The Price of Aging: Will It Break National Budgets?

Growing old is costlier than ever, and in many countries, the rising expense of caring for graying populations threatens to inflate national debts to unsustainable levels. If nothing is done to address the problem, 30 of 49 major developed countries will see their sovereign credit ratings reduced to junk status by the year 2050, according to a recent Standard & Poor's study.

The financial meltdown over the past two years hasn't helped. "Because of the global economic crisis, government deficits are significantly wider, and the debt levels are significantly higher than just two years ago," says Marko Mrsnik, a Madrid-based S&P credit analyst and the principal author of the report.

If current policies remain in place, age-related expenses could launch Japan's national debt into an unsustainable 750% of its gross domestic product by 2050, according to the report. The credit-rating agency estimates those costs could soar to nearly 600% of GDP in the Netherlands and 415% of GDP in the U.S. by that time. Currently, national age-related expenses average less than 40% of countries' GDPs.

Health Care Is the Biggest Problem

In reality, most countries' national debts will never get that high: Either voters or financial markets will force governments to cut costs and turn their budgets around before they lose their investment-grade status, Mrsnik says.

He points to Greece as an example. The European Union and the International Monetary Fund earlier this year forced the country to adopt sweeping pension benefit cuts to quality for the $146 billion international bailout package Greece needed to avoid defaulting on its debts.

But while pension costs are the biggest component of age-related spending today, health care costs will soon overtake pension outlays as the primary deficit-booster, Mrsnik says. That's particularly true in the U.S., where pensions mostly come from private companies, while medical costs are covered by the publicly funded Medicare program. In Europe, both health care and retirement benefits are primarily government responsibilities.

The Very Old Require Far More Spending

The most expensive piece of the growing health care costs is likely to be long-term care, including nursing homes and residential care. "Costs tend to rise very quickly at the older ages, and that's the main increase we've seen -- in the age 90+ groups," says Michael Murphy, a demographer at the London School of Economics. Within that category, the biggest cost will come from caring for elderly people with dementia who need acute health care, he says.

Health care costs are harder to cut than pensions. Murphy says that while governments can adjust pension spending by enacting a higher retirement age or other measures, "there isn't a lot you can do about health care costs really." As it is, even pensions have proven difficult to reduce in some countries. While Sweden has indexed the retirement age to life expectancy, France continues to resist raising its retirement age past 60, Murphy notes.

The demographic time bomb will hit Europe and Japan harder than the U.S., where the population is still growing, which will allow younger people to continue supporting the retirement and health care spending that goes to the elderly. By 2060, Europe's population will include twice as many adults over the age of 65 than children, according to European Union statistics. The old-age dependency rate -- the number of seniors compared to the working-age population -- is set to double, giving Europe fewer people with jobs to pay the costs of caring for the elderly.

Making Changes Now

Britain is reacting to these statistics by rapidly raising the age at which a person can claim a state pension, Murphy says. Starting next year, it will abolish the retirement age altogether so that older workers can continue in jobs indefinitely.

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Italy, renowned as it is for financial profligacy, is in a surprisingly good position to deal with its age-related costs, Mrsnik says. The country has adopted a severe pension reform, which -- if fully implemented -- will make it one of the countries with the smallest expected old-age budget problems.

Mrsnik charts what he calls a "sustainability gap," the difference between current national revenues and what will be needed to fund age-related expenditures in the future. In the U.S. the sustainability gap currently stands at 12% of GDP, if no changes are made. But if Washington manages to balance the budget in 2014, the gap would be much smaller long into the future, he says.

Such moves will be necessary for countries with aging populations that want to avoid seeing their credit ratings turn to junk in the future.