Pensions Core Course 2013: Adequacy and Sustainability of Contributory and Non-contributory Pensions - An ILO View

Adequacy and Sustainability of Contributory and

Non-Contributory Pensions: An ILO View

April 4, 2013

Krzysztof Hagemejer

International Labour Office

Contents

• How societies define adequate pensions? Concept of adequacy

• Lessons from Europe

Balancing adequacy

with sustainability

• How to close global coverage gap? Facing the coverage challenge

Adequacy of pensions

• How societies define adequate pensions? Concept of adequacy

Questions to be asked and answered to

determine what pension provisions are

adequate

What is retirement?

What society should

guarantee?

Social contract:

What pension system

country should have?

Changing perceptions what is adequate may

lead to changes in explicit and implicit

social contracts

• Happens only when person is not able to work anymore?

• Is a well deserved period of rest after working life?

Definition and timing of

retirement

• Guarantee aims only at alleviating poverty for those unable to support themselves?

• Guarantees every resident a minimum income at old-age?

• Guarantees also certain proportion of pre-retirement income (replacement rates)?

Level of societal

guarantees

• People should save for themselves

• Those unable to contribute/save should be supported

• Younger should support old generation

Degree of solidarity

Changing social contracts determine changes

in financial and institutional solutions

Social contract behind pensions

What is retirement?

What is guaranteed by the society?

How much solidarity and redistribution towards

the poorer?

Financial and institutional alternatives

Mandatory versus voluntary

Defined benefit versus defined contribution

PAYG versus advanced funding

Public versus private provision

Defining pension adequacy

● Adequacy and sustainability are joint and

interlinked objectives of social policy

● Adequacy is defined nationally as part of the

broader implicit or explicit social contract which

sets the design of the pension system

● National social contracts cross the borders:

● there are standards accepted internationally (like ILO

Convention no 102 or Recommendation no 202)

● European Union Open Method of Coordination: Adequate

old-age pension systems should prevent poverty in the old

age but also provide income replacement after retirement

preventing sharp decline in living standards

Lessons from Europe

• Focus on sustainability but what about adequacy?

Recent reforms of European

pensions to face

demographic challenge

In many European countries already introduced pension reforms

may successfully counterbalance financial impact of

demographic change (Projected change of public pension expenditure due

to different factors in GDP percentage points between 2010 and 2060)

-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30

LVPLEEIT

DKPTFRSEELBGUK

EU27EA17

ATDECZHUFILTNLESROIE

NOSKMTBESI

CYLU

Demographic dependency Benefit reductions Other changes

In some countries public pension expenditure are

even projected to decrease and average projected

increase in most countries is far from dramatic

-5 0 5 10 15 20

Latvia

Poland

Estonia

Italy

Denmark

Portugal

France

Sweden

Greece

Bulgaria

UK

EU27

Austria

Germany

Czech Republic

Hungary

Finland

Lithuania

Spain

Netherlands

Romania

Ireland

Norway

Slovakia

Malta

Belgium

Slovenia

Cyprus

Luxembourg

Percentage points

Resulting change

Benefit reduced

Other reforms

However in many countries reforms will significantly

affect future benefit levels... Replacement rate in public pension schemes 2010 and 2060

Italy

Luxembourg

Spain

Greece

France

Malta

Portugal

Finland

Slovakia

Bulgaria

Poland

Norway

Latvia

EU27

Austria

Cyprus

Romania

Germany

Hungary

Lithuania

Ireland

Estonia

15

20

25

30

35

40

45

50

55

60

65

70

75

80

15 20 25 30 35 40 45 50 55 60 65 70 75 80

Rep

lace

men

t ra

te a

t re

tire

men

t in

206

0

Replacement rate at retirement in 2010

Czech Republic

Even 40% replacement rate however does not

prevent poverty for those with low earnings

0

10

20

30

40

50

60

70

80

90

100

Bulgaria

Czech Republic

Estonia

Slovakia

Luxembourg

Latvia

Spain

Lithuania

Hungary

Slovenia

Malta

Portugal

France

Romania

Croatia

United Kingdom

Netherlands

Belgium

Poland

Greece

Ireland

40%

of m

inim

um w

age

as p

erce

ntag

e of

rel

ativ

e po

vert

y lin

e

C102 benchmarks40% of minimum wage as percentage of relative poverty line, 2010 (poverty line thresholds at 40% and 60% of median income)

40% median income poverty threshold

60% median income poverty threshold

Nearly all EU member countries ratified:

● either ILO Convention no 102 (C.102) on

minimum standards in social security or

● European Code of Social Security (ECSS) of

the Council of Europe,

● and some ratified in addition also ILO

Convention no 128 on Invalidity, Old-age

and Survivors benefits (C.128).

