561Japan’s pension arrangements are fragmented and inefficient and lack coherence with the tax system. It could learn from other countries’ experiences as it faces up to the most significant ageing (and now reducing) population of all. Reform is not optional. 2012-05-14T13:05:332008<strong>PensionReforms’ summary and comments</strong><br />
Japan changed its pension rules in 2004 to align future contribution income with benefits’ outgo “to stabilize pension finance”. It was recognised at the time that it would have to be revisited in 2017 when the scheduled increases in contributions levelled off.<br />
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PensionReforms has already looked at a major administration shortcoming – the 50 million ‘missing’ pension contribution records – see <a href="http://www.pensionreforms.com/Preview.aspx?359">here</a>. Part of the reason for that shortcoming, according to this 2008 report, is the fragmented nature of the pension system. There are three systems – for the self-employed, employees and civil servants. <br />
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The 1985 ‘Basic Pension System’ (payable after 40 years’ contributions) was supposed to fix things across all three systems but hasn’t. For example, more than one third of people who are nominally required to contribute, do not do so for a variety of reasons. There are also the problems of old-age poverty (the PAYG Basic Pension is less than that from ‘social insurance’ and “cannot provide adequate income security”) and “unequal burden-sharing”.<br />
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So the “integration of pension systems” is on the agenda; what the report describes as part of a “critical agenda”. Social assistance and taxation should also be on that list. One third of the Basic Pension’s cost comes from general taxation. That is expected to increase to more than half and yet the Japanese system is nominally based on ‘social insurance’ principles. The fact that pensioners pay lower rates of tax than workers with the same income also needs justifying.<br />
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“The fundamental question throughout this paper is how to provide an adequate income to prevent poverty in old age or retirement.” <br />
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In this context, the report concludes that income-tested benefits have their problems:<br />
“In theory, providing means-tested benefits could be more efficient than universal benefits because the latter may require a much larger public pension system, but in practice, means-testing tends to create stronger disincentives because it raises the marginal rates of tax and benefit withdrawal.” A ‘minimum pension guarantee’, focusing just on pension income, may be better.<br />
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The report looks at the pension arrangements of ten OECD countries (including the only country with a true Universal Pension – New Zealand), analysing the different ways they address the issues. PensionReforms notes that ‘replacement rates’ feature here as a measure of a system’s strength but should not. See <a href="http://www.pensionreforms.com/Preview.aspx?543">here</a> for an explanation of the preference for measures of ‘retirement wealth’ rather than ‘replacement rates’. In fact, as the report itself notes, what really matters is the levels of poverty in old age.<br />
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The report initially concludes that “…the Japanese pension system is "inefficient" in terms of both smoothing income (insurance role) and providing adequate income (redistribution role), although the overall income level of Japanese elderly relative to young workers is better than that of the OECD average.”<br />
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The report suggests a debate about the underpinning philosophy of Japan’s pension arrangements. What should the objectives be and how should success be measured? Six alternatives are suggested, drawing on the experience of other countries.<br />
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PensionReforms might quibble at some of the details of the different countries’ arrangements; also at the liberal use of ‘universal pension’ that seemingly includes means-tested and contributions-based options. In either of those cases, the pension cannot be payable to everyone and so does not qualify as ‘universal’. However, the report has a good discussion of the way that different countries do things and what lessons Japan might draw from those experiences.<br />
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PensionReforms suggests an addition to the concept of pension costs. They should include the concessionary tax treatment of contributions to retirement saving schemes, investment income as well as the pension treatment that the report did discuss. For example, in Australia, including that taxation cost would about double the current cost of pensions over the amount that Australia pays through the Age Pension.<br />
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PensionReforms disagrees with the report’s conclusion that “there is no conclusive evidence for [choosing] either social insurance or non-contributory universal pension.” Poverty in old age is not necessarily correlated to poverty during working life though that is often the case. Where ‘social insurance’ benefits are contingent on a contributions’ record (that is itself based on salary/wages), they do not necessarily resolve post-retirement poverty. The only way to do that reliably is a pension that directly limits or eliminates poverty. By definition, only a non-contributory Universal Pension can do that.<br />
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However, PensionReforms agrees with the report’s conclusion that the Japanese system is “inefficient.” It is poorly run, inequitable, complex but, worst of all, as the report notes, Japan has unacceptable levels of poverty amongst the old. That last should take precedence over some of the measures used in the report as a test of any pension system’s efficacy. Current poverty levels may, as the report notes, be a reflection of the way things used to be done but it’s a present problem that any reform must address. (File size 315 KB; 85 pp) 560<br />
http://www.ier.hit-u.ac.jp/pie/stage2/Japanese/discussionpaper/dp2008/dp370/text.pdfIntegration of Pension, Assistance and Taxation: How to Balance Insurance Role with Redistribution Role (2008)560The US Social Security pension is based on a beneficiary’s lifetime earnings. Pension wealth reduces the effect of short-run volatility in incomes but not by much. High volatility seems associated with higher financial wealth but slightly lower relative Social Security wealth. 2012-05-14T12:57:492008<strong>PensionReforms’ summary and comments</strong><br />
The US Social Security pension is based on a claimant’s best 35 years’ inflation-adjusted ‘pensionable earnings’ (that have an annual ceiling). The benefit formula pays an income that is greater in proportion to incomes for those with lower than average ‘pensionable pay’ under the ceiling than higher earners; that is, the system is ‘progressive’: “The structure (e.g. progressive replacement rates) of Social Security provides insurance for lifetime income.”<br />
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In the US, household income has become more volatile over the period 1990 to 2004 but the ‘own incomes’ of Social Security claimants has tended to reflect the business cycles over the last 40 years, though with a lower volatility than household incomes.<br />
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This 2008 report is based on longitudinal data from 1990 to 2004 (the Survey of Family Income and Participation) “…matched to Detailed Earnings Records (DER) where available, and Summary Earnings Records (SER) elsewhere, and also to the Master Beneficiary Records (MBR)”.<br />
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The report focuses on the 1943-49 birth cohorts (with data for the birth cohorts 1936-1942 and 1950-1954 also examined) and suggests “…that the impact of short-run earnings volatility on Social Security wealth is largely inconsequential.”<br />
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As might be expected, “…higher average levels of earnings volatility are associated with higher financial wealth” and, perhaps less expected, “…increases in earnings volatility are associated with lower financial wealth”. This, the report suggests seems to indicate that, during changes in earnings volatility, individuals tend to draw down on previous financial savings.<br />
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The report found that the ‘insurance’ effect on household wealth through these periods of volatility was small:<br />
“Social Security seems to have a negligible insurance value with respect to earnings volatility, and even the small effects volatility has on Social Security wealth are often in the wrong direction to provide insurance, as higher earnings volatility is associated with lower Social Security wealth.”<br />
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The report cautions against drawing too many conclusions from these findings as “…neither average levels of earnings volatility nor increases in earnings volatility are randomly distributed in the population, so we cannot treat these associations as causal.” The authors aim to do further work to see the effects of local labour market conditions on wealth.<br />
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PensionReforms again wonders at the need for a state pension system to so closely associate post-retirement benefits to pre-retirement incomes over at least 35 years. Despite the formula that rewards the lower paid proportionately more than higher paid beneficiaries, the fundamental premise seems misplaced. Apart from producing a necessarily complex system of collections and payments, it seems to fall over on what should be the state’s first obligation – to reduce or even eliminate poverty in retirement. Social Security reduces poverty but is some distance from eliminating it. In one of the world’s richest countries, that outcome should be unacceptable. (File size 221 KB; 41 pp) 559<br />
http://crr.bc.edu/wp-content/uploads/2008/11/2008-14.pdfThe Impact of Changing Earnings Volatility on Retirement Wealth (2008)559‘Knowing’ how long you might live in retirement should be central to decumulation decisions; even your chosen retirement date. US Social Security lets beneficiaries choose their starting date. Financially, they seem consistently to get that decision wrong. 2012-05-14T12:50:522011<strong>PensionReforms’ summary and comments</strong><br />
When people ‘retire’ and become dependent on pensions and their other wealth, knowing how long that ‘other’ money might have to last should be an important component of decumulation decisions; even the date of retirement itself.<br />
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State and private pensions are annuities that will last as long as the pensioner is alive.<br />
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Spending other wealth depends on how long it needs to last and planning would be easier if we knew how long that would be and what investment income will be earned on the diminishing balance. Buying an annuity is a form of insurance against both those unknowns. A private, purchased annuity mimics Defined Benefit pensions in this regard. The trouble is that they look expensive for what they deliver.<br />
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A surprisingly small proportion of retirees (16%, according to findings cited in this report) worry about the risk they might outlive their wealth.<br />
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“Theoretical calculations of the value of annuitization assume that individuals have population average annual mortality risk. But this assumption may not be realistic.” <br />
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Under US Social Security, beneficiaries can choose to start the pension earlier or later than the State Pension Age (currently age 66, rising to age 67 by 2027) so ‘knowing’ when you might die should guide the start date decision because getting it ‘right’ relative to average statistics that drive the reduction and increase formulae creates winners and losers. Delaying the starting date adds to entitlements and so is similar to ‘buying’ an extra annuity; in the usual case, delaying the date is good value but most do not take advantage of the possibility. <br />
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Apparently, individuals seem to think they “know whether they are more or less likely to survive to specified ages, relative to the predictions of life tables.”<br />
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The report looks at what people think about their chances (at age 65) of surviving to age 75 and how that might influence the choice of the US Social Security pension’s staring date.<br />
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“Using HRS data, we show that women, but not men, are pessimistic about their chances of surviving to age 75, and that, relative to the predictions of life tables, individuals are considerably more confident of their ability to forecast their age of death.”<br />
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Men get it about right, on average, but women underestimate the probability of reaching age 75 by an average 10 percentage points.<br />
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As to the chances of forecasting their own expected death dates, individuals seem more confident. In fact, retrospective comparisons show that “…self-assessed survival probability strongly predicts actual survival, but that it is statistically insignificant after controlling for observable health status and socio-economic characteristics, indicating that responses do not incorporate private mortality information.” There is a problem with the data in this regard with some predicting survival probabilities at zero and 100%.<br />
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In any event, relative to the Social Security starting date decision, it seems not to matter much:<br />
“[S]ubstituting the above beliefs for the assumption that individuals have population average mortality has only a small effect on the optimal claiming age and the returns to delayed claiming of benefits. Our calculations of optimal behavior confirm the findings of empirical research, namely that subjective mortality beliefs have only a small effect on claiming behavior.”<br />
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PensionReforms notes that the decision whether the US Social Security pension should start at, say, age 64 rather than 65 or 66 is complex but relatively straightforward because one exactly equivalent benefit replaces another (aside from the annual amount payable). Despite this, most seem to make the wrong decision by starting it earlier than they should, if maximising lifetime value is the measure.<br />
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Choosing one private annuity provider over another is another order of magnitude more complicated.<br />
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Though not a topic for discussion in the report, PensionReforms wonders why the US Social Security system offers the kind of choices that beneficiaries seem unable to weigh up to their individual advantage. Having a fixed State Pension Age seems preferable. However, if beneficiaries are consistently underestimating their survival probabilities, that means the Social Security system consistently ‘wins’ and the long-term cost is less by the result. For a state system, that seems not to be a desirable social policy objective. (File size 1.35 MB; 41 pp) 558<br />
http://crr.bc.edu/wp-content/uploads/2011/11/wp-2011-22-508.pdfHow Do Subjective Mortality Beliefs Affect the Value Of Social Security and the Optimal Claiming Age? (2011)558Despite reforms, the UK government is looking at further changes to pensions and age-related financial support. Changes might encompass increasing participation rates, ‘future-proofing’ the State Pension Age and integrating other welfare support. 2012-05-09T15:18:402011<strong>PensionReforms’ summary and comments</strong><br />
PensionReforms has already looked at the UK government’s ‘green paper’ <em>A state pension for the 21st century on the challenges facing an ageing population</em>: see <a href="http://www.pensionreforms.com/Preview.aspx?466">here</a> for a review and for PensionReforms’ suggestions on other things the government should also add to the debate’s agenda. The government’s ‘white paper’ that says what the government proposes to do is due soon.<br />
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This report from The Oxford Institute of Ageing was published before the government’s ‘green paper’ and covers some of the same territory, taking advantage of some early government signals as to what the ‘green paper’ might cover.<br />
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The UK faces an ageing population with “…[s]teep declines in mortality in middle and late life [that] mean we have a much better chance of living to claim a state pension, and then to receive it for much longer than has ever previously been the case.” That is compounded by ‘below replacement rate’ fertility levels so there will be “…fewer individuals in subsequent generations paying contributions to finance a growing outgo.”<br />
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The report notes that ‘disability-free’ life expectancy has improved somewhat in the UK. For males after age 65, that has increased from 7.6 years in 1981 to 10.0 years in 2006 and from 8.5 years to 10.6 years for females. However, the extra years with some or significant disability has also grown from 5.4 years to 7.1 years for males and 8.4 years to 9.3 years for females over the same period. The disability-free period post-age 65 has stayed at 58% for males and increased from 50% to 53% for females.<br />
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Despite all the changes that have been (and are still being made) to the UK’s pension arrangements, the report suggests “…arguments for further reform to the system”. Apart from anything else, “…the current system [is] only partially successful in its role as a safety net for people with very low lifetime earnings.”<br />
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The report examines reforms in four areas:
<ul>
<li><strong>Labour force participation:</strong> What the report calls the “demographic deficit” might be addressed if policies continue to “incentivise labour force participation” at all ages, not just amongst those of pension age.</li>
<li><strong>State Pension Age:</strong> There should be a formal link between “measures of life expectancy” and the State Pension Age that would see automatic adjustments rather than the current ad hoc approach.</li>
<li><strong>Health costs:</strong> Reductions in the cost of pensions might be undermined by increased demands on other aspects of the welfare system such as the unemployment and disability benefits. “By paying particular attention to measures of “healthy life expectancy” when setting state pension age, the risk of substituting state pensions with other welfare benefits can be mitigated.”</li>
<li><strong>Equity:</strong> Some older people face relatively shorter periods after the increasing State Pension Age. “These same individuals tend to be those who rely most on the state safety net and for whom the risk of substituting state pension with disability benefit is greatest.” Perhaps different State Pension Ages “…based upon lifetime earnings or a requirement for a minimum contribution period are ways of reflecting diversity”.The government’s ‘green paper’ picked up on some of these ideas, in particular on the issue of the State Pension Age.</li>
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The government's 'green paper' picked up on some of these ideas, in particular on the issue of the State Pension Age.<br />
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PensionReforms thinks that the UK’s pension arrangements are amongst the world’s most complicated and yet, despite all the money spent both directly on state pensions and indirectly on tax breaks for private provision, the system seems to let down the most vulnerable – see <a href="http://www.pensionreforms.com/Preview.aspx?497">here</a> for more on elder poverty levels and how the latest raft of 2012 changes won’t change those enough.<br />
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The report acknowledges this but then focuses on different ways of ‘tightening’ the present arrangements. The suggested variable State Pension Age (or even ‘personalised’ State Pension Ages) will make things even more complex. The history of the UK’s state pension arrangements is characterised by notions of ‘fairness’ which might be commendable but that come at the expense of numbing complexity.<br />
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PensionReforms thinks that State Pension Ages should change but only on a well-signalled basis with at least, say, 20 years’ warning so that older workers can re-adjust their retirement saving programmes.<br />
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The New Zealand experience was that when the income test on the Tier 1 pension was abolished, labour force participation rates amongst the population over age 65 rose from 9.2% in 1996 to 17.1% in 2006. Data from 2010 indicates a participation rate of 36% of those aged 65-69 and 14% of those 70-74. <br />
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If the UK adopted the Universal Pension discussed in the government’s ‘green paper’, that may well attend to some of the report’s reform themes and may even extend the disability-free life expectancy as well. The report’s concern about the possibility of a Universal Pension acting as an “incentive to early exit from the labour force” seems misplaced. PensionReforms expects the reverse to be the case – that seemed to happen in New Zealand. (File size 1.4 MB; 66 pp) 557<br />
http://www.ageing.ox.ac.uk/system/files/110110%20Living%20Longer%20and%20prospering%20Final.pdfLiving longer and prospering? (2011)557So-called ‘active-ageing’ is seen as a way to help control the health costs of ageing populations. In Austria, even if greater numbers are living better lives into old age, the number needing close care is also growing. Looking after their needs will be a challenge. 2012-05-09T15:00:072011<strong>PensionReforms’ summary and comments</strong><br />
‘Active ageing’ is the tag often used as a catch-all to cover policies that aim to keep older people out of close, and expensive care. The report describes policies under the ‘healthy ageing’ tag as the “ideology – not to say, the myth”. However, there are some older people who will never qualify as ageing healthily.<br />
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“[…W]ith a steady increase both in life expectancy and chronic diseases in later life, today more older people do not comply with a normative and often idealised image of “healthy ageing”. They live and age – often for decades – with health limitations and dependencies in different areas of life.”<br />
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Societies need to think carefully about this larger group as its members will increase claims on physical and medical resources and, of course, on taxpayers. They are often ‘socially disadvantaged’ and difficult to reach. The report suggests that the challenge cannot be addressed by the “…passive “keeping” of older and care dependent people in care homes.” A “better integration of health and social systems” seems preferable.<br />
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The case of Austria is discussed in the report to illustrate the issues.<br />
“Assistance to the informal/family care sector through adequate and appropriate formal/professional care services remains unsatisfactory in many areas despite improved support for family caregivers … and amendments in respective legal frameworks.”<br />
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The position is different in the general area of prevention and health promotion where “…there exists a clearly stronger legal as well as structural basis, which is certainly also internationally regarded as exemplary” but directed mainly at younger people.<br />
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The report lists some examples of initiatives associated with long-term care. But they aren’t enough. In Austria, apparently 80-85% of “vulnerable older people are cared for at home by (mostly) female family members” and that resource may not continue to be available for baby boomers.<br />
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The report recommends the development of “…a new and comprehensive understanding of long-term care” that doesn’t necessarily mean “entering a nursing home or the need for 24-hour care!”<br />
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“It should be the central aim of long-term care to offer frail older people with long-term support needs a coordinated network of appropriate therapy, care or support at the right time and place in order to best compensate for dependencies and to promote and maintain individual resources for autonomous, dignified and active ageing.” And that includes “…older people who act as informal caregivers themselves and, thus, are at high risk to suffer from related physical, psychological and social problems.”<br />
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PensionReforms notes that baby boomers have changed every aspect of society as they moved from birth through childcare, education, employment, housing and then the bringing up of their offspring. As the first of them have now reached State Pension Age, they will almost certainly change retirement and ageing. Even though there will be much larger numbers of older people leading active retirements, there will also be much larger numbers needing ‘long term care’. <br />
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Aiming to improve long-term care has the potential to do a better job for the elderly needing the care, their families and taxpayers. (File size 463 KB; 17 pp) 556<br />
http://www.euro.centre.org/data/1310723769_53386.pdfActive Ageing and Prevention in the Context of Long-Term Care (2011)556An ILO report recommends the adoption of a ‘social protection floor’ in developing countries. For the old, a ‘basic, non-contributory pension’ seems the most efficient way of achieving that. As an aside, developed countries might learn something as well. 2012-05-09T14:53:142011<strong>PensionReforms’ summary and comments</strong><br />
There are things that only governments can do, such as alleviating or even eliminating poverty (by, for example, taxation/redistribution). There are other things that governments and others can do such as basic health, clean water and effective sanitation. Then there are things that governments do but that might be better delivered in other ways such as safe food, adequate housing and education. Who actually does these things and how they are financed is a country’s choice.<br />
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This 2011 report from the International Labour Organisation (ILO) started with a 2004 conference’s declaration that a “minimum level of social protection needs to be accepted and undisputed as part of the socio-economic floor of the global economy”. A ‘Social Protection Floor Advisory Group’ was informed by seven conferences (in late 2010 and early 2011) two country visits (Vietnam and China) and numerous “high level” consultations. This report is the result.<br />
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The key message is about a country’s ‘social protection floor’ (SPF):<br />
“The social protection floor is neither a prescription nor a universal standard. It is an adaptable policy approach that should be country-led and responsive to national needs, priorities and resources. It facilitates a comprehensive approach to social protection, focusing on basic benefits first, having been conceived and developed on the basis of recent innovative experiences.”<br />
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Obviously each country must develop its own SPF that will be influenced by “…a framework of nationally specific institutional structures, economic constraints, political dynamics and social aspirations. In other words, there are no one-size-fits-all solutions.”<br />
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With respect to poorer countries, the report recommends “a number of principles and modalities” that should be taken into account, including, with respect to older people, preventing poverty and “[m]inimizing disincentives to labour market participation”.<br />
