The payout phase of pension systems : a comparison of five countries

This paper provides a comparative summary of the payout phase of pension systems in five countries -- Australia, Chile, Denmark, Sweden, and Switzerland. All five countries have large pension systems with mandatory or quasi-mandatory retirement savings schemes. But they exhibit important differences in the structure and role of different pillars, regulation of payout options, level of annuitization, market structure, capital regulations, risk management, and use of risk sharing arrangements. The paper summarizes the experience of these countries and highlights the lessons they offer to other countries.Pensions&Retirement Systems,Debt Markets,Emerging Markets,Insurance&Risk Mitigation,Investment and Investment Climate

Pension Reforms in India: Myth, Reality and Policy Choices

Escalating costs of the pension system is forcing the Indian Government to reevaluate the formal programmes that provide social security to employees. The government has so far received three official reports (namely, OASIS, IRDA and Bhattacharya), which have examined the issue and suggested several measures to provide a safety net to the aging population. This paper examines the recommendations made in these reports and analyses the potential effects of them. It is organized around five policy questions: 1. Should the reformed system create individual (funded defined-contribution) accounts, or should it remain a single collective fund with a defined-benefit formula? The changeover involves a larger public policy choice issue: who should ultimately bear the risk? Should employees/retirees shoulder those risks alone arising from variations in asset yields and unexpected changes in longevity, or should these risks be shared more broadly across participants, if not society? Choice would depend upon to which group the individual belongs. Financially successful people may believe in individual ownership and choice, while low wage earners may want assured returns because they do not have other resources to fall back upon. Unfortunately most Indians, unlike those in many other countries, are in the latter category which cannot bear any risk, more so in the old age. 2. If individual accounts are adopted, should the reformed system move toward private and decentralized collection of contributions, management of investments, and payment of annuities, or should these functions be administered by a public agency? In privately managed funds, associated problems would be intermediation costs, agency problem (principal-agent fiduciary relationship), and greatly increased costs to administer the plan. Several studies across the world have shown that periodic fee may look deceptively low but, over longer time horizons, the cumulative effect can be dramatic, sometimes reducing the benefits by 30 to 50 per cent. 3. Should fund managers of retirement savings be allowed to invest in a diversified portfolio that includes stocks and private bonds? In recent years equity investments, particularly index investing, have become a favoured strategy. Index funds are subject to tracking error, and being loaded with few big stocks, there are much higher risks in index investing than people perceive. Over the period, real annual return on index funds may be more, but people retire only once. Equity markets are highly volatile and go through long periods of feasts and famine. Guarantees would have to be provided in the form of minimum return or providing minimum basic pension on retirement. World bank studies show that government ends up acquiring conjectural liabilities wherever a pension system based on private providers is mandated. How would that be different from the present system where a government agency (EPFO) provides retirement benefits? 4. Should the government move toward advance funding of its pension obligations for its employees, or should these obligations continue to be financed on pay-as-you-go basis? Studies have shown that a simultaneous implementation of funded, diversified, individual accounts is not a "free lunch" once you properly account for existing unfounded obligations and risk. The Bhattacharya Committees estimates show that the government would have to pay out more on account of pensions to its employees for the next 38 years before the new scheme starts showing reduced government expenditure. These amounts do not include the tax foregone by the government on the employees contribution. Several assumptions have been made about the scheme, which the committee hopes would remain valid and that the future governments would behave responsibly. The proposed scheme does not consider intermediation costs and agency risks; in fact, the committee presumes that agents would behave more responsibly than principals. 5. What should be the level of government fiscal support in the form of tax subsidy, foregone tax collections, grants, administrative costs incurred by its agencies, and level of assumed contingent liabilities in case the government guarantees minimum pension? The crucial question is: how much and to whom is this subsidy accruing? Are beneficiaries of the proposed system the ones who need subsidy? Tax treatment of pension is a critical policy choice. A generous tax treatment may promote savings but may be costly in terms of revenue foregone. Apparently, an exercise in balancing is necessary. The priority should, therefore, be putting in place a policy vision and road map with specific goals in relation to pre-determined milestones. These should include a tax financed and means-tested system for lower income groups. If government cannot afford it, then it has no moral or political justification to even consider providing further tax benefits to privileged income groups. If there are no government funds for the first pillar in the World Bank recommended multipillar system, the third pillar should remain out of policy discussions. Emphasis should be on strengthening the second pillar. Suggested reforms neither enhance efficiency nor make the social security system more equitable. It would only privatize the gains while costs and risk for the government would increase considerably. It would only help well-off segment of society in availing more tax concessions. Present problem in the government pension system is due to successive governments behaving like Santa Clauses ignoring the cost to exchequer. Fund managers would not be able to solve these problems. Specific fiscal and other measures for implementing a feasible and viable pension system in Indian conditions have also been suggested in the paper.

