Basic Societal Schemes for Old Age, Disability and Death

Transcription

1 Basic Societal Schemes for Old Age, Disability and Death David C. Lindeman World Bank consultant* Pension Reform Options for Current Systems in Kyrgyzstan, Tajikistan and Uzbekistan *Formerly with the World Bank and US government in various pension and tax related capacities. Currently Principal Analyst (Pensions) with the Organization for Economic Cooperation and Development (Directorate for Fiscal, Financial and Enterprise Affairs). Analysis and views expressed here are the author s own and do not necessarily reflect those of the Bank or OECD.

2 Part One Thinking about Basic State Systems for Retirement, Disability and Death

3 Introduction Focus today mostly on legally mandated schemes that attempt to be universal -- at least for those employed in the formal sector and are managed by the state. No common or clear definitions for these objectives, particularly as regards self-employed (and farmers). Countries often combine types of basic schemes and/or types of benefit rights (next two slides). Countries may mandate or strongly encourage private sector schemes to replace, supplement state schemes: full substitution (as in Chile, etc. in Latin America or Kazakhstan but note state-provided minimum benefit.) partial substitution/supplement in many countries through both (1) occupational schemes, (2) personal pension plans.

4 Three Types of Fundamental Legal Entitlements Benefits determined by labor inputs (see next slide for more detail). Usually labeled social insurance or provident funds. But also mandated funded schemes, as in Chile Benefits determined by citizenship: volkspension or demogrants or national pensions. New Zealand, Canada, Nordic countries. But also many backdoor demogrants hidden in social insurance (discussed later). Benefits determined by need (income, wealth). Australia is a pure case (in practice the means-testing is soft ). Most countries have needs-based supplements to social insurance and/or volkspension.

5 Standard Labor Input Structures (Social Insurance, Provident Funds, Solidarity Schemes) Time worked only (first tier or basic pension in UK, CR, Lithuania). Usually graded from minimum to maximum number of years. Often both time and wage/salary/self-employment income (most OECD, FSU, CEE). Uses concepts from funded annuity contracts, private occupational defined benefit schemes. Contributions instead of time and wage/etc. France s second-tier occupational arrangements since 1940s; Provident Funds UK legacy in Commonwealth countries (and Thailand) from 1950s, 60s; notional ( defined contribution ) account schemes in Italy, Sweden, Poland, Latvia 1990s.

6 Basic Design Issues How much emphasis on adequacy (poverty-prevention) objectives versus vertical equity (incentive) objectives? Funding versus PAYG (or current disbursement, solidarity, repatriation): more a continuum than dichotomy especially when funding takes the form of government bonds. Allocation of risks between individual and collective within cohorts; across cohorts. Investment risk in funded schemes, and available resources risk in PAYG (or partially funded) schemes PAYG risk of available resources is correlated with birth rates, labor force participation, formal sector participation, full reporting. Usually ex post adjustments because of constraints (e.g., through cost of living adjustments), but can be legally ex ante (in theory) as in French solidarity occupational schemes or in notional defined contribution schemes. Longevity risk within and across cohorts in any scheme. What is the annuity table promise during the accumulation period? Fixed vs. participating annuities during the payout period?

7 Functions and Pillars The Dilemma of Whose Three Pillars? The Bank s Averting the Old Age Crisis attempted to bundle. Adequacy (redistribution) + PAYG + collective risk = mandated 1 st pillar Vertical equity (and income smoothing) + funding + individual risk = mandated 2 nd pillar OECD and EU use pre-bank terminology Basic state scheme(s) = 1 st pillar Occupational scheme = 2 nd pillar 3 rd pillar in both classifications is personal and voluntary (maybe with tax advantages or other incentives). Switzerland is the model three pillar country under both classifications. But does either classification capture the complexity of choices societies can and do make?

8 Components of Retirement Provision (John Piggott s Trinity with modifications) SAFETY NET COMPULSORY EMPLOYMENT RELATED VOLUNTARY SAVING Publicly Provided Publicly Mandated Other Universal Targeted PAYG Funded (only partially--?) Privately Managed (funded) Publicly Managed (state workers?) Employment Related Tax Preferred Non Tax Preferred Private Saving Co-mingled Schemes

9 What is defined benefit, defined contribution? Some argue terms reflect how a legal entitlement or contractual right is defined. But what really matters is whether there is a contingent liability. If yes, then defined benefit. If once contributions are paid that ends the contributor s responsibility, then defined contribution. In funded schemes, terms generally reflect who bears investment risk and, less so, longevity risk. Is there a promise by the sponsor concerning minimum rate of return? Promise of an annuity option? (But if annuity option, when fixed?) In funded schemes, distinction is made more complicated by insured pensions with risk shifted to insurance entities (in theory).