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The report notes other studies (from the UN and HelpAge) that ‘basic, non-contributory pensions’ are not out of reach in those countries. In the UN study (cited at page 43), “…the cost of abolishing extreme poverty in old age by providing a basic universal pension equivalent to US$1 per day to all people over the age of 60 would amount to less than 1 per cent of gross domestic product (GDP) per annum in 66 out of 100 developing countries.”<br />
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The report recommends collaboration amongst agencies, donors and affected countries. <br />
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“We recommend that international organizations join forces at national level to support, initially on a pilot basis, a group of self-selected countries. For these countries, we recommend that the social protection floor approach be considered part of the United Nations Development Assistance Framework (UNDAF) and integrated into national development plans.”<br />
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How to monitor progress?<br />
“We encourage countries to include information on the implementation of social protection floors when reporting regularly under UN treaty obligations. We also invite the relevant treaty bodies and committees to consider preparing a general recommendation on the contribution of national social protection floors to the realization of the social rights set out in various conventions.”<br />
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All this is seen as part of the pathway towards achieving the ‘Millennium Development Goals’. The G20 countries are apparently “…encouraging international donors to devote some Official Development Aid to strengthening social protection floors in low-income countries, while respecting the individual approaches these countries wish to take with regard to implementation.” The report suggests that the “…G20 prepare an action plan to implement its conclusions and establish periodical monitoring and reporting mechanisms regarding global progress towards the establishment of social protection floors.”<br />
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PensionReforms thinks this looks like progress. At least the idea of ‘basic, non-contributory pensions’ (what PensionReforms prefers to call ‘Universal Pensions’) receives a fair airing though the report’s language is sometimes laden with diplomatic obfuscation. But, as the report notes, countries do not need to get there in one go. They are usually short of money (what the report describes as needing “additional fiscal space”) but, whatever money is available can be turned into a Universal Pension by the manipulation of the two key drivers of cost: the age of entitlement (State Pension Age) and the annual amount payable.<br />
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“International experience shows that effective country-specific floors, which can gradually expand, are not only affordable, but can pay for themselves in the long run…” Improving a country’s income tax collection rate “…will help to mobilize resources for the phasing-in of social protection floors.”<br />
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PensionReforms has already covered a number of cases where pensions seem to have made a real difference to families’ lives in poorer countries. Swaziland (a near-Universal Pension) <a href="http://www.pensionreforms.com/Preview.aspx?441">here</a>; India, Lesotho, Namibia and South Africa <a href="http://www.pensionreforms.com/Preview.aspx?475">here</a> and Tanzania <a href="http://www.pensionreforms.com/Preview.aspx?471">here</a> show how pensions can change things. For more examples, go to the ‘Search & options’ tab on PensionReforms <a href="http://www.pensionreforms.com/Sort.aspx">here</a> and choose ‘Poorer country strategies’ as the search ‘Topic’ from the drop-down menu. There are currently 26 reports listed there.<br />
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PensionReforms thinks the report could have gone on to say that ‘developing countries’ are not the only ones that might profit from introducing the SPF concept for the old. Elder poverty levels in many <em>developed</em> countries are a disgrace. The OECD suggested (see <a href="http://www.pensionreforms.com/Preview.aspx?289">here</a>) that, in the mid-2000s, poverty levels in five ‘developed’ countries exceeded 20% despite very large amounts of money being directed through pensions, forced private provision and expensive tax breaks for retirement savings. Korea (45%), Ireland (31%) and Australia (27%) topped this ‘dubious distinction’ group. A Social Protection Floor should help these governments to focus on what really matters. (File size 2.3 MB; 150 pp) 555<br />
http://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/---publ/documents/publication/wcms_165750.pdfSocial Protection Floor for a Fair and Inclusive Globalization (2011)555Rating agencies seem not to worry about a country’s ‘implicit pension debt’. In fact, using debt to reduce the IPD may be seen as counter-productive because it increases risk on account of now explicit debt. Privatising pensions from a position of surplus may be better (but may not). 2012-05-07T11:12:092008<strong>PensionReforms’ summary and comments</strong><br />
Some people worry a lot about what is called a country’s ‘implicit pension debt’ (IPD). This is based on present value calculations of expected pensions in the face of ageing populations. The argument runs that we know about when citizens are to retire; we know about how much their pensions will be and that, as with private employers, we need to recognise those financial commitments in some way on today’s ‘balance sheet’. We may even be able to partially pre-fund those obligations to reduce their impact once the pensions begin.<br />
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This 2008 report from the IMF looks at whether countries might do something about their IPD and whether, in fact, the IPD actually matters. It uses the reforms carried out in Mexico as a case in point.<br />
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“We find that, rating agencies do not take into account IPD when assessing sovereign risk, but focus on the country’s explicit financial debt.”<br />
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The report wonders whether the rating agencies think that explicit debt is more significant than the IPD or whether the failure results from the agencies’ own myopia. But that seems not to matter:<br />
“This bias (if we can call it so) in the assessment of sovereign risk appears to be robust to a reasonable range of model specifications, and does not just reflect problems in the measurement of IPD.”<br />
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So, if a country decided to do something about its IPD, that seemingly will make little difference to the way that its creditworthiness is regarded. Unless, that is, the country decided to set aside money today by effectively increasing its debt. The report suggests that this should give countries pause for thought when considering reform of their pension financing arrangements. It would not apparently help to explain that the reform is simply making explicit something that is already implicit.<br />
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“A clear policy implication of the paper is that a radical pension reform that aims at improving a sovereign’s long-term solvency by reducing implicit pension liabilities could end up increasing the riskiness of the government’s balance sheet in the short and medium term, thereby hurting the country’s credit rating, unless fiscal adjustment keeps the explicit debt trajectory from deteriorating.”<br />
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The report concludes that a reform of this nature (‘pension privatisation’) can be contemplated only when there is “fiscal space” to do that. If a country wanted to do that, cutting other costs to finance the change seems preferable.<br />
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“The second [implication] is that when governments do not have room to implement the needed fiscal adjustment to offset the near- and medium-term cash costs of a pension privatization, it might be preferable to follow a gradual but decisive parametric approach to improve the sustainability to the PAYGO pension system before a transition to a fully-funded system might be undertaken.”<br />
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In other words, cut pension entitlements.<br />
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PensionReforms is pleased to see that rating agencies seem not to care about a country’s IPD because PensionReforms doesn’t worry about it either. It is very surprising to see the concern about the financing of future pensions when there is no equivalent concern about the financing of future roads, education services, policing or any of the other things that governments spend their revenues on. What is it about pensions that attract these very complicated calculations that rating agencies seem not to be worried about? Is it because private employers are required by accounting standards to show net pension obligations as a contingent liability? PensionReforms understands why capital markets need that information for private employers but the same does not apply to governments in respect of state-provided pensions.<br />
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In fact, it doesn’t really matter which particular cookie jar the money for future pensions comes from – in 2050, the ‘affordability’ of pensions in that year will be determined by the strength of the 2050 economy and the willingness of 2050 taxpayers to support those benefits. A PAYG pension is in financial substance no different from the financing requirement of a new motorway or the wages paid to policemen in 2050.<br />
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In summary, the IPD calculations seem not to matter much so PensionReforms hopes that this might discourage future researchers from working out what they are. Markets seem not to care about them because, unlike explicit debts, they think IPDs aren’t real debts. (File size 356 KB; 27 pp) 554<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp08195.pdfPension Privatization and Country Risk (2008)554The design of the US Social Security pension intends to pay a higher rate of benefit to the low paid over the high paid – it is ‘progressive’. The benefit’s income tax treatment can change that; but only by a bit. 2012-05-07T11:02:422011<strong>PensionReforms’ summary and comments</strong><br />
Pension systems tend to pay higher benefits, proportionately, to retirees with lower pre-retirement incomes than to the higher paid. The US Social Security retirement pension has higher accrual rates for the first tranches of ‘pensionable’ pay. It also caps pensionable pay but charges ‘contributions’ at a flat rate to the ceiling. Then again, high Social Security pensions attract higher levels of income tax thus increasing the progressive nature of the benefit formula. Finally, the fact that contributions are levied on an individual basis but benefits calculated on a household basis means that spousal entitlements can change the redistribution effect.<br />
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PensionReforms recently looked at a 2000 report that demonstrated equivocal effects when lifetime incomes and mortality statistics are taken into account – see <a href="http://www.pensionreforms.com/Preview.aspx?546">here</a> for more.<br />
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This 2011 report looks at just the effect of federal income taxes on the ‘progressivity’ of Social Security pensions. The report acknowledges that mortality and marital status also affect the scheme’s progressivity but that the effect of federal income taxes alone had not been isolated.<br />
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“This study calculates the impact of federal income taxes on the progressivity of the OASI program. It uses HRS data linked with the Social Security Earnings Records to estimate OASI contributions and benefits for individuals and households, before and after income taxes.”<br />
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The first tax effect is provided at the contribution level – individuals pay contributions from after-tax pay whereas the employers can claim a deduction for the business expense. The net benefit of contributions is therefore worth more to the highly paid and makes Social Security more regressive.<br />
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Then there is the tax on the benefits themselves. About one third of recipients now pay that so tending to make Social Security more progressive.<br />
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“[The report] uses two measures of progressivity - redistribution by decile (the difference between the share of total benefits received and the share of total taxes paid), and effective progression (the change in the Gini coefficient). Under both measures, the results without the income tax are exactly what others have found: Social Security is progressive on an individual basis, and about half as progressive when measured on a household basis for the HRS cohort. Adding income taxes could make the program either more or less progressive.”<br />
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The combined effect of all the contribution, tax and household effects is “relatively small”.<br />
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“The net result is that adding the personal income tax to the analysis makes Social Security more progressive than without taxes, on both the individual and household bases. Importantly, however, the impact of taxation on redistribution increases significantly among younger cohorts. Under current law, the Social Security system becomes more progressive over time.”<br />
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PensionReforms notes that this is an extremely complex issue but that the benefit designers may be a bit relieved at the report’s conclusions. The results are seemingly more by accident than good management.<br />
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The only valid reason for carrying out a lifetime tax calculation of the kind done in the report is because the benefits are calculated on a ‘working lifetime’ basis. However, any such analysis is based on a somewhat heroic assumption: that benefits remain largely unchanged. We know that isn’t happening now and the present rollbacks are likely to continue.<br />
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PensionReforms therefore wonders at the utility of such comparisons. Apart from anything else, “[v]irtually all progressivity measures require transforming tax and benefit streams into present discounted values. That transformation requires assumptions about mortality probabilities and discount rates.” There is at least one thing about which we can be certain – those numbers may ‘work’ across populations but they have little significance for individuals and households.<br />
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PensionReforms questions instead why the state might be involved in facilitating the continuation of a pensioner’s pre-retirement standard of living. Making a more effective job of eliminating poverty amongst the old might be preferable. (File size 1.1 MB; 31 pp) 553<br />
http://crr.bc.edu/wp-content/uploads/2011/11/wp_2011-21-508.pdfHow Does the Personal Income Tax Affect the Progressivity of OASI Benefits? (2011)553Countries with some form of compulsory, Tier 2 retirement savings arrangement must have rules about who can invest those savings in the accumulation phase. The choices of ‘AFORE’ by Mexican employees seem ‘sub-optimal’ with consumers confused by the ‘noise’. 2012-04-30T13:59:402008<strong>PensionReforms’ summary and comments</strong><br />
In theory, the state should be the provider of last resort for incomes in retirement. Those who can afford to look after themselves should do just that. The trouble is that individuals seem short-sighted when making saving decisions for the retirement income project, thus exposing the state to the risk of private under-provision. The World Bank’s ‘solution’ for this was a Tier 2 system of forced saving that took the 1981 Chilean experience as its model.<br />
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According to this 2008 report on Mexico, the IMF thinks that “[e]mpirical evidence from these regimes is clear cut in terms of their macroeconomic success. Individual capitalization schemes have contributed to a decline of fiscal deficits, the increase in domestic savings and financial markets development.”<br />
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The report looks at a difficulty at the micro level in Mexico. Tier 2 systems of the kind espoused by the World Bank set up ‘approved’ managers of the employees’ savings. Usually, as in the Mexican case, savers must choose a provider. The issue is how they make that decision and, having made the initial decision, what might motivate them to change provider?<br />
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“Individual accounts systems have the implicit assumption of active and well-informed consumers regarding their retirement savings, which in general has not been the case. Well-informed consumers tend to respond swiftly to price variations or to changes in the quality of service. Hence, under the assumption of informed workers, pension fund managers that do not provide a proper service or charge a fee that exceeds that of the rest, will simply witness their customers opting out to another competitor.”<br />
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That’s the theory. How does it turn out in practice in the case of Mexico? Not very well: “[E]mpirical evidence seems to suggest that individual capitalization systems are characterized by a marked demand inelasticity. This implies that the worker’s choice of pension fund administrator does not respond, as expected, to changes in fees or returns.”<br />
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The interests of the successful provider should be aligned to the savers’ best interests – lower than average fees, better than average investment returns for given levels of risk and outstanding service levels should see savers switching to the ‘winners’. Again, practice seems to confound theory:<br />
“[I]ndividual capitalization schemes have not yet been able to completely satisfy this conjecture. The article presents evidence for the case of Mexico and shows that account transfers among pension administrators barely respond to price or return considerations and that AFORE switching has most of the time not improved the consumer’s situation.”<br />
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But it gets worse. It seems that the way in which Mexicans choose their AFORE is ‘suboptimal’. When switching providers, instead of rewarding the better providers and strengthening the competitive environment created by the compulsory environment, “…AFORE switching has so far undermined the system and resulted in the destruction of value.”<br />
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The problem seems to be caused by the providers’ sales forces who apparently have more sway in where savings go than the savers themselves. Allowing savers an unlimited number of transfers in a year has seemingly made things worse. 17.7% of members switched in 2006 alone.<br />
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The report finds that having more providers seems to have worsened the position.<br />
“In general, the addition of 10 new administrators since 2003 has not favored the consumer.”<br />
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The report suggests that normal competitive processes don’t work “in markets of complex goods or services, such as pension funds” because savers really don’t understand what they are doing and are ‘confused’. <br />
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“As a result, the consumer can not easily distinguish the main attributes or features of the product to make an appropriate decision. Hence, “noisy” evaluations of the product by the consumer tend to undermine the power of competition. This allows firms, even in highly competitive markets characterized by a large number of players, to reach equilibrium prices with mark-ups.”<br />
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So, more competition also doesn’t seem to affect prices much. <br />
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The answer, according to the report is to have the regulator address the reduction of the confusing ‘noise’. A more ‘transparent system’ will “facilitate [the consumer’s] decision-making process”.<br />
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“A market without “noise,” in which the worker becomes an active and well-informed consumer when choosing AFORE, will eventually strengthen competition among pension funds for the benefit of the consumer.”<br />
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PensionReforms suggests that this is all highly unsatisfactory. For a start, PensionReforms suggests that attributing the changes in the macro-economic environment throughout Latin America to just the introduction of Tier 2 schemes seems optimistic. Macro-economic conditions may have improved during the lifetimes of the various schemes but that may just be correlation rather than causation.<br />
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PensionReforms has noted on a number of occasions some singularly unsuccessful aspects of the reforms, low coverage being just one of those (in 2008, it was just 30% in Mexico). <a href="http://www.pensionreforms.com/Preview.aspx?456">Here</a> is a 2011 analysis of coverage and other problems in Latin America.<br />
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Even Mexico’s arrangements seem, at heart, a money-go-round – see <a href="http://www.pensionreforms.com/Preview.aspx?245">here</a> and <a href="http://www.pensionreforms.com/Preview.aspx?250">here</a> for more.<br />
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The expanding network of Tier 1 pensions in Mexico seem also to underline the Tier 2 failures – see <a href="http://www.pensionreforms.com/Preview.aspx?4">here</a> for the case of Mexico City’s own solution to the problem of poverty amongst the old.<br />
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So, in this context, worrying about competitive aspects of Mexico’s network of AFOREs seems a bit of a sideshow. There are so many more significant issues to worry about. However, it is interesting to see that state-induced ‘competition’ doesn’t produce anything close to a proper competitive market. PensionReforms suggests that that difficulty will persist regardless of (or perhaps because of) the number of laws passed that are intended to improve things. (File size 894KB; 63 pp) 552<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp08177.pdfConsumer Confusion - The Choice of AFORE in Mexico (2008)552The US Tier 2 ‘Social Security’ requires at least 10 years’ contributions (or a qualified spouse) for a pension entitlement after age 62. About 4% of those aged 62-84 in 2010 won’t get a benefit. The group’s make-up is predictable; their unmet needs great. 2012-04-30T13:51:582011<strong>PensionReforms’ summary and comments</strong><br />
Most state-provided retirement pensions require long periods of either residence or some form of ‘contribution’ or tagged tax to qualify for the full potential entitlement. So it is in the US.<br />
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Under the Social Security system, a retiree must have made contributions for at least 40 quarters (10 years) to qualify for any pension. The alternative is to acquire a spouse who qualifies in order to obtain a non-contributory spousal benefit worth 50% of his (or her) pension, rising to 100% on becoming a widow(er). Those who do not meet either test are known as the ‘never-beneficiary population’. They amount to about 4% of everyone aged 62-84 in 2010. In 2010, that was about 1.6 million people.<br />
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“This article describes the prevalence, demographic characteristics, and economic well-being of this group.”<br />
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The make-up of this group contains few surprises:<br />
“The never-beneficiary population generally has lower education levels and higher proportions of women, Hispanics, immigrants, the never-married, and widows than the beneficiary population.”<br />
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There are also not too many surprises about their living standards:<br />
“Never-beneficiaries have a far higher poverty rate (about 44 percent) than current and future beneficiaries (about 4 percent).”<br />
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Nearly all of the never-beneficiaries (95%) have not contributed for at least 10 years and most of them are older immigrants and “infrequent workers”. The poverty levels amongst these two groups are high: the poverty rate is about 43% for older immigrants and 57% for infrequent workers. These two groups rely on the heavily tested Supplemental Security Income (SSI).<br />
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PensionReforms notes that the SSI doesn’t seem to do a good job at preventing poverty amongst the never-beneficiaries. The poverty rates are evidence of that.<br />
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The report should also have noted that the two key groups have not only missed out on accruing sufficient entitlements in their own right but have also failed to acquire a qualifying spouse. On any count, these groups may have contributed to Social Security but, because they did not complete the minimum 40 quarters’ coverage (10 years), their contributions have effectively been ‘wasted’.<br />
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PensionReforms also notes that the US uses absolute rather than relative measures of poverty lines. They are adjusted each year, but only by price inflation, not by wages or per capita GDP. The Weighted Average Poverty Thresholds for 2010, estimated by the Census Bureau, are $US10,458 (22% of per capita GDP) for a person living alone, aged 65 or older, and $US13,195 (28% of per capita GDP) for an elderly couple. In 1980 the poverty thresholds were 32% and 41%, respectively, of per capita GDP (see <a href="http://www.census.gov/hhes/www/poverty/data/threshld/index.html">here</a> for more). <br />
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The other key point to note in this context is that the Tier 1 SSI is very difficult to access. Eligibility requires both low income and few assets. Any person with 'countable' assets worth more than $2,000 ($3,000 for a couple) does not qualify. The maximum SSI benefit is currently $8,080 a year for an eligible individual and $12,132 for an eligible couple. SSI benefits, after a modest exempt amount, are reduced by one dollar for each dollar of 'unearned' income (interest on savings, Social Security, gifts, inheritances, deemed income from other members of the household) and by 50 cents for each dollar of 'earned' income (wages).<br />
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It isn’t clear to PensionReforms why at least ten years’ contributions are required to pay any Tier 2 pension entitlement at all. The only possible justification is some form of <em>de minimus</em> provision but, given the possible fall-back to Tier 1’s SSI and the much higher costs involved in the administration of an income and asset-tested benefit, that doesn’t seem much of a justification. (File size 332 KB; 8 pp) 551<br />
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1831635Who Never Receives Social Security Benefits? (2011)551‘Income replacement rates’ are unhelpful to measure financial preparation for retirement. ‘Economic wellbeing’ matters and consumption is a measure of that. In the US, a ‘substantial majority’ have things under control. Some groups will have to reduce consumption. 2012-04-18T10:46:092008<strong>PensionReforms’ summary and comments</strong><br />
PensionReforms has recently looked at a report on the futility of comparing income replacement rates between Germany and Australia (see <a href="http://www.pensionreforms.com/Preview.aspx?543">here</a>). This 2008 report looks at the issue in the US from a different perspective, but with a similar conclusion.<br />
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The ‘income replacement rate’ compares the ratio of incomes before and after retirement. The higher that ratio, the thought runs, the better prepared financially is the individual for retirement. There are all kinds of difficulties with that kind of calculation with tax and household composition being only two of those. However, there is a much more significant difficulty – comparing just incomes tells only part of the story.<br />
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“…[B]oth economic theory and common sense say that someone is adequately prepared if she is able to maintain her level of economic well-being, which is not the same as maintaining her level of income or some fixed proportion of income. Economic well-being is typically measured by consumption, which is the measure we use.”<br />
