In the second of a five-part series examining the impact of the ageing of Bermuda’s population, we look at the outlook for pensions.

Bermuda’s shifting population demographics have serious implications for the future long-term economic prospects of both individuals and the wider economy.

The recently released report, Bermuda’s Population Projections, 2016-2026, reveals that, based on current projections, some 24.9 per cent of the population will have reached the pensionable age of 65 in seven years’ time, while the overall population will decline by 111 people as the number of deaths exceed births.

The demographic shift based on age will result in more retirees taking money out of the pension pot, while a reduction in the number of people in the workforce will mean fewer people will be paying money in.

The island’s Fiscal Responsibility Panel, in a report issued in November, said that a 2016 actuarial review for the year ending August 2014 showed that Bermuda’s Contributory Pension Fund, funded by private sector workers and employers, is dramatically underfunded, although it said estimates of the actual amount range from $500 million to $1.8 billion depending on assumptions made as to the magnitude of future accrued benefits and contributions.

Moreover, the two public-sector pension schemes, which benefit government employees (PSSF) and Ministers and Legislators (MMLPF), have an unfunded liability of some $975 million as of March 2018, the panel wrote, adding: “Unless tackled, this will be a burden on future budgets.”

Addressing both shortfalls, the panel wrote: “Debt reduction needs to be complemented by actions to address these deficits.”

Of particular interest to anyone who is aged 35 or younger is that the actuarial review of the assets of the CPF revealed that it is likely to run out of money by 2049 unless steps are taken to address the long-term viability of the plan.

In its Pre-Budget Report, released last week, Government said its “policy of increasing contribution rates by 2.5 per cent above the rate of pension increases has allowed a significant level of fund to build up and thus the plan is partially funded, which provides further security of benefits”.

At September 30, Government says, the fund had total assets of more than $1.9 billion, which is approximately 11.7 times the annual value of benefits paid in the 2017-18 fiscal year.

“The 2014 actuarial report of the fund indicated that the viability of the fund in the short to medium term is good, with the fund being positive for the next 25 years,” Government said. “However, recognising the long-term challenges of the fund, the ministry will continue to closely monitor its performance.”

The island’s fertility rate — the rate at which women of child-bearing age (15-49) give birth ­— is a major contributor to the issue of underfunded pensions. In order for a couple to replace themselves, and account for infant mortality, a country’s fertility rate must be 2.1, the population report says. Between 2016 and 2026, Bermuda’s fertility rate is expected to remain constant at 1.4 children per woman. The report, citing the World Bank as a source, said that “many developed countries such as Australia, Canada and the United Kingdom also had sub-replacement level fertility in 2016”.

“The reduction in fertility rates had a great impact on Bermuda’s demographic profile,” the report says, noting that the island’s crude birth rate, which is the number of live births per 1,000 population in a given year, plummeted from 30.4 in 1950 to 9.3 in 2016. It is projected to decline further, to 7.3, by 2026. The decreasing birth rate trend, the report says, aligns with a decline in the proportion of the population that are females aged 15 to 49 from 22.5 per cent to 19.9 per cent over the projection period.

“The decline in the number of births ... has far-reaching consequences for pay-as-you-go type pensions such as the CPF,” the population report says. “This is because the contributions that are paid into the fund in a given year by workers are generally paid out as benefits in the same year. “The financial viability of this type of pension scheme can be problematic if the number of pensioners is rising at a faster rate than the number of workers.”

Financial analyst and The Royal Gazette columnist Nathan Kowalski, said: “Bermuda suffers from a ‘denominator problem’ – its obligations continue to rise while this amount is getting divided among fewer and fewer people.

“Without a rising denominator (contributors to the CPF) the numerator (retirees and pensioners) will eventually swamp the fund’s ability to pay. Plain and simple, the declining population is and will continue to be a major factor that places entitlements at risk.”