Administrative costs and the organization of individual retirement account systems : a comparative perspective

What is the most cost-effective way to organize individual accounts that are part of a mandatory social security system? Defined-contribution individual account components of social security systems are criticized for being too expensive. The authors investigate the cost-effectiveness of two methods for constructing mandatory individual accounts: a) Investing through the retail market with relatively open choice among investment companies (the method first used by Chile and adopted by most Latin American countries). b) Investing through the institutional market with constrained choice. For the retail market, they use data from mandatory pension funds in Chile and other Latin American countries and from voluntary mutual funds in the United States. For the institutional market, they use data from systems in Bolivia and Sweden and from larger pension plans and the federal Thrift Saving Plan in the United States. The institutional approaches aggregate numerous small accounts into large blocks of money and negotiate fees on a centralized basis, often through competitive bidding. They retain workers'choice o some funds. Fees and costs are kept low by reducing incentives for marketing, avoiding excess capacity at system start-up, and constraining choice to investment portfolio that are inexpensive to manage. In developed financial markets, the biggest potential cost saving stems from constrained portfolio choice, especially from a concentration on passive investment. The biggest cost saving for a given portfolio and for countries with weak financial markets comes from reduced marketing activities. In the retail market, where annualized fees and costs range from 0.8 percent to 1.5percent of assets, use of the institutional market in individual retirement account systems has reduced those fees and costs to less than 0.2 percent to 0.6 percent of assets. This reduction can increase pensions by 10 - 20 percent relative to the retail market. Countries that can surmount rebidding problems, weaker performance incentives, inflexibility in the face of unforeseen contingencies, and an increased probability of corruption, collusion, and regulatory capture should seriously consider the institutional approach, especially at the start-up of a new multipillar system or for systems with small asset bases.Economic Theory&Research,Business in Development,Business Environment,International Terrorism&Counterterrorism,Access to Markets

Pension reform in the Dominican Republic

Arguably, the most important public policy initiative underway today in the Dominican Republic is the reform of its social security programs. The reform is taking place in the context of an economic crisis that will make a complex implementation process even more difficult in the first few years. In the longer run, the complete overhaul of the health and pension systems will have a major impact beyond social policy. It will affect labor markets, fiscal policy and even financial markets. In terms of the country's economic development, much is at stake. This paper describes the systemic pension reform introduced by legislation in 2001 but implemented only in mid-2003Pensions&Retirement Systems,National Governance,Poverty Assessment,Environmental Economics&Policies,Banks&Banking Reform

Pension reform, fiscal policy and economic performance

The volume collects the essays presented at the 11th Workshop on Public Finance organised by Banca d'Italia in Perugia on 26-28 March 2009. The workshop examined the issue of pension reform with the purpose of highlighting the recent analytical developments and the most relevant policy issues. Session 1 examined the impact of pension reforms on the labour market and their effects on investments in human capital and productivity growth. Session 2 was devoted to the impact of pension reforms on capital markets, and specifically on the effects of funded schemes. Section 3 considered the impact of reforms on income distribution, within and across generations, and macroeconomic developments. Section 4 dealt="" with the political economy of pension reforms and their role in the broader fiscal policy context.pension reform, fiscal policy

Pensions in the Middle East and North Africa: time for change

While other regions — Central and Eastern Europe and Latin America in particular — have been active in pension reform, the Middle East and North Africa have lagged behind. In part this is because of the belief that favourable mean financial problems are still far in the future and pension reform is therefore not a priority. However, pension systems in the Middle East and North Africa face important structural problems. They distort the economy, tend to favour middle- and high-income workers at the expense of low-income workers and cover only a modest share of the workforce (33% on average), mostly workers in the public sector and the formal private sector. Financial problems are also starting to develop: even if favorable demography persists, benefit promises are out of line with contribution rates and retirement ages. This book puts forward a comprehensive framework to guide discussion about pension reform in the Middle East and North Africa

Compliance with the Stability and Growth Pact: An Economic Analysis of Emerging Pressures Relating to Pension Provision

The Treaty of Rome assigns overriding importance to price stability in the firm belief that maintaining stable prices on a sustained basis is a crucial pre-condition for increasing economic welfare and the growth potential of an economy. Price stability is given formal expression in the Stability and Growth Pact, which confines the budgetary freedom of Member States within precisely defined parameters. The European Union takes the view that by helping to create a favourable economic environment, sound monetary policy should secure the broad objectives of the Community laid down in Article 3. One of these objectives is the promotion of social justice and protection. The thesis focuses on an aspect of social protection: the provision of old age security. The realisation that current pension schemes in many Member States will not be fiscally sustainable has forced their governments to start the process of legislative reform. The challenge is to design pension systems that do not place too heavy a burden on members of working age, while still offering an adequate level of benefit to retired members. Pension system reform has often proved a particularly difficult and awkward political undertaking. The thesis argues that Member States with ageing populations will find it increasingly difficult to maintain high standards of social provision and still comply with the obligations of the Pact. It is contended that continuing demographic imbalance will be a constant impediment to the required maintenance of budgetary balance. Countries have implemented changes, such as increases in statutory retirement age, and reductions in replacement rate, so as to avoid further increasing the contribution burden borne by the diminishing proportion of workers. The thesis concludes that public pension design modifications, whether parametric, such as raising the retirement age, or systemic, such as the introduction of a funded component, will only alleviate and not solve the problem. The only answer is an increased number of younger workers, and that requires birth-rates to move towards replacement level