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Measuring economic wellbeing is more difficult than just incomes and that probably explains why income replacement rate measures are more common.<br />
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“We define and estimate measures of economic preparation for retirement based on a complete inventory of economic resources, particularly wealth, which we compare with optimal consumption paths.”<br />
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As the report notes, consumption from a given amount of income before retirement will normally be less before retirement than after retirement. Taxes (including Social Security contributions) work-related expenses and saving for retirement are all taken from income and those change when work finishes:<br />
“The implication is that income could change by a great deal at retirement, yet consumption could be maintained.”<br />
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“We define a wealth replacement rate which shows the amount by which bequeathable wealth at retirement either exceeds or falls short of the amount needed to finance a consumption plan from retirement through the end of life. The consumption plan begins at an observed starting value and follows a path whose shape is determined by observed consumption change with age in panel data. To the extent that current retirees are optimizing their consumption choices the consumption plan is optimal. We define a consumption replacement rate which is the amount by which consumption could be increased in the case where economic resources are more than adequate, or the amount by which consumption would have to be reduced in the case where economic resources are less than adequate.”<br />
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In other words, the report suggests that if the chances of an individual dying with ‘positive’ wealth are 95% or greater, the individual is ‘adequately prepared’ at and into retirement.<br />
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The report uses data from the Health and Retirement Study (HRS) and from the ‘Consumption and Activities Mail Survey’ (CAMS). It “…simulated consumption paths over the remaining life cycle for a sample of households observed shortly after retirement.” It also used the “…resources that will permit the consumption path to be followed with a high degree of probability.”<br />
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“We find that a substantial majority of those just past the usual retirement age are adequately prepared for retirement in that they will be able to finance a path of consumption that begins at their current level of consumption and then follows an age-pattern similar to that of current retirees.”<br />
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Couples are seemingly much better prepared (83% of them) than singles (64% of them) and there are, inevitably, some groups for whom the general finding does not hold:<br />
“In particular, almost half of singles who lack a high school education are likely to be forced to reduce consumption.” In that group only 43% of women and 63% of men were ‘adequately prepared’.<br />
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The report does other calculations to illustrate the change in annual consumption required to make pre-retirement preparation ‘adequate’.<br />
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PensionReforms suggests that all this sounds quite satisfactory and must be seen as unsurprising. Alarmist statements often portray citizens as proceeding, zombie-like towards financial oblivion in retirement. Real life seems less dramatic. However, the report highlights a point often made by PensionReforms – what matters is wealth at and in retirement, not incomes, nor even pensions though those are usually an important component of retirement wealth.<br />
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The report’s findings should probably encourage US policymakers to wonder why they use tax breaks to encourage citizens to save specifically for retirement. PensionReforms thinks that US citizens (and their employers) may be able to decide what to do all by themselves and without the ‘guidance’ of tax incentives. It should be particularly poignant that the people who seem to need most help (based on the report’s findings, the less educated, single people) are those least likely to use tax incentives (but they help pay for them). Getting rid of tax breaks might also help directly address the less well-prepared by allowing the government to install a universal pension. (File size 175 KB; 35 pp) 550<br />
http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp184.pdfThe Adequacy of Economic Resources in Retirement (2008)550Before the current (2008 to ?) fiscal crisis in the Euro countries, it was apparent that ageing populations would strain compliance with the Stability and Growth Pact. As it has turned out, future pensions are currently the least of the EU’s worries. 2012-04-18T10:38:132008<strong>PensionReforms’ summary and comments</strong><br />
Europe’s common currency, coupled with the Global Financial Crisis (GFC) and serious internal imbalances have combined to create almost unbearable fiscal strains on some EU countries. Before that happened, the future financial pressures created by ageing populations seemed to be a significant issue in terms of each country’s compliance with the Stability and Growth Pact (SGP). <br />
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Originally adopted in 1997, the two key elements of the SGP were to:
<ul>
<li>restrict annual budget deficits to 3% of GDP;</li>
<li>maintain national debt at no more than 60% of GDP.</li>
</ul>
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Changes in 2005 fudged the edges of these commitments, allowing breaches as long as compliance was achieved over the cycle and taking account of conditions beyond the country’s control. Since then, the 2011 ‘Euro Plus Pact’ has tried to stiffen the rules. However, as of 2010, the EU as a whole was well short of the targets. Of the EU27, only five countries (Denmark, Estonia, Finland, Luxembourg and Sweden) complied on both counts and 16 were in breach of one or both criteria for at least three years (see <a href="http://en.wikipedia.org/wiki/Stability_and_Growth_Pact">here</a>). Generally, if the SGP is an important agreement, current compliance rates are low.<br />
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This 2008 report looks at the post-2005 situation from the specific perspective of the costs associated with population ageing.<br />
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“Although the SGP, especially after its revision in 2005, clearly aims to ease the financial burden on future generations, it does not incorporate intergenerational equity explicitly and systematically.”<br />
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The report thinks that “actuarial neutrality” across generations should be a policy objective. This “…means that generations that are identical in terms of demography (longevity and fertility) and retirement age should face the same tax rate for the same level of benefits.”<br />
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Against this benchmark “…a pure PAYG rule does not, in general, comply with actuarial neutrality, but tends to shift an increasing burden to future generations.”<br />
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The report’s conclusions are “…derived from a partial equilibrium analysis that ignores the behavioural responses of private-sector agents. It is clear, however, that the demographic and pension system variables would dominate the results even if the model would comprise some endogenous private-sector reactions. Qualitatively speaking, and in terms of orders of magnitude, we would expect our results to be unaffected by such extensions.”<br />
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According to the report, this means that countries must change policies to “help contain the increase.” Part of the answers involve reducing ‘replacement rates’, increasing the ‘retirement age’ but those will not be enough because, especially allowing also for healthcare costs, “…as a result of the ongoing change in the age structure of the population, expenditures increase.” The only choice, in these circumstances, will be to run “a significant surplus for several decades.” In other words, the SGP’s requirement for deficits to be less than 3% of GDP doesn’t go far enough.<br />
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“Our results show the inevitable downside of this: a partial privatisation performed on a fully actuarially neutral basis of a reformed and sound mono-pillar pension system may not easily be abandoned or delayed. This is hardly in the spirit of the EU budgetary rules as they were originally drafted.”<br />
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The SGP, as currently worded, would not allow a government to include the Pillar Two ‘surplus’ to help meet the fiscal or debt targets.<br />
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“…if serious plans for significant privatisation would be considered by some Member State, the solution could be a limited clause (requiring a unanimous decision of the EU Council) that the surplus in the second pillar be included in the government budget balance for the purposes of the [Excessive Deficit Procedure].”<br />
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In the meantime, work needs to continue by “…pension actuaries and statisticians to gather estimates on implicit pension liabilities [that] will greatly help in analysing the issues and designing economically sound reforms.”<br />
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“Hence, while there might be sound economic reasons for privatisation (e.g. a reduction in the distortionary effects of the pension system on the labour market), it is clear that under otherwise similar policies a country that maintains a mono-pillar system can be much more comfortable with the SGP rules than a country that contemplates and implements a partial privatisation of the system. More concretely, a significant privatisation may lead to an Excessive Deficit and prevent the Member State from adopting the euro. For this reason, the reforms to establish a fully funded second pillar may be accommodated under the current rules.”<br />
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PensionReforms suggests that this analysis treats pension systems as somehow self-contained (as between contributors and beneficiaries) while at the same time being disconnected from the real economies of the EU. “Implicit pension liabilities” have no real place in the assessment of the future financial obligations of a government – see <a href="http://www.pensionreforms.com/Preview.aspx?476">here</a> for more on the apparent problems faced by Germany. There seem to be no compelling reasons to apply private sector concepts of actuarial assets and obligations to public pension arrangements. What is it particularly about pensions that warrants that kind of attention? Why are the same principles not also applied to education, security, roads and anything else a government might have to spend future tax income on?<br />
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“Actuarial neutrality” across generations is also pointless. What actually matters is the strength of the economy in the year of pension payment and which particular parts of the economy get to share that. Pensioners as a whole in any year are just one of the groups of claimants.<br />
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Given the SGP framework against which the EU27 as a whole now fails to comply (in 2010, the average fiscal deficit was 4.7% of GDP; the average gross government debt was 80.2%), the ageing population is likely to make things worse. Worrying about the denominator (GDP) is likely to be more productive than the numerators (who gets what).<br />
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Gaining exemptions against the debt requirement in respect of Pillar Two assets is like re-arranging the deck chairs on the Titanic and will probably encourage unhelpful behaviour by governments. ‘Pre-funding’ the public pension obligation should give way to reducing debt. For the government’s accounts as a whole, having both financial assets and debt on the balance sheet is the same as borrowing to invest in financial markets. That is not something that governments are uniquely placed to undertake.<br />
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Finally, “pure PAYG” does not “shift an increasing burden to future generations” as the report suggests. ‘Pure PAYG’ means that this year’s taxpayers meet this year’s pension costs. It has nothing to do with ‘future generations’ and is the only way a government should run the financing of its core pension commitments. Carrying out future projections should be done to satisfy current workers of the likely sustainability of current arrangements but they should stay as projections and as a political exercise. Paying for state pensions is a current issue. (File size 194 KB; 30 pp) 549<br />
https://www.bancaditalia.it/studiricerche/convegni/atti/fiscal_sustainability/session_2/beetsma_oksanen.pdfPensions under Ageing Populations and the EU Stability and Growth Pact (2008)549The US Social Security arrangements are subject to actuarial valuations that extend 70 years and more into the future. The discount rates are ‘soft’ and ‘under-price’ the net retirement liability by about one fifth. Should contributors and/or taxpayers be concerned? Probably not. 2012-04-10T11:00:292008<strong>PensionReforms’ summary and comments</strong><br />
Everyone ‘knows’ that the US Social Security Trust Fund will ‘run out of money’ sometime in the next 40 years. Its current assets (all ‘lent’ to the government at less than market rates) together with expected future ‘contributions’ and interest are less than the expected benefit outgoes. That means “…there is an implicit, intergenerational debt that needs measuring in the government’s accounts. ‘Generational accounting’ is one way to measure the government’s intertemporal budget constraint, [as] it treats all government commitments on a consistent basis regardless of their legal status.”<br />
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This 2008 report argues that the government’s accounts need to take proper account of risk, in the same way that private institutions are required by accounting standards to do.<br />
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“No one would suggest that the prices of explicit financial securities are independent of their risk properties. Such a proposition would deny fact, let alone theory. But the same financial laws that determine the prices of marketed securities govern the pricing of nonmarketed assets and liabilities; they cannot be priced by treating their variable returns as sure things and discounting at safe rates. Nor can safe government payments and receipts be valued using discount factors that differ from the discounts associated with safe marketed securities. This, however, has been standard U.S. practice since our government began considering its implicit debts.”<br />
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The report says that proper ‘mark to market’ valuations should be applied to expected liabilities, like Social Security pensions. If that happened, “[p]roper asset pricing delivers a measure of this net liability that exceeds SSA’s valuation by almost one quarter.” The ‘proper’ approach is something known as ‘arbitrage pricing theory’ (APT) that “treats future government payments and receipts as securities whose returns comprise two components – a market component, which is spanned by traded securities, and an idiosyncratic component, which can be fully diversified.”<br />
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The numbers involved are very large, using the report’s ‘benchmark year’ 2005. Social Security’s ‘net retirement benefit liability’ in respect of working-age Americans (aged 26-60) is valued by the Social Security Administration (SSA) as $US8.5 trillion. The report suggests it should instead be more like $10.4 trillion as this is the amount, according to the report that “…the US government would have to pay private parties or foreign governments to retire this liability.”<br />
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The point of this, the report argues, is to see whether, by valuing all of the government’s activities consistently, taxpayers can see “…whether its overall current policy is sustainable, i.e., whether the government’s entire fiscal enterprise breaks even as a matter of present valuation.”<br />
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The major ‘gaps’ in the SSA’s calculations, according to the report are two-fold: first, there is no allowance for “uncertain future economy-wide average wage growth”. Secondly, the SSA makes “…no attempt to mark their risk-free benefit obligations to market notwithstanding the availability of risk-free securities to do such pricing.”<br />
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That is a much wider project than just Social Security pensions but the report’s approach can apply to other similar obligations. The report deals with a number of potential objections to its recommendations including:
<ul>
<li>The size of the Social Security obligations that would dwarf the financial markets that the APT methods seeks to rely on;</li>
<li>The “idiosyncratic component of wage growth”;</li>
<li>A failure to allow for future policy changes, a charge to which the authors “plead guilty”;</li>
<li>The gulf between the values that workers might place on benefits compared with the APT result;</li>
<li>Lastly “there is the question of relevance” – does it really matter of the market’s view (APT-driven) of a government’s future financial position varies from the government’s declared position.</li>
</ul>
<br />
PensionReforms has a more fundamental objection to these kinds of calculations. The APT-driven alternative is really no better than the SSA’s valuations to which the report takes exception. In fact, the eye-watering size of the more ‘realistic’, APT-driven approach may cause some to wonder what the point of the SSA’s regular valuations themselves might be. PensionReforms thinks that might be progress.<br />
<br />
Both sets of calculations are hostage to the administrative framework of Social Security itself. This disguises the true nature of pension entitlements that are, in fact, a set of economic claims on tomorrow’s economic output. These will have no particular <em>economic</em> priority over all the other claims of the day. Regardless of ‘entitlements’ that have been ‘purchased’ by ‘contributions’ that are ‘held’ in the Social Security Trust Fund, there has been a long history of changes (initially improvements but now reductions) in the value of pensions payable. The ‘entitlements’ are less than formal contractual commitments though PensionReforms acknowledges that the framework in which they accrue provides an element of protection from future change. However, in PensionReforms’ view, the malleability of those entitlements illustrates an important point. The real value of economic claims is effectively set by taxpayers of the day and has only some connection to the amounts contributed in respect of pensioners over their working lives. That is the way it should be. PensionReforms concedes that the Social Security contributions impose a barrier to change but they have not and cannot prevent changes. The increasing US State Pension Age is a current case in point.<br />
<br />
PensionReforms suggests it makes no more sense to arrive at a $10.4 trillion ‘net liability’ for just the pensions’ obligations than it does to NPV the expected payments for defence, education, roads or even the future costs of federal elections. These are all things that should fall to be resolved under the regular process of setting annual Budgets. The real point should be that there are far too many poor, old Americans and that issue needs addressing now. It has nothing to do with either $8.5 trillion (or the report’s alternative $10.4 trillion) worth of ‘net retirement benefit liabilities’. (File size 362KB; 35 pp) 548<br />
http://people.bu.edu/kotlikoff/The%20True%20Cost%20of%20Social%20Security,%20September%202008.pdfThe True Cost of Social Security (2008)548Argentina adopted the Chilean pension model but it didn’t seem to work. In the meantime, the Argentine government ran out of money and needed the pension assets. Each country has recently changed its system, trying to reduce pensioner poverty. 2012-04-10T10:51:352010<strong>PensionReforms’ summary and comments</strong><br />
In 1981, Chile introduced a pension system that later became the basis for the World Bank’s three (then five) pillar model (see <a href="http://www.pensionreforms.com/Preview.aspx?1">here</a> for more). A compulsory, Tier 2, Defined Contribution scheme was a central plank. Unfortunately, the experience of countries that have adopted this framework hasn’t been great; see <a href="http://www.pensionreforms.com/Preview.aspx?31">here</a>, <a href="http://www.pensionreforms.com/Preview.aspx?157">here</a> and <a href="http://www.pensionreforms.com/Preview.aspx?211">here</a> for examples. The transition issues are themselves difficult to deal with as Chile discovered – see <a href="http://www.pensionreforms.com/Preview.aspx?48">here</a> for more.<br />
<br />
Chile itself has illustrated some of the difficulties of forcing people to behave in a particular way. One of the major gaps was that, even after 30 years, too many people were retiring in poverty – see <a href="http://www.pensionreforms.com/Preview.aspx?408">here</a> for more. The 2008 reforms lifted Tier 1 entitlements on an income-tested basis.<br />
<br />
In the meantime, Argentina has illustrated its own version of the difficulties with compulsory Tier 2 schemes. Its 1994 model lasted until only 2008. PensionReforms thinks that one aspect of the Argentine experience merits particular attention:<br />
“In no way can it be claimed that the changes introduced at that time constituted a “definitive” reform. Since the original law was passed in October 1993, some 850 new regulations on the retirement pension system have been approved, including 34 laws and 135 decrees. Although many of these were adopted to complement the original system design, the tendency was clearly to make short-term corrections and amendments.”<br />
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In other words, the pension system in Argentina was inherently unstable. Over the 14 years to 2008, the system was dogged by low numbers of contributors (never more than 50% of workers) and beneficiaries, large investment fluctuations and erratic economic conditions. The number of pensioners fell from 2.1 million to 1.6 million between 1992 and 2005 despite growing numbers of the age 65+.<br />
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This 2010 report looks at changes that took place in 2008 in both countries with very different processes and outcomes.<br />
<br />
In Argentina, special interest groups started unwinding the 1994 reforms so that, by 2005, teachers, researchers, diplomats and justice officials all had Defined Benefit, PAYG arrangements installed. Then came contributors over age 50 (men), 55 (women) with less than $20,000 in their accounts. They were transferred to the PAYG system unless they wanted to stay. Other contributors were given the right to transfer every five years. These changes saw about 21% of contributors switch. The final change came in December 2008 that saw all contributors to the pre-funded Tier 2 transfer to the PAYG system. Their savings ‘followed’ them. The final major change came by way of the ‘Senior Citizens Plan’ that saw the opening of eligibility to many age 70+ by eliminating the restriction on the number of non-contributory pensions. The number of pensioners doubled between 2003 and 2006 and the real value of benefits also doubled.<br />
<br />
“The reforms also meant the annulment of a key part of the changes introduced in 1993, by abolishing individual capitalization accounts and returning to a unified form of operation managed by a public agency, in a system that reverted to a defined benefits framework. The existence of private pension-fund managers thus ended.”<br />
<br />
Some elements of the 1994 framework remain “including current contribution rates, retirement ages and replacement rates” but “to this day, there has been no official estimate of the fiscal impact of the reforms, in either the short or medium term.” <br />
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PensionReforms has already covered the detail of the 2008 Chilean reforms (see <a href="http://www.pensionreforms.com/Preview.aspx?408">here</a> for more). The report sums up the changes:<br />
“In Chile, meanwhile, most of the reforms will produce their effects gradually through time. The beneficiaries of the new [Tier 1] solidarity pillar will be few at first, but their number will gradually increase as the system is implemented. Clearly, this is the main novelty of the recent reforms, since they will lead to a universal coverage system in the near future. Another set of reforms affect operational aspects of the existing system and the institutional structure of government supervision and oversight agencies. Moreover, a number of changes aimed to eliminate systemic inequities, such as those relating to gender differences.”<br />
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The report notes the very different approaches to reform in the two countries. In Chile, a Council of Experts led the research and discussions. In Argentina, the government decided what to do with “very brief and limited consultation and discussion”. <br />
<br />
“The more cautious and careful approach taken by the Chilean authorities in introducing pension reforms will probably help achieve more sustainable results through time. Nonetheless, the execution of a more rapid reform in Argentina managed to give an immediate response to the major problem of the massive decrease in coverage. Most older adults excluded from the system were receiving a pension within a year, thereby achieving an immediate improvement in relation to their previous situation. In Chile, by contrast, the process that means covering all registered beneficiaries will be slower and more gradual.”<br />
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PensionReforms agrees that we have not seen the last of reforms in either country but observes that Argentina seemed more interested in contributors’ savings than in contributors’ pension entitlements. There used to be about $US29 billion in those accounts and now the accounts are notional. The President said the move was designed to protect investors from losses associated with the Global Financial Crisis. In fact, they were more about the Argentine government’s fiscal problems.<br />
<br />
The Chilean changes, on the other hand, were designed to improve the country’s pension performance. As PensionReforms has noted before, the 2008 changes had been inevitable for some time and necessarily flow from complex rules that are designed to force citizens into doing something they might prefer not to do. Even more complex future controls are also inevitable.<br />
<br />
The process of change might have been sounder in Chile than in its neighbour Argentina but, in each case, and for their separate reasons, the pension systems do not rest on firm foundations. Stand by for further ‘reforms’. (File size 710 KB; 24 pp) 547<br />
http://www.eclac.cl/publicaciones/xml/0/41890/RVI101Rofmanetal.pdfReforming the pension reforms: Argentina and Chile (2010)547US Social Security intends to redistribute from higher to lower earners. What look like reasonably progressive benefits become less progressive when lifetime incomes and mortality are allowed for. Other supportable adjustments turn it regressive. 2012-04-02T12:27:002000<strong>PensionReforms’ summary and comments</strong><br />
The US Social Security pension intends to give lower lifetime earners more annual pension for given amounts of contributions than higher lifetime earners. That would make the scheme ‘progressive’. That’s the theory; the outcomes in practice are more equivocal. In fact, it’s not too difficult to image circumstances in which what should be a progressive system of income re-distribution becomes regressive.<br />
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This 2000 report looks at just Social Security’s retirement pension entitlements and examines lifetime earnings’ data for 1,778 individuals and mortality statistics to work out how much they (and their employers) contributed and how much in pensions they might expect to receive. The report notes that the other benefits of Social Security, notably death and disability entitlements are themselves markedly progressive.<br />
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“For a given set of “facts” about the net flows received by each individual, measured progressivity of the retirement benefits depends on many assumptions. This paper attempts to capture and to quantify all of the individual characteristics that are relevant to determine the progressivity of a life-cycle program like social security.”<br />