The fiscal responsibility panel said it urged action on the underfunded pension liabilities in its 2017 report. “We said it would be important to address this over time with a range of measures that should certainly include, as in other countries, a rise in the retirement age — a measure that also has the merit of increasing the working-age population.

“Our 2017 report also noted that the 2016 actuarial review might have understated the potential risks that could arise if the financial environment fails to deliver an adequate real rate of return on pension investments. The latter possibility is also a risk faced by Bermudians reliant on privately managed pension returns.

“While the Government is not legally obligated to cover any CPF shortfall (let alone shortfalls in private pension schemes), the CPF system plays too significant a role for the retirement income support of many elderly for the Government to allow it to fail.

“Adjustments in the contribution and benefit formulae and the age of eligibility for CPF benefits remain an urgent priority that needs to complement the announced policy to maintain an annual COLA (cost of living allowance).”

The fiscal responsibility panel warned in 2017 that many people wholly dependent on CPF pensions will fall below the poverty line. This will be particularly relevant for elderly women, the panel wrote, because they are likely to have “a greater need for assistance with services such as income maintenance, housing, meals, transportation and healthcare because they have less financial resources. Addressing this through financial assistance is a contingent risk on the budget.”

The fiscal responsibility panel report praised “outstanding proposals” from the previous Government’s Pension Benefit Working Group, which said that reforms of the PSSF might require increases in contribution rates by both Government and its employees, an increase in the retirement age for unreduced pensions, a shift to a final five-year average salary as the basis for calculating the pension, and application of actuarial reductions on early retirement prior to age 65.

Government has announced that it is considering increasing the retirement age to 67 on a voluntary basis and will examine what impact that might have on the plan.

Government’s actuaries have prepared a 75-year baseline projection to assess the implications of instituting the PBWG’s proposed policy changes, the panel says. According to Government’s Pre-Budget Report — released last week — that actuarial report has been delivered and is being reviewed by the Government.

“We have little doubt that [the report] will reveal that the assets of the system are at risk of being depleted within the next couple of decades and that the Government will have little option but to implement the types of reforms suggested by the PBWG,” the fiscal responsibility panel wrote. “Achieving the Government’s targets for explicit debt would not provide fiscal resilience unless the pension debt overhang is also addressed.”

While Government has no legal obligation to ensure the viability of the CPF, it would be “politically untenable” to let it fail, says Craig Simmons, senior economic lecturer at Bermuda College, who takes the view that the CPF shortfall will result in an “intergenerational injustice”.

“Taxpayers will shoulder that burden, but not current taxpayers,” he said. “Instead, future taxpayers will, resulting in an intergenerational injustice. The taxpayers of the future have no chance to vote on these issues — but the burden will be dumped on them.

“They will be making contributions to the pension scheme without any guarantee of getting money out of it.”

In the 2018 Throne Speech, Government announced that Bermuda’s social insurance system will be changed from a fixed-rate contribution to one based on a percentage of income. As a result, finance minister Curtis Dickinson said recently, “contribution increases will be delayed until the actuary completes the modelling to effect this policy objective. The actuary is currently working on the 2017 actuarial report for the CPF and it is anticipated that this report will be completed in the second quarter of 2019 at the latest. Contributions were last increased in August 2018 by 4.2 per cent”.

The fiscal responsibility panel praised Government’s intention to introduce measures to increase the progressivity of CPF’s financing, thereby ensuring that the most vulnerable among us will carry a lesser share of the burden.

“We support this movement away from a flat rate to a more progressive system and would hope that this is achieved, not only by a cap on the level of contributions by lower-wage Bermudians, but by progressivity in the rates applied to higher wage earners,” the panel wrote.

“If you make more money, you’ll make bigger contributions,” Mr Simmons says. “If you make less, you will make smaller contributions. That is a fairer and more sustainable way to address the problem. Sustainability is the priority of pension funds — we can’t afford to let them run out of money.”