Fall 2008 Version Professor Dan C. Jones FINA 4355

Risk Management and Insurance: Perspectives in a Global Economy 7. Societal Risk Management and Changing Demographics Professor Dan C. Jones FINA 4355

3 Study Points The demographic transformation Implications for fiscal balance Economic growth and labor market challenges The challenges to financial markets Implications for international relations and stability

The Demographic Transformation

5 Issues Population aging Increasing life expectancies Decreasing fertility rates Replacement rate – the birth rate needed to maintain a stable population over time, ignoring immigration

6 Life Expectancy, Fertility and Income (Figure 7.1)

7 Trends in Life Expectancy at Birth (Figure 7.2)

8 Fertility Rates in the G7 Countries (Figure 7.3)

Implications for Fiscal Balance

10 Issues Economic insecurity and resulting social unrest occasioned by ever-expanding populations of involuntarily unemployed dominated social thinking in developed countries during much of the 20th century. The resulting solutions to this problem of societal risk were labor laws that often sacrificed efficiency for stable employment, especially in Europe, and substantial social insurance programs such as in the U.S. Social Security system.

11 World’s Population Aged 65+ (Figure 7.4)

12 Population Aged 65+ in G7 Countries (Figure 7.4)

13 Effective Retirement Ages of Males in OECD (Figure 7.4)

14 Contributors to Retired Beneficiaries in G7 (Figure 7.4)

15 Pay-as-you-go Public Pension Governments in the developed countries decided to expand public pensions – the most expensive component of social welfare programs – they decided to fund them on a pay-as- you-go (paygo) basis. Paygo appeared to be affordable, as it did not require pre-funding for those who had already retired and were eligible for pension benefits. At program inception, the number of retired beneficiaries was comparatively small and the number of contributing workers was large.

16 Effects on Public Budgets The European Commission and the OECD Public pensions in the typical developed country could grow from 8.8 percent to 13.2% of GDP by The Global Aging Initiative at the Center for Strategic and International Studies The total portion of national output dedicated to public pensions in the typical developed country grows from 8.8% to 15.8% of GDP by Healthcare for the elderly also constitutes a large burden. In developed countries, each elder on average consumes 3–5 times more healthcare than a younger adult. The older the elders, the more costly their care becomes.

17 Spending on Public Pension in G7 (Figure 7.4)

18 Solutions Traditional strategies – cutting pension benefits – not working because: Tax rates already high Reducing other government expenditures likely insufficient Borrowing additional money likely infeasible Typo (fourth last line in page 160) – “30 to 60 percent”

19 Solutions – New Strategies Reduction of pension costs Reducing the generosity of new pensions Reducing the generosity of current pensions Restricting pension eligibility Changing retirement incentives

20 Solutions – New Strategies Funded retirement savings – issues Is the funding mechanism held in the public or private sector? How are the transition costs from paygo to a funded system handled? Should the system rely on partial or full funding? Is participation mandatory or voluntary and, if the former, will it be so for all workers or only for younger and new workers? Economic development and workforce productivity

Economic Growth and Labor Market Challenges

22 Issues Expected decline in labor force The economics of national output and growth Savings and investment in aging populations Population aging and technical progress Theory of endogenous growth (a positive correlation exists between the development of productivity and economic growth.)

23 Changes in Working-age Populations (Figure 7.9)

24 Solutions Removing obstacles to work by adopting strategies to persuade those who do not work to get jobs and those with jobs to work more Making disability and unemployment benefits less generous in countries in which their generosity provides little incentive for recipients to return to work Encouraging employers to provide benefits, such as daycare and eldercare, that make it easier for employees with dependents to work Ensuing equal pay for equal work, thus drawing more females into the work force

25 Solutions Emphasizing improvements in education and training at all age levels Raising productivity growth by altering regulatory and tax policies that discourage entrepreneurship or promote capital misallocation Rewarding child rearing through public funding of family allowances and other prenatal incentives Increasing immigration

The Challenges to Financial Markets

27 Challenges to Financial Markets Population trends could affect the stability of global financial markets. Fiscal crises resulting from budget deficits could undermine saving rates, and provoke fears of default of sovereign bonds and currency shocks. Even in the absence of crisis, financial markets could be significantly affected as burgeoning populations of aged, retired workers across the developed world spend down their life savings, more or less in unison.

28 Challenges to Financial Markets Potentially adverse financial trends in developed countries could be reinforced by population aging in Eastern Europe and in East and Southeast Asia. Most economists believe that unfunded pension benefits substitute for genuine savings and thereby reduce capital formation and economic growth.

Implications for International Relations and Stability

30 Two General Theories Political power theory Countries with large populations are more powerful politically than are countries with small populations. Economic power theory Deteriorating population bases mean declining economic strength, which, in turn, invites other countries to expand into that space.

31 Global Generation Gap At one extreme of this generation gap are the aging developed economies. In the middle is a group of emerging economies that are aging rapidly amidst the throes of industrialization and urbanization. At the other extreme is a group of countries, mainly in the Islamic world and Africa, that will remain very young and continue to experience high birthrates for at least the next 20 years and possibly beyond.

32 The Global Challenge Exploding child dependency is causing a decline in living standards and fostering resentments in ultra-youthful societies. Ultra-youthful societies also are characterized by high levels of social violence. Many of the middle group of developing countries discussed above face a double challenge. They too will face population aging – just later – and they are not yet “rich.” All face the prospect of growing old before they grow rich.

33 Defense and Social Welfare Spending (Figure 7.10)

34 12 Largest Countries by Population (Figure 7.11)

Discussion Questions

36 Discussion Question 1 In the context of the several demographic factors that affect the insurance industry worldwide, why is the aging of societies an especially significant factor?

37 Discussion Question 2 Is tampering with the aging process desirable?

38 Discussion Question 3 How do the demographic profiles of the U.S., Japan and Europe differ? What might be the implications for economic growth and labor markets of these differences? What might be the implications for world security of these differences?

39 Discussion Question 4 Could you envision the forthcoming worldwide demographic transformation as causing the U.S. to become more isolationist? Why or why not?

40 Discussion Question 5 What could thwart the realization of the supposed forthcoming demographic transformation?