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Is Phased Retirement Really A Solution?

By: Ian Markham & David Burke

Labour shortages and phased retirement are often mentioned in the same breath these days. The thinking is that keeping older workers on the job longer may be the solution to looming labour shortages. Ian Markham and David Burke, of Watson Wyatt Canada, look at the reality of the situation.

Phased retirement is talked about increasingly these days, and no wonder. Baby Boomers are now reaching their early retirement years and the ones who chose their employers or their personal investment strategies carefully, or were simply lucky, can afford to leave the workforce early. But there are plenty of reasons to continue working reduced hours rather than retire cold turkey – whether for extra pocket money, the love of work, the social interaction, the intellectual challenge, or to get out of the house.

Phased retirement and labour shortages are often mentioned in the same sentence. This is on the grounds that we will need more workers and it is the older workers who have the most experience. The thinking is ‘why lose them altogether if we can at least keep them working two or three days a week?’ However, this is only a small speck in the range of solutions needed to offset any labour shortages.

The fact that we have an aging population in Canada, and in numerous other countries, is well known. The drop in the birth rate in the last few decades, combined with much longer life expectancies and a desire and ability to retire early, have had a dramatic impact on the work force. The median retirement age declined from 65 years in 1976 to 60.6 in 2002. Table 1 shows the expected percentage change in the size of the working population in Canada, by age, within the current decade.

One important result of all this demographic change is that a dramatic reduction is occurring in the number of workers available to fill positions in middle management and below. On the other hand, there is a potential excess of those available to fill the upper-middle management and senior positions. Unless employers can persuade older workers to accept much slower and/or lateral career progression and fill the jobs normally performed by younger people, the lack of young able-bodied workers will change the nature of the workplace dramatically. The potential for demotivation at all job levels is very significant and is bound to have negative repercussions on future productivity levels.

Labour Shortages
We generally do not use the term ‘labour shortage’ to refer to a shortage of skills according to age groups. Rather, it is applied to a whole industry or to the entire working population. Table 2, based on Statistics Canada data, shows that there are several industries where more than 25 per cent of their workers are within 10 years of the median retirement age for that industry. These industries must devise means of rejuvenating themselves. Compare this statistic to that of the industry with the smallest percentage of workers who are within 10 years of that industry’s median retirement age, namely the Accommodation and Food Services industry at 11 per cent.

When we look at Canada as a whole, there is a basic equation that drives the degree to which labour shortages may be experienced. The Basic Equation Governing Labour Shortages is GDP Growth Rate = Labour Growth Rate + Productivity Growth Rate.

Let’s look at the three components in this equation.

GDP Growth Rate
The rate of growth in the Gross Domestic Product (GDP) depends on consumer demand and the ability of the economy to be able to meet that demand. GDP growth leads to improvements in the standard of living. The population as a whole is used to an ever-improving standard of living and these expectations will continue despite the fact that increasing numbers of Canadians will no longer be productive as they move into retirement. If the combination of poor productivity improvement and low – or even negative – growth in the labour force means that GDPgrowth stays low for many years, the result is likely to be a change in government at every election since voters will hold the ruling political party accountable for a slowing down in improvements in the standard of living, regardless of the reason.

Labour Growth Rate
The Canadian labour force growth rate over the next 20 years will depend significantly on changes in the labour force participation rate by age, as well as immigration levels. According to the World Bank, the annual growth rate in the current decade is expected to be 0.73 per cent, but in the 2010s this is expected to decline to 0.09 per cent and then become negative in the following decade. Any changes in the birth rate will, of course, only impact the labour force growth rate 20 years from now.

Productivity Growth Rate
Productivity is what makes it all come together. The greater the quality of workers, capital stock, and technology, the more likely it is that we will be able to achieve our desired standard of living when we have a labour force that is moving towards retirement. That is why David Dodge, governor of the Bank of Canada, recently described Canada’s productivity record as ‘lacklustre’ and encouraged the government to place policies aimed at driving productivity gains high on its agenda. He said the need to boost productivity is “perhaps the most important micro-economic issue facing Canada.”