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The first analysis is to apply Gini coefficients to the emerging pensions themselves. That calculation shows that “…social security is highly progressive.”<br />
<br />
However, with each subsequent re-calculation, the results become less progressive. The tests that seem to unwind Social Security’s intentions were:
<ul>
<li>Lifetime incomes were used as the measure rather than income near retirement; the system is still progressive, but less so.</li>
<li>Removing the cap on measured earnings. The cap exempts higher incomes from contributions and also potentially reduces benefits, but not necessarily.</li>
<li>Switching from “…actual to potential lifetime earnings (the present value of the wage rate times 4,000 hours each year). This measure captures the value of leisure and home production, so those out of the labor force are less poor, and net payments to them are less progressive.”</li>
<li>“Fifth, we assign to each married individual half of the couple’s income. The low-wage spouse is then not so poor, and social security becomes even less progressive.”</li>
<li>Next, the report looked at different mortality rates that vary by lifetime incomes. “Since the rich live longer and collect benefits longer, social security is no longer progressive.”</li>
<li>The last adjustment was to change the discount rate (used to bring incomes and incomes to a present value for comparison purposes) from 2% to 4%. This “…puts relatively more weight on the earlier-but-regressive payroll tax and less weight on the later-but progressive benefit schedule.”</li>
</ul>
<br />
That last adjustment is sufficient to turn the “whole social security system” regressive.<br />
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“[W]e seek to measure the extent to which the current social security system redistributes resources from rich to poor. To do so, we build a model that incorporates all the information needed to categorize individuals by alternative definitions of income, to classify individuals from rich to poor. Income may be measured annually or for a lifetime; the data may be truncated at the wage cap; individual or family income may be used to measure well-being; actual or potential income may reflect lifetime resources. For each person, we calculate income, taxes paid, and benefits received from the social security system. We change the definition of income incrementally, to see how each re-definition affects measured progressivity. Ultimately, when individuals are classified as rich or poor based on their command of economic resources, we conclude that the current social security system cannot be considered progressive.”<br />
<br />
PensionReforms notes that the best intentions of public policy makers are often confounded. With the US Social Security framework, the Law of Unintended Consequences seems alive and well, at least with respect to retirement pensions. Any lifetime-contributions-based pension system will exhibit aspects of the patterns identified in the report. There seem no compelling public policy reasons for governments to run those risks. Equity has nothing to do with it. Politics is probably the main driver and should not be.<br />
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The report does not include tax in its calculations. PensionReforms reviews a report <a href="http://www.pensionreforms.com/Preview.aspx?553">here</a> (to come) on the impact of tax. (File size 4.1 MB; 48 pp) 546<br />
http://www.nber.org/papers/w7520.pdf?new_window=1The Progressivity of Social Security (2000)546As with nearly all other countries, Brazil is ageing. By 2050, 23% of citizens will be age 65+. Social security and social assistance will become ‘unaffordable’ and will need scaling back. It’s time to think about a new approach. 2012-04-02T12:19:372011<strong>PensionReforms’ summary and comments</strong><br />
The populations of all but the least developed countries are ageing and Brazil is no exception. By 2050, 23% of all Brazilians will be age 65 or more; and the workforce will still be shrinking. The World Bank recently took a look at Brazil’s demographic challenges – see <a href="http://www.pensionreforms.com/Preview.aspx?495">here</a>.<br />
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This report suggests, in similar vein, that:<br />
“Brazil’s social security and social assistance provisions are too expensive and becoming more so relative to the country’s age profile and per capita GDP…Brazil’s social provisions must undergo deep regulatory changes if they are to meet the challenge posed by the country’s shifting demography, as population ageing is the single most important factor affecting social security in Brazil.”<br />
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“…Brazil experienced …population growth averaging 2.8% per year in the 1950-1980 period. Despite rapid population growth, the country’s age distribution barely changed in the first seven decades of the century.”<br />
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That, however, has slowed in the last 20 years. The proportion of Brazilians aged under 15 was more than 42% in the years 1940-1970 has now reduced to about 30% in 2000 and the number has been reducing in absolute terms since the 1990s. The ‘working’ population (aged 15-64) will peak at 70% of the population by the 2020s - 12 of that age for every Brazilian age 65+ - so that by 2050, the proportion will be 3:1.<br />
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“There are three main ways to counterbalance this long term trend: immigration, faster productivity growth and incentives that encourage people to stay longer in the workforce and draw to it people that potentially could be in it.”<br />
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Currently, ‘social security and social assistance’ costs about 12% of GDP and the proportion of the population aged 65+ is set to triple (from 7% to 23%) by 2050. <br />
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The report suggests that “…neither immigration nor productivity growth by themselves seem enough to counterbalance the rise in pension liabilities.” <br />
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The report summarises the current pension arrangements that seem fragmented and inconsistent. It looks at some specific recommendations for changes to social security arrangements.<br />
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“The country’s social security and welfare provisions are comprehensive and a strong argument can be made in their favor. They play an important role in decreasing inequality and poverty levels and in promoting social stability. Arguably, a case can be made for their importance in helping to smooth out the economic cycle, since they constitute a steady income, not derived from work or capital gains and so help to steady demand.<br />
<br />
“But an even stronger argument can be made in criticizing the focus and cost of these provisions. In particular, the existing social security regulation exacerbates the impact of the demographic changes the country is experiencing, because of three regulatory shortcomings: low eligibility age, the use of social insurance to promote welfare policy and the high value of benefits relative to past contributions.”<br />
<br />
The authors argue that the following factors need to be addressed:
<ul>
<li>Social security pensions are currently indexed to the minimum wage and, over the years, this has tended to grow at a faster rate than inflation.</li>
<li>There is low eligibility age: a male urban worker can qualify for a pension as young as age 53 and a female at age 48. In 2007, 36.5% of male pensioners and 26% of females were still working.</li>
<li>Pensions are high relative to past contributions.</li>
<li>There is a short minimum contribution period.</li>
<li>There is the possibility of accumulating different benefits.</li>
<li>Some social security benefits are dispensed as social assistance benefits. That arises because the minimum benefit is equal to the minimum wage and over two-thirds of Brazilians earn less than twice the minimum wage.</li>
</ul>
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PensionReforms agrees that Brazil has some quite difficult political questions to address. Commenting specifically on the report’s recommendations:
<ol>
<li>PensionReforms supports the current linkage to wages. Anything less will be unstable over the very long term.</li>
<li>The major retirement pension should be payable from a retirement age rather than after a contributions-based eligibility period. It should deliver financial support in old age rather than a ‘return’ from contributions.</li>
<li>The age pension should aim to relieve or even eliminate poverty in old age; contributions while working do not define poverty in old age.</li>
<li>The age pension should therefore be the same for all who are entitled. In that way, ‘affordability’ will be the total that taxpayers of the day ‘think’ is ‘fair’.</li>
</ol>
<br />
In other words, PensionReforms thinks that a Universal Pension should be explored to address the issues identified in the report. (File size 212 KB; 18 pp) 545<br />
http://www.anpec.org.br/encontro2009/inscricao.on/arquivos/000-e6d0011319207f05be65600a329a09c2.pdfDemographic transition and the regulatory shortcomings of Brazil's social security (2011)545If a Universal Pension reduces poverty amongst the old, we might expect to see positive changes in health and well-being. That seems to be so with Mexico’s universal pensions, as a natural experiment in the Yucatan seems to demonstrate. 2012-03-26T11:13:282011<strong>PensionReforms’ summary and comments</strong><br />
Mexico is taking an unusual approach to the reform of its pension arrangements. Mexico City adopted its own Universal Pension in 2001 (see <a href="http://www.pensionreforms.com/Preview.aspx?4">here</a> and <a href="http://www.pensionreforms.com/Preview.aspx?381">here</a> for more). Probably because of that local success, the idea seems to be spreading gradually.<br />
<br />
Mexico's federal government provides a Universal Pension to all rural residents through a programme known as ‘70 y más’ (‘70+’ - from age 70). ‘Rural’ was defined as any community with fewer than 2,500 inhabitants when the programme began, in 2007. The following year the allowable size increased to 20,000 and in 2009 it increased again, to 30,000. The President began to extend the programme to all urban areas of Mexico in 2012, but on a pension-tested rather than universal basis.<br />
<br />
Only two of Mexico's 31 states – Chiapas and Yucatan - followed Mexico City’s example and the federal 70+ scheme by promising residents a Universal Pension with no eligibility requirements other than age and residence. The monthly pension is 550 pesos ($US41), more than the 70+ pension of 500 pesos. Thirteen states provide no non-contributory pensions at all to elderly residents; the other 16 provide means-tested benefits rather than Universal Pensions.<br />
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Chiapas in 2007 launched its scheme (‘Amanecer’), which provides pensions to all residents – rural and urban – from the age of 64 – see <a href="http://larrywillmore.net/blog/2012/01/16/universal-pensions-in-chiapas/">here</a> from one of PensionReforms’ editors for more. Yucatan also launched a pension scheme (‘Reconocer Urbano’) in 2007, but it is universal only in intent. To date, the state provides universal pensions in only one community: Valladolid, the third largest city in Yucatan – see <a href="http://larrywillmore.net/blog/2012/01/15/universal-pensions-in-yucatan/">here</a> for more. Because the Yucatan state government was phasing in the programme so slowly, researchers could measure the impact of social pensions by looking at changes over time in a ‘treated’ community (where all the elderly receive pensions), compared with a similar, but ‘untreated’ community that serves as control. The researchers chose Valladolid (population about 46,000) as the treated community, and Motul, with 21,500 inhabitants, as the control.<br />
<br />
“In this study we have presented initial results of an experimental research project that designs and evaluates the impact of a non-contributory social security program as a poverty alleviation policy for the elderly. We analyzed the effects of the program on the health and well-being of elderly recipients, using data from the first phase of the experiment. We also described the evaluation design, capacity building efforts, survey instrument, and field operations.”<br />
<br />
The results were predictable:<br />
“The initial results are a decline in hunger, cutting meals, and running out of food due to the lack of money. The elderly recipients are spending more on food, visits to the doctor, and medicines and show improvement in memory function…. There is some indication of improved subjective well-being and a decline in acute conditions. For many of the indicators we would expect substantially larger effects over a longer period.”<br />
<br />
The researchers also observed a decline in alcohol consumption. PensionReforms suspects that may either have been a coincidence or unrelated to the provision of a Universal Pension.<br />
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Unfortunately for the researchers, Motul became ‘treated’ in 2009, shortly after the data were first gathered, so they had a period of only six months to make the comparison.<br />
“Although the fact that Motul now also gets treated, makes it unsuitable any longer as a control town, the treatment of Motul introduces intertemporal variation in treatment that can be taken advantage of in further analyses.”<br />
<br />
PensionReforms thinks that the effects of introducing a Universal Pension are as we might expect. It is perhaps a shame that the value of Motul as a control was nullified by its ‘treatment’ during the period covered by the research, though not, PensionReforms hastens to add, for the eligible citizens of Motul. The report notes that researchers carried out a second follow-up survey in both towns in 2010, but does not report the results. PensionReforms suspects there was nothing of interest to report. (File size 1.0 MB; 54 pp) 544<br />
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1979033Experimental Analysis of the Health and Well-Being Effects of a Non-Contributory Social Security Program (2011)544Comparing just pension systems in different countries is difficult. Worse, such limited comparisons are simplistic. Germany and Australia have very different systems. Comparing just the pensions misleads rather than illuminates. 2012-03-26T11:02:042009<strong>PensionReforms’ summary and comments</strong><br />
How do we know whether one country’s pension arrangements are ‘better’ than another’s? Comparing the detail during the accumulation phase is difficult enough; looking at the outcomes (incomes in retirement) is more helpful. That, after all is the main point of the different types of system. However, ‘proceed with care’ should be added to such comparisons.<br />
<br />
The report looks at retirement living standards in Australia and Germany. They offer two very different frameworks; in summary:
<ul>
<li>Australia: Tier 1 is an income and asset tested, PAYG pension financed out of general taxation. Tier 2 is a compulsory, Defined Contribution, tax-favoured system that produces lump sums from the ‘preservation age’. Tier 3 is everything else and includes a tax-favoured, voluntary system of ‘superannuation schemes’, either workplace-based or retail.</li>
<li>Germany: Tier 2 is a contributory, Defined Benefit, PAYG pension system that aims to deliver retirement incomes that, up to a pay ceiling, maintain pre-retirement standards of living. There is no minimum pension. Employees and employers contribute equally - currently a total of 19.5% of covered pay (up to €54,000 in the west and €45,000 in the east). Tier 3 is everything else.</li>
</ul>
<br />
International comparisons (notably the OECD’s Pensions at a Glance: see <a href="http://www.pensionreforms.com/Preview.aspx?299">here</a> for an example), compare pension systems by focussing on outcomes – usually net (after-tax) replacement rates of employees on average earnings. On this basis, using the relevant OECD numbers (for 2002), Germany rated at 71.8% (just above the OECD’s average of 68.7%) whereas Australia languished at only 52.4%.<br />
<br />
“The main policy conclusion invariably drawn from these comparisons is that those European countries, including Germany, which have relatively generous welfare provisions, including long standing national pension schemes, provide retirees with much higher living standards than liberal Anglo-American countries, including Australia, in which many citizens rely on flat rate old age pensions.”<br />
<br />
The report says that this is wrong, or at least offers an incomplete picture of each country’s total frameworks and so comparisons of this kind are misleading.<br />
<br />
Pension assets are certainly important retirement assets but they are not the only assets owned by retirees and may, in fact, not even be the most valuable assets. The report uses panel studies of incomes and wealth in both countries (HILDA in Australia and SOEP in Germany) to compare living standards of the retired in each country. Total assets (capital as well as pension wealth) are put on to a common basis to allow a proper comparison. Australians had more financial wealth whereas Germans had greater pensions.<br />
<br />
Notwithstanding those differences, “…we show that the living standards of Australian and German retirees appear to be about the same. This seems true whether the focus is on measures of central tendency (means, medians), or on measures of dispersion or inequality. The basic point is that the living standards of retirees depend on their total economic resources, and particularly their total wealth (net worth), not just on pension entitlements. Both the SOEP and HILDA panels have invested heavily in detailed measures of household wealth, so we are in a good position to assess the living standards of retirees, who more than any other population group, depend on accumulated wealth.”<br />
<br />
Specifically, Australian households with a ‘retired’ head had 97.3% of the wealth of their German equivalents at the mean and 96.8% at the median, based on a ‘purchasing power parity’ comparison. The Gini factor in Australia was 101% of the German equivalent.<br />
<br />
The factor that adjusted the comparison of just pension incomes most markedly was financial assets - Australian retirees’ financial assets were 29% of total retirement wealth; in Germany, it was only 10%. Property, mostly housing, constituted 47% of the Australian retirees’ portfolios. In Germany, it was 37%.<br />
<br />
By contrast, just the ‘pensions’ component was about 50% of the German retirement portfolio by contrast with the Australians’ 21%.<br />
<br />
“After many gyrations, our final estimate is that Australian and German retirees probably have almost exactly the same standard of living.”<br />
<br />
“The political economies of different Western countries, especially their tax and pension regimes, offer quite different opportunities for wealth accumulation and so for living standards in retirement. Other things equal, high compulsory contributions to national pension schemes impose significant opportunity costs. They reduce opportunities to accumulate wealth via home ownership, share ownership and household savings generally. In the absence of these constraints, in countries where saving for old age is not compulsory, households make their own decisions.”<br />
<br />
PensionReforms suggests that none of this should seem surprising. In fact, what is surprising is that anyone might draw policy conclusions from a comparison of just pension incomes. Even including just statutory retirement accumulation arrangements (such as Australia’s compulsory, Tier 2, SG scheme) as happens in some other international comparisons doesn’t provide a useful picture of how retirees manage in retirement. The thing that really matters is total wealth in retirement, not incomes.<br />
<br />
PensionReforms thinks is good now to have evidence as to how unhelpful are past, simplistic comparisons. The report’s conclusions support what PensionReforms thinks is the pensions’ counterpart of Ricardian equivalence. The more the state intervenes in the accumulation process, the less individuals do for themselves. Notwithstanding, the final results in retirement of very different sets of interventions in Germany and Australia are remarkably similar. It appears that, overall, individuals have an intuitive sense of what seems appropriate, regardless of the environment. Countries could learn some valuable lessons from this about how much to intervene but we will need some more equivalent comparisons to build that case. (File size 102 KB; 11 pp) 543<br />
http://www.diw.de/documents/dokumentenarchiv/17/diw_01.c.86653.de/soep08_full_frick_headey.pdfLiving Standards in Retirement: Accepted International Comparisons are Misleading (2009)543US 401(k) plans are deferred remuneration with tax breaks. Higher-paid members tend to benefit particularly from the tax breaks while the lower-paid do better from the employer’s subsidy. Non-members miss out on both fronts. 2012-03-19T11:16:152011<strong>PensionReforms’ summary and comments</strong><br />
A subsidised Tier 3 retirement savings scheme is a common addition to employees’ remuneration. The employer contributes either directly or as a proportion of the amounts contributed by the employees themselves. In the latter case, the more employees contribute, the greater is their ‘total remuneration’.<br />
<br />
Usually, those savings are subsidised through the income tax system and the typical treatment is summarised as EET. The first ‘E’ indicates that contributions by employees are deductible against their tax liability and/or that the employer’s contributions are not treated as taxable income. The second ‘E’ indicates that the investment income on the accumulating savings is exempt from income tax and the last ‘T’ says that the benefits at retirement are taxed as income. In a world where most tax is collected from incomes, EET is a highly favoured treatment. A ‘neutral’ treatment, by contrast, would be TTE where savings are made from after-tax income, investment income on the accumulating savings are taxed as income and the resulting benefit is tax-paid capital and so ‘exempt’.<br />
<br />
There are variations on the detail of the tax treatment but favoured tax treatments for retirement savings are available in all countries.<br />
<br />
The report looks at the distributional effects of, particularly, US 401(k) schemes on employees’ after-tax remuneration from the combined impact of employer subsidies and tax breaks. A 401(k) scheme is a Defined Contribution, Tier 3 retirement saving scheme, subsidised by employers and tax-favoured. The question is ‘who are the winners?’<br />
<br />
“Economists frequently assume that employees “pay for” employer-provided fringe benefits, including contributions to qualified retirement plans, in the form of reduced wages. But they often assume that contributions displace wages dollar-for-dollar for all employees. For example, studies of the distributional effect of tax incentives for retirement saving estimate the benefit of these incentives as the present value of increased lifetime income from additional amounts invested in tax-qualified retirement saving plans. These studies value the tax benefit under the assumption that total pre-tax compensation is unchanged. Our results challenge these assumptions.”<br />
<br />
The problems start because lower-paid employees often can’t afford to save or do not see the value of locking savings up until retirement. They also receive relatively smaller benefits from tax concessions because their marginal tax rates are lower. Then, in the US, because Social Security entitlements are weighted to the lower-paid, the relative value of Social Security contributions is higher for them than for the higher-paid. That potentially affects the after-all-taxes remuneration because the employer subsidies to Tier 3 schemes are not subject to Social Security contributions and are also not included in qualifying pay for benefits. On this basis, the value of the employer’s subsidy is eroded for the lower-paid.<br />
<br />
“For these reasons, high-income employees are likely to value employer contributions to retirement plans more than low-income employees. Because of non-discrimination rules, employers must induce participation of low-income employees in order to provide qualified benefits to high-income employees. Therefore, employers who wish to contribute to plans in order to attract high-income employees may be unable to reduce money wages to low-income workers in exchange for compensation in the form of retirement plan contributions.”<br />
<br />
It’s quite difficult to separate these threads to see whether employer subsidies do really substitute for wages. Controlling for ‘worker quality’ in comparisons is another difficulty. The report uses a new data match that it says is “a better way of adjusting for worker quality.”<br />
<br />
The conclusion?<br />
“… we find that availability of pension coverage (either DC, DB, or CB plan) and health insurance coverage is still positively correlated with earnings, holding other worker and job characteristics fixed. This suggests the labor market may be segmented between better employers that offer both higher wages and fringe benefits and low wage employers not offering benefits. But, within the group of employers offering DC plan coverage, we do find that higher employer contribution rates substitute for cash wages.”<br />
<br />
DC schemes offer an interesting sub-plot:<br />
“And, more strikingly, we find evidence that additional employer contributions to DC plans reduce money wages much less for low-income than for high-income employees.”<br />
<br />
This suggests that lower-paid workers benefit relatively more from the extra remuneration than the higher-paid while the latter gain greater relative advantage from the tax breaks.<br />
<br />
“These results are preliminary and more research needs to be done. They do suggest, however, that tax-advantaged fringe benefits that must be supplied on a fairly uniform and non-discriminatory basis to workers could induce employers to raise total compensation of low-income workers so that high-income workers can gain access to the tax preference.”<br />
<br />
PensionReforms suggests that this is making a silk purse out of a sow’s ear; perhaps showing that a combination of employer subsidies and tax breaks isn’t quite as bad as some feared. It should be up to employers to decide how and how much to pay employees but it is another matter for public money to subsidise those savings. As PensionReforms has often observed, tax breaks for retirement saving are expensive, complex, regressive and distortionary but worst of all, they seem not to work (raise saving).<br />
<br />
From the employer’s perspective, it seems wrong for them to pay more in total to employees who can either afford to save or can see the point of deferring remuneration to a retirement age. PensionReforms suspects that many (including employers) probably do not appreciate that; nor do they understand the significance of Social Security entitlements forgone as a result of the deferred remuneration. Those who do not/cannot join miss out on both the extra pay and the tax breaks. There is some compensation for those losses with Social Security entitlements. Whether all this should be so is at least questionable. (File size 494 KB; 46 pp) 542<br />
http://crr.bc.edu/images/stories/Working_Papers/wp_2011-14_508.pdfDo Low-Income Workers Benefit from 401(k) Plans? (2011)542The rural pension scheme in China hasn’t got off to a good start. The NRPP seems unable to ‘attract’ younger contributors, so undermining its basis. Older citizens understandably support it but the young may have more attractive alternatives. 2012-03-19T11:08:412011<strong>PensionReforms’ summary and comments</strong><br />
China faces significant potential social problems with 800 million rural residents. The government wants them to stay there and also wants them to be more content with their lot. The ‘New Rural Pension Program’ (NRPP) was intended to help fix this.<br />
<br />
“In order to promote the development of its rural population, and to avoid the social instability that may result from relative deprivation of peasants, the Chinese government launched the ambitious NRPP to cover all rural residents in old-age social insurance. It is aimed to provide sufficient old age support to more than eight hundred million peasants, almost none of whom have had any previous social security.”<br />
<br />
In brief, the NRPP started in 2009. 310 counties initially ‘piloted’ the scheme; that has now increased to 838 by the end of 2010. However, only 24% of eligible participants had joined. Although it has been running for only two years, there are already some lessons to be learned about the future.<br />
<br />
There are two components to the NRPP:
<ul>
