EUROPEAN PAPERS ON THE NEW WELFARE

Pensions, Social Security and Private Insurance Solutions: Opportunities Squandered

1. Introduction

Modern societies are trying to develop concepts that allow them to protect their citizens and at the same time stay competitive in the globalized markets. The approach of the new welfare state is no longer to arrange for full coverage of (ideally) all risks but to replace the existing extraordinarily expensive systems with more targeted and efficient approaches. They achieve this through requiring people to assume more risks individually and to organise adequate protection themselves. This is the so-called ‘risk shift from public to private’, a concept we have been developing for a number of years at The Geneva Association1.
Unfortunately, usually as a consequence of half-hearted or partial reforms, this has often led to an erosion of the protective systems rather than their real modernization. Genuine protection mechanisms, like insurance, provide cover for those risks that somebody cannot (or does not want to) bear. Today’s social security systems do anything but that, often protecting people against risks that they need no (or different) protection for, while excluding others2.It is then up to each person to compensate for the inefficiencies and short-comings of the existing state systems and to find individual solutions that adequately cover their risks. The need to augment the ordinary provisions, as commonly set up by the social security systems, is particularly substantial in the area of old-age pensions. It is here where private insurance solutions can and have to play a significant role.
Few things in life are as costly as a bad pension arrangement. Nevertheless, few people fully realize this. There are scores of papers that analyse this phenomenon and try to explain why people behave in a non-economical and myopic way3.
• Insurance can play a key role in providing solutions for old-age income but the key question to our industry is: does it so efficiently, fulfilling customer needs?
• The risk shift ‘public to private’ opens opportunities, but does insurance want to take the risks and can it take the risks?
• The future economic environment needs good pension solutions, but does society provide the best rules for the private industries to operate?
It is important to remember that pension provision is chiefly future business with the current and next generations. Hence long-term economic and legal aspects play a key role.
There are risk transfer mechanisms between individuals on the one side and insurance companies, the capital markets or government and society on the other. While insurance contracts and pension funds provide direct legal relations between the original risk owner, that is individuals, and/or the companies, there are also a set of informal relationships that dominate the social security world. Ultimately, the role of government in our modern society is key in defining the risk transfer mechanisms and in also ensuring that they operate efficiently over time providing enough accessible and sustainable solutions for people to cope with the individual risks that they are facing. This is at the very heart of the modern welfare state.
As we all know, we are living in a time of unprecedented increases in life expectancy. The population explosion of the elderly above the age of 60 years is something that is projected into the future — and this is not only true for Europe where the current focus of most research lies. It is especially true for countries in Asia. If we were to draw a conclusion from an analysis from past and future population developments, then we can only conclude that Asia will be in the year 2040 where Europe is in the year 2005 (see attached slide — Asia versus Europe: Population Development). However, a key difference between Asia in 2040 and Europe in 2005 is that the next 3 decades in Asia will see a much accelerated phenomenon as the old population will increase much faster than it did in Europe and the younger population will shrink much faster than it has done in Europe. Consequently, we are dealing with a global problem, that affects different parts of the world in different decades, but it will be a persistent challenge of the 21st century.

2. Certainty Versus Uncertainty of Projections and Future Developments

Before developing the theme of this paper further, I want to briefly highlight what is certain against what is uncertain about our future in this domain:
1. It is certain that the population development effects are unavoidable. Few projections into the future are as reliable as population developments.
2. It is also certain that fertility levels and changes in fertility only impact these developments and their effects in the very long run. Influencing fertility will not solve immediate problems.
3. The first big uncertainty, future mortality: There are currently two schools of thought on mortality trends.
a) Positive: Past demographic projections have underestimated mortality improvements — this leads some specialists to predict that life expectancies will go on increasing at a sustained rate.
b) Negative: Some factors point in the opposite direction: decreasing returns on medical progress, new pathologies, quicker/more widespread transmission of viruses, delayed impact of decreasing selection at birth, increasing obesity and health risk factors associated with it, etc. These either decrease gains in life expectancy or even lead to the opposite, that is, a shortening of life expectancy in the future. We do not know at present which of those two scenarios is the more likely one4.
4. The impact of technological breakthroughs in medicine and related fields on mortality and morbidity is notoriously difficult to predict. It is uncertain what the effects will be on population development but not only on population development but also on the possible activity level that can be expected of the population from the age cohorts above the age of 60 years.
Summarizing this, we can deduce that while there is no apparent inflexion for Western developed countries, things generally remain open. This is especially true in the emerging countries where the longer time-lines add more room for special developments.

Patrick M. Liedtke:The author is Secretary General and Managing Director of The Geneva Association (www.genevaassociation.org), leading international insurance research centre.
1 See especially issue no. 281 of the Etudes et Dossiers Working Papers “The Risk Shift from Public to Private: Which Role for Insurance and Financial Groups?” published by The Geneva Association in March 2004.
2 An obvious example is the ubiquitous state employment ‘insurance’, a particularly strange protection arrangement where the groups with the highest risks usually pay the lowest premia, where moral hazard and asymmetric information are almost expressly built into it, and where the enormous redistributional effects seem to be the prime reason for its existence. Many of the key elements of this scheme have little to do with proper risk analysis of the insured risks and the efficient risk management of the portfolios.
3 Among others see: Hu, S. (1996) “Myopia and Social Security Financing” Public Finance Quarterly, Vol. 24 pp. 319-48. Feldstein, M. (1987) “The Optimal Level of Social Security Benefits” The Quarterly Journal of Economics, Vol. 100 pp. 303-320.
4 A recent session at The Geneva Association’s Chief Risk Officer Assembly, which was hosted by Munich Re in November 2006, lead to inconclusive results with the experts present at the meeting. The ‘middle position’ in the analysis expected longevity to improve in the future but at a somewhat slower pace than in recent decades. Much improved trends were seen as less likely as was a collapse of the positive future increase of life expectancies (regional special situations excluded). Conference papers have been assembled by The Geneva Association and will be made available in early 2007.


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