Fresh Off The Press

This Sunday’s second article is a fresh update on SeLFIES-Bonds and retirement security.

Springer Verlag, Berlin, has been publishing the Financial and Monetary Policy Studies since 1979. It just published its 48th volume: https://link.springer.com/book/10.1007/978-3-030-29497-7.

This volume was sponsored by the European Union (EU). Late 2018, the EU invited Prof Nazaré Costa Cabral and Assistant Prof Nuno Cunha Rodrigues to be the editors. At the time, both were at CIDEEFF - Center for European, Economic, Financial and Tax Law Research at the Faculty of Law of the University of Lisbon.

Since then, Prof Nazaré Cabral has been proposed by Bank of Portugal and the Court of Government Accounts for President of the Public Finances Council. This appointment was accepted by the Portuguese Prime Minister on January 25 2019 and runs for 7 years and is not renewable. The Public Finances Council was set up in the aftermath of the Great Financial Crisis and is one of the many measures taken during the so called Troika years.

Anyways, cutting a long story short, Prof Nazaré Cabral knew of Prof Arun Muralidhar’s innovative work on retirement security and invited him to write one of the chapers of the book. Prof Arun Muralidhar is Adjunct Professor at the Department of Finance of the George Washington University and wrote 5 books on retirement security and pension management topics since 2001.

He in turn, decided the chapter to be about SeLFIES-Bonds, as applicable to Portugal and thus turned to his source and inspiration, Nobel Laureate Prof Robert C Merton, Distinguished Professor of Finance at MIT Sloan School of Management and the John and Natty McArthur University Professor Emeritus at Harvard University. Prof Arun Muralidhar then invited me to be the third co-author, relying on me to deliver the Portuguese context and specific challenges. Obviously, I fell over backwards when faced with this invitation but it ended up being one of the most satisfying projects I have worked on for many, many years...

The chapter has been finished late Spring of 2019 and was available on two websites publishing academic papers. The printing of the book as such, took a while but is finally commercially available at https://link.springer.com/book/10.1007/978-3-030-29497-7#editorsandaffiliations. It’s bloody expensive but don’t worry. I don’t see a penny of it. My endeavour was purely for a noble cause. It was my way of volunteering for a civic cause and a cause it is. The EU citizenry is slowly but steadily marching back to the days of retirement poverty. Something I remember well seeing in my youth and early adulthood in Portugal and Germany.

The book has 3 sections and 18 chapters. Its introduction by the editors reads as follows.

"This edited volume takes a closer look at various European pension-plan models and the recent challenges, trends and predictions related to the design of such schemes. 

The contributors analyse new ideas, both from national governments and European institutions, and consider current debates on topics such as the Capital Markets Union (CMU) and the so-called ‘European Pillar of Social Rights’ – calling for a new approach to social policy at the European level in response to common challenges, such as ageing and the digital revolution.

This interdisciplinary work embraces economic, financial and legal perspectives, while focusing on previously selected coherence aspects in order to ensure that the analyses are comprehensive and globally consistent."

“Our” (!) chapter is 9th and falls under the 2nd section "The Capital Markets Union (CMU) and the Future of Pension Plans: Opportunities, Risks and Drawbacks.” Its title is "SeLFIES for Portugal: An Innovative Pan European Retirement Solution”. Its executive summary, so to speak, reads as follows.

"With a rapidly aging population, Portugal faces some serious pension challenges including a Social Security system which is under pressure, and pension benefits gradually approaching levels that will require individuals to supplement Social Security with private savings. In addition, Portugal has a low rate of financial literacy and hence transferring the responsibility of retirement planning to the general population runs a major risk of many individuals retiring poor. While some attempts have been made to create private pension plans, they have not had the level of acceptance as has been the case in some of the Anglo-Saxon countries. This paper argues that the government of Portugal could issue a new form of Sovereign Contingent Debt Instrument (SCDI) that can address the growing retirement challenge and achieve other goals as well. SeLFIES (Standard-of-Living indexed, Forward-starting Income-only Securities) are a new type of bond that greatly simplify retirement planning to the level of basic financial literacy and can not only address retirement security, but also improve the government’s debt financing and funding for infrastructure. Finally, since Portugal is part of the EU, the demand for these new bond instruments could be Euro-wide thereby providing additional benefits to the government in reducing its overall financing cost."

Prof Nazaré Cabral also wrote a chapter, as did her co-editor Assistant Prof Nuno Cunha Rodrigues. The former’s chapter has the title “Pensions at a Crossroad Between Social Rights and Financial Markets: Which Way to Be Chosen?" and the latter's reads "The Pan-European Pension Product and the Capital Markets Union: A Way to Enhance and Complete the Economic and Monetary Union?"

Now, I did not pay for the book and somehow I still hope to get a hand on a free copy for my labours. Thus, I did not read both of the above chapters but being philosophically inclined, I am keen to read the chapter by Prof Nazaré Cabral. This is because, I feel that the biggest barrier for the adoption of SeLFIES-Bonds is a political/ideological one and which seems to go right back to the issues raised in her chapter.

Her own abstract reads as follows.

