Transcript Initial Conditions

Pension Reform Options:
A General Framework
AFDC Workshop
“Government’s Role in building
sustainable Pension Systems:
Meeting the challenges of the
Ageing Societies”
Gustavo Demarco
Shanghai, October 15, 2007
Some common challenges of current
pension systems
Adequate benefits to ageing populations
Financial sustainability
Coverage extension
Higher compliance
Better governance and administration
Institutional soundness (fragmentation)
Regulation and supervision
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Demographic trends - 1
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Demographic trends - 2
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Cross-Country Relation between Income and Pension Coverage
Life Expectancy at Age 60
120
23.0
Contributors/ labor force (%)
22.0
CH
100
21.0
80
20.0
Mongolia
60
19.0
18.0
17.0
y = -0.14x 2 + 7.35x + 0.88
40
R2 = 0.89
20
Gabon
16.0
0
15.0
0
5
10
20
25
30
Income per Capita (in thousands)
14.0
5
15
1960
1970
1980
World
1990
Low & middle income
1998
2010
High income: OECD
2020
EU 15
EU 27
2030
2040
EU 12 7/21/2015
Old-Age Dependency Ratio: 65+/(15-64)
0.6
0.5
ODR=65+/(15-64)
0.4
0.3
0.2
0.1
0
1960
6
1967
1970
1975
World
1980
1985
1990
1995
Low & middle income
1999
2005
2010
High income: OECD
2015
2020
EU 15
2025
EU 27
2030
2035
EU 12
2040
2045
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Contributors/ labor force (%)
120
100
80
60
y = -0.14x 2 + 7.35x + 0.88
40
R2 = 0.89
20
0
0
5
10
15
20
25
30
Income per Capita (in thousands)
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Setting the targets…
There is space for ‘social choice’ … but this
choice needs to respect some basic principles:
Sustainability
Equitability
Affordability
Feasibility
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Choosing the mandate of the system…
120
110
Gross Replacement Rates
100
90
80
Morocco
70
60
50
40
30
9
0.5
1
1.5
2
Individual Income as a Proportion of Average Earnings
2.5
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…
120
110
Gross Replacement Rates
100
90
80
Morocco
70
60
Argentina
50
40
30
10
0.5
1
1.5
2
Individual Income as a Proportion of Average Earnings
2.5
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…
120
110
Gross Replacement Rates
100
90
80
Morocco
70
60
Argentina
50
Chile
40
30
11
0.5
1
1.5
2
Individual Income as a Proportion of Average Earnings
2.5
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…
120
110
Gross Replacement Rates
100
90
80
Morocco
70
60
Argentina
50
Chile
40
Mexico
30
12
0.5
1
1.5
2
Individual Income as a Proportion of Average Earnings
2.5
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…
120
110
Uruguay
Gross Replacement Rates
100
90
80
Morocco
70
60
Argentina
50
Chile
40
Mexico
30
13
0.5
1
1.5
2
Individual Income as a Proportion of Average Earnings
2.5
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Sustainability: ‘static’ approach
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Contributions:
Benefits :
c * W * L
r * W’ * P
Equilibrium:
c * W * L = r * W’ * P
c* (W / W’) * (L/P) = r
If W = W’ =>

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c / d = r
. . . Where d = P/L
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Sustainability: ‘dynamic’ approach
2.10%
Sustainable IRR = 2% per year
1.90%
Accrual Rate
1.70%
Contribution rate = 20%
1.50%
1.30%
1.10%
0.90%
Contribution rate = 15%
0.70%
Case of Egypt
0.50%
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15
57
59
61
63
Retirement Age
65
67
69
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Current trends in Pension Reforms
General principles, not universal ideal models
Financial Sustainability
Efficiency
Equitability
Feasibility (Economically and politically)
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Customized solutions
Pragmatic approach
Regional approach (rather than Global)
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The Pension Reform process
 Diagnosis (What problems?)
 Options (What possible solutions?)
 Potential impacts
 Economic feasibility:
 a) Enabling conditions
 b) Costs of transition
 Political feasibility :
 a) Social preferences
 b) A strategy of consensus
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Pension Reform Options
Alternative contributory schemes:
 PAYG - Parametric
 PAYG - NDC
 Fully Funded
 Multipillar
The non-contributiry options
 “Zero” pillar
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Multi pillar Reforms
Pillars:
 Zero
 First
 Second
 Third
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Fourth
Non-contributory/social pension
Parametric or NDCs
Funded, private management
Voluntary, structured retirement
plans
Access to housing, health
care, etc…..