Future replacement rates from contributory

pensions will be significantly reduced

● Reforms implemented or being implemented across

Europe are significantly reducing replacement rates

provided through the contributory, earnings related

parts of the national pension systems

● Replacement rates after 30 years in many countries

will be lower than 40 per cent required by

international standards

● Many of those with shorter or broken careers and low

incomes will not be eligible to pensions from

contributory parts of the pension system high enough

to prevent them from falling into poverty in the old-

age

Protection of those with broken careers and

lower life-time incomes weakened by reforms

● Many new reformed pension schemes are not just

translating differentiation of earnings at the labour market

into differentiation of pensions: these differences may

actually be amplified

● Reforms often removed from benefit formulas redistributive

components aimed to protect against poverty those with

lower earnings and shorter careers

● For a time being this changes has not yet been everywhere

adequately compensated by increased role of various non-

contributory provisions like basic minimum pensions or

subsidies to contributions of those caring for children or sick

and elderly, unemployed, persons with disabilities etc.

How to prevent from poverty those with lower

incomes and those having no possibility to have

long unbroken careers?

● Either one should preserve or restore in one way or

another the redistributive defined benefit formulas in

first pillars, or

● Secure that in the overall pension system there are

much stronger than before non-contributory income

guarantees (like basic state pension, universal or

means-tested) as well as contribution subsidies

compensating adequately some non-contributory

periods

● To secure sustainability, conditions have to be created

to effectively extend duration of working lives and

delay retirements

Automatic mechanisms will not replace good

policy making in social dialogue

● Many reforms introduce various automatic mechanisms to

ensure long-run financial sustainability of pensions

● There are no similar mechanisms to guarantee adequacy...

● ...other than good policy making through well informed

social dialogue based on agreed adequacy targets,

balancing shorter and longer term needs as well as benefit

adequacy with financial sustainability

Closing the coverage gap

• How to close global coverage gap? Facing the coverage challenge

Demographic ageing will worsen

the global coverage gap

1. Now already 61% of the worlds’ elderly live in less developed regions with lowest pension coverage

2. This percentage will increase to 83% in 2100

3. More than half of these not covered elderly are – and will be - in Asia

4. now has only 5% of older than 65 live in Africa, it will be more than 20% in 2100

5. There is more women than men among those not covered

6. Now 35% of older than 65 live in Europe and North America, in 2100 it will be only 15%

Greatest challenge in the ageing

world: coverage gap

• Only minority of the world’s working population contributes to any pension scheme (30%)

• Only small minority of the world’s older persons receives any pension (20% in low-income countries)

Provide at least basic income security to uncovered majority of the elderly is a priority

Recommendation no 202 (2012) concerning national floors of social protection

Role of non-contributory pensions in closing

coverage gaps

1. Low-income countries with very low coverage (i.e. Africa and Asia): non-contributory pension the only way to provide at least basic income security for majority of the elderly. Attractive option to be selected as one of the first step to gradually build comprehensive social security system

2. Countries with significant coverage gap mainly concerning poor self-employed (like Chile etc.): the way not only to close effectively coverage gap but also to strengthen minimum guarantees within the whole pension system

3. Countries with coverage high now but which introduced reforms aiming at having “actuarially fair” pensions: as the coverage in terms of number of people entitled to reasonably adequate pensions will be falling, the role of non-contributory pensions will be growing in all respects: filling the emerging coverage gap, guaranteeing minimum incomes and taking over redistributional functions eliminated from contributory part of the system

Policy choices and parameters:

1. Entitlement conditions: universal pension for everybody over certain age more equitable, simpler and cheaper administratively then solutions with additional entitlement criteria or “tests”

2. Age: should be coordinated with age in the contributory programmes, in the longer run can be easily linked to life expectancy or demographic structure, in some low income countries however may be chosen at a higher level for cost considerations and then gradually reduced.

3. Benefit level: chosen depending on the structure and provisions of the overall pension system in the country and minimum income guarantee levels targeted by social policy

4. Affordable everywhere if policy space available

Adequate and sustainable pensions part of

wider national social protection floors:

access to a set of goods and services

constituting essential health care including maternity care

basic income security for

children

basic income security for

persons in active age unable to earn sufficient income

basic income security for

persons in old age

The social protection floors should comprise at least the following

basic social security guarantees

national definition of minimum levels

Guarantees should be provided to at least all residents and children, as defined

in national laws and regulations, subject to Members’ existing international

obligations