"Departing from the two basic historical models of social protection, the Bismarckian or labour model and the Beveridgean or universal model, the author proceeds with analysing two contrasting alternatives for the future design of pension systems: (i) The individual insurance model; (ii) The universal tax-financed model. Although motivated by common drivers—an ageing society and technological revolution—the responses and incentives are substantially (philosophically) different. Ultimately, there is a tension between social rights and financial markets that may end up with the predominance of one over the other. In the current (liberalizing) environment and considering past and recent EU policy guidance on this matter—the timidity of the social-rights centred strategy (contained in the European Pillar of Social Rights) in contrast with the impulse given to the development of the Capital Markets Union—may after all mean the triumph of a financial market-driven approach."

There is a deeply set conviction in our European democracies that it is the solidarity contract between generations that holds social security pensions together. Indeed the social contract between sovereigns and subjects is based on this “togetherness”. It is what keeps our societies civil and away from the "horrors of US-style” capitalism.

As demographic, technological and labour market trends make it ever harder to keep paying up the promises made to future retirees based on the social security contributions of current employees, a number of private sector solutions have been allowed to help provide for financial retirement security. First, defined benefit pensions, then defined contributions pensions and finally individual pension saving schemes similar to the 401k’s in the USA. Most, if not all, of these schemes are under water and are no substitutes to social security pensions. Defined benefit schemes offered by employers have been all but closed to new members. A majority of them have not been adequately funded by employers. Defined contributions schemes have not been able to earn the required returns and/or members and employers have not set aside enough capital. As for the private pensions plans, they are mostly just funded with enough capital so to exhaust any possible income tax deductions. In Spain and Portugal for sure, the arrangement does look like an unplanned tax subsidy to the asset management industry. The amounts saved privately are inconsequential, except for taxes saved in the year income was earned but to be paid later in retirement.

Realities of the financial markets over the last 20 years are turning private sector solutions into very risk value propositions and even the very professional and admired Dutch corporate sector pensions are under water because they refused to run these risks. Individual pension plan savers have no chance to get their asset allocation right. They just go with the flow and are fleeced annually with duties, fees & commissions, independently from whether their portfolio(s) go(es) up or down. Compounded, these costs can easily eat up 25% of their portfolios.

So I wonder how much solidarity is left in the sacrosanct European generational contract. When retirement ages keep going up from year to year. When income replacement in retirement is adjusted downwards or surviving spouses get less and less. When the deduction periods are lengthened. I mean, how is this fair to the soon to be retirees, when the rules of the game are changed on an ad hoc basis? How can it be solidarity for current contributions payees to pay for current retirees, when the future pensions of the current payees cannot be guaranteed by the contributions of the younger generations following them? And how fair is it, for those to be encumbered by the pension promises made (and debt incurred) to the soon to be retired? Is it fair for current retirees to enjoy pensions which are not funded by their own past contributions but by ever higher social security contributions on present employees and employers alike, and with a nice amount of long term debt added for good measure? And as pension entitlements get cut, eligibility twisted and turned, by stealth or otherwise, retiring folks end up with much lower pensions than planned, indeed below or near poverty levels. This in turn, forces fiscal transfers from annual government budgets to social security ministries to fund retirement complements or minimum pension incomes. These fiscal transfers happen at the cost of all citizens and corporations and not just working folks. They also divert government budget funds from much needed present and future productivity enhancing investments.

Indeed, retirement complements or minimum pension income force older folks through humiliating procedures. Who wants to say he/she is poor after having worked and paid social security contributions all their lives? According to respected economic research institute DIW Berlin, even in Germany there are already 625,000 retiree households which are entitled to, but not claiming, the minimum pension income top up. This means, in Germany there are over 1.3mln retiree households which already need income supporting pension top ups from the government outside the social security budget and a horrifying 50% plus of those are not claiming those top ups. This is the mirror effect of old age poverty. These retirees are not applying for that subsidy for reasons DIW suggests are stigma, complexity or ignorance. This sum is budgeted at €2bln in Germany's annual budget and makes up 30% of the pensioners’ income. In this case, this money is neither spent by the government nor received by the retirees.

https://www.dhirubhai.net/posts/marcel-fratzscher_diw-berlin-starke-nichtinanspruchnahme-von-activity-6607987580665376768-aSNH

SeLFIES would add a personal accountability and protective dimension to the social security pension. They can be embedded with the current social security system and I gather, they lie precisely at the crossroad discussed by Prof Nazaré Cabral in her chapter “Pensions at a Crossroad Between Social Rights and Financial Markets: Which Way to Be Chosen?". For starters, government entities managing still existing surplus social security funds would be able to manage their future long term liabilities with SeLFIES holdings, instead of holding 10 year bonds at near negative, or indeed negative, rates and with cash flows which in no way mirror future pension payments.

On a final note, CIDEEFF (https://www.cideeff.pt) is holding a conference on “The Pan-European Pensions Plan” on February 28 2020 at the rectorate building of the University of Lisbon. The European Institute of Lisbon University is co-sponsoring it (https://institutoeuropeu.eu) and yes, the book with “our"(!) chapter will be presented as well.

For sure, I shall be there listening to what kind of reactions the book’s chapters may lead up to.