International Labour Office Providing income security in old age ? A quick review of pension reforms Michael Cichon Social Security Department 1 November 2011
Feb 24, 2016
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Providing income security in old age ? A quick review of pension reforms
Michael Cichon Social Security Department 1 November 2011
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Structure of presentation
Point One: The background noise: were paradigmatic reforms
really necessary?
Point Two: The theoretical pros and cons of paradigmatic pension reform
Point Three: Pension reforms in the crisis stress test
Point Four: What went wrong with pension reform in principle
Point Five: Elements of generic repair
strategies
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One . Was paradigmatic reform
necessary?
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The history of pension reform: the return to and old risk coping mechanism: savings….
PARADIGMATIC reforms introducing individual savings components into national pension systems attracted most attention :
– 1980/81 the Pinochet reform in Chile– During the 1990s and early 2000s 11 countries in Latin
America introduced fully funded elements into their pension schemes
– Between 1997 and 2008 10 Eastern European plus some Central Asian Countries followed countries followed
– SWEDEN Notional defined benefits 1994 – 2008 Reversal in Argentina– 2008 Renewed reform in Chile...– 2009 – 2010 Reversals in Eastern Europe
But PARAMETRIC reforms were equally prominent :
– Since the 1990s and many European and OECD countries largely focussing on pension age increases
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Point One: beyond the ageing hype: were paradigmatic reforms really necessary ? Projected system dependency rates -source EU
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Point One: beyond the ageing hype: were paradigmatic reforms really necessary ? Projected system dependency rates
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Point One: The need for paradigmatic reforms remains in doubt…projected cost in % of GDP
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Point One: The need for paradigmatic reforms remains in doubt…projected cost in % of GDP
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The challenge beyond the ageing hype… Projected total social expenditure in the EU…
Age related Government expenditure in % of GDP EU 27
2007 2060 ChangePensions 10.2 12.6 2.4Health 6.7 8.2 1.5Long-term care 1.2 2.3 1.1Unemployment 0.8 0.6 -0.2Education 4.3 4.1 -0.2Total 23.2 27.8 4.6
Source: EU EPC
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Point One: The challenge beyond the ageing hype… Projected total social expenditure in the EU…
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Labour
Office
Age related social expenditure, EU, 2007-2060
-4-202468
1012
Belgium
Czech
Rep
ublic
German
y
France
Netherl
ands
Poland
Sweden UK
Pensions
Total
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Point One: The challenge beyond the ageing hype… The 50:50 rule
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Point One: The challenge beyond the ageing hype…
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Point One: The challenge beyond the ageing hype… The 50:50 rule
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Two. A quick review of the theoretical pros
and cons of paradigmatic pension
reform
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Financing Social Protection: The PAYG vs. Funding debate
Pro funding– Funding would avoid ageing triggered CR
increases– Create domestic resources for investment– Increase national savings rate and hence growth– DC schemes are in automatic financial equilibrium
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Contra funding– Future benefit levels vulnerable to inflation and
capital market performance– Low compliance = low protection– No social redistribution and risk sharing– Double burden during transition or implicit debt
(through borrowing)– on the level of GDP all schemes are PAYG
anyway– Funded system equally vulnerable to ageing– Concentration of investment power in too few
hands– ageing can be counteracted by activity rates and
pension ages– Ageing will not lead to exploding social
expenditure 16
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Financing Social Protection: The PAYG vs. Funding debate
• On (tentative) balance:– Funded and unfunded schemes both subject to
demographic and economic risks; on GDP level both are PAYG
– Both vulnerable to bad governance and bad management– Contribution rate stabilisation easier under funded schemes– Social redistribution easier under PAYG schemes– Financing of transition cost can be difficult– Funding might support economic development– Defined benefit schemes with intelligent collective
funding ??
