Risk at Every Level

Another level of risk the paper addresses is to institutions that oversee private and public pensions. "The financial crisis put into sharp relief some deep problems with corporate pensions," says Mitchell, who points to General Motors' $20 billion in unfunded pension liabilities as an example of the magnitude of problems faced by many traditional defined-benefit corporate plans. Her paper notes that many of these plans were invested heavily in equities and suffered severe declines in value during the economic downturn. In the public sector, states and municipalities on average hold only about half of the money needed to meet pension obligations, according to the paper. Meanwhile, government reinsurers established to protect pensions, such as the Pension Benefit Guaranty Corporation (PBGC) in the United States and the Pension Protection Fund in the United Kingdom, are also running into financial trouble. While the PGBC has enough money to cover current retirees, it is not solvent in the longer run, and may require a future "TARP-style bailout," Mitchell writes. "Pensions as an institution are in bad shape in many countries."

Individual 401(k) plans will help make up the shortfall for many people, Mitchell continues, but not for others, because this savings vehicle has also been hard hit by the equity market collapse. Meanwhile, she says, behavioral factors -- including the tendency to remain heavily invested in employer stock and the failure to annuitize -- continue to limit the ability of defined-contribution plans to provide retirement security. "The 401(k) plans are part of the answer, but not the entire answer."

The financial crisis and sharp decline in equity prices also are challenging traditional thinking about constructing portfolios that call for more risk for younger workers who could benefit from strong gains in the stock market, yet still have time to bounce back from a downturn. Many companies with 401(k) plans have made workers' automatic enrollments default into the employee's target retirement date. Funds based on such a "life cycle" model typically have more equity market exposure for younger employees, but then the fund managers rebalance their portfolios toward safer investments, such as bonds, as retirement grows near. "The fact remains that any portfolio heavy with equity in the last year has done very poorly, which is challenging the auto-enrollment strategy into target maturity date funds in the future," according to Mitchell.

Problems at the national level are also creating threats to retirement income, says Mitchell. When deciding about how much to save and when to retire, it is critical to have some idea about future taxes, inflation and medical care costs, she writes. "But good forecasts are simply not available." In addition, government retirement programs, such as Social Security in the United States, are creaking under the weight of aging populations combined with revenue shortfalls and higher demand from unemployed workers. She notes that because of the harsh recession, more unemployed people have elected to retire or seek Social Security benefits. As a result, the system is projected to take in less revenue than it pays out this year -- a threshold the agency had not expected to cross until 2016.

In addition, Mitchell points out that Medicaid, the federal medical program for the poor, faces new stresses as a result of the economic climate, as well as new provisions of the recent health care reform legislation that mandates long-term care coverage. An economic recovery could reverse the trend for a time, she adds, "but the point is, we're on the knife-edge."

Beyond risk at the national level, the financial crisis has shown that the global economy is not necessarily a safe harbor for investment, either. "In the old days, we were taught that we could diversify our portfolios globally and reap the benefits of geographic diversification," Mitchell says. "Now, we realize with the financial crisis that the tide rises and sinks all boats together. There is simply not as much benefit from global diversification as we once thought."