Arguably, all state-managed pension funds in the world are broke, from America to Zambia. The reasons may be different: typically, there is some degree of corruption involved (funds syphoned for personal gain) and some degree of mismanagement (funds diverted for political purposes to destinations that did not provide sufficient return). There is also some degree of plain incompetence, investing funds in securities that went bad.IMG_0164

Regardless of the reasons, the fact remains that official pension funds are broke because they are practically always “defined benefit” funds. That is, they promise to pay out a previously defined benefit (a fixed amount, or a percentage of salary) while the returns from the moneys invested are not sufficient to afford that promise.

Many private pension funds have suffered from similar problems in the past 30 years, but private funds have found a way out: most of them have converted themselves into “defined contribution” plans. These plans do not promise a fixed amount or a percentage of salary; their promise is simply “whatever the result of your investment will be when you reach retirement age.” In theory, the amount of the benefit might be bigger or smaller than a “target” amount, depending on how well the investments are managed throughout the funding period. This might therefore be better or worse than you expected, but in all cases it will be better than having no pension at all because your fund went belly up!

Greece’s pension funds are a particularly prime example of bad management. As the situation stands, they are broke: they do not have the funds to fulfill their promises, and the only way they can pay out the promised benefits is through additional funding made directly by the Greek government, which means indirectly by international creditors (basically European Union taxpayers and EU financial institutions).

So, the creditors want the Greek government to reduce the pensioners’ benefits, present and future. The Greek government does not want to do that, because if they do it, they will be kicked out of office (to say the least).

Greece is just a glaring instance; basically, all countries are facing similar problems, to a less visible degree. Governments should follow the examples of many private fund situations (I was personally involved in addressing three such instances successfully).

It’s not rocket science. What needs to be done (we’ve done it successfully, I repeat, on three occasions) is to create a new defined contribution plan that will simply be bankruptcy-proof, and offer people the option to move to the new plan. The implementation of such a strategy is not just a walk in the park, but it works. The new plan has to be attractive enough that people will choose for it; it needs to be perceived as solid and providing enough of an upside that will cause people to embrace it. This is not as difficult as it sounds, if the alternative is to remain in an old plan that threatens to pay out much less (if at all). Just providing people with an alternative to bankruptcy may be advantageous enough. Providing people with choices regarding the portfolio that the new fund will be investing in is also a plus: typically, individuals can choose for more aggressive or more conservative portfolios. This gives people a greater sense of responsibility for the eventual outcome, rather than just blaming the government. Every year people are given the opportunity to continue with their choice of portfolio or to change it. Millions of people are already doing that in private funds in different countries. State-managed funds should follow their lead.

Of course, there will be criticism dished out generously; but the sooner the issues are tackled, the better. Most governments worldwide are simply postponing the problem, or dealing with it with “half-measures” like extending the minimum retirement age from 65 to 70 or 75. This does not really solve the problem; it is just a delaying tactic.

It does take guts to face the crowds and tell them the truth: that the pension funds are broke. And it takes creativity to design a new pension plan that will be solid and provide certain advantages over the old, bankrupt ones. To my knowledge, only Chile has shown previously this combination of creativity and courage. I’m sure there must be many people in Chile who might be critical of their system today (you can never please everybody), but I believe they are better off than most other countries in the world. If there are issues with the Chilean strategy, Greece and other countries might learn from that and do it even better. Delaying the problem will not help to resolve it; things will end badly, like in a Greek tragedy.