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Three. Pensions in the crisis stress test
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Point Two: The crisis stress test: effects on the individual pension saver in DC schemes under different crisis scenarios
0
2000
4000
6000
8000
10000
12000
age 23 27 31 35 39 43 47 51 55 59 63
Total savings at 3% realrate if return withoutcrisisRate of return 3% withcrisis at age 40 andfurther rate of 3%Rate of return 3% withcrisis at age 40 andfurther rate of 5%Rate of return 3% withcrisis at age 50 andfurther rate of 5%Rate of return 3% withcrisis at age 55 andfurther rate of 5%Rate of return 3% withcrisis at age 60 andfurther rate of 5%
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Point Two: what we see in funded pension schemes – fund losses in 2008 ….and lost years of pension savings
2530
19
35
2622 22
3.1 3.8 2.2 4.6 3.2 2.6 2.65.6 7.0
4.18.4
5.9 4.8 4.8
05
10152025303540
Que
bec
pens
ion
plan
s (1
)
Dut
chP
ensi
onFu
nds
(2)
Chi
lean
AFP
s (3
)
Irish
Pen
sion
Fund
s (4
)
US
Sta
tean
dM
unic
ipal
Pen
sion
Fund
s (5
)
Nor
way
G
over
nmen
tP
ensi
onFu
nd (6
)
Sw
edis
hpe
nsio
nFu
nd A
P1
(7)
loss in % of value ofreserves at the end of 2007
loss of pension savings inyears (assumed 9% annualincrease) (8)
loss of pension savings inyears (assumed 5% annual
increase)
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Point Two: …what we see in funded pension schemes
Development of funding levels in Dutch second tier pensions funds, 2007 - 2009
0
2040
60
80
100
120
140
160
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
perc
ent Estimated funding ratio ( % )
Share of pension schemes underfunding ratio of 105%
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Point Two: Effect of the crisis: what we see in funded pension schemes …
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Point Two: Effect of the crisis: what we see in funded pension schemes …
Table: Years of contributions lost for standard savers since July 2007 by category of portfolio (adjusted losses net of fees)
Fund A Fund B Fund C Fund D Fund E Fund F December 2009 -199% -142% -5% none none None? April 2010 -270% -249% -108% none none None? Source: R. Bluhm, 2010
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Point Three: what the crisis has shown so far
– Temporary and permanent losses of pension funds which were at peak times as big be as big as the fiscal stimulus package of 5-6 trillion US $ ,
– Even if pension funds levels may have recovered individual losses of contribution years remained
– crisis and pension reforms have increased the insecurity about future pension levels dominantly in DC schemes
– Crisis amplified the systemic fiscal stress that the pardigmatic reform created
– In the long run – if crisis related unemployment persists for half a decade - then DB schemes may also have to be adjusted but the burden can be shared between contributors and pensioners
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Generic problems : Response… Table 2: Recent changes in second-tier systems in Central European Countries5
Change in contribution rate diverted to second tier Change in state mandate to
invest contributions in privately managed individual accounts
Previous rate Adjustment of rate
Hungary 8% of earnings Reduced to zero (December 2010) Mandate repealed
Poland 7.3% of earnings Reduced to 2.3% of earnings (2011), rising to 3.5% in 2017 ---
Estonia 6% of earnings
Suspended (June 2009-December 2010); restored to 3% (2011) Planned increase to 6% (2012) and 9% (voluntary) depending on GDP growth (2014-2017)
---
Latvia 8% of earningsa
Reduced to 2% (2009) Planned to increase to 6% by 2013, if financial conditions permit
---
Lithuania 5.5% of earnings Reduced to 2% of earnings (2009)b
Government proposed worker option to withdraw from second tier; currently before Parliament
Romania 2% of earnings Frozen at 2% (May 2008-March 2010); raised to 2.5% (March 2010)
---
Slovak Republic 9% of earnings N/A
Existing account holders could opt out of second tier (November 2008-June 2009); second tier made voluntary for new hires (since 2008)
Sources: SSA 2006 & 2010; SSA 2007-2011; World Bank (2009); Zaman (2010); IPE "Baltic Round-up," December 2, 2010; Leppik (2011) a. The rate had been scheduled to rise to 10% in 2010. b. Since their inception, individual accounts have been voluntary; but those who join have contributions diverted from the public pension systems, creating transition costs. Once enrolled, workers may not opt out.
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Three. What went wrong with pension reform
in principle?