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Who defines what in Pension
Reform?
There is space for ‘social choice’ … but this
should be limited to ‘sustainable’ and
‘equitable’ options
The decision has a strong political
component, and a strategy of consensus is
always required (‘feasibility’)
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Parametric Reforms
 Main advantages:
 No major change in the operation of the pension system
 Principles of solidarity and intergenerational solidarity
remain unaffected.
 Problems:
 Not necessarily easier to pass and put into practice.
 Parametric changes are often discretionary or “ad hoc”.
 Parametric reform is not a “one time” reform.
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Main parameters of a DB pension system
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Income measure:
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Eligibility conditions:
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Retirement Age (normal/early retirement)
Vesting period
Benefit Formula:
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Ceiling on pensionable earnings.
Number of past salaries included in the calculation of the pension.
Revalorization mechanism for past salaries.
Accrual rate.
“Reduction factors” for retirement prior or after the statutory
retirement age.
Maximum/minimum replacement rates and/or pensions.
Indexation mechanism for pensions.
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Some common issues with parametric
reforms
 Gradualism;
need to define a transition
path
 Accrued rights and implicit pension debt.
 Political constraints: difficult to cut
benefits and increase retirement ages.
 Myopia to adjust to long term objectives
 The reform will be a long term process.
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PAYG – Notional Accounts (NDC)
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Individual accounts
Unfunded
Notional return
Benefits calculated to reflect contributions, notional returns
and demographic changes
 NDC is simple and transparent, but it must respect some rules
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Choice of appropriate interest rate, life expectancy
A balancing mechanism against shocks
A financing mechanism to handle inherited commitments when
moving from existing system
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Experiences with NDC reforms
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Countries with NDC-reformed schemes
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Countries with NDC-inspired reformed systems
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China, Brazil, Russia
Countries with NDC-type systems
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Sweden
Latvia
Poland
Italy
Kyrgyz Republic
Germany and France
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Some advantages of NDC
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Public debt is a source of financing transition from
DB system.
Mismanagement risk is lower than in funded
schemes.
Can improve fiscal management:
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Implicit pension liabilities of NDC system appear as a debt
of the government.
Can facilitate the gradual transition to a FF system
when the bonds are allowed to be traded.
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Basic features of funded pension
schemes
Managed by private companies (Insurance
Companies or Specialized Pension Managers)
Funded schemes
No surplus or deficits => No fiscal effects
Defined contribution schemes: Benefits
depend of funds accumulation and of life
expectancy
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Contributions in funded schemes
Contributions are retirement savings
The system may have more incentives to
contribute, especially for higher income
workers and those who contribute on a
regular basis
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Benefits in funded schemes
Normally defined contribution
Automatic adjustment
No need of financial support to deficits (no
fiscal impacts)
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Funded schemes = Options
 Public or private managers?
 Specialized managers? Insurance
companies? Other financial intermediaries?
 Mandatory or voluntary?
 Substitutive or complementary to public
pensions?
 Individual or group (occupational) plans?
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Funded schemes: Individual or
group?
In individual plans workers may choose fund
managers
In group or occupational plans the employer
chooses the pension manager
Group plans offer more protection and with
lower costs, but they limit individual choice.
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Advantages of funded schemes
 Automatic response to the problems of aging
population
 No deficits
 In principle, less exposed to political manipulation
 More incentives to contribute => higher expected
benefits
 Higher return on savings
 Macroeconomic environment : possible effects on
capital market development and savings (?).
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Problems of funded schemes
No redistribution of income is possible (only
some cross subsidies among members)
Minimum pension schemes must be defined
as PAYG schemes
Private costs of administration sometimes
higher than public management
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Discussion of advantages and
problems
Private mandatory pension schemes may not
be exempt from government interference
Incentives to contribute do not operate
automatically
Level of pensions are not necessarily higher
in private pension schemes
Higher financial education is required
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Comparison based on
macroeconomic effects
No mandatory pension (funded or not,
privately or publicly managed) is independent
of the macroeconomic context
Funded schemes may accompany and
facilitate the development of capital market
institutions, but the effects on the savings
rate and the rate of growth of the economy
have not been proved.