<li>A PAYG component that provides a basic ‘social pension’ at 55 RMB a month (about $US8.70 at 1 March 2012) and financed by the central government. Local governments are encouraged to contribute as well.</li>
<li>A Defined Contribution account in the employee’s name and to which members pay between 100 and 500 RMB a month, as they choose. The local government also contributes a modest regular subsidy: at least 30 RMB a year (about $US4.75) that is supposed to increase as the member chooses higher contribution levels. Also, the operating costs are paid by the local government. There can be local variations to the contribution rules.</li>
</ul>
<br />
Pensions are payable from age 60 to any who are not entitled to receive the ‘urban basic pension’, as long as they have contributed for at least 15 years. Older employees can qualify without contributing for the full 15 years as long as younger family members also join. The monthly amount is currently 55 RMB plus the balance in the Defined Contribution account divided by 139. According to the report, this is payable for only 139 months though another report <a href="http://oaithesis.eur.nl/ir/repub/asset/10322/Wu,%20Dan.docx">here</a> suggests that it is a pension for life.<br />
<br />
Although the NRPP has been welcomed, three quarters of the eligible have so far chosen not to join: “[E]mpirical and anecdotal evidence shows that young peasants are reluctant to participate, and those participants prefer the lowest premium standard [100 RMB a month - $US15.80].”<br />
<br />
The reasons for the low take-up rate, especially amongst the young is apparently related “…to the distrust that peasants have of governmental projects”. The report, however, focuses on improvements that might be made to the NRPP’s design.<br />
<br />
One of the problems appears to be the poor returns relative to alternatives:<br />
“Therefore, the key is to raise the return rate of the individual account.”<br />
<br />
The report makes a seemingly radical suggestion:<br />
“One possible way is to operate the pension fund in a commercial manner, and thus reap a market return…. Of course, a reasonable return rate depends on efficient operation and efficient capital markets. These may require the government to relax or remove regulations on the operation of the pension fund and make capital markets function through the market mechanism.”<br />
<br />
The report suggests that, with better returns, the need for government subsidies would be lessened. <br />
<br />
PensionReforms thinks that requiring the local funds to act ‘commercially’ may perhaps be too much of a change from the way things have happened in the past (think of the ‘empty accounts’ that have plagued pension arrangements). However, it does not need the report's mathematical formulae to prove that, unless returns (or subsidies) improve, potential rural members (fetchingly referred to in the report as “peasants”) are likely to have more pressing needs for money today than running the risks associated with locking savings up until age 60. There would need to be a significant return margin (including the subsidies) over, say, bank deposit rates to justify the regulatory and administrative risks involved. (File size 555 KB; 15 pp) 541<br />
http://www.iza.org/conference_files/CIER2011/lei_x6071.pdfIncentive Problems in China's New Rural Pension Program (2011)541The Seychelles should be on the list of countries with a Universal Pension. A monthly $US196 is paid to all from age 63 after five years’ residence. It started in 1979 after the 1977 Marxist coup. Since a return to democracy in 1993, the pension continues. 2012-03-19T10:58:462011<strong>PensionReforms’ summary and comments</strong><br />
There are now 13 countries or territories with a truly Universal Pension, including (countries) New Zealand, Mauritius, Bolivia, Nepal, Samoa and (territories) Mexico City, Chiapas State (Mexico) along with rural Mexico (the Federal ‘70+’ programme – see <a href="http://larrywillmore.net/blog/2012/01/22/non-contributory-pensions-in-mexico-2/">here</a> for more). The Seychelles has flown under PensionReforms’ radar in this regard and this 2011 report plugs that gap.<br />
<br />
The Seychelles is an archipelago of 115 small islands in the Indian Ocean, just north of Madagascar. Its population is just 90,000 and 7% are over age 65 with the median age at just 32.5 (see <a href="https://www.cia.gov/library/publications/the-world-factbook/geos/se.html">here</a>).<br />
<br />
The pension started in 1979 and was introduced by the then Marxist government. However, it survived the return of democracy in 1993 and is payable to all who are age 63 or more and who have five years’ continuous resident in The Seychelles at the time of applying. In 2011, the monthly amount is SR2400 ($US196), about 70% of the gross minimum wage. It is financed out of general taxes (until 2010, it was provided from a payroll tax). The pension is not taxed as income so it amounts to 82.4% of the net minimum wage.<br />
<br />
The report is from the Commonwealth Secretariat, with help from UNRISID and covers the economic history of Seychelles as well as social policy issues generally, including pensions.<br />
<br />
“Before independence in 1976, formal and institutionalised social protection was patchy .... There were no pensions or social security for the elderly, except for public servants and employees of certain firms.”<br />
<br />
Pressure for social protection followed the introduction of universal suffrage in 1967. <br />
<br />
“The [Defined Contribution] National Provident Fund (NPF) was established in this context in 1971. The NPF was a compulsory social security savings plan aimed at working Seychellois. .... The scheme only benefited those in formal employment and those employees who contributed. Contributing employees were paid the full amount of the benefit they had contributed as a lump sum payment ....”<br />
<br />
In 1977 there was a Marxist-led coup that was, in part, prompted by a “lack of progress in social development.”<br />
<br />
“The return of multi-party democracy to Seychelles in 1993 only served to expand the scale and scope of social protection programmes. .... The right to social protection and the state's responsibility to `undertake and maintain a system of social security' was enshrined in the 1993 constitution as an unalienable right ....”<br />
<br />
The NPF) continues as the Seychelles Pension Fund (SPF) and pays benefits to contributors on top of the Universal Pension entitlement.<br />
<br />
The Seychelles faces significant economic issues though the most recent years indicate a re-adjustment to current conditions, with significant external help, including restructuring and writing down debt. Its current (2011) central government debt is 46.2% of GDP but the government ran a budget surplus in 2011 of 1.5% of GDP. The pension seems safe but it is apparent that there is little research to measure its impact. PensionReforms supports the report’s call for good data:<br />
“What is certain, however, is the need for serious analytical research on social development issues in the ‘new’ Seychelles. It is hoped that this paper contributes to furthering this important research agenda.” (File size 1.03 MB; 140 pp) 540<br />
http://www.unrisd.org/80256B3C005BCCF9/%28httpPublications%29/3A9A74B074A08D26C12579580049787F?OpenDocumentSocial Policies in Seychelles (2011)540As in many countries, Canada is experiencing increasing labour force participation rates amongst older citizens. There is no single explanation but the news is good for the government for now, and improving. But mortality rates are still improving. 2012-03-13T16:21:492011<strong>PensionReforms’ summary and comments</strong><br />
Many countries are seeing improving labour force participation rates amongst the elderly and so it is in Canada. This report describes the shift in retirement ages as dramatic over the three decades of data covered.<br />
<br />
“Prior to 1945, cohorts of retirees (reaching age 65 prior to 2000) were retiring earlier. Starting with cohorts reaching 65 years in 2000, we are seeing a reverse trend with expected retirement ages increasing year after year.”<br />
<br />
The trend applies to both males and females though it appears at earlier ages for females and later ages for males.<br />
<br />
“Another pattern is emerging: return to work after retirement is more frequent. This has also the effect of increasing overall labour force participation.”<br />
<br />
The numbers are clear but there seem to be several possible explanations for the relatively sudden changes. Early retirement programmes seemed to be the cause of reducing retirement ages in the 1980s and 1990s and those seem to have been reversed.<br />
<br />
“Over the last 10 to 15 years, we have now seen a decrease in the generosity of private pensions and also a change from defined benefit to defined contribution pensions, which are more neutral in terms of retirement incentives.”<br />
<br />
The expected retirement age seems relatively unchanged for workers with private pensions over those without them but they expected previously to work for longer periods anyway. PensionReforms thinks that seems unsurprising. <br />
<br />
“The evidence we present in this report is mostly good news for government and pension fund managers. Although pensioners are living longer, increasing the annuity burden of pension funds, and dependency ratios continue to grow, workers are now working longer and often return to work after their first retirement which should lower the pressures on public and private pension funds.”<br />
<br />
It seems too early to tell whether the change is just to make up for less generous pension entitlements and the fact that the report’s data predate the global financial crisis (GFC) means we cannot be certain how that might change things. However “…our results show that the expected trend in delayed retirement should be reinforced by the loss of jobs and wealth created by the crisis.” The uncertainties created by the GFC will probably prompt employees to delay their retirements. <br />
<br />
“Finally, given the strong public policy interest on aging and retirement, we suggest that a special longitudinal survey on aging and retirement be created in Canada as in England and the United States.”<br />
<br />
Other influences include:
<ul>
<li>income effects that tend to reduce labour force participation rates and increase early retirement expectations;</li>
<li>education as the more highly educated tend to work longer;</li>
<li>poor health by “pushing individuals out of the labour market permanently.”</li>
</ul>
<br />
The report concludes that the recent trend is likely to continue with increasing participation rates of Canadian 45-70 year olds.<br />
<br />
PensionReforms supports the report’s call for better longitudinal data that would help to illuminate this issue (and many others). While the observed later retirement ages may be driven by pension design issues, the GFC and uncertainties about pensions, it is possible that more older people simply want to work, not just for greater financial security. It seems that the main reason for returning to work after retiring in two recent surveys (2002 and 2007) is financial. A “sense of boredom or uselessness in retirement” features next. The better longitudinal data suggested might help policymakers to understand the significance of the ‘financial’ reason.<br />
<br />
Interestingly, the patterns of retirement before age 60 vary significantly across Canada (45% in Quebec, 33% in Ontario and 25% in the West) and the reasons for that are probably significant. (File size 1.25 MB; 44 pp) 539<br />
http://ftp.iza.org/dp5979.pdfThe Recent Evolution of Retirement Patterns in Canada (2011)539Thailand’s means-tested Tier 1 was introduced in 1993, but few qualified despite elderly poverty levels. Local authorities administered the tests unevenly. In 2009, the monthly ‘Universal’ Pension (500 Baht) started. Pensioners went from 1.9 million to 5.65 million. 2012-03-13T16:15:482011<strong>PensionReforms’ summary and comments</strong><br />
Thailand faces similar ageing issues to most countries. Specifically, the proportion of the population aged 60 and over will be 20% of the population by 2023 and the number of working age per pensioner will fall to 2.57.<br />
<br />
A means-tested Tier 1 pension started in 1993 and there was a range of supplementary occupation and work-related pension schemes that covered a minority of the population. In the early years, fewer than 400,000 elderly qualified for the Tier 1 pension. In 2005 screening of applications was outsourced to local authorities and by 2006 more than a million elderly pensioners were receiving 500 Baht (about US$15) a month. By March 2009, the last month of means-tests, there were 1.9 million pensioners (about 26% of the population over age 60).<br />
<br />
“In practice, there were many limitations to the implementation of a means-tested old-age allowance system. All local authorities had to follow the process that was made clear by the Ministry of Interior .... However, ... the local authorities' understanding of the process was extremely diversified. Some allocated the transfer to all elderly without applying any means-tested eligibility criteria while others followed the process strictly. .... More than 50 per cent of underprivileged elderly did not receive the old-age allowance ....”<br />
<br />
The government treated this state of affairs as an “implementation failure”. It felt “…forced … to go from a means-tested to a universal scheme. .... The change in government ideology was also a critical factor in the transformation. It was reflected in the policy speech that Prime Minister Abhisit Vejajiva delivered ... in April 2009, in which he showed concern that the old-age allowance be a right for the elderly and a reward representing gratitude from society.”<br />
<br />
The 500 Baht Universal Pension Scheme started in April 2009 and its administration will be returned to the central government. A total of 3.6 million were enrolled in the six months April to September 2009. For the 2010 year, the cost was 0.37% of GDP, met from general taxation.<br />
<br />
“All elderly (60 years of age and older) who are not in elderly public facilities or do not receive permanent income (i.e., recipients of a government pension, government-employed persons) are eligible for the Scheme. ....”<br />
<br />
PensionReforms notes that this is not a true ‘universal’ pension though it is so named by the Thai authorities. According to government statistics, 360,700 of the over 60s (5%) are ‘government officers’ and so presumably do not qualify for the pension. Another 1.23 million (17%) are ‘unregistered’ and are presumably not receiving the pension. The government thinks that many would qualify and the report does not explain why they have not registered.<br />
<br />
“Thailand is gradually moving from a targeting approach to universalism. For both health and elderly-income allowances, the country previously used a targeting approach because of fiscal constraints. However, there was concrete evidence that the poor were not protected properly and some non-poor received this benefit from both inclusion and exclusion errors.”<br />
<br />
PensionReforms notes that the 2007 poverty line across the whole population was 1,443 Baht per head per month (according to a 2008 report from the National Economic and Social Development Board). The number will be different for just the elderly who in any event depend on family support. However, that does put the 500 Baht pension into context.<br />
<br />
PensionReforms thinks the Thai government was right to make the change to Tier 1 pension. It will be interesting to see what impact the 500 Baht pension has on the economic position of the elderly and their families. The costs of administering the old arrangements will have fallen significantly, particularly once the central government resumes control of its distribution. (File size 217 KB; 15 pp) 538<br />
http://www.ilo.org/gimi/gess/RessFileDownload.do?ressourceId=24378500 Baht Universal Pension (2011)538The OECD has taken a look at ‘long term care’ across its member countries. A comprehensive comparison offers a backdrop for a discussion on policy options for governments that all face much higher future LTC bills. 2012-03-07T11:31:302011<strong>PensionReforms’ summary and comments</strong><br />
The full report (336 pp; $US105) is available from the OECD; the supporting web page <a href="http://www.oecd.org/document/23/0,3746,en_2649_37407_47659479_1_1_1_37407,00.html">here</a> gives chapter-by-chapter access; also to the 31 country summaries.<br />
<br />
In most developed countries, ageing populations will see much larger amounts of money (both public and private) spent on retirement incomes and long-term care (‘LTC’). The current costs incurred by OECD member countries vary significantly as the country summaries demonstrate. LTC is largely, but not exclusively, used by the old.<br />
<br />
“Spending on long-term care, which now accounts for 1.5% of GDP on average across the OECD, will rise accordingly. Sweden and the Netherlands today spend the most, at 3.5% and 3.6% respectively of GDP, while Portugal (0.1%), the Czech Republic (0.2%) and the Slovak Republic (0.2%) spend the least.”<br />
<br />
Across the OECD, costs are likely to more than double as greater proportions of the population will comprise those aged 80+. Over the last 60 years, that proportion has quadrupled across the world (from 1% to 4% of the total population. Over the coming 40 years, that will more than double again (from 4% to 10%).<br />
<br />
“With population ageing, no clear signs of a reduction in disability among older people, family ties becoming looser and growing female labour-market participation, it is not surprising that the need for care for frail and disabled seniors is growing.”<br />
<br />
There will be two main impacts. There is first the direct cost of care but also there will be a reduction in “… the potential supply of individuals available to provide both formal and informal long-term care. The pool of potential family carers is likely to shrink because people are having to work longer and female participation in the labour market is rising.”<br />
<br />
As the pool of family carers diminishes, responsibility for care will shift from unpaid family members to paid professionals. “This could exacerbate the expected rise in LTC spending, by about 5 to 20% by 2050.” Finding and training potential staff will be a challenge.<br />
<br />
“Taken all uncertainties into account, LTC expenditure could even triple between now and 2050.”<br />
<br />
Engaging with family carers has the potential to limit some of these increases. “Support for family carers is often provided as recognition of the fact that they perform a socially useful and difficult task. But more than a gesture is needed.”<br />
<br />
Designing that kind of direct support presents its challenges:<br />
“Addressing these future challenges will be difficult but not impossible. It will require a comprehensive approach covering both policies for informal (family and friends) carers, and policies on the formal provision of LTC services and its financing.”<br />
<br />
PensionReforms notes that there is an unsurprising correlation between the proportion of a population that is aged 85+ and the amount spent by the country on LTC. The country summaries supported this though some of the numbers there did not look robust or directly comparable. It would have been nice to see the country summaries in a common format with respect to the data. Given an average 1.5% of GDP expenditure on LTC across the OECD, it’s not easy to see how Portugal and the Czech and Slovak Republics currently spend 0.2% of GDP or less. That may be a function of necessity for the immediate families of those who, in other countries, would get LTC.<br />
<br />
The ‘more’ button goes to the online executive summary. (File size 118 KB; 18 pp) 537<br />
http://www.oecd.org/dataoecd/53/56/47887770.pdfHelp Wanted? Providing and Paying for Long-Term Care (2011)537What matters for growth seem to be income distribution, democratic institutions, openness to trade and foreign investment and a structure that favours manufacture and sophisticated exports. A stable macroeconomic environment also helps. Saving rates do not feature here. 2012-03-07T11:24:312008<strong>PensionReforms’ summary and comments</strong><br />
Some think that if citizens save more for retirement (especially if forced to do so through a Tier 2 scheme), it will lead to more savings, greater investment and higher economic growth. As baby boomers retire, they will need a stronger economy to support them and will, through the accumulation phase, have contributed directly to that.<br />
<br />
There is little doubt that a stronger economy will be better able to sustain an ageing population so it is important to understand the factors that might make that possible.<br />
<br />
In this 2008 report, the IMF takes a look at 140 countries to see what factors seem to contribute to sustained periods of growth. The report uses an analysis of “structural breaks in economic growth paths around the world” to define “growth spells” and so allow us to understand the drivers for “growth duration”.<br />
<br />
“The paper identified a handful of economic and political characteristics that appear to sustain growth: more equal income distribution, democratic institutions, openness to trade and foreign direct investment, and an export or production structure that favors manufacturing and relatively sophisticated exports. We also found that stable macroeconomic environments, with lower inflation rates and fewer instances of high depreciation, are conducive to longer growth spells.”<br />
<br />
Conversely, what seems to encourage lower and/or more volatile growth are “less equal and cohesive societies” that can potentially lead to populist policies, “weaker institutions and a reduced capacity for managing external shocks”. <br />
<br />
“Export orientation may help growth by building constituencies in favor of better institutions;… and the idea that current export or production structures matter for future growth because they favor innovation and allow economies to react more flexibly to shocks…”<br />
<br />
PensionReforms suggests that none of this seems too surprising and it is nice to have the supporting evidence. But what seems to be missing is the ‘savings’ component though running current account surpluses during growth periods seems “…to increase the chance that growth will be sustained.”<br />
<br />
Instead, what seem to be important are things that only governments can do (or facilitate directly) and that seems appropriate. Governments should worry about their responsibilities rather than focus on the behaviour of their citizens and/or their employers. (File size 451 KB; 35pp) 536<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp0859.pdfWhat Makes Growth Sustained? (2008)536In the US, seemingly generous Tier 3 pension entitlements do not mean that state-local workers have their retirement saving needs covered. That’s because they typically serve less-than-complete careers. Is that a worry? 2012-03-05T13:20:252011<strong>PensionReforms’ summary and comments</strong><br />
A Tier 3 occupational pension for a state-local authority employee in the US typically provides a pension of about 2% of pay for each year of membership. That would mean a 70% pension after 35 years’ service and what could be wrong with that, from the employees’ perspectives? (The taxpayers’ position is another story.) Adding Social Security pensions means that long-serving employees should be in a good financial position at retirement.<br />
<br />
The report suggests the trouble with this scenario is that it depends on employees’ spending long enough as members of these schemes to accrue anything like the target benefits. The report uses data from the Health and Retirement Study to look at this. It then reviews actuarial reports on state schemes to analyse the schemes’ experiences.<br />
<br />
In summary, there are several reasons for the apparent shortfalls:
<ul>
<li>only “32 percent of workers who leave state-local employment each year claim an immediate benefit [that, on average is] equal to 49 percent of their pre-retirement earnings.”</li>
<li>“…another 27 percent leave state-local employment with a deferred benefit based on their earnings at termination…” Subsequent declines in real value will see those as “…less than 10 percent of their projected earnings at retirement.”</li>
<li>“…40 percent leave without any promise of future benefits.”</li>
</ul>
<br />
The other shortfall in projected ‘replacement rates’ for households is caused by the fact that “…most households with a state-local worker contain a person employed in the private sector, and replacement rates for private sector workers are considerably lower since many end up with nothing more than Social Security.”<br />
<br />
PensionReforms wonders what might be wrong with this picture. It does, again, illustrate the shortcomings of any Defined Benefit, Tier 3 occupational pension scheme in that most employees do not actually ‘retire’ from the sponsoring employer. That is probably ‘worse’ with private sector employment than with state-local employees but, even here, the proportion is less than one third.<br />
<br />
And that, perhaps is the real problem rather than apparent shortfalls in ‘replacement rates’. PensionReforms suggests that ‘replacement rates’ should not be a concern of public policy; nor even of the employers. PensionReforms also questions the benchmark target of 80% of pre-retirement income (five year average) as a measure for ‘adequacy’. The report suggests this as the minimum “needed to maintain pre-retirement living standards” but then looks at just formal retirement saving schemes (including Social Security) and financial assets to work out whether the employees concerned do (or might) reach the target. The Tier 3 occupational schemes may be important to former state-local employees but they will not be their only sources of financial support in retirement. Even when they first start receiving Social Security benefits (the report’s definition of ‘retirement’) an increasing proportion will still be working so that wages will make a direct and increasingly important contribution to retirement security.<br />
<br />
PensionReforms would prefer to see post-retirement consumption patterns as a measure of retirement income adequacy. Neither the employer, nor even public policy need be particularly concerned about whether current/former employees reach a fixed target, such as 80%. That’s for employees themselves to worry about, if indeed concern needs to be expressed. The only possible interest a government might have in this kind of replacement rate would, perhaps, be to cap tax breaks on retirement savings.<br />
<br />
PensionReforms thinks that state employers might wonder whether they should be sponsors at all of DB, Tier 3 schemes as they seem not to be achieving their stated objectives for about two-thirds of employee members, never mind the non-members. (File size 477 KB; 34 pp) 535<br />
http://crr.bc.edu/images/stories/Working_Papers/wp_2011-15_508.pdfHow Prepared Are State And Local Workers For Retirement? (2011)535The EU requires the Czech government to improve its fiscal position to comply with limits on deficits and debt. A 2008 report looks at the long-term implications of tax and benefit changes. Pre-funding pensions may help (apparently). 2012-03-05T13:02:492088<strong>PensionReforms’ summary and comments</strong><br />
In this 2008 report, the IMF has run its ‘Global Fiscal Model’ (‘GFM’) over the Czech economy to see how it can sustainably bring its deficit below an EU-mandated 3% of GDP (in fact to 1% by 2012). The Global Financial Crisis (GFC) has overtaken things somewhat in the meantime and the government is still struggling to get the deficit below 3% by 2013. Currently (2011) it is 4.2% (see <a href="http://www.bloomberg.com/news/2011-07-20/czech-cabinet-passes-deficit-cutting-budget-plan-after-dispute.html">here</a>).<br />
<br />
Regardless, the principles of the IMF’s proposals deserve examination. It looked at the Czech government’s decisions to reform income tax and reduce expenditure. Among the tax reforms were a flat income tax (15%) on a broader definition of ‘income’ that replaced a four-step regime; a reduced corporate tax rate (from 24% to 19%); increased lower rate of expenditure tax (increased from 5% to 9%); caps on pay for pensions and health insurance and reduced social benefits. Overall, the report expects government deficits to increase as a result of the tax changes and for total debt to be less but still significant (250% of GDP by 2050).<br />
<br />
There were also proposals to partially privatise pensions through a ‘carve-out’ from state contributions/benefits.<br />
<br />
This is part of what the IMF calls ‘fiscal consolidation’. Apart from complying with the EU’s rules: <br />
“…fiscal consolidation also needs to improve incentives to work and enhance competitiveness. Longer term spending pressures stemming from pensions and health care, given significant demographic pressures, also call for early reform efforts to put public finances on a sustainable path.”<br />
<br />