When consumer demand for goods and services (a product of our desire for an increasing standard of living) exceeds the supply (a product of the size of the labour force and its rate of productivity), and when a logical solution to the lack of supply is more workers with the necessary skills to produce those goods and services, we have a classic labour shortage.

Going back to our basic equation, we can solve the upcoming lack of growth and eventual shrinkage in the size of the labour force (which is a virtual certainty) by achieving productivity gains and by gaining access (through immigration or offshoring) to workers who live and work abroad. Watson Wyatt’s workforce projection model shows that with labour productivity increases of 2.5 per cent annually over the long term, the potential for Canada-wide labour shortages would largely disappear. However, its 2005 Survey of Economic Expectations shows that economists predict a median labour productivity level of only two per cent in the medium and long term, which would mean that general labour shortages are almost inevitable at some stage.

There is no longer much room for what used to be another major solution, namely increasing the labour force participation rates at all age levels – other than by tinkering at the edges. Such tinkering includes offering phased retirement programs that might cause a potential retiree to keep working for a year or two more.

Solving The Labour Shortages
Many of the solutions to labour shortages rest with government. Governments can:

Other solutions rest with individual employers. They can hire from abroad. They can invest in their businesses and in training programs to enhance their workers’ productivity levels. They can improve the attractiveness of their workplace through monetary or nonmonetary means, so as to minimize turnover of their skilled workers and attract new ones. And they can try to keep their older workers through phased retirement programs.

Designing A Phased Retirement Program
The object of a phased retirement program is to encourage workers to delay their full retirement and instead work on a parttime basis. However – and here is the major challenge that is often neglected – the more generous a phased retirement program the more attractive it will become to those who could have retired, but have chosen to carry on working full-time. These people currently realize that there is a sizeable financial penalty when shifting from working five days a week to full-time retirement – but working three days a week with a decent financial package could be appealing. A generous phased retirement program could, therefore, be completely counter-productive to a goal of keeping older workers.

This challenge is less pronounced for companies whose pension plans provide relatively low income replacement rates at retirement. A change in pension plan design to reduce early retirement subsidies for future pension accruals (possibly in return for higher pensions payable for those who reach their normal retirement age, or other forms of compensation) could achieve this goal over a period of years.

In fact, keeping an older worker goes well beyond designing a monetary solution. Other solutions are needed relating to the job content, the training of new skills, and successfully appealing to these older workers’ desire to put something back into the community – namely, the community of their fellow workers.

For example, an eldercare program can make a difference, especially for men. Men who are responsible for their aging parents’ well-being will appreciate it if their employer gives them access to professional advice that helps them find institutions and programs to make their life easier. Thirteen per cent of medium to large U.S. employers offer such a program and our research shows that such a program stretches men’s average retirement age by eight months.

Yet an eldercare program only delays women’s average retirement age by one month. Of U.S. women aged 55 to 64 who leave the workforce altogether, 23 per cent do so in order to take care of family members. The reason women retire early for caregiving is because they would prefer to provide as much care as they can directly and eldercare programs only help them identify and evaluate caregiving providers. Given a choice between an eldercare program and phased retirement, women will usually choose phased retirement, as this allows them extra hours and flexibility to provide direct care without having to retire completely. This, amongst other reasons, helps explain why, in the U.S. in recent years, phased retirement programs have had the effect of raising the average retirement age by 21 months for females and five months for males.

Are we saying that governments should devote little effort to creating a sensible regime that will better accommodate phased retirement programs? Far from it. All employers who face labour shortages will be interested in phased retirement programs, even if these are just a micro-solution to buy them some time while they train younger workers in an attempt to find the needed skills elsewhere.

Of course, it definitely helps that there are so many media stories telling Canadians that more and more workers believe that they will have to delay their retirement because they can’t afford to retire. Reading these articles will slowly change attitudes, even amongst those who can afford to retire.

Ian Markham is director of pension innovation and David Burke is national retirement practice director for Watson Wyatt Canada.

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