Last week witnessed a fleeting ripple of concern among Israeli citizens about their pensions. A report surfaced that the Treasury was about to, instruct the pension funds to reduce the rate of expected return on their assets. In plainer English, this means that the pension funds would calculate the future value of their assets on the basis of an annual rate of increase of x%, instead of y% as had been done hitherto – where x is LESS than y. Even people with very limited understanding of maths and finance will grasp that if something grows at 2% a year for five, ten or twenty years, it will end up being worth less than if it had grown at 4% a year. In this case, the ‘something’ being referred to is pensions, the largest financial asset that most people possess and the one they ‘rely on to see them through their old age’, as the standard cliché has it.
It is therefore quite understandable that this report triggered concern amongst the relatively few people who were in the country and still following the news in mid-August. However, the story faded after a few days, following a reassuring statement from the Treasury. But it actually doesn’t make a jot of difference what the Treasury said by way of reassurance, as will be explained shortly. What fascinated me was the fact that the reaction to the initial report, among most of the media and hence most (of the relatively few) people who heard about it, was to view the whole subject as being a Treasury initiative. Indeed, it was presented as ‘another attack on citizen’s pensions’ on the part of the Treasury, for some nefarious goal which was not spelt out but left to the fertile imagination of the reader/listener/ viewer. Given that perception on the part of the public, it’s not surprising that the denial of any such intent or plan made people feel better, although their suspicions probably remained.
The reality – the very grim reality – is this: the Treasury, of Israel or any other country, does not have the ability to determine how large people’s pensions will be in the relatively distant future when they retire. Treasury officials, along with all other mortals, have not the faintest idea what the rate of return on investments will be over the medium-to long-term. What the report suggested was that the department of the Ministry of Finance responsible for oversight of the pension and insurance sectors, was catching up with historical facts. Specifically, it is belatedly coming to grips with the sad but true fact that the rate of return offered on new investments in the fixed-income area (bonds and loans) have been very low in recent years. That historical reality has already undermined the imputed value of pensions – because these continue to be calculated on the assumption that the rate of return will be y%, when it has already dropped to x%. Some damage has already been done and the longer the markets continue to provide low returns, the more damage will accumulate.
The implication of this reality for the average pension saver is unpleasant, in some cases unpalatable: the estimated value of your pension assets, and hence the estimated amount that your pension fund says it will pay you per month when you retire, IS WRONG. To be more precise, it is TOO HIGH. That is because these numbers have been based on an unrealistic assumption of how much your pension assets will earn, which does not take into account what has happened to pension savings these past seven years – first during the crash of 2007-09 and then during the era of low interest rates. The pension funds should come clean about what is happening and the Treasury should force them to do so. But if the entire apparatus – pension funds, regulators, employees and employers who save in the funds – continues to bury its head in the sand, the damage will continue to mount up and the eventual shock will be much greater.
The good news, such as it is, is that Israeli pension savers are less badly-hit than most others, and less vulnerable going forward. There are many reasons for that, but as of now that statement is a valid generalization. American pensions are in a very sad state, but American savers have woken up to the world in which they live, rather than the one they dreamt of – which is why the only demographic group that has seen persistently rising rates of employment over the last five years is the 55-64 age-group. It is high time for Israeli pension savers, of all age groups, to wake up to the challenges facing them and to adjust their expectations and plans to current realities.