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Comparison based on
administration costs
Explicit costs of administration are usually
high for private pensions, but public systems
usually have huge implicit costs
(inefficiencies, disability system costs, etc.)
It is difficult to compare the costs of public
and private administration. Concepts
involved and levels of risks are usually non
comparable
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Funded schemes: The voluntary
option
 Complement public pensions
 Improve benefits without imposing a burden on
labor costs
 Types: a) Individual accounts; b) Occupational plans
 Quantitative impact usually modest, but qualitative
effects may be important (development of
institutions and regulations)
 Problem: Fiscal treatment of voluntary retirement
savings
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Funded schemes: Alternatives and
international experience

Voluntary
Chile
Kazakhstan
Total
Partial
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Mandatory
Canada
USA
Mauritius
UK
Australia
Argentina
Costa Rica
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Feasibility : Technical preconditions
Financial and actuarial projections
IT – Databases
Administrative procedures: Defined and
flexible
Regulatory framework and supervisory
bodies
Trained human resources
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Feasibility: Economic environment
Financial markets and institutions
Capital markets and Insurance
Macroeconomic environment
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Financial markets and institutions
Financial intermediaries: Experienced,
competitive
Financial Assets: Diversification, Liquidity
and low Volatility
Market transactions
Strong regulatory and supervisory body
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Capital Markets and insurance
Develop capital market institutions,
regulation and supervision
Liquidity and low volatility
Secondary markets of public bonds
Individual insurance and annuities:
institutions, mechanism, regulation and
supervision
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Macroeconomic environment
Economic stability
Growth
Fiscal discipline
Role for foreign investments
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Political feasibility
 Consensus among social partner:
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Government
Parliament
Workers (Labor Unions)
Employers
Beneficiaries
Financial Sector, Insurance
Public opinion
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Restructure administration: A
minor reform?
Reforms in the administration may be
independent from parametric or structural
reforms
But….
No country has gone through a successful
parametric or structural reform without
strong reforms in the administrative
institutions and procedures
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Components of an administrative
reform - 1
 Institutions
 Processes
 Governance structure
 Human resources
 Budget and resource allocation
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Components of an administrative
reform - 2
Information systems and IT
Audits and supervision
Customer service
Communication, public education
and public information
Strategic Planning
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Restructuring institutions
Institutional organization usually responds
to history, rather than to the present
needs.
Options (I) : centralized vs. decentralized
administration
Options (II) : Autonomy vs. Integration
(with Ministerial structure)
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Centralized or decentralized
administration?
Advantages of centralization:
Lower costs
Common rules (ie, less inequalities)
Disadvantages:
 Costs of monopoly
 Diseconomies due to lack of specialization
 Coordination with local or regional offices
(particularly in large countries)
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Autonomy or integration?
Advantages of autonomy:
a) More efficiency
b) Less interference
Disadvantages / Risks of autonomy:
a) Loose of broad policy perspective,
“introspective” institutions
 b) “Political isolation” ; lack of support when
major reforms are needed
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Re-defining procedures: Identify
critical processes
Membership
Collection
Record keeping/individual accounts (history
of contribution for every member)
Investment of reserves
Customer service
Benefits procedures and actuarial
calculation
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Governance structure and
accountability
 Clear definition of roles and responsibilities
associated to all critical processes
 Need to translate the definition of roles and
responsibilities into an organizational chart
 Privilege professionalism; minimize political
interference in the appointment of staff in decision
making processes that require technical expertise
 Define procedures of accountability of staff at all
levels, and especially at the highest levels of the
organizational pyramid (Link with Communication)
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Information Systems
Income related schemes rely on good
records of contributions.
These records are often poor, and
databases need to be developed or improved.
Adopting IT requires a clear assessment of
needs (including system operation and
updates).
In house or outsourced IT development?
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Audits
Independent auditing services may help
identify problems, find solutions and reduce
costs
Regular external audits are recommended in
addition to internal audits
Reviews need to include operational audits
in addition to financial or actuarial audits
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Conclusions
There is not an ideal model for pension
systems, but there are principles that
should guide the operation and reform of
any pension system.
The political component of a pension system
is reflected in the mandate; the design and
operation should not be subject to
discretionality or political manipulation.
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Conclusions
The international experience provides
several examples of reforms options, but
each country should find its own path.
The macroeconomic and political environment
are constraints to the adoption of some
types of reforms.
Multipillar schemes are adequate when
multiple objectives are pursued.
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