the weighting process. DALY is a discounted figure, to better reflect future burden (an annual interest rate of 3% interest is assumed). It is not a perfect indicator (see Arnesen and Nord, 1999) and has a substantial degree of subjective judgment and uncertainty, but it is a fairly useful instrument for describing a complex problem by a single measure. A complementary measure is the Quality Adjusted Life Years (QALY), which measures the years lived in good health and is used to calculate Healthy Life Expectancy (HALE). Published by the WHO for the entire population at birth, the HALE figures run in the range of 35-45 years for the least developed countries, around 50-60 for more developed countries and around 65-75 for most of the post-industrial nations. The difference between the life expectancy and HALE measures the average equivalent number of years lost due to bad health and disability.
The expectation of lost healthy years at birth does not show a clear-cut border line between the least developed and most developed countries. In some of the least developed countries with the poorest health conditions, the number of years lost due to poor health can be fairly low — even 3-4 years, simply because life expectancy itself is very low (35-40 years). In others it can be as high as 8-11 years, compared to a life expectancy of around 60-65 years. In the developed countries the variation of this figure is somewhat lower, and the expectation of lost healthy years at birth runs around 6-9 years. A better measure might be the ratio between the expected lost years and the life expectancy at birth. For the developed counties this figure typically runs around 10%, compared to 15-18% for the least developed countries.
The main problem in the post-industrial world is that a substantial part of the years lost due to poor health occurs during the retirement period. So a better analysis would be through the ratio of lost years to life expectancy at retirement (although some lost years relate to the pre-retirement period). Calculation of these ratios with WHO data, for the life expectancy of 60 year-old males, shows that in the least developed countries these ratios are very high (67-100%), whereas in the post-industrial countries they are in the 35-45% range. These ratios show that the health issue is becoming a major part of the retirement issue.
Medical procedures become more sophisticated and very costly. Part of the increased costs is related to the young ages. There are many conflicting factors, some tending to increase the health costs for the young population while others decrease the costs. A variety of factors increase the costs. For example, in post-industrial countries highly paid women may prefer not to have repeated pregnancies, and the use of surrogates for having children may increase. Technological developments may even enable families to have children outside of the human womb. On the other hand, genetic testing is becoming much more precise, and therefore fewer families will have children suffering from physical and mental disabilities. (On the other hand, however, the ability to save the very young fetus increases the prevalence of other birth defects.) Future developments may enable us to rectify many birth defects. Abortions will be rarer as contraception becomes automatic and foolproof. At the same time, however, some parents will elect for abortion if their fetus does not meet their wishes (in terms of gender, or other societal standards).
For the older part of the population most factors operate in one direction: towards a continuous increase in medical and health costs. Among these are a variety of surgical procedures meant to replace or fix problems of ageing or failing organs (transplants, angioplasty), special aids (like hearing aids, dentals, vision support, special instruments), new and expensive drugs, etc.
With costs escalating, health care is becoming the number one retirement related problem in post-industrial economies. As with all other risks, the most effective treatment seems to be prevention, which can be accomplished in a variety of ways, including dieting, exercising, better balancing between body and spirit, pre-emptive medicine etc. Apparently, some of the sicknesses of old age stem from our behavior at the young ages, if not ‘childhood diseases’, and could probably be treated at that time.

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