pensions are big, but they are definitely NOT debt

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State pensions are not debt. They are not even debt-like. Eurostat is exceptionally clear on this point, going out of its way to capitalise ‘NOT’ in its description of their non-debt-like status.

This is of course because state pensions are social security benefits that can be scrapped without consequence. Government accountants collectively decided this many years ago, so it must be true. No one seems to have told the UK Pensions Ombudsman, but that’s another story.

Cash flows stretching far into the future that governments will bend over backwards to pay in a timely manner do feel a teensy bit debt-like to us though. Earlier this year, Eurostat came out with its third stab at quantifying quite how big these non-debt-like liabilities are.

Their answer is big. Actually, make that BIG.

Here’s a chart showing unfunded entitlements as percent of local GDP for EU and EFTA countries at the end of 2021, together with the value of asset-backed pensions:

The sizes of these definitely-not-debt-but-maybe-sort-of-liabilities are often a multiple of the face value of sovereign debt. But as well as the size of the non-debt, the spread between highest and lowest tallies is striking. 

A bean-count of Spain’s social insurance pension entitlements eclipses 500 per cent of GDP, while Denmark’s are less than 25 per cent of GDP. The challenges facing fiscal policymakers of the future look radically varied.

Some may argue that these are just made-up numbers. And, to be clear, yes: these ARE ABSOLUTELY made-up numbers. They represent the present value of actuaries’ estimates of distant, unfunded sort-of-perhaps-but-not-quite-promises to pay cash, and are hugely sensitive to changes in the discount rate used to calculate them. This second chart shows how these numbers jump about if the discount rate was 1 per cent higher or 1 per cent lower:

Leaving aside the weird convexity in the Estonian numbers, this is a bond-yield-up-price-down thing of immense proportions. Nudging the discount rate up by 100 basis points changes the present value of Spanish pension promises by a full 120% of GDP. BIG!

 Given that Eurozone bond yields have risen by almost 250 basis points since this data was put together you’d be forgiven for reckoning these estimates would all be due for a monumental shrinkage.

Nope.

It looks like the EU’s Ageing Working Group – who set common discount rates across European statistical agencies – haven’t checked their Bloombergs in a while. They’re using 2 per cent real and 4 per cent nominal discount rates – rates that the market hasn’t regularly seen since before the Global Financial Crisis. Admittedly, different European governments have different long-dated bond yields, but with French and German nominal bonds yielding between 0.6 – 1.4 percentage points less than the Working Group’s nominal 4 percent discount rate, even after one of the most brutal bond market sell-offs in recent history, it’s fair to say that marking pension entitlements to market would make them look a lot bigger. Indeed, these rates make the UK’s SCAPE look positively penal.

This left us scratching our heads as to how things might compare elsewhere in the world. The OECD has been collecting this sort of data, and this is what it looks like:

For the most part they are reassuringly close to Eurostat’s 2021 estimates, though we don’t completely understand why some of the numbers are so different for a couple of countries. The OECD numbers differentiate between unfunded public sector occupational schemes like the NHS Pension Scheme in the UK, and more general social security benefits for elderly people. In some countries, like the UK, occupational schemes are entirely different to general state pensions, but we are conscious that this is not the case everywhere.

What are the takeaways?

 As Eurostat reminds us, pension entitlements are:

…an important part of households’ wealth and is therefore relevant for an analysis of households’ consumption and saving behaviour.

The ECB puts housing wealth at around 350 per cent of GDP. The present value of pension entitlements under current social insurance systems are in the same ballpark. 

Challenges facing aging societies are manifold. Some of the fiscal and economic challenges will look the same across European finance ministries. But some will look radically different. The heterogeneity of social insurance arrangements is probably something that deserves closer scrutiny by macro investors and monetary policymakers.