When taking into account the increasing role of fully pre-funded schemes in old-age protection – and the associated requirement to soundly invest these growing funds – the immediate negative impact of the current global financial crisis on social security is obvious: according to the OECD, developed country stock markets have lost 43 per cent of their value in a year.

In the United States alone, assets in retirement plans dropped in value by about USD 4 trillion, half of which were in defined benefit plans. The knock-on effect of the financial crisis is now translating into economic recession, which will affect social security programmes more generally, not least through reduced earnings (thus lower income from contributions and also from tax revenues) and higher levels of unemployment (thus higher expenditure for unemployment benefits).

Unsurprisingly, questions are being asked. What will be the wider ramifications for social security provision? Should pension funds continue to rely so heavily on financial markets? What are the longer-term implications for the financial sustainability of social security programmes?

There is a common concern that social security programmes will be affected negatively by the global financial crisis. Among a small sample of national social security bodies that rely on reserve funds to help finance pay-as-you-go pension schemes (Figure 1), the majority experienced some loss in returns in 2008, ranging from 7.7 to 17.3 per cent.

 

 

Figure 1: Year-to-date nominal returns in selected reserve funds

 

These figures are largely consistent with OECD data for pension funds in industrialized countries, showing a real rate of return of between minus 2.5 to 33.4 per cent. (Figure 2).

 

Figure 2: Year-to-date nominal returns in selected OECD pension funds

 

 

Losses in the value of funds held by defined contribution pension schemes will have a direct impact on pension benefits, especially so for individuals close to retirement. The scale of the impact will also depend on the nature of the pension income that individuals expect to receive: whether the major source of income comes from (often private) pension funds or a public social security old-age pension. In the former case, questions may be asked about the wisdom of making old-age protection mainly dependent on financial market performance.

For the majority of countries globally that rely on public defined benefit pension schemes (Figure 3), the impact of the crisis will be different. In contrast to countries with defined contribution plans, the effects on defined benefit pension schemes will be indirect. Nonetheless, this will require a new assessment of the financial sustainability of these schemes. In the short term, other social security programmes will have to meet the immediate challenges of, and face the growing social needs created by, the economic downturn. Unemployment benefit programmes will be in the front line: according to a preliminary estimate from the International Labour Office (ILO), global unemployment could increase by 20 million by late 2009. Health care and family benefits programmes will also have to take measures to help mitigate the negative effects of the crisis.

 

Figure 3: Types of mandatory systems for retirement income in 172 countries

 

In view of these considerations, the International Social Security Association (ISSA) plans to organize a joint meeting with the ILO in 2009 in order to assess the likely impacts of the financial crisis on social security programmes and especially on ISSA member organizations. To this end, a worldwide survey has already been launched.

While we wait for the findings of this survey, and despite a pressing need for further study and analysis of the effects of the financial crisis on social security provision, a few issues are already clear. In countries that rely mainly on pension funds, the financial crisis will have a direct negative impact for many individuals close to retirement. However, for a majority of countries, there is no reason to panic, especially in cases where funds have been duly managed following “prudent person” rules as outlined in the ISSA Guidelines for the investment of social security funds . The financial crisis is now spilling over into the real economy, and this will impact negatively on employment levels. As such, additional efforts to protect unemployed people and promote employment will be required. In many countries, support has already been granted to the financial sector. In coordination with this, what is now required is for appropriate support to be similarly provided to the social sector.

 

Related:

ISSA Guidelines for the investment of social security funds >>
(Technical Report 13)