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Generic problems
Privatised schemes helped to stabilise pension contribution rates but…
In LA failed to increase coverage Charged too high fees In Eastern Europe:
– Covering of transition cost left completely unclear (Hungary 0,8 – 1,4% of GDP for 43 years, Poland 1.5 – 2.2. % of GDP over 50 years )
– Same concern in Chile … – No provisions for the payout modalities of the second tier in Hungary and
Poland… – Reform was interest driven by private insurance companies (e.g. Poland and
Slovakia…)– Asset and contribution based fees reduced the savings of workers considerbaly
…
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Generic problems : fees…
Table 3.Fees and contributions in individual accounts in Latin American countries as of June 2007 (percent)
Country Admin fee a Mandatory contribution a Fees as apercentage ofcontributions
Argentina 1.00 4.61 17.8 Bolivia c 0.50 10.00 4.8 Chile 1.71 10.00 14.6 Colombia d 1.58 11.00 12.6 Costa Rica 0.29 3.96 6.7 Dom Rep 0. 0.60 7.40 7.5 El Salvador 1.40 10.00 12.3 México 1.02 7.48 12.0 Peru 1.81 10.00 15.3 Uruguay e 1.79 12.22 12.8
SOURCE: AIOS 2007. NOTE: AIOS = Asociación Internacional de Organismos de Supervisión de Administradoras de Fondos de Pensiones
a. As a percentage of the worker's salary. b. The employee's contribution as a percentage of salary, except in Colombia, Dominican Republic, El Salvador and Mexico where the
figure also includes the employer's contribution as a percentage of covered payroll.
c. A fee for administering the investment portfolio is also charged. d. Fees are also charged for transferring, exiting, and making voluntary contributions.
e. A custody fee on the account balance is also charged.
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Generic outcome of paradigmatic reforms
Financial stabilisation of individual funded pension tiers
Increased social uncertainty for individuals
Financial destabilisation of PAYG tiers
Increased fiscal de-stabilisation
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Four. Generic repair strategies
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Point Four: Generic repair strategies …a few reminders first
Transfer schemes /pension schemes can only define entitlements to a share of present/future consumption (not absolute amounts) – no society can promise more
Markets cannot be asked to secure the income of people who cannot or can no longer operate in markets
The statement that pension schemes can only be stabilised by paradigmatic reforms is a myth…
The statement that countries can only afford a basic social safety net type welfare state in the globalised economy and an ageing society is likewise a myth…
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Key principles of ILC Policy recommendations for the extension of coverage : focus on outcomes not on institutional set-ups
Universal coverage of basic income security and essential health care –not necessarily uniform coverage.
Progressive realization of universal coverage and higher levels of security Benefit levels and poverty protection as predictable rights (i.a. through
Ratification of ILO conventions), Social and economic adequacy of benefit levels
Financial and fiscal sustainability
Good governance with the state as the ultimate guarantor of social security rights and benefit levels and the participatiosn of sociaL partners
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Point Four: Options for solutions combining financial and social stabilisation...are not abundant
Process: Solutions have to be found in a process of national dialogue
System wide: Adopt social floor guarantee and adhere to convention C. 102
DC pillars: – Find innovative pension level guarantees – if second pillars
have to survive... ; – reduce the size if fiscal space does not allow the financing of
the transition DB pillars:
– long-term planned increases of contribution rates and definition of government subsidies
– Phased increase of retirement age + reasonable relationships between time in work and time in pensions Or adopt NDC schemes with social redistribution...
– Changing indexing method but protecting purchasing power of pensions
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What is needed… A DB Guarantee for a DC or NDC scheme…
– In a given country the General average premium (GAP) for a pension scheme with an accrual rate of 1.33 % be calculated at a defined point in time
– If a DC scheme charges a contribution that is equal to a fraction or a multiple of the GAP it has to provide for the same fraction or multiple of the accrual rate of 1.33 percent.
– At the age of retirement in year n her scheme has to provide a present value (or the above fraction thereof) for the total number of insurance years t (starting from 0) of contributions that is equal to
– If I=w then
for funded schemes and at least that for NDC schemes
Side comment: This means that the NDC tier in Russia may be underfunded
tntnx
n
ottn
ttn
twWeiWCR
)1(***0133.0)1(** ,0
0133.0*,nxeCR
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A side-kick: The identity of the NDC benefit formula and the classical DB pension formula
An NDC is equivalent to a DB scheme with a linear pension formula, constant contribution rate and with actuarial reductions or increments for early or late retirement and an:
accrual rate in the equivalent DB scheme that is equal to = constant contribution rate/life expectancy (annuity factor) at normal retirement age
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What is needed to avoid « a waste « of the crisis …
National and interntional reviews of three decades of pension reforms based on
Observed experience on systemic effects of pension reforms
New academic knowledge An analysis of the reasons for reform A return to basics (i.e. redefining the primary function
of pension systems…securing old age income security )
A contextual view (i.e. pensions in the context of overall social budgets and their role in economic devlopments)