10 Distinguish the DB-DC dichotomy from the contributory versus noncontributory. This second dichotomy can have two different meanings. Under one very general meaning, contributory pension means that contributions were paid by employer or worker or both. Noncontributory pension means an old age, etc. pension financed by the general budget. Under more restrictive meaning, contributory means contributions were paid solely or partly by workers, and noncontributory means that contributions were paid solely by employers (including the Budget in the case of public worker schemes). People usually have DC type rights for worker contribution refunds. Other than that, a DB scheme can be contributory or noncontributory (narrow sense). So also, DC schemes can be either. Tax laws often determine how much one or the other Economists believe workers always bear the cost of contributions, whether paid by them directly or by their employers.

11 Traditional Defined Benefit Sponsor promises outcomes. Performance/ longevity risks on sponsor, contributions are variable liability for sponsor. Perpetually Negotiated Schemes Expectations but no clear promises. Neither performance/longevity risks clearly allocated, nor contribution responsibility clearly fixed. Defined Contribution Schemes Contributions are fixed liability for sponsor. Insurance DC Schemes Participant risk DC Schemes Managed by Participants Managed by Sponsor Performance and longevity risks allocated to participants and/or insurers Contribution Uncertainty Investment Performance, Longevity Risks

12 Old Age Insurance versus Forced Savings to Smooth Consumption Initially emphasis was on old age insurance force people to buy a deferred annuity payable at an advanced age at a level above poverty. Overtime became more like forced savings to smooth consumption as more people live to the unchanged advanced age that gets lowered to still earlier ages. These two objectives may call for different instruments and a reintroduction of the concept of old age insurance at a meaningful age. For the early-old years, it is a question about how much government should mandate (versus incentives), and even within the context of a mandate, whether the payout modes should be more flexible.

13 PART TWO PARAMETIC REFORMS

14 Outline of Topics Adjusting wage histories and benefit payments Valorization = adjusting wages to determine benefits. Indexing = adjusting benefits in payment. Adjustments for longevity Special early retirement issues Civil Servants, public workers, military and other uniformed groups Farmers; self-employed Adequacy options Fiscal discipline Summary Thoughts

15 Valorization -- Alternatives Final pay or best 10, 15 years of [adjusted] wages. Fixed unit adjusted by some measure of wage and/or price growth. UK basic pension. Adjust wage histories by measure of wage/price growth, then apply replacement rate formula. US, pre-91 Germany, Switzerland, Yugoslavia, many others. Co-efficient or point systems that record wage histories as percent of average wage; that apply pension factor. Pension factor adjusted by measure of wage/price growth. Post-91 German system, Croatia. Notional account systems. Accounting by contributions (actual or adjusted?). Impute investment returns based on wage/price/gdp and then apply annuity factor.

16 Valorization -- Analysis Final pay and similar options are less stable and equitable in general schemes than the other options. Serbia, M/N already have wage histories and valorization. (Final pay may be reasonable in some occupational schemes if funded and overall macroeconomic stability.) For same valorization rules (cost), traditional DB = coefficient/point = notional account. Many valorization options (depending on objective). Average wage growth, GDP growth, price growth, combination of wage and price growth (unique solution in Croatia). Gross wage versus net wage? Wage sum growth has some theoretical appeal but also some severe risks and potential inequities. Average wage growth minus x points may be the most predictable means to achieve downsizing in replacement rates.

17 Indexing -- Alternatives For same long term aggregate cost, choices lie in a continuum between: higher initial replacement rate and price indexing; lower initial replacement rate and wage indexing. Short term fiscal constraints may limit normal indexing rule (e.g. price growth but wage growth if lower) Available resources indexing rule is politically unstable (many examples from region, including restitution debate in Croatia). Even if limited, some stable rule is better. Half wage, half price growth has become a popular choice among policy makers. May be a necessary compromise, but not obviously the right choice.

18 Indexing Analysis Considerations include: Why be the richest the day you die? Household preferences for more spending in earlier active retirement years. Possible social need to force delay in pension wealth to compensate for erosion in other parts of retirement portfolio. Perceptions of equity across close cohorts: the three school teachers problem. Complicated (but sensible) Swedish solution presume rate of return (average wage growth) during payout period to set higher initial replacement rate, price index result, and then adjust price indexing down or up if wage growth deviates significantly from assumed path. Price growth with a wage growth cap, or price growth minus x points probably are the most predictable options if downsizing in average benefits is needed.

