U.S. Debt and Aging: Don’t Ignore that S&P Alarm

U.S. Debt and Aging: Don’t Ignore that S&P Alarm

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What’s most interesting about the Standard & Poor’s announcement that the U.S. triple-A credit rating is in jeopardy, is how quickly,  after plummeting  for several hours, the markets shrugged it off.  But  the markets interpreted the alarm bells as nothing new and instead focused on America’s strength –  technology driven by our solid brainpower and entrepreneurial spirit.

Yet it would be a mistake to shrug off the warning, which correctly identified our “unfunded entitlement programs” as the chief culprit, accounting for almost half of federal spending.  Nor should we forget that the same affliction also has not gone away in Europe, as noted earlier in the week amid new concerns regarding Greek debt.

What Greek debt worries and the U.S. credit alarm have in common is the impact of aging populations’ demands on public spending, particularly pensions and healthcare.  A March 28 analysis  by Michael Tanner, a senior fellow at the Cato Institute, should have prepared us. “The U.S. government is about to exceed its statutory debt limit of $14.3 trillion. But that actually underestimates the size of the fiscal time bomb,” he wrote. “The unfunded liabilities of programs sets the true national debt as high as $119.5 trillion.” While everyone seems to believe we can manage that pesky retirement thing, healthcare is the nut that will truly unhinge us. Precisely for that reason, public pensions might not be a bad place to start our really serious overhauls. 

A recent paper from AEGON, the Dutch-based global insurance company, is clear and direct: Demographic transformations are bankrupting public pensions. We are operating on a pay-as-you-go scenario in which public pensions are funded by those who are currently working, and they pay out to retirees.  Not only are we living longer, requiring more total pension funding, but birth rates are down and fewer people are paying in.

AEGON, and likely S&P,, understand the central problem: Public pension systems have been based on outdated actuarial mortality tables. Pensions use these tables to figure out how much money needs to be put into a system in order to support those taking from it for the remainder of their lives. As AEGON points out, these tables have not sufficiently adapted to the rises in longevity – one reason pensions are underfunded.

A solution starts with understanding how much more we need to invest in our pensions given increases in longevity and decreases in birth-rates. According to AEGON, every year of additional life expectancy is generally thought to add4 percent to the present value of a typical pension fund’s obligations.

It’s true that in the U.S., we are in better shape than Europe due to our higher birth rates. roughly at replacement.  Across the Atlantic, about 80 percent of the population (versus less than 40 percent here) relies on the public pension system – and while their lifespan is about the same as Americans’, they have stunningly lower fertility rates . Reform is needed far more desperately. 

But despite this comparative comfort, U.S. credit-rating predictions will come true unless we undertake the serious reforms needed to meet the new demographic realities of our aging populations.

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Executive director of the Global Coalition on Aging, Michael W. Hodin, Ph.D., is also managing partner at High Lantern Group and a fellow at Oxford University's Harris Manchester College.