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September/October 2014

The Global Quest for Retirement Income Adequacy


Retirement income adequacy

 

As the 21st century recovers from the Great Recession and both emerging and mature economies find more solid footing, a central challenge shadows the global workforce as people live longer and healthier lives: retirement income adequacy. While the nations of the world face a variety of fiscal factors, some basic realities underscore the urgency of this issue.

For example, a 2008 World Economic Forum report predicted that by 2050, the dependency ratio — the ratio of elderly people to the working-age population — could be as high as 50% globally, with the developed world most affected by aging population issues. Indeed, all the G-8 nations are laboring under sub-replacement birth rates. Meanwhile, gender differences further complicate things, since women tend to have intermittent work patterns, with more part-time work, and they have longer life spans than men yet are generally paid less. Thus, the female half of the world’s population potentially faces a heightened threat of retirement income inadequacy, and research is under way at Mercer to understand the impact of this further.

Far too many workers have not saved enough to ensure a financially secure post-working life. And in the key geographies of the world, the issue is being faced in different ways. In Europe, for example, flexible pension options are increasingly being built into plan design, allowing for an extra pension buildup to the age of 75.

Better forecasting and planning tools are becoming available to employees, along with discounts on employee benefits such as medical and critical illness coverage (due to better “bulk item” negotiations); discounted health checkups and gym memberships (partially employer sponsored to improve retention); and other available benefits, such as preventive flu shots.

More focused reward strategies are being developed to retain and motivate older workers, including bonuses aligned to capabilities (age neutral); flexible benefit programs to accommodate the different needs dictated by generational and specific circumstances; and “back to basics” reward design discussions, aligning programs to the long-term service preferences of the business.

In Asia Pacific and the Far East, the picture is much more differentiated by cultural norms. The conventional wisdom of these societies holds that the older generations have truly earned their way up the ladder. Thus, the East’s seniority-based “push” systems can create congestion in the workforce, with promotion linked to tenure. Managing workers out of the workforce can be done, but the methods are sometimes extreme, and the lifelong-job culture can become unproductive. There is a lump-sum retirement funds culture, so longevity is not financially secure. Yet much of Asia never retires because workers there simply cannot afford to, and in some countries, family members look after each other following the Confucian ethic. Malaysia, for example, has an extremely high ratio of elderly dependence. And in Australia, many workers already phase in their retirement by working part time or in their own business.

In the Americas, where workers have been increasingly weaned from the guaranteed pension income of defined benefit plans (via defined contribution investment savings plans, such as 401(k)s, that combine employee savings with employer contributions), the picture is decidedly mixed. Many workers have had to put off

their retirement for five or more years due to the recession-induced depletions of their 401(k) investment portfolios, and the outlook for many is somber. Indeed, from 1999 to 2010, the number of 65- to 69-year-olds still working increased 50%.

A QUESTION OF TENURE

A key factor in assessing the pros and cons of an aging workforce is the question of tenure, which can be looked at from a number of perspectives. One company, “A,” may believe that short service and high turnover provide a competitive advantage, and thus the company relies heavily on a contingent workforce to fit short-term needs and can readily source skills to deliver business goals. Another company, “B,” may believe that long service and low turnover create a competitive advantage. It therefore relies heavily on experience and specialist skills or relationships, making it difficult to replace those skills and causing strong competition for top talent. Company B may benefit more from the aging population trend, provided it retains its older talent. Company A may not profit, as the workforce shrinks and ages.

So, then, is it possible to quantify the value of tenure? It is a fairly complicated measurement, requiring an assessment of such factors as economic cost, the leakage of talent, lower/higher productivity, career-path sticking points, and the frequency of innovation. Companies need data to assess all this, including workforce analytics and segmentation considerations; population demographics based on job families, geographies, and lines of business; as well as succession plans and talent pipelines. HR leaders must then factor in the likelihood of retirement in the employee population, its retirement income adequacy, health considerations, and employees’ stated preferences. Depending on which part of the business cycle the company is facing (growth or recession, status quo, increased competition, etc.), HR must have the resources and be prepared to deal with this complexity of issues.

From the standpoint of rewards, the looming questions are how to make employees more accountable for their own financial security in retirement, and what education tools and support need to be made available to help them make that transition. Broader questions arise, such as whether a linear approach to pay is still appropriate for an aging workforce, especially if the career trajectory takes the nonlinear path shown in Figure 1. Companies are re-examining the direct or implied messages sent by the reward program on the importance of retention and whether this is aligned with business strategy and tenure needs.

Ultimately (and especially in the UK, with its changing pension regulations that will allow employees greater flexibility in tapping the cash in their defined contribution accounts), companies must face concerns about the adequacy of their funded and unfunded plans or be faced with a workforce that cannot afford to retire. They will want to know whether their defined contribution plans provide enough income to retire and, if so, at what age, in order to facilitate some measure of workforce planning. From a budget-planning perspective, they must have a laserlike focus on when their workforce will retire and how much extra pensions and benefits will cost per year of delay.