19 Longevity Adjustment -- Alternatives Pension schemes of any kind can not ignore that life expectancy at retirement has been and is increasing. Less mortality during working years but enough to offset. Shift of annuity table risk back to households In funded occupational schemes (mandatory or funded), in US, shift to employer DB plans that use DC language (cash balance plans) and to participant directed DC plans, and in Europe and other OECD, shift to fixed contribution insurance DC plans and (less so) to participant directed DC plans. In mandated personal pensions, DC is the mode. Annuity conversion remains a problematic area, even in UK. In state DB schemes, Use of notional account language to justify lower conversion factors with each successive cohort (or cohort groups). Increase normal retirement age relative to first retirement age with increasing longevity and actuarially neutral decrements.

20 Longevity Adjustment Analysis 1 Fewer dependent children may offset more elderly. In 1960 US had higher overall dependency ratio than one projected for But elderly are supported more from public funds; greater health and long-term care costs. Children also are an asset. How rich is the society and what is its real growth rate? More wealth leads to more leisure allocation to the early, active retirement years may be economically efficient. But without funding (or proxy measures) state systems drift toward encouraging too much early retirement. Proxy measure: long term projections and normal cost financing It may not be enough to shift annuity risk at retirement; unanticipated increases post retirement may have to shifted to retirees (participating annuities) as in Swedish NDC. What happens when the artery clearing pill is developed?

21 Longevity Adjustment Analysis 2 For same cost, choice between higher initial retirement ages and higher benefits versus lower initial retirement ages and lower benefits Unfortunately, age does not always bring more careful foresight. Economic myopia remains an issue. Not obvious even that funding early retirement fully compensates society for early withdrawal. Auctioning early retirement options? With some few exceptions, politicians in most countries are refusing to face this most fundamental trade-off. Example of Latvia having to go through two iterations of NDC reform. Lithuania is back and forth. In U.S., Sweden, and other countries policy-makers continue to hope that incentives will resolve issue.

22 Special early retirement categories? Should those in hazardous, strenuous jobs be allowed extra early retirement? Yes, if they truly have shorter life expectancies and no other compensating measures. But this logic typically leads to abuse. Higher pay may be better solution. If life expectancies the same as general population but ability to perform demanding jobs diminishes, should be handled through higher pay or distinct occupational schemes, provisions. Move to funded schemes to cover early-early retirement as quickly as feasible. Slovenia, Bulgaria offer good examples. Extra PAYG tariffs are not a good proxy for real funding.

23 Civil Servants; Military, etc. Fine to create supplementary occupational schemes for civil servants (similar to private sector service industry schemes). But try to avoid completely distinct schemes for them -- if only to force them to think about others. Distinct schemes lead to gaps, windfalls and gaming ( pension maharajahs in Brazil). Hungary? To extent possible, supplementary schemes should be funded. See Denmark as a good practice example. (At least, proxy funding within government accounts at national level.) Military, etc. present particularly difficult problems of training and optimal retention. No good examples from either OECD or elsewhere. Consider funded supplementary schemes at normal retirement and pre-retirement severance pay packages in lieu of either distinct schemes (Croatia) or privileges.

24 Self-employed, Farmers? Do not attempt to cover them in general earnings related scheme (restrict to the employed ) Only quite late were these groups included in most OECD schemes. Even today, Germany excludes the liberal professions who must purchase private pension insurance Chile continues to exclude them from mandatory coverage; contrast to Argentina that includes them but fails to collect Cover but only up to imputed minimum income, discretionary above that (similar to current law) But exclusion or minimal coverage can lead to unintended windfalls and gaming opportunities, coverage gaps and unequal burden sharing Difference between worker and independent contractor? See next slides on adequacy for more discussion.

25 Adequacy Options --1 Rely solely on means-tested supplements in addition to strictly earnings-related pensions. Often considered demeaning for various deserving groups Annuity payout disadvantages the relatively short-lived Redistribute within the benefit formula Frontload accrual rates (as per current law; heavier weight on initial years) Formula brackets that replace lower earnings at higher rate; higher earnings at lower rate) US, Switzerland and Hungary have such formulas Two-tier structures as in UK, CR that combine a flat basic pension (though work related) with earnings replacement.

26 Adequacy Options -- 2 Minimum top-up benefit only if long service (e.g., 30 plus years). Also minimum benefit guarantee in Chile after 20 years. Alternative flat benefit formula for those with lower earnings histories using years of work. E.g., Croatia probably both too generous and too limited in coverage United States very minimal Germany recently increased to match social assistance levels Subsidize contributions attributable to pre-birth pregnancy periods, child care years (also stay-at-home fathers?); unemployment and temporary disability periods; periods of education; other solidarity periods?