The tax changes will apparently support growth because the tax system will be less distortionary. However, “…debt dynamics remain unsustainable over the long run” in part because of the ageing population. The population aged 65+ as a proportion of the ‘working age’ population is expected to increase from about 20% in 2003 to nearly 60% by 2050. That is a worse trajectory than the EU average.<br />
<br />
“Given the aging pressures, restoring debt sustainability will require additional reforms... A further increase in the retirement age is desirable, but will also not suffice.”<br />
<br />
The factors that will influence pension ‘reform’ include “…intergenerational equity and consumer myopia.”<br />
<br />
What the report calls “upfront consolidation” includes pre-funding of pension promises to “…promote generational equity in sharing the fiscal burden of aging.”<br />
<br />
In summary, the report suggests that “…raising the [statutory] retirement age [from 63 to 65] and prefunding future aging costs would be needed to keep debt below 60 percent of GDP through 2050.”<br />
<br />
“Prefunding … provides several advantages. By ensuring that the output costs are borne primarily by the beneficiaries of the government transfers, greater generational equity is achieved. Early consolidation is also attractive as it ensures that output losses occur at a time when the economy is still experiencing the gains from income convergence. Prefunding could be achieved by reducing gross debt or by building up a separate pension reserve fund: the two would be equivalent if the costs of borrowing is equal to the return on the reserve assets.”<br />
<br />
The report looked at a possible model – allowing employees to divert 4% of pay (one third of total contributions) to private accounts. Whether that would change things (apart from increasing short-term deficits) would depend on the possible levels of “consumer myopia” and whether the reduced state contributions are actually ‘saved’.<br />
<br />
PensionReforms suggests that, in the face of given pension levels, whether pre-funding helps will depend on the impact of the pre-funding accumulations on economic growth. Somehow, current pensions still require current money and reducing social security contributions means higher immediate deficits and debt, other things being equal. The only way to reduce the pension ‘burden’ is to cut benefits and it doesn’t much matter whether those benefits are ‘public’ or ‘private’. Requiring today’s workers to pre-fund (and so ‘pay for themselves’) means, in fact, that they have to pay twice – once for today’s pensioners and again for themselves. That doesn’t sound too much like “greater generational equity” to PensionReforms. Cutting benefits (or reducing their value by changing, for example, the State Pension Age) seems inevitable. (File size 570 KB; 27 pp) 534<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp08125.pdfTax and Pension Reform in the Czech Republic: Implications for Growth and Debt Stability (2008)534A US Commission has looked at ‘strengthening’ Social Security for ‘people of color’. The disadvantages they face after retirement are in fact the outcomes of lower career incomes and work discontinuities. These problems are not confined to minorities. 2012-02-27T10:39:162011<strong>PensionReforms’ summary and comments</strong><br />
The US Social Security system, based on current contributions and benefits will be able to maintain full benefits until 2036, 25 years after the publication of this report. Changes will be needed if things are to stay on much their present footing. In the meantime, the population is changing – most babies born in 2011 were ‘children of color’. By 2042, the population as a whole is expected to become “majority/minority”.<br />
<br />
The report’s authors (“a group of experts from or representing African American, Asian American and Pacific Islander, Latino, and Native American communities”) was asked “…to identify proposals to extend Social Security’s long term solvency while also modernizing the program to meet the needs of an increasingly diverse society.”<br />
<br />
“Despite the growth of racial and ethnic populations of color, the socioeconomic outlook for this rising majority is not rosy. The vast majority of children of color are born into lower-income, low-wealth households. This historical phenomenon has its roots in discriminatory labor market practices and social policies. However, the current socioeconomic circumstances of families of color have also been shaped by increased economic insecurity and stagnating wages for working class Americans of all backgrounds and the loss of U.S jobs due to globalization and the Great Recession.”<br />
<br />
The report expressed concern that Social Security might fall victim to a scrutiny by policymakers “at every level of government”. Instead, the report suggests that any review should focus not just on Social Security’s so-called ‘solvency’ but also on “how to increase the adequacy of benefits for vulnerable recipients.” It describes Social Security as “…an especially important asset for workers and families of color who are more vulnerable to economic instability and who are the least likely to have wealth as a direct result of past racial discrimination in American life and policies.”<br />
<br />
These aspects mean that Hispanics and African-Americans receive benefits, on average, that are greater in value than contributions paid by and in respect of them. Also that roughly half of the value of Social Security benefits received by these groups are survivor and disability benefits. For white populations, about 74% depend on Social Security for retirement benefits. That in part is due to their better mortality and morbidity statistics at both older and younger ages.<br />
<br />
“Although the Social Security benefit formula is gender- and race-neutral on its face, in reality the program affects people in different ways based on the interplay between program rules and demographic factors.”<br />
<br />
The disparities between the various racial groups (and subsets attributable to gender) are well documented (and, to PensionReforms, unsurprising) but how might reforms address the Commission’s concerns? Whatever changes are made, the report suggests that vulnerable populations need greater security; access needs improving; intergenerational equity is needed while ensuring long term solvency and adequacy.<br />
<br />
Here are the recommendations:
<ol>
<li>Remove the ‘tax max’ – the salary cap on contributions of, currently $US106,800. Incomes above that should receive reduced entitlements.</li>
<li>Include all new hires who are employed by states (currently exempted).</li>
<li>Increase Social Security contributions by 0.5% over 20 years from both employers and employees.</li>
<li>Impose contributions on payroll deductions for healthcare, transit and dependants’ plans (currently exempt, unlike 401(k) schemes).</li>
<li>Increase benefits for those over age 85 by a fixed dollar amount.</li>
<li>Increase the widowed spouse benefit to 75% of the worker’s benefit.</li>
<li>Allow dependant care to provide up to five years of benefits set at, say, half the average wage.</li>
<li>Reinstate the student benefit that was abolished in 1981.</li>
<li>Compensate low earners for a likely lack of private pension provision by having a special minimum benefit set at 125% of the poverty threshold for those who have at least 30 years’ contributions.</li>
<li>Increase benefits by a uniform 5% of the average benefit. That would benefit poorer recipients.</li>
</ol>
<br />
Raising the State Pension Age is not recommended as the burden of this would fall more heavily on the ‘vulnerable’ who depend more heavily on Social Security benefits. The same applies to reducing the annual increases in benefits.<br />
<br />
The report suggests that all this would satisfy the test of ‘solvency’ over a 75 year period.<br />
<br />
PensionReforms notes that Social Security in the US is about more than retirement benefits and some of the report’s focus is on issues that are not of direct concern on the pensions front. It isn’t possible to address Social Security’s financing issues without recognising those other benefits.<br />
<br />
Most of the retirement income issues noted in the report are in fact a function of incomes and work histories; also of family circumstances. They are not issues specifically confined to ‘people of color’ as there are white people facing the same issues, just as there are ‘people of color’ who have high incomes, stable families and complete work histories. PensionReforms observes that most of the current problems would disappear if Social Security pensions depended on something other than incomes, dependencies and work history. ‘People of color’ are perhaps the canary in the mine of Social Security: illustrating the problems but not necessarily illuminating the solution. (File size 910 KB; 52 pp) 533<br />
http://www.insightcced.org/New_Future_Social_Security_Commission_Report_Final.pdfPlan for a New Future: The Impact of Social Security Reform on People of Colour (2011)533Paying for care in old age is a significant social issue. A UK Commission finds its current system “not fit for purpose….being confusing, unfair and unsustainable”. Life-time care costs should be capped at £35,000. Other administrative aspects need reform.<br type="_moz" />2012-02-27T10:32:212011<strong>PensionReforms’ summary and comments</strong><br />
The UK’s Dilnot Commission (led by Andrew Dilnot) looked at ‘social care’ in the UK and reported in 2011. Its findings were less-than-comforting.<br />
<br />
“The current adult social care funding system in England is not fit for purpose and needs urgent and lasting reform.”<br />
<br />
After income in retirement, the next most expensive cost to developed societies of ageing populations around the world is for healthcare. Across whole populations of the elderly, the cost of healthcare increases inevitably with age but its incidence can be very uneven. In most countries, the main financial burden of that rests with taxpayers.<br />
<br />
The UK has a system that is as complex as most but that complexity is compounded by the dispersed nature of decision-makers at the coal-face. There are effectively 152 “different adult social care systems – one for each local authority in England.” That potentially makes decisions for given cases different across the country.<br />
<br />
“The current system is confusing, unfair and unsustainable. People are unable to plan ahead to meet their future care needs. Assessment processes are complex and opaque. Eligibility varies depending on where you live and there is no portability if you move between local authorities. Provision of information and advice is poor, and services often fail to join up. All this means that in many cases people do not have good experiences.”<br />
<br />
It isn’t really possible to buy insurance against these expected costs; and even if that were possible, the premiums under private cover would become prohibitive with age. Currently, one-in-ten UK citizens at age 65 face lifetime healthcare costs of more than £100,000. For the disabled young, the lifetime cost can be much higher.<br />
<br />
That breeds uncertainty and concern about the future. The Commission found that individuals recognised the need to contribute to those costs “…but they want a fairer way of sharing costs and responsibility between the state and individuals and they want to be relieved of fear and worry. There is consensus on the need for reform.”<br />
<br />
In summary, the Commission rejected a “private, insurance-based solution, instead recommending a shared responsibility model [as] best because risks are shared between the state and the individual.” The insurance market would be able to participate in the capped personal liability created by the proposed scheme.<br />
<br />
The report makes ten main recommendations:
<ol>
<li>Capping the ‘lifetime’ adult social care costs at £35,000 beyond which the state would pay. It will be up to individuals to decide how to meet their personal share.</li>
<li>Means-testing support will continue for those who cannot pay £35,000 and “…the asset threshold for those in residential care beyond which no means-tested help is given should increase from £23,250 to £100,000.” Currently, there is broadly no help with assets of more than £23,250.</li>
<li>Those with congenital disabilities should get support without a means test.</li>
<li>“Universal disability benefits for people of all ages should continue as now.”</li>
<li>A national standard rate to pay for ‘general living costs’ in care of £7,000 to £10,000 should apply. This would be on top of the healthcare component and would, for the old, typically come from regular pension income.</li>
<li>Eligibility criteria for service entitlements should be set and applied nationally.</li>
<li>The government needs to inform its citizens about the financial implications of the new regime, once implemented.</li>
<li>There needs also to be “…better, easy-to-understand and reliable information and advice about services and funding sources” when people need help.</li>
<li>Carers need more help; also better information and advice.</li>
</ol>
Finally:<br />
“10. In reforming the funding of social care, the Government should review the scope for improving the integration of adult social care with other services in the wider care and support system. In particular, we believe it is important that there is improved integration of health and social care in order to deliver better outcomes for individuals and value for money from the state.”<br />
<br />
All this will be at some cost to taxpayers – with a lifetime cap at a possible £50,000, the expected annual cost would be about £1.3 billion, increasing to about £2.2 billion if the cap were set at £25,000. The recommended cap of £35,000 would see that cost somewhere between those. Currently, the government spends £14.5 billion a year in England on ‘adult social care’.<br />
<br />
PensionReforms agrees that, given the government’s deep financial involvement in providing care, it makes no sense for a person’s entitlement to be an accident of political boundaries. A nationally funded arrangement demands uniformity of entitlement and implementation.<br />
<br />
However, the fact that “Everyone who currently gets free care under the means-tested system will continue to do so, and everyone else benefits from our proposals” means that someone else has to pay for that improvement. There is a potential inter-generational dilemma here – if retired people leave more in their estates as a result of the long-run effects of the proposals, their children will receive larger inheritances at the expense of taxpayers as a whole. On the other hand, if a means-test regime is severe enough, avoiding it creates financial planning opportunities. A balance has to be struck – one that seems ‘fair’ to the retired (so as to discourage avoidance activities) while it asks the affected population for a ‘reasonable’ contribution to costs. In the end, this may see a greater private contribution than is currently received under a much more stringent test. One possibility, in the case of age care, is to ask the whole population of potentially entitled citizens to share the risk, rather than all taxpayers. That would be intra-generational rather than inter-generational.<br />
<br />
One practical difficulty: the proposal is for a ‘lifetime’ test of £35,000. PensionReforms assumes this will require a record of all ‘social care’ expenditures on every adult citizen over their lifetimes. PensionReforms understands the rationale but wonders at the social value of maintaining that record. There is probably a need to separate care of the old from the rest for this purpose. A formal, intra-generational approach to risk-sharing would require that separation. (File size 2.3 MB; 82 pp) 532<br />
http://www.dilnotcommission.dh.gov.uk/files/2011/07/Fairer-Care-Funding-Report.pdfFairer Care Funding - the Report of the Commission on Funding of Care and Support (2011)532‘Proxy means testing’ is apparently a more objective way of targeting households that really need financial help. This matters where anti-poverty programmes are used as a form of aid. For a number of reasons, the PMT is deeply flawed statistically. 2012-02-20T11:10:142011<strong>PensionReforms’ summary and comments</strong><br />
It would be nice to say, with confidence, that people who really need financial help receive it while those who have no need for state-sponsored financial assistance do not. The World Bank has lent its support to a statistical analysis technique dubbed ‘Proxy Means Testing’ (PMT) that claims it can help countries to work out who needs help.<br />
<br />
“Proxy means tests generate a score for applicant households based on fairly easy to observe characteristics of the household such as the location and quality of its dwelling, its ownership of durable goods, demographic structure of the household, and the education and, possibly, the occupations of adult members. The indicators used in calculating this score and their weights are derived from statistical analysis (usually regression analysis or principal components) of data from detailed household surveys of a sort too costly to be carried out for all applicants to large programs.” (see <a href="http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTSOCIALPROTECTION/EXTSAFETYNETSANDTRANSFERS/0,,contentMDK:20795790~menuPK:1552914~pagePK:210058~piPK:210062~theSitePK:282761,00.html">here</a>). <br />
<br />
The PMT does not, seemingly, withstand analysis. In this report for the Australian government’s AusAID staff, the PMT receives a statistical demolition. It suggests that policymakers approach the PMT with great caution. Specifically, it identifies a number of deficiencies.<br />
<br />
“Proxy means testing uses multivariate regression to correlate certain proxies, such as assets and household characteristics, with poverty and income. This study assesses regression accuracy in Bangladesh, Indonesia, Rwanda and Sri Lanka and finds that the PMT has high in-built errors, especially at relatively low levels of coverage (20% of the population and below). Exclusion and inclusion errors vary between 44% and 55% when 20% of the population is covered and between 57% and 71% when 10% is covered.”<br />
<br />
In other words, based on the countries analysed, it would not be possible to have more than a relatively vague idea of poverty in individual households. Sampling errors contribute to that disconnect between aggregate and household data sets. Even such a basic issue as what constitutes a ‘household’ creates difficulties; also a natural reticence for households to tell strangers what their true position is. <br />
<br />
These shortcomings help “increase the arbitrary nature of the methodology yet affect whether individual households receive social protection benefits.”<br />
<br />
These fundamental problems are not helped by the fact that national surveys tend to be a point-in-time snapshot at three or five-yearly intervals whereas ‘poverty’ is a much more dynamic concept. Using current assets (rather than incomes) also tends to focus on past, rather than present incomes.<br />
<br />
These are not the only difficulties:<br />
“The PMT is expensive to administer and has associated social and political costs. There is evidence that it can generate social conflict and stigmatise beneficiaries. Politically the methodology - as with all other forms of poverty targeting - is less likely to be popular because it excludes the middle class and those who are better-off.”<br />
<br />
The administration difficulties are quite basic and, after the PMT scoring system has been developed, include such practical issues as finding beneficiaries to be surveyed, the ‘capacity’ of the enumerators, verifying the indicators (such as age, education, occupation, property, livestock etc.), identifying the interviewee, verifying the data, political interference and so on.<br />
<br />
Given the World Bank’s emphasis on the apparently ‘objective’ statistical analyses that underpin the PMT, the report’s final verdict is less than encouraging:<br />
“This study’s findings show that the PMT is inherently inaccurate, especially at low levels of coverage, and it relatively arbitrarily selects beneficiaries. It therefore functions more like a simple rationing mechanism that selects some poor and non-poor but excludes large numbers of eligible poor from receiving benefits and support.”<br />
<br />
In other words, the PMT fails its own test. It seems not to target just the poor but many of the poor miss out. It suggests that policymakers need to understand that "this combination of theoretical errors means a majority of eligible poor households may be permanently excluded from social grant benefits as a result of PMT scoring".<br />
<br />
PensionReforms is unsurprised by all this. Said quickly, it sounds ‘sensible’ to pay taxpayer- (or aid-) financed benefits only to people who actually need them. Run well, the benefit programme can give more to each recipient (for a given overall budget) identified in the target group. The devil, however, is in the detail – who qualifies? Also in the assumption that potential recipients can be easily identified and do not change their ‘natural’ behaviour when confronted by the measures used in the income and assets tests. Even if a country’s administrative capacity can cope with the complexity of administering means tests (by no means a given) the PMT implies a relatively high quality of information-gathering and bureaucracy that simply aren’t present in the types of country that might benefit from an assault on poverty through direct benefits.<br />
<br />
PensionReforms has looked at a number of Universal Pension programmes in poorer countries: see, for example Mauritius <a href="http://www.pensionreforms.com/Preview.aspx?215">here</a>, Lesotho <a href="http://www.pensionreforms.com/Preview.aspx?212">here</a> and Samoa <a href="http://www.pensionreforms.com/Preview.aspx?269">here</a>. <a href="http://www.pensionreforms.com/Preview.aspx?412">Here</a> is a report that recommends Universal Pensions as a way of most directly fixing the problem of poverty in old age in low income countries. The same applies to richer countries. (File size 1.72 MB; 52 pp) 531<br />
http://www.ausaid.gov.au/keyaid/pdf/targeting-poorest.pdfTargeting the Poorest: an assessment of the proxy means test methodology (2011)531Australia’s pension system has grown haphazardly and piecemeal-wise since the mid 1980s. The tinkering continues and the complexity grows. Is it working? It’s still apparently too early to tell but the system tends to encourage early retirement. That’s probably not a ‘good’ thing.2012-02-20T10:59:242008<strong>PensionReforms’ summary and comments</strong><br />
There is quite a lot wrong with Australia’s pension system. An extensive 2010 report (see <a href="http://www.pensionreforms.com/Preview.aspx?405">here</a> for more) – the ‘Cooper Review’ – suggested that the whole Tier 2, compulsory arrangements needed to become more ‘member centric’. Another government report (see <a href="http://www.pensionreforms.com/Preview.aspx?407">here</a> for more) recommended changes (but nothing radical) to the whole tax and transfer arrangements.<br />
<br />
This 2008 report gives some historical background to Australia’s pension arrangements since the state’s first involvement in 1900. In summary, these now comprise a relatively generous, non-contributory ‘Age Pension’ at Tier 1. It is both income and asset-tested (but there is a proposal to drop the asset test in favour of a more stringent income test). In addition, there is a raft of <em>ad hoc</em> benefits for pensioners such as the:<br />
“…pharmaceutical allowance, telephone allowance, utilities allowance, remote area allowance and a pensioner concession card which reduces the costs of medicines under the Pharmaceutical Benefits Scheme, as well as other benefits such as reductions in property and water rates, reduced fares on public transport, and reductions on motor vehicle registration.”<br />
<br />
At Tier 2, employers must contribute 9% (increasing gradually to 12% by 2019-20) to an ‘SG’ [‘Superannuation Guarantee’] scheme. At Tier 3, employers and individuals can do what they like but formal schemes at both Tiers 2 and 3 can qualify for significant tax breaks.<br />
<br />
“Australia’s retirement income system, consisting of the Age Pension, superannuation, and other savings, has gone through substantial changes over the past two decades, the most significant being the introduction of the Superannuation Guarantee in 1992. For most Australians, the main source of retirement income has been the Age Pension, and this will continue to be the case until the Superannuation Guarantee is fully mature.”<br />
<br />
The compulsory Tier 2 scheme started as a 3% deferred pay increase for union-based employees in 1986 but was extended to all employees in 1992.<br />
<br />
“Since the beginnings of compulsory superannuation, starting with Award Super in the 1980s, the Australian Retirement System has undergone a spate of changes, which, for the most part, have added to its complexity. Furthermore, these policy changes have not always been consistent.”<br />
<br />
The report describes examples of these “inconsistencies” as changes to the way the Tier 2 benefit can be received, the so-called ‘surcharge’ on high earners (now removed), the changes in tax treatment, changes in the access age for Tier 2 benefits and the government’s ‘co-contribution’ to help the low paid.<br />
<br />
“This constant flux in government regulation and policies – particularly changes in the tax treatment of superannuation and the level of benefit available from the Age Pension – may, in itself, make it difficult for those planning their retirement in the short- to medium-term to make informed decisions about their retirement arrangements.”<br />
<br />
Policy makers seem concerned about the labour force participation effects of all this and whether the ‘Transition to Retirement” pensions will increase participation by older workers and reduce reliance on the income and asset-tested Age Pension at Tier 1:<br />
“Indeed, some have argued that these policy changes create perverse incentives, and will encourage early retirement. However, it is clear that one major shortcoming of Australia’s current retirement income system is the different ages that various policies take effect, with the superannuation preservation age currently at 55, tax concessions on superannuation applying at age 60 and Age Pension eligibility at 65 for men and being gradually increased to 65 for women. This variation makes it possible for individuals to draw down their superannuation prior to Age Pension age, creating an incentive for early retirement.”<br />
<br />
It seems to PensionReforms that the results of all this complexity and cost (to Australian workers) have yet to be justified. For example, the bias towards early retirement may contribute to Australia’s unacceptably high levels of poverty amongst the age 65+ population (see <a href="http://www.pensionreforms.com/Preview.aspx?289">here</a> for more).<br />
<br />
PensionReforms thinks that Australia’s retirement income system seems not to be working on a number of measures. It is very complex, regressive, distortionary and seems not to have achieved what should be its primary objective – eliminating poverty in old age. And, as the report documents, it is subject to constant, significant changes:<br />
“Over the past decade, changes to Australia’s retirement income policy have been announced in almost every Federal Budget, with no signs yet that reform is coming to an end.”<br />
<br />
But then, the current overall structure has been in place for ‘only’ 20 years so perhaps it is still too early to pass judgement. One thing seems certain, however: despite Australia’s system being labelled by the World Bank as ‘world best practice’, the system’s complexity means that the future incomes of financial planners and other financial service providers seem assured in Australia over the next few decades. (File size 285 KB; 41 pp) 530<br />
http://www.melbourneinstitute.com/wp/wp2008n23.pdfAustralia's Retirement Income System - Historical Development and Effects of Recent Reforms (2008)530In a 2005 report, the IMF predicted that governments faced a squeeze between revenues and expected benefits from ageing populations. The roles of the state and private sectors require ‘rebalancing’. Reports on future projections require ‘scenario analyses’. 2012-02-15T09:22:562005<strong>PensionReforms’ summary and comments</strong><br />
In a 2005 report, the IMF looked at the structural issues created for countries by ageing populations. Even before the Global Financial Crisis (GFC) there were risks that countries were not addressing fully. Governments seemed to be heading inevitably towards a squeeze between falling incomes and rising costs. The EU-15 countries illustrated that.<br />
<br />
“Policy-makers have quite appropriately focused on the implications of aging populations for fiscal policy. The dense nature of social insurance commitments, particularly in the spheres of pensions, disabilities, and survivors benefits justifiably has fueled attention on the ramifications of an increasing share of the elderly dependent on a relatively smaller share of the population of working age, at current legislated retirement ages.”<br />
<br />
And then there are the costs of healthcare.<br />
<br />