SIX THEMES FOR A SUCCESSFUL AGE MANAGEMENT STRATEGY

These concerns were addressed in recent Mercer client group discussions and a seminar poll. The resulting comments and ideas fell into six main themes and were ranked for importance. (See Figure 2.)

  • Talent retention and attrition.
  • Cost and financial considerations.
  • Flexibility in working patterns and job design.
  • Education, plan design, and employee accountability.
  • Implementation challenges, including legal issues.
  • Using rewards and financial mechanisms to shape the workforce.

HR leaders were uniformly thoughtful in considering these themes. Consensus emerged in a number of areas. Historically paternalistic companies now want to transfer more accountability for financial and health well-being to employees and move to a facilitative basis, with good education and the right benefits available to achieve this.

And although the affordability of retirement is not an issue for the high-earning sector of the workforce, lower-earning segments of employees are likely to find that their pensions will be increasingly inadequate by the expected age of retirement, as state benefits get pushed further out. Businesses are struggling to make this culture shift, and cost and financial considerations are not making it any easier.

Meanwhile, increasing longevity is an immense challenge and pension expense, adding 3%–4% to liabilities in pension funding, according to one client group. In terms of flexibility and job design, one client group agreed that it is important to find ways to accommodate career breaks and “stop/start” career patterns, which will feature more in job design and career progression patterns in the future. Some companies are losing female talent because there is little appetite to offer flexible working conditions, so there is a clear need to look at flexible working practices with age and gender diversity in mind. Some are retraining employees from heavy manual work to take on less demanding roles as they get older.

As for talent retention and attrition issues, the consensus was that experience and tenure are important, but that a certain level of turnover is healthy, with a need to address the attrition of younger talent, who are spoiled by a high degree of choice of employers and opportunities. Thus, building talent pool models is very focused on critical jobs and “ready now” pipelines, along with exploring external talent to add to the pool. There is also the need to re-examine the leadership definition of “talent” and focus on creating the right future pipeline.

When it comes to shaping the workforce, rewards and financial mechanisms are crucial. One client group described major restructuring and cost-cutting efforts. Some were exploring an enhanced early retirement program in the US and were likely to extend this into more regions. In addition, pay for performance and potential is under intense consideration, as is rethinking the definition of “potential” as it applies to both the younger and aging workforces.

On a very practical level, there is still significant use of severance and/or restructuring packages in locations such as Spain, France, and Italy, which contrasts with the use of early retirement packages — as seen, for example, in the UK — some years ago, and these two options are now being compared from a cost-efficiency perspective. And more companies spoke of exploring capability management (focusing on the right skills for the right job) and reinforcing this through the performance and rewards process.

The implementation challenges for companies are significant. Macro-level issues are becoming higher profile for companies, but solving global problems is truly challenging, given multiple stakeholders to manage. It was pointed out that, for many, “retirement” is not the right word — it means “withdrawal,” and retirement in the future may not mean withdrawal from work but rather a change in working patterns. Some respondents argued that “hard stop” retirement is over in many geographies already. Diversity and inclusion of gender and nationality are also under serious consideration in conjunction with the aging population.

From an employee education perspective, it was noted that preretirement courses provide a reality check on how to prepare for hard-stop working.

TWO STAGES OF ANALYSIS

After discussions in several geographies across Europe,it was felt that the answers lay in a two-stage analysis process, exploring the differences between “want to retire” and “affordability to retire.” 

The first stage would thus focus on quantitative data to identify potential issues, such as:

  • What is our age profile by critical role?
  • What is our retirement eligibility risk?
  • What are our actual retirement statistics?
  • Who will/will not reach an acceptable savings replacement ratio for that period of employment?
  • What will benefits cost for each year of additional age in the workforce?

This analysis would yield a key group of at-risk critical skills, plus information about the intervention points from which companies can quantify and compare costs of benefits, severance, enhanced early retirement, improved employee education to improve personal savings ratios, or consideration of job redesign. This provides the financial business case for change.

The second stage would be a qualitative assessment to understand what employees actually want to do. When polled in June, a group of more than 80 companies expressed that understanding employees’ intentions was the main obstacle they will face in this challenge.

For many, if not most, companies in today’s global business environment, it may seem a tall order to tackle the complexities of an aging workforce and the mutual responsibility of employer and employee to ensure retirement adequacy. But it’s a task well worth it on every level — and as important for competitive business strategy as for the individual well-being of the world’s workforce.

 

Learn more about creating a retirement-ready workforce.

 

CONTACTS

Yvonne Sonsino (London)
Partner, Retirement
+44 20 7178 3725
E-mail
Sue Filmer (London)
Principal, Talent
+44 20 7178 5546
E-mail
Haig Nalbantian (New York)
Senior Partner, Talent
+1 212 345 5317
E-mail
Rick Guzzo (Washington, DC)
Senior Partner, Talent
+1 202 331 3695
E-mail

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