27 Adequacy Options -- 3 Subsidize contributions of farmers, clergy and other good but impecunious groups first-tier basic pension in Lithuania and Croatia; minimum benefit in Uzbekistan; within a distinct scheme for farmers as in Poland.

28 Adequacy Options 3 Approaches to National Pensions (This and next 2 slides from L.Thompson, Vilnius, June 2001) In pure form, paid to all residents who attain a particular age (or become disabled) found in Canada, Denmark, Netherlands, New Zealand, Finland and Sweden only requirement is minimum period of residence In less pure form, require some contributions, but are made available to almost everyone found in Japan, Norway and Switzerland certain similarities to heavily subsidized pensions for farmers in Poland and subsidies of agricultural contributions in Lithuania.

29 Adequacy Options 4 Characteristics of National Pensions Ratio to Financed by Country Average Wage* Wage Tax? Canada 13% No Denmark 20% No Netherlands 33% Yes New Zealand 40% No Sweden 14% Yes ********* Japan 23% Yes Norway 17% Yes Switzerland 18% Yes *ratio of full rate benefit to average manufacturing wage

30 Adequacy Options 5 Characteristics of National Pensions Financing some are financed through wage taxes that are essentially pension contributions; some are financed from general budget receipts Coordination most are first tier/pillar of multi tier or pillar system; are not intended to be the only source of income, particularly for urban wage earners second tiers or pillars often rest of top of basic pension; in many countries earnings up to the level that is covered by the basic pension may be excluded from the second tier or pillar program where not financed from worker contributions, benefits are frequently reduced for high income individuals or those who have substantial other pension income

31 Fiscal Disciplines Managing DB schemes to stay balanced or sustainable. Means constant adjustment to what is promised; therefore, how defined is the benefit in reality? Impose a defined contribution-like constraint on ongoing PAYG-partially funded scheme through a balancing mechanism as in the Sweden NDC system. (See annex on Swedish NDC) Other NDC countries (Italy, Poland, etc.) have incomplete DC contracts and therefore remain really DB. Impose constraint by pseudo-funding as if invested in government bonds. US civil service DB. Impose constraint by funding in marketable government bonds (possibly including bonds of other countries).

32 Guarantee pensions Basic security for those with low or no income-related pension Income related + guarantee Guarantee Income-related pension Income-related pension

33 Summary Thoughts -- 1 Take care about minimum benefit (or guarantee). Important for social adequacy goals, but Can undermine incentives if not carefully designed. It is the system for a large percent of population. Integrate civil servants, military, etc. as much as possible in general scheme; provide separate add-on schemes as necessary (versus privileges in general scheme). Integrate non-farm self employed but be realistic about level. Special tax on them for national pension? Be prepared to subsidize the farmers via pure or backdoor national pension.

34 Summary Thoughts -- 2 What matters more than the form of scorekeeping are replacement rate objectives, burden and fiscal balance. Create space for supplementary schemes (possibly mandated, maybe just encouraged) on funded basis. Keep basic state system s objectives modest, universal as feasible, demographically realistic thresholds for retirement. Today s retirement ages (and easy access to disability) and working pensioners may be necessary as part of economic transition; but consider more time limited benefits (Bank help?). Huge opportunity costs of too much spending on aged, etc, and not enough on children/education and infrastructure. Foremost purpose for funding is risk diversification May help economic growth but worry about the initial conditions in wake of Argentine example Pre-funding basic scheme for actuarial neatness rarely works

35 Summary Thoughts -- 3 Change in basic form may help achieve paradigm shift in public s (elite s?) views, allowing reforms to proceed that are otherwise unacceptable as parametric changes. Swedish, Italian reforms aided by adoption of notional account rhetoric. Common denominator of a savings account. The radiating effect of changes within historical spheres of influence. E.g., Germany s effect on Croatia, Sweden on Latvia. And Czech Republic on Germany? Legacy effects (e.g., the strong norm in the former YR space that valorization and indexing should move together). BUT change in form usually brings transition rules in tow. Can become very complicated and not transparent.

36 Questions for Discussion - 1 Given a limited budget, what is more important to your system -- assuring a basic level of minimum income for everyone with some minimum number of years of work (or spouse of such a worker), or giving benefits roughly proportional to earnings? How do you weigh the trade-offs?

37 Questions for Discussion - 2 Should public sector workers be treated differently than other formal sector workers with money wages? If so, why? And how? What should be done about farmers with little or no money wages?

38 Questions for Discussion - 3 What should be done about well-off selfemployed (e.g., doctors, lawyers and other such professionals who are not salaried)? What should be done about urban selfemployed whose work is intermittant and/or hard to monitor and who are not well-paid professionals (e.g. casual labourers, vendors, taxi cab drivers, and so on)?