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Asia’s Pension Plans Face a Big Black Hole

Governments in Asia have been caught ill-prepared by their rapidly aging populations as they struggle to provide adequate pension cover for the elderly.

STR | AFP | Getty Images

There is a yawning gap between what's currently in state pension coffers in Asia and what's needed to cover the elderly in retirement. And experts say if governments don't step up pension reforms, they risk a massive funding shortfall.

"Older people already constitute a large proportion of the poor in Asia. And by the middle of this century, there will be more older people in the region than people of working age to support them. This presents a serious policy challenge for governments in the Asia and Pacific region," said Sri Wening Handayani, principal social development specialist at the Asian Development Bank (ADB).

The Organization for Economic Cooperation and Development (OECD) said in a recent report that "many of the Asia-Pacific pension systems are unlikely to prove sustainable in the long term, and aging Asia needs to face up to its pension problems and needs to do so soon."

China, Asia's largest economy, is a good case in point. The country is aging fast - in 2010, there were 110 million people 65 and above in China; by 2030, the number will increase by more than 100 million, according to the United Nations. By 2050, more than a quarter of the population will be over 65.

The funding gap between what's needed to make sure these retirees get some sort of retirement income and what's currently in the state pension system could blow out to $10.8 trillion in the next 20 years from $2.6 trillion in 2010, according to a Reuters report.

Although the Chinese now have $3 trillion in onshore savings, the biggest hoard of domestic savings in the world, it is inadequate to cover the gap, said experts.

"There is no way to really estimate how big the hole is because there are so many different pension systems," Patricia Cheng, regional insurance analyst with CLSA in Hong Kong told CNBC. "Millions of workers in rural areas in China, for example, are promised 55 yuan ($8.80) a month (in post-retirement income) while civil servants can get up to 5,000 yuan ($795.60)."

"It's quite a problem, but they're (Chinese government) in denial," she added.

Shortfalls Across Asia

China is not alone; countries across Asia face a huge funding hole when it comes to providing retirement cover.

In Indonesia, for example, which still boasts of a youthful population, the current pension system covers only 14 percent of all private-sector workers, according to data from the ADB.

Also, in Vietnam, social security plans only cover 20 percent of workers in the private sector. The country's system is so underfunded that the International Labor Organization (ILO) warned in August that it could run out of money by 2029.

"While the average OECD countries show that about 70 percent of the working population is covered by a pension plan, this is much lower in Asia, only 11 percent in South Asia and 37 percent in East Asia," Herald van der Linde, head of Asian Equity Strategy at HSBC, said.

To compound the problem, the replacement rate — or the percentage of a worker's pre-retirement income that is paid out by a pension program upon retirement — is very low. At about 40 percent in Asia, it is far from what's needed. OECD says pension funds require a 70 percent replacement rate in order to ensure there isn't a significant drop in living standards of individuals after retirement.

Solutions?

Reforms such as allowing pension funds to invest more in riskier assets and increasing the retirement age could help bridge the gap, experts said. Countries such as Philippines and Indonesia allow only a very small portion of investments in riskier assets such as equities, with most of the money of local pension systems locked in long-term income products such as government bonds.

(Read more: Can Japan's Elderly Become Its Growth Engine?)

"The initial investment policy is very conservative," said HSBC's Van der Linde. "In India there's a national pension system, and they can invest 15 percent into equities, but they're not doing it. In certain countries, they are starting to do that but it's still not sufficient to meet obligations over the longer term."

Increasing the retirement age can be another solution, but something that will be politically unpopular and nearly impossible to implement without widespread protest, said experts.

The average pension age for men in Asia-Pacific countries is around 59, while for women it is 57, according to the OECD.

Japan is the latest example of how difficult it is to make people work longer. Earlier this year the government had to shelve a proposal to raise the compulsory retirement age for national government employees from 60 to 65. Instead, it opted for a plan that would give employees the right to decide whether to stay on until 65 on lower wages, according media reports.

"It is tough — nobody wants to work longer and nobody wants pension benefits cut. People won't be pleased. It is a difficult reform to get people to rally behind," CLSA's Cheng said.

But unless reforms are implemented and soon, the funding hole in Asia's pension systems is only going to go deeper, warn experts.

-By CNBC's Jean Chua.

Contact Aging in Asia