The report concludes that, before the GFC, countries were understating the “downside risks arising from the uncertainty of the policy environment.” It suggests that allowances for being wrong about the underpinning assumptions need to be specifically incorporated into future projections.<br />
<br />
The report also suggests that governments have limited and reducing scope for cuts in other expenditures:<br />
“Efforts since the early 1990’s to consolidate budgets (e.g., in the context of the Maastricht criteria and the Stability and Growth Pact) have narrowed significantly the potential for further cutbacks in the most obvious expenditure categories.”<br />
<br />
Finally, there seems limited and reducing scope for increasing taxes to pay for the costs associated with the ageing populations.<br />
<br />
“Together, this means that most governments will have to adopt a more ambitious fiscal policy stance cum policy reform framework aiming at a rebalancing of the role of the state and the private sector in the face of aging populations. With little scope left for tinkering with the existing expenditure framework, the focus must now be on long-term structural reform programs that achieve a steady and sustainable decline in expenditure commitments arising from aging populations and in the extent of the state’s obligations in the medical care sphere.”<br />
<br />
That really means reducing benefits though the report said that “…rationalizing such programs go far beyond the scope of this paper”. What the report does suggest though is that governments need to ‘harden up’ on the underpinning assumptions – in the report’s more constrained language: they need to become “…attuned to potential vulnerabilities in making long-term expenditure forecasts of economic and functional expenditure categories.”<br />
<br />
In the meantime of course, the world is still in the midst of the GFC. One of the “downside risks” mentioned in the report was “The appropriateness of the implicit assumption of an absence of “shocks” to the budget, or the economy more generally…”. PensionReforms notes that we did not have to wait long for that to happen; and that particular ‘downside risk’ has not played out by some distance yet. (File size 341 KB; 35 pp) 529<br />
http://www.imf.org/external/pubs/ft/wp/2005/wp0591.pdfCharacterizing the Expenditure Uncertainties of Industrialised Countries in the 21st Century (2005)529The US has significant poverty issues amongst its retired population. Social Security, in its present format can’t address them directly so benefit changes are needed, targeted at the poor. Given fixed contributions, some must expect lower future benefits. 2012-02-15T09:17:512008<strong>PensionReforms’ summary and comments</strong><br />
One of the problems with public pension policies in the US is that they seem not to work for the bottom end. The US suffers from what should be unacceptable levels of poverty amongst those over age 65. As PensionReforms has noted previously, the design of Social Security demonstrably does not prevent poverty in old age but, in a way, contributes to it with its dependence on working-life incomes (and ‘contributions’). The OECD has ranked the US as fourth worst in an international comparison of poverty rates amongst the retired old (see <a href="http://www.pensionreforms.com/Preview.aspx?411">here</a>). <br />
<br />
This 2008 report wonders whether the design of Social Security might be improved to address this:<br />
“Although Social Security has had a tremendous effect on well-being in old age, it could be reformed to better serve lower-income beneficiaries, among whom women and people of color are over-represented.”<br />
<br />
The report suggests that the well-known future ‘deficits’ faced by Social Security seem to preclude improving the lot of the low paid. Faced with a fixed expected income from Social Security contributions, changes to help the needy seem to mean necessary reductions in benefits for other contributors.<br />
<br />
“This would require difficult choices, in that many workers’ returns to FICA [Federal Insurance Contributions Act] tax contributions would decline. Some program advocates suggest that universality and attendant middle-class importance and support are vital to Social Security’s survival as a major component of the U.S. social safety net. Given that large and persistent differences in a wide array of life course processes offset some of the existing progressivity mechanisms, we argue that adding more progressivity to the system without fundamentally altering its character is still possible.”<br />
<br />
The report suggests the following to increase the ‘progressivity’ of Social Security:
<ul>
<li>pension credits for caregivers – this might involve ‘decoupling’ the supplemental benefits from marriage as a pre-condition.</li>
<li>minimum benefits and other formula changes – this might involve changes such as reducing the minimum years required, moving from wage to price indexation or inserting a third ‘bend point’ in the formula.</li>
<li>changes to the taxes – the proportion of total pay covered by Social Security has reduced; another approach would be to reduce contributions for the lower-paid. PensionReforms looked at a paper about the so-called ‘tax max’ <a href="http://www.pensionreforms.com/Preview.aspx?519">here</a> .</li>
<li>‘period certain’ pensions and lump sum benefits might reduce the disparity between benefits received by different groups with higher and lower mortality rates.</li>
</ul>
<br />
The report then analysed the options within the constraints of current and expected contributions.<br />
<br />
“Our results are only illustrative, however. In the current highly constrained fiscal environment, designing changes to Social Security will require careful attention to trade-offs.”<br />
<br />
PensionReforms suggests that the report inadvertently highlights a more major issue with Social Security: its close relationship between in-work economic status and post-retirement entitlements. Given that and given also its ‘social welfare’ role, the scheme has already had to incorporate design elements to reduce those linkages. Having done that (with the report’s acknowledged deficiencies), changes with a similar design strategies are easier to think about rather than root and branch reform. There is also the uneven nature of the benefits that emerge for workers with similar employment histories. It would have been nice to see some real life cases in the report showing how the current system actually works and how the suggested changes might improve things. The uneven treatments delivered to workers with different marital histories, for example, are the result of thinking from a different era where more than one marriage in a working life would have been a rarity.<br />
<br />
Given Social Security’s present set-up, the only really reliable way of addressing the issues raised in the report is income and/or asset testing with a higher initial benefit as the starting point but PensionReforms would counsel against those. PensionReforms thinks it’s time for the US to start thinking about a Universal Pension. That would allow the whole FICA-based system of payroll taxes to be dismantled. A flat-rate pension would automatically give the needed progressivity that would have the potential to lift all retirees out of poverty. (File size 111 KB; 29 pp) 528<br />
http://www.taxpolicycenter.org/UploadedPDF/1001231_social_security.pdfAre There Opportunities to Increase Social Security Progressivity despite Underfunding? (2008)528India’s new (2004) pension arrangements move new civil servants from DB to DC and provide investment options for savers. That may interest private fund managers but doesn’t come close to meeting the needs of most Indian workers. 2012-02-13T09:29:432007<strong>PensionReforms’ summary and comments</strong><br />
India is trying to reform the complex pension system that covers less than 12% of its 450 million workers.<br />
<br />
This 2007 report from the IMF looks at the then recent 2004 regulatory arrangements for pensions in India dubbed the “New Pension System” (NPS):<br />
“The move shifted all new central government employees to a defined contribution plan from the current noncontributory defined benefit scheme, shifting the risk of retirement financing from the government to individuals. Once the law is approved, participants in the new scheme will have access to a range of investment products from selected private sector companies. The NPS would be open on a voluntary basis to non-government workers, including those in the unorganized private sector. An important element of the reform will be to set up a proper regulatory framework.”<br />
<br />
Employees must contribute 10% of pay (matched by the employer) and, on retirement from age 60, at least 40% of the resulting accumulation must be used to buy an annuity. Members can choose from four fund management strategies. The tax treatment is broadly EET.<br />
<br />
The new arrangements are compulsory for new government employees (except in the Armed Forces) from 1 January 2004 and voluntary for everyone else (those aged between 18-55). 19 state governments have also introduced the NPS. The report saw two flaws in the new framework:<br />
- “The absence of a first pillar” and <br />
- “the only partially mandatory participation”.<br />
<br />
It thought that these would result “…in concentration of pension portfolios in government securities and higher-than-expected management fees as economies of scale are not realized early on.”<br />
<br />
The report’s main focus is on the likely implications of the reforms on capital markets. It first suggests that the extent of the scheme should be widened to achieve “critical mass” more quickly. Perhaps the management of all existing reserves in partially funded schemes should also be “outsourced”.<br />
<br />
More flexible investment regulations for funds under management would “…ensure both faster growth of pension-led securities demand and optimal diversification of pension portfolios.”<br />
<br />
The potentially fast growth in pension assets suggested that better capital market regulation was needed to ensure the efficient pricing of securities.<br />
<br />
“In particular, debt management agencies and regulators can support the provision of new instruments for retirement savings by ensuring liquid government bonds (that serve and important benchmark function for the private sector) and issuing price-indexed bonds (to support the issue of price-indexed annuities).”<br />
<br />
There should also be greater eventual freedom for the NPS arrangements to invest overseas.<br />
“While immediate liberalization of foreign investment restrictions may not be viable, over time it should be considered as the efficiency and effectiveness of PFMs improves.”<br />
<br />
PensionReforms suggests that India’s pension reforms may have been necessary but, to suggest that they have broad significance misses the fact that India’s workforce is largely ‘informal’ as the report itself notes. While the report’s focus is on the capital market implications of the NPS, PensionReforms thinks that the NPS is really about getting governments in India off the Defined Benefit hook. That is a reasonable objective but says nothing about the pension needs of the vast majority of India’s workforce who aren’t even formally employed. (File size KB; 23 pp) 527<br />
http://www.imf.org/external/pubs/ft/wp/2007/wp0785.pdfFinancial Market Implications of India's Pension Reform (2007)527A 2006 IMF report found Asia generally well-placed economically to deal with ageing populations. However, evidence ‘on the ground’ is mixed. Governments tend to avoid direct involvement with social insurance programmes. The potential problems will not go away. 2012-02-13T09:24:312006<strong>PensionReforms’ summary and comments</strong><br />
This 2006 report from the IMF on the economic and fiscal implications of ageing populations was written before the global financial crisis (GFC). However, the 10 Asian countries covered in the report (China, Hong Kong, India, Indonesia, Japan, Malaysia, Philippines, Korea, Singapore and Thailand) have so far managed to avoid many of the difficulties created for western countries by the GFC.<br />
<br />
Governments seemed (in 2006) relatively well placed as far as macro-economic policies were concerned.<br />
<br />
“Most Asian countries are pursuing policies supportive of rapid income growth that will enlarge the size of the income pie available for financing higher living standards at the time their populations become aged. Most have also pursued a policy of fiscal consolidation, reducing public debts and providing flexibility to absorb greater burdens of public spending in connection with their aging population in the future and also providing fiscal space to deal with inevitable uncertainties in the pace of aging and its fiscal consequences.” <br />
<br />
However, the picture looks a little different ‘on the ground’. <br />
“It is in the sphere of social insurance for pensions and health and of labor market policies where much effort is still needed to create a policy framework that can accommodate the challenges of an aging population. With the exception of Singapore, there is little evidence of policies to create incentives for a longer participation in the labor force.”<br />
<br />
In fact, China had been encouraging early retirement apparently to help with unemployment amongst its citizens. PensionReforms suggests that China will eventually conclude that this doesn’t work.<br />
<br />
The report suggests that the countries covered needed “more comprehensive social insurance systems” with existing systems being reformed “in some key policy provisions”. <br />
<br />
“These include a gradual deferral in the age of eligibility for retirement benefits; actuarial neutrality in linking benefit levels to the length of the prospective retirement period; adequate incorporation, in benefit calculations, of the prospective longevity of cohorts at the time of retirement; a move to payout methods that provide for income payouts rather than lump-sum payments; and restrictions on the use of funds before retirement.”<br />
<br />
Unless there is change, countries “…will face difficult issues of intergenerational burden sharing and complex ethical issues associated with medical-care options for the elderly.” The report suggests that China seems to be doing more about these issues than India.<br />
<br />
Across Asia, there seems to be a need for “…a zero-pillar safety net scheme to address the needs of the large number of the elderly who have resided in the urban informal sector or the rural sector, outside the coverage of formal social insurance schemes.” Reducing family sizes mean a concentration of the future financial burdens.<br />
<br />
Healthcare needs to be part of this discussion. Only Singapore and Korea seem to be thinking seriously about this.<br />
<br />
The report suggests that China’s “inadequate pension system for rural households” may lead a government to allow greater land ownership rights to help “finance their retirement”.<br />
<br />
“Strengthening financial institutions and markets would allow greater productivity to be achieved on the savings accumulated by households for retirement. Encouragement of some emigration may allow a segment of the elderly population to be supported by remittances from family members. In the sphere of health care, coordinated policy actions across sectors, including education, urban planning and the environment, may be needed to promote healthy lifestyles and reduce the burden of chronic diseases.”<br />
<br />
As the report notes, concerns about the governance of the investment of funds in the various Chinese Defined Contribution arrangements need to be addressed.<br />
<br />
PensionReforms thinks there are some useful data in the report but wonders at the value of a comparison of so many, such disparate systems. Singapore, for example, is no closer to China than Australia is to the US. That is why the report concludes that “The report card on Asia’s preparedness for an aging population is decidedly mixed.” That is much as we might expect. <br />
<br />
The main lesson may be, in fact, that governments can (and do) influence behaviour but in the end, only governments can ensure delivery of the safety nets described in the report. Given the rising proportions of the future elderly, the best way of minimising welfare requirements is to foster growth. Aside from anything else, a stronger economy probably means greater participation at all ages, including the old. (File size 385 KB; 35 pp) 526<br />
http://www.imf.org/external/pubs/ft/wp/2006/wp06272.pdfIs Asia Prepared for an Aging Population? (2006)526When state benefits are tied closely to work income, minorities tend to end up with lower than average retirement benefits as the UK’s arrangements demonstrate. The same applies to women, and the disabled. 2012-02-07T08:45:142008<strong>PensionReforms’ summary and comments</strong><br />
The UK’s complex state pension arrangements are closely tied to incomes during working life. The recent lowering of the contribution period that drives the Tier 1 pension entitlement (to earn maximum benefits) from up to 44 years (males) down to 30 years (males and females) means that most will now qualify for the Basic State Pension. However, the same does not apply to the ‘State Second Pension’ (S2P) nor to the new NEST at Tier 3. These are both related to actual pay and contributions over the working life. <br />
<br />
This 2008 report looked at the expected pension incomes of particular groups in the UK:<br />
“Overall, it finds that disabled people and people from ethnic minorities have many of the ‘alarm bell’ characteristics that are associated with lower pension incomes. If current trends continue, they are likely to have lower pension incomes in future than the traditionally-employed median-earning male.”<br />
<br />
The reasons that women and others expect to receive lower pensions haven’t changed:<br />
“Although the link between individuals’ earnings and their state pension entitlements is reducing, private pension income is linked to paid employment. The gender pay gap is improving but women still earn less than men on average, so their private pension incomes are likely to remain lower than men’s on average for some time.”<br />
<br />
For the disabled, the problems are compounded by enforced absence from work, lower lifetime incomes with a consequence of not being able to afford participation in private pension saving schemes. Apparently, “Thirty-three per cent of disabled people might not qualify for the Second State Pension each year, compared to 24 per cent of non-disabled people.” Disabled people are also somewhat less likely to work after the State Pension Age.<br />
<br />
Any identifiable group with lower lifetime incomes (such as, from ethnic minorities) will be similarly affected.<br />
<br />
“For example, around a third of Pakistani (31 per cent) and Bangladeshi (35 per cent) people work part-time compared to around a quarter (26 per cent) of White people and, as with the White population, women in these groups are considerably more likely than men to work part-time. Around 26 per cent of Pakistani people are self-employed, compared to 13 per cent of White people, and the self-employed do not qualify for State Second Pension.”<br />
<br />
The report concludes that while recent reforms may have improved things for groups that traditionally suffered, by comparison with other sections of the community, the changes have only made things ‘less bad’ than they were.<br />
<br />
“However, people from ethnic minorities may be more likely than the rest of the population to opt out of saving, due to higher rates of in-work poverty, lower levels of financial capability and possibly lower levels of familiarity with the English language.”<br />
<br />
What to do about these problems?<br />
“A variety of policy options could be considered, including:<br />
• Further widen the system of credits for state pensions.<br />
• Continue to encourage private pension saving.<br />
• Continue to encourage labour market participation, including reducing discrimination.<br />
• Continue to address the pay gap.”<br />
<br />
PensionReforms understands the practicalities of the report’s findings and recommendations – changes are likely only at the margins of the complex overall arrangements that have emerged from the latest raft of changes to the UK’s pension arrangements. However, the real problem with those complicated, expensive arrangements is the connection between lifetime incomes and state-provided or, now, mandated pension arrangements. PensionReforms made a number of suggestions <a href="http://www.pensionreforms.com/Preview.aspx?466">here</a> as to what the UK government should be thinking about. Those were not directly intended to fix the problems described in this report, but they would help more than the report’s tentative suggestions.<br />
<br />
PensionReforms thinks that poverty alleviation/eradication amongst the old should be the primary objective of state pensions, not helping retirees to maintain pre-retirement standards of living. It seems that the reformed system will help to improve things a little but there is much more needed. A future government in the UK will eventually come to the same conclusion. (File size 440 KB; 92 pp) 525<br />
http://www.pensionspolicyinstitute.org.uk/uploadeddocuments/PPI_EHRC_The_Underpensioned_Nov_2008.pdfThe under-pensioned: disabled people and people from ethnic minorities (2008)525Chinese households grew their saving rate to one quarter of disposable income in the ten years to 2005. Increasing private expenditure on housing, education and health care seems the best explanation. Then there are the data. 2012-02-07T08:39:032008<strong>PensionReforms’ summary and comments</strong><br />
Economic life for Chinese households has changed dramatically in the last 20 years and that seems to be reflected in economic data. Overall, the Chinese were, as at 2005, saving about 50% of GDP.<br />
<br />
This 2008 report from the IMF looks at the data to see what may have driven a dramatic increase in household saving rates (from 17% to 24% of disposable income) over the ten years to 2005. Is it possible that households were saving too much?<br />
<br />
The behaviour also seems not to conform with standard explanations:<br />
“When trend income growth is high, households seeking to smooth their consumption should borrow against future income, especially if real interest rates are low. If that is not possible, households (particularly younger ones) should at least postpone their savings. But, as we show in this paper, saving rates have increased across all demographic groups, including those that can expect rapid income growth in the future. As with most other studies using household data … we find very limited consumption smoothing over the life cycle.”<br />
<br />
Saving rates increased “…across all demographic groups, although the age-profile of savings has an unusual U-shaped pattern, with saving rates being the highest among the youngest and oldest households in recent years.”<br />
<br />
It seems that this apparently unusual behaviour is being driven by the state’s relative withdrawal (by comparison with the past) from housing, education and health provision. It seems not to have been caused by relatively rapid increases in income; nor (cautiously) by ‘target saving’ objectives where a household might want to have accumulated a particular amount by a retirement age, for example.<br />
<br />
The patterns in fact seem best explained by the rising private burden of expenditures on housing, education, and health care. For example, in 1995, average expenditure on health and housing was only 2% of ‘consumption expenditures’. By 2005, this had grown to 14%. Similarly, following an extensive programme of ‘privatisation’, house ownership grew from 17% in 1990 to 86% in 2005.<br />
<br />
Such huge changes seem to have introduced much economic uncertainty into household’s financial lives and increasing saving seems a natural response.<br />
<br />
“The overall macroeconomic uncertainty associated with the transition to a market economy may also have contributed to precautionary saving motives, although that effect is difficult to quantify as it affects all households. One interesting result is that the cohorts that were in their 40s and 50s in 1990 tend to save more, perhaps because they are the ones most exposed to the uncertainties generated by the market-oriented reforms and do not have many working years ahead to benefit from those reforms. The cohorts most likely to have been among the first affected by the one-child policy are not among the main savers.”<br />
<br />
Demography seems, at the moment, not to be a material driver. PensionReforms suspects that demographic influences are likely to become more important as China faces one of the most significant changes in the age profile of its population of any country.<br />
<br />
PensionReforms also notes the report’s own qualifications about the depth and quality of data (“The availability of household-level data from China is limited.”). And there is the usual disconnect between macro and micro saving data though they are perhaps greater in China than elsewhere. The report highlights the difficulties of trying to analyse complex situations in the absence of high quality, longitudinal data. Hopefully, that will improve with time. It needs to. (File size 662 KB; 51 pp) 524<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp08145.pdfWhy are Saving Rates of Urban Households in China Rising? (2008)524Some still think that encouraging the old to retire will reduce unemployment amongst younger people. Belgium proves the fallacy of this ‘connection’ (again). 2012-01-31T10:02:452008<strong>PensionReforms’ summary and comments</strong><br />
Unemployment rates amongst the young are a major social issue, particularly in Europe. Youth unemployment across Europe (in 2011) averaged 20.4% (see <a href="http://www.ft.com/intl/cms/s/0/8c907618-39ca-11e0-8dba-00144feabdc0.html#axzz1jlIyqNzu">here</a>) with Greece (35%) and Spain (42.8%) being notable current examples.<br />
<br />
Some still think that older workers are selfishly holding down their jobs when they should be making way for younger people. This is an example of the ‘lump of labour’ fallacy where it is assumed there is a fixed amount of work available. If the amount that can be done by the old is restricted, that will seemingly benefit those not currently working, particularly the young.<br />
<br />
This 2008 report looks at the case of Belgium that has policies echoing that assumption. The average retirement age was 60.6 years in 2005 (up from 56.8 years in 2001). Early retirement benefits have been specifically enhanced for the last 25 years. Older people are also more generously treated with unemployment entitlements.<br />
<br />
“Belgium is characterized by a relatively high rate of unemployment of the young [20% at the date of the report; 22% now] and a low rate of activity of the elderly workers. The latter is the consequence of high incentives to exit the labour force and these incentives are generally justified in the name of fostering youth employment.”<br />
<br />
The report was sceptical from the outset and that was justified in the analysis.<br />
“At the outset, we were not expecting too much from these tests for two reasons. First, theoretically one knows that there is no foundation for the idea that there would be such a thing as a fixed lump of labour implying that less elderly workers means more young workers. Second, the nature of youth unemployment in Belgium is such that it is pretty insensitive to variations in labour demand, but rather is the result of structural weaknesses in the areas of education, unemployment compensation and wage formation.”<br />
<br />
The report discovers that the structure of early retirement incentives offer a reasonable explanation for the behaviour of the old.<br />
<br />
“We could not observe any positive link between early retirement and youth employment. On the contrary we observe a negative link indicating that the activity rates of both young and elderly workers are sensitive to business cycles.”<br />
<br />
PensionReforms thinks the report’s findings suggest a two-pronged approach to the issues:
<ul>
<li>If the young cannot, because of education, experience, qualifications etc, replace older retirees, it does not seem sensible for early retirement incentives to be built into pension entitlements. The skills and experience should be retained.</li>
<li>The specific barriers to entry into the workforce by the young need addressing directly.</li>
</ul>
<br />
As the report concludes, there is no direct link between the two groups, at least from a public policy perspective. (File size 551 KB; 33 pp) 523<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp0830.pdfThe Effects of Early Retirement on Youth Unemployment: The Case of Belgium (2008)523Brazil’s changes to old-age benefits in 1991 show the power of incomes on labour participation rates. About 40% of the entitled chose to stop working. This apparently justifies means tests to limit the damage to labour markets. Perhaps. 2012-01-31T09:53:582002<strong>PensionReforms’ summary and comments</strong><br />
The social security system in Brazil was changed dramatically in 1991. Large numbers of older people became newly entitled to pensions. The report was originally written in 2002 (accessible from ‘more’ below) and was finally published in 2008. The later version is effectively the same as the earlier.<br />
<br />
“The reform in the Brazilian Social Security System in 1991 provides a unique opportunity to learn about labor supply responses to reductions in the minimum eligibility age for old-age benefits, increases in benefit levels, and about how social programs reach groups with different education levels in developing countries.”<br />
<br />
The reform increased the minimum benefit, reduced the entitlement age for rural workers from 65 to 60 for men and 55 for women, and extended coverage to rural workers who were not heads of households, drawing in many married female rural workers. The report looks at the impact of all this on labour force participation rates amongst older rural workers. <br />
<br />
“It is worthwhile noting that <em>aposentadorias rurais</em> (rural benefits) contain no incentives for total withdrawal from the labor force. There is no earnings test and, unlike their urban counterparts, rural workers do not have to quit their jobs to become eligible for benefits.” This also allows comparisons between the two groups of workers.<br />
<br />
Because of the style of changes made, the report can identify “a pure income effect - the vast majority of the existing literature has estimated total effects that are the sum of an income and a substitution effect, the latter due to means, income, earnings or retirement tests.”<br />
<br />
The impact was apparently significant – “…when given the opportunity of earning a benefit that guarantees their subsistence, withdrawal of the labor force is found to be the preferred decision for about 40% of benefit receivers.” Because of the way this is measured, the report suggests this is likely to be an underestimate.<br />
<br />
The report suggests that this justifies means-testing to lessen the impact on the labour market.<br />
<br />
“These results indicate that estimates of the poverty reduction effect of old-age benefits in developing countries should take into account the negative labor supply impact of those benefits.”<br />
<br />
The report tried to analyse differences across education groups but did not have sufficient information to come to any conclusions.<br />
<br />
PensionReforms thinks that the outcome of Brazil’s 1991 changes was fairly predictable but has three observations:
<ul>
<li>It does not necessarily follow that means-tests are a necessary consequence – the better answer to deal with the relatively sudden and significant changes to participation rates would be to make the pension unequivocally universal.</li>
<li>Having the difference between so-called ‘rural’ and ‘urban’ workers (the case in Brazil) seems logically unsupportable.</li>
<li>The 1991 reform was aimed at seemingly significant poverty amongst the rural old. If the minimum wage (the amount of the minimum pension) was all that was needed to address the issue (that seems to have been the case for at least 40% of the covered population) then a reduction in the rural labour force was inevitable and not necessarily a bad thing. In a way, that was the aim of the reform.</li>
</ul>
<br />
PensionReforms also wonders about the seemingly large response to the new benefit. Rural workers are very apt to work in subsistence agriculture, which the data do not pick up. There may well have been shifts from paid work to subsistence agriculture with receipt of a pension. The report mentions this only briefly: "The large estimate for the effect of current benefits on earnings can be explained by substitution of non-remunerated activities, such as subsistence agriculture, unpaid work and leisure, for wage earning and remunerated activities." Including leisure with unpaid work seems unusual.<br />
<br />
PensionReforms suggests a couple of alternative objectives for reform: first, to eliminate the artificial distinction between rural and urban workers; secondly to signal an increase in the State Pension Age and the unification of ages between men and women. Getting rid of the contributions-based ‘length of service’ benefits should be a longer-term aim. (File size 480 KB; 18 pp) 522<br />
http://ssrn.com/abstract=352840Old-Age Benefits and Retirement Decisions of Rural Elderly in Brazil (2002)522The reunification of Germany provided a natural experiment that seemingly confirms the life cycle hypothesis. Older East Germans have higher saving rates, declining by age cohorts. That may have been precautionary behaviour but probably not. 2012-01-31T09:47:522008<strong>PensionReforms’ summary and comments</strong><br />
The ‘life cycle hypothesis’ suggests that individuals smooth their consumption over the long haul. Savings and expenditure tend to even things out, especially between working lives and retirement.<br />
<br />
“The natural experiment of German reunification provides strong evidence in favor of the life cycle hypothesis.”<br />
<br />
The changes were large and rapid. For example, the report notes that: <br />
“Nominal household incomes in the East, including transfers and social security payments, rose from around 35% of the West level in the spring of 1990 to about 80% in 1994. From 1996 on, they have stagnated at around 85% of the West level”.<br />
<br />
As might have been expected under this scenario, “…East Germans have higher saving rates [by households] than West Germans after reunification, that the East-West saving rate difference is larger for older cohorts, and that this difference is declining over time for every cohort.”<br />
<br />
The report suggests that the principle of ‘precautionary savings’ is necessary to explain the differences between older citizens of the East and West in the 1990s. However, “…accounting for changing demographics over the life cycle decreases the performance of the model in matching the saving rate behavior of the younger generations.” <br />
<br />
There are several possible reasons that older East Germans seemingly saved more than their Western counterparts: for example, they were not used to the higher incomes or they may have been more risk averse. However, the report suggests that the life cycle model seems to be the main explanation. On the other hand, it may be that East Germans are in catch-up mode: West Germans had significantly greater levels of wealth, especially at older ages.<br />
<br />
The difference between the German experience and other studies is the transformational change for the East after reunification. A lesson could be that “…households might have to learn how to behave optimally.”<br />
<br />
“This study - while analyzing the effects of an income shock, rather than a preannounced income change - falls into the category of studies analyzing large changes, and clearly finds evidence in favor of rational consumption behavior.”<br />
<br />
PensionReforms is unsure what this might mean in considerations of public policy, given the reliance on complex economic modelling. It is certainly interesting to see how citizens respond when unexpected, large changes like the German reunification happen. As ever, real-life data are more interesting than the output from models. The responses documented in the report seem unsurprising and, rather than necessarily providing support specifically for the life cycle hypothesis, seem to illustrate that citizens are often more rational than policy-makers anticipate.<br />
<br />
One of the things the life cycle model cannot yet explain is why the retired do not run their savings down quite as the model might expect. It will be interesting to see how East Germans react to their relatively new-found wealth after retirement. (File size 34 KB; 53 pp) 521<br />
http://crr.bc.edu/images/stories/2008-21.pdfThe Response of Household Saving to the Large Shock of German Reunification (2008)521When tomorrow’s benefits exceed the capacity of earners to support them, something must give. Benefits must reduce either for all or just for those who can manage on their own. Means-tests present significant design issues for US policymakers. 2012-01-24T10:03:172011<strong>PensionReforms’ summary and comments</strong><br />
The ageing population in the US will increase pressure on state-financed benefits associated with the old such as Social Security and Medicare. There will be twin constraints on the one hand of a growing proportion of people actually or potentially entitled and, on the other, of a reducing proportion of workers on whom to impose taxes (or ‘contributions’ if you will). Something will eventually have to give.<br />
<br />
“It is impossible to support a European-style universal welfare state without European levels of taxation, so the provision of relatively generous entitlement benefits to rich and poor alike must shift over time to a more targeted approach.”<br />
<br />
The trouble though is that people react to targeting in sensible but unintended ways or may even fail to claim the benefits to which they are entitled. Either reaction may mean that the best of intentions are confounded.<br />
<br />
“Means tests are a good example of this very principle. On paper, they can provide significant budgetary savings while sparing the poor from benefit reductions. In practice, however, they can generate disincentives to work and to save, and do more harm than good.”<br />
<br />
The report notes that there are many difficulties with means-tests. Some apply specifically to the US system but others have more general application:
<ul>
<li>Some will see a means-test as a ‘punishment’ for those who work hard and succeed.</li>
<li>If employees change their work/saving habits, that may mean reduced economic growth for the country.</li>
<li>A means-test on income is a form of tax but one that is targeted at the old. When added to the top marginal rate (in total, the ‘Effective Marginal Tax Rate’ or EMTR), the incentive to engage in avoidance activity is increased. That applies at all income levels and to all types of income and may, again be counterproductive.</li>
<li>The authorities must necessarily become more intrusive as they will need to know more about the household’s financial position to enforce the tests.</li>
<li>Benefits have been ‘paid for’ and so represent ‘entitlements’.</li>
</ul>
<br />
“There is an alternative approach — one that achieves many of the ends of traditional means-testing, but without inviting many of its drawbacks. The plan’s essential and distinguishing feature would involve limiting benefits based not on individuals’ incomes in retirement, but rather on their lifetime earnings. …Social Security already effectively does this, by paying proportionally lower benefits to people with higher average lifetime earnings. Today’s reformers could do the same, if to a greater degree.”<br />
<br />
The report suggests this would reduce the disincentives to save but would not necessarily reduce work disincentives but would be ‘better’ than a test based just on income in retirement.<br />
<br />
“The challenge for today’s policymakers is to craft policies that make the most of the benefits of means-testing while avoiding its worst consequences.”<br />
<br />
PensionReforms notes that a ‘lifetime earnings’ test might be more attuned to the benefit accrual (based on lifetime, indexed wages) but carries with it significant difficulties. The current benefit formulae are complex enough – tying full entitlements to something based on lifetime incomes would make it virtually incomprehensible. Then there is the already complex spousal allowance and increasingly fluid family arrangements that will have no connection to the household’s financial condition during the different stages of working life and/or in retirement.<br />
<br />
The lifetime test may reduce avoidance activities in retirement (that are such a feature of the Australian arrangements) but would the contributions also need to be similarly constrained? Also, the acknowledged work disincentive is a concern, given the skill shortages that the US faces. The system should be encouraging older people to work longer or, more realistically, not discouraging early exits.<br />
<br />
PensionReforms agrees that Social Security benefits may have to become less generous for the well-off. One way of doing that would be a replace Social Security with a non-contributory, Universal Pension that is taxed along with other income. That would disconnect benefits from contributions and, more importantly, address the real blight of poverty amongst the US old. (File size 226 KB; 16 pp) 520<br />
http://www.nationalaffairs.com/doclib/20110919_Biggs.pdfMeans Testing and Its Limits (2011)520In the US, Social Security contributions and benefits are partly related to pay, but with a ceiling. The so-called ‘tax max’ has changed each year since 1982, in relation to a national wage index so is unchanged in real terms since then. 2012-01-24T09:53:342011<strong>PensionReforms’ summary and comments</strong><br />
The Tier 2 ‘Social Security’ system in the US provides, amongst other benefits, a Defined Benefit pension from, now, age 66 (increasing to age 67 by 2027). Contributions are 6.2% of covered pay from each of employers and employees. The pension is based on the average covered earnings since 1950 (or age 21, if later) and indexed for past wage inflation, up to age 62 (or death, if earlier) excluding the 5 years with the lowest earnings. <br />
<br />
However, not all earnings are covered. The current annual ceiling is $US106,800 – the so-called ‘tax max’. In real terms (measured against pay), the ceiling has retained its real value since the mid-1980s. Contributions are not required on pay above this and benefits do not accrue.<br />
<br />
“…Social Security’s projected funding shortfall has led some policymakers to propose increasing the tax max beyond the indexed levels to help restore financial balance. This brief does not take any position for or against modifying the tax max; instead it provides context for the Social Security reform debate by summarizing the changes that have occurred in the tax max and covered earnings since 1937.”<br />
<br />
There are three main conclusions from the briefing note:
<ul>
<li>"The percentage of workers with earnings above the tax max (“above-max earners”) fell from 15 percent in 1975 to about 6 percent in 1983 and has remained at that level since.</li>
<li>“Historically, an average of roughly 83 percent of covered earnings have been subject to the payroll tax. In 1983, this figure reached 90 percent, but it has declined since then. As of 2010, about 86 percent of covered earnings fall under the tax max.</li>
<li>“The percentage of earnings covered by the tax max has fallen since the early 1980s because earnings among above-max earners have grown faster than earnings among the rest of the working population.”</li>
</ul>
<br />
In real terms (against indexed wages) the tax max is now at about the level when Social Security started in 1937. The percentage of covered workers whose earnings exceed the tax max was about 3.5% in 1937 and is now about 6%. <br />
<br />
PensionReforms wonders why the US government intervenes in this way (to help retirees maintain a continuation of their pre-retirement economic status). It would be nice to report that the Social Security system prevents poverty in old age but it does not. An OECD report (see <a href="http://www.pensionreforms.com/Preview.aspx?289">here</a>) ranked the US as fourth-worst in an international comparison of poverty rates amongst the retired old. Another report <a href="http://www.pensionreforms.com/Preview.aspx?411">here</a> confirms, based on a wider, consumption-based measure, that actual poverty levels may be 57-89% higher than official levels.<br />
<br />
This was not, of course, the reason for the report. PensionReforms agrees that, given the current structure of the Social Security system, lifting the pay ceiling should not be seen as a way of helping to repair the fiscal deficit in the government’s overall accounts. But it might be a better idea to fold ‘contributions’ into general tax payments and disconnect benefits from pay. That would allow the focus to shift to getting rid of pensioner poverty. It’s difficult to see why anyone would object to such a proposal. (File size 482 KB; 9 pp) 519<br />
http://www.ssa.gov/policy/docs/policybriefs/pb2011-02.pdfThe Evolution of Social Security's Taxable Maximum (2011)519Ageing populations will test the capacity of New Zealand’s health and care systems in the next 20 years and beyond. The need for buildings, staff (and money) will about double as this survey of providers shows. 2012-01-16T11:27:522010<strong>PensionReforms’ summary and comments</strong><br />
New Zealand’s population is ageing:<br />
“In the 20 years between 2006 and 2026 the New Zealand population is expected to grow by 20% (from 4.2 million to 5 million). The over 65 population, however, is estimated to increase by 84% (from 512,000 to 944,000).”<br />
<br />
Based on current trends, this presents significant cost and resource considerations for taxpayers and providers of services. <br />
<br />
“To address these challenges, leaders from the residential care sector and District Health Boards (DHBs) commissioned this Aged Residential Care Service Review… to comprehensively assess the cost, capacity and service delivery implications of the increasing number of elderly New Zealanders likely to require aged residential care services.”<br />
<br />
A large number of providers participated; according to the report it was “…the highest provider participation rate of any comparable international study.”<br />
<br />
Here are the report’s main findings:<br />
“− Supply of facilities: Sector bed numbers need to increase by 78% to 110% by 2026 to accommodate the projected increase in extra residents and to replace aging facilities. <br />
<br />
“− Costs and investment: Financial returns currently being generated for subsidised aged residential care operations are insufficient to support building new capacity and replacing aging stock. Approximately half of current stock is now over 20 years old. <br />
<br />
“− Workforce implications: The workforce employed in the aged residential care sector has doubled in the last 20 years to 33,000. Workforce demand is expected to increase between 50% and 75% (on an FTE basis) by 2026. The workforce is expected to adjust to demand through mechanisms such as remuneration and population growth. <br />
<br />
“− Models of care: Four alternative service configuration scenarios were considered worthy of further consideration: improvement in the current approach, an enhancement of professional services in the community, an individualised funding approach and the development of low income community housing for the elderly.”<br />
<br />
With most of the costs involved being currently delivered in New Zealand through the public sector, these inevitable developments pose significant challenges, particularly for the expensive, ‘end-of-life’ high dependency facilities.<br />
<br />
“Demand for rest home care will begin to increase between 2012 and 2015. Demand for high dependency services (hospital and dementia) will continue to grow at a similar rate to that of the past decade.”<br />
<br />
The recent increased use of home support services, according to the report, “…will not be able to absorb all of the future demand for aged care services.” Also, current returns to private providers are “…below those an investor would require to encourage new investment to replace aging facilities or to stimulate new capacity in rest home, hospital and dementia facilities.” That had led to a growth of high-end facilities that charge fees (58% of facilities built in the last ten years).<br />
<br />
Occupancy rates across three levels of facilities are high (91% for rest homes, 93% for hospital and 96% for dementia).<br />
<br />
“Total greenfield capital costs are relatively similar across types of care. Total capital costs for a greenfield facility range between approximately $160,000 per bed to $200,000 per bed [NZ$], depending on land costs.”<br />
<br />
Based on a model developed for the report, the representative daily cost including capital charges, ranged from $NZ155 for a rest home resident to $NZ181 for a dementia unit at a mid-price cost of land ($NZ350 per square metre).<br />
<br />
The report looked at possible ways to improve capacity and the ability of the support services to cut costs. In summary, New Zealand’s services and costs were between 27% to 200% greater than a comparable international benchmark.<br />
<br />
“The survey information on which the costing analysis in this Review is based has a high level of integrity. There were 389 responses from aged residential care facilities, with the 360 useable surveys representing about 61% of all beds operated in New Zealand. The response rate from the survey is the largest percentage response to any survey of its type globally.”<br />
<br />
PensionReforms thinks the report provides some great data along with 15 recommendations on a topic that will not be going away. Though there are gaps in current coverage, the report’s findings show that current demands are being met but there is a significant challenge, beginning less than five years from now.<br />
<br />
“This Review is the start of a long term process of ensuring that New Zealand retains a sustainable contemporary aged residential care sector that evolves to meet the demands of its aging population.” (File size 3.3 MB; 222 pp) 518<br />
http://www.grantthornton.co.nz/Assets/documents/home/Aged-Residential-Care-Service-Review.pdfAged Residential Care Service Review (2010) 518Sub-Saharan Africa illustrates two main models of social protection – the South African-style social pensions and newer income-transfers that are replacing some emergency programmes. If the new schemes are to last, they must be cemented in politically. 2012-01-16T11:17:212010<strong>PensionReforms’ summary and comments</strong><br />
This 2010 report summarises some recent developments in the provisions of financial assistance to the poor (not just the old) from the different countries that make up Sub-Saharan Africa. It identifies “…two main models of social protection in sub-Saharan Africa: the Southern African model and the Middle African model.”<br />
<br />
The Southern Africa model is a traditional, usually work-centred, social insurance programme, with what the report describes as “categorical grants for older people, and more recently children…”. Entitlements are enshrined in legislation. The report includes South Africa, Mauritius, Lesotho and Swaziland in this group.<br />
<br />
“The Middle Africa model describes a group of programmes implemented only in the last five years or so. They are a new wave of social protection programmes and include Ethiopia’s PSNP, Ghana’s LEAP, Kenya’s CT-OVC, Zambia’s pilot programmes, and the scaling up of the Mchinji Programme in Malawi.”<br />
<br />
The distinguishing feature is that payments are often associated with what the report describes as an objective to “integrate service provision and utilisation.” This means, for example in the Kenyan case, combining “…transfers to households in extreme poverty with conditionalities in health and schooling…”<br />
<br />
The report suggests that these Middle African ‘social assistance’ programmes “… signal an important shift in policy thinking in Middle Africa, moving from the delivery of emergency humanitarian relief towards regular and predictable programmes providing income-transfers and ensuring access to, and utilisation of, basic services.” In other words, the experimental programmes reported on move away from emergency food-aid and other “humanitarian responses” towards direct, conditional payments. However, most are “projects, not policies”.<br />
<br />
The early results of some of these initiatives seem promising but the report wonders whether they are being driven more by donors than by the governments of the countries involved. The report reaches no conclusion on this but suggests that “…the programmes under the Middle Africa model have significantly weaker domestic political embedding and institutionalisation.” They will not be helped by the global financial crisis.<br />
<br />
“Weak delivery capacity in the region has led to a plurality of providers: public, nor for profits, and for profits, mirroring the institutional dynamics and potential difficulties associated with health care. Community involvement in the delivery of pilot programmes may well prove unsuitable for large scale programmes, which once again reinforces the importance of state-led policy responses.”<br />
<br />
The report says there is a need for “… donors to become more attuned to the politics of social protection in Africa and to align their efforts more adroitly in support of forms of social protection that are likely to foster the growth of political constituencies (elite or mass or combined) that will support the evolution and public financing of long-term social protection policies. Getting the politics right may be as important, or even more important than getting the initial technical design of programmes right.”<br />
<br />
In some of the countries covered, governments have yet to see a connection between social protection and economic growth/productivity.<br />
<br />
PensionReforms agrees that unless local governments are taken along with the aims of the programmes, their futures must be limited. PensionReforms has covered a number of reports on some of these programmes that try to alleviate extreme poverty, including some that the report puts into the Southern African category: see <a href="http://www.pensionreforms.com/Preview.aspx?212">here</a> (Lesotho), <a href="http://www.pensionreforms.com/Preview.aspx?269">here</a> (Samoa), <a href="http://www.pensionreforms.com/Preview.aspx?381">here</a> (Mexico City) and <a href="http://www.pensionreforms.com/Preview.aspx?471">here</a> (Tanzania). As with this latest report, the results seem very encouraging.<br />
<br />
If the point of any government intervention is to reduce poverty levels, particularly amongst the old, then direct assistance seems the most obvious strategy. Traditional contributory, social insurance programmes cannot function in labour markets where most ‘work’ is unrecorded and even unpaid. The case for “conditionality-based” benefits seems weak for the old. In the countries covered, being old is almost always associated with being poor. As a number of reports have suggested, payments to the old seem to improve the lot of families because the old are often living in households that include the young and are often in fact the principal care-givers. (File size 146 KB; 40 pp) 517<br />
http://erd.eui.eu/media/2010/Hulme.pdfSocial protection in sub-Saharan Africa: Getting the politics right (2010)517The OECD reviews coverage amongst ‘voluntary funded’ plans in several countries (in 2008). An ‘uneven’ distribution means there is a need to increase coverage amongst the young and low-income earners. The OECD lays out the policy options. 2012-01-08T06:19:562008<strong>PensionReforms’ summary and comments</strong><br />
The OECD looks at eight of its member countries (Australia, Canada, Finland, Germany, Ireland, Norway, United Kingdom and the United States) to see why membership of voluntary Tier 3 schemes (occupational and personal) is so variable. This 2008 report looks at a number of policy options to fix the problem, including “compulsion, soft-compulsion, product regulation, financial education, better information disclosure, and improving eligibility and incentives for enrolment.” The underpinning problem seems to be that, left to their own devices, some citizens “may not save enough for retirement”. <br />
<br />
Compulsion (at Tier 2) may be the most reliable way to increase membership of pre-funded pension schemes but there is a problem: “…compulsion may need to be accompanied by labour market measures that reduce informality, otherwise, compulsion may not lead to universal coverage, as the case of Chile suggests.”<br />
<br />
Perhaps soft compulsion is preferable:<br />
“It has been suggested that automatic enrolment in pension plans with appropriate default options with respect to contribution rates and investment allocation may achieve the dual goal of preserving individual choice and ensuring an adequate level of saving for retirement even if they do nothing.”<br />
<br />
This seems to be the lesson from the behavioural finance literature but, as the report notes, that lesson “may also bring some problems”. The reliance on the default option by most auto-enrolees seems significant.<br />
<br />
Access to Tier 3 schemes may be restricted for low-income earners; or in respect of firms that tend to employ low-income earners. Simplifying scheme rules may help the first group (but PensionReforms observes, will not touch the second group).<br />
<br />
“Financial education can also be a means for improving coverage in voluntary funded pensions. National awareness campaigns have been shown to increase understanding of the pension system and the need to save, which should lead to greater coverage rates. In addition, employment based campaigns have been shown to increase participation and contribution rates in pension schemes.” <br />
<br />
Better disclosure regimes will also help.<br />
<br />
The report also suggests that the design of tax incentives needs attention as they are usually regressive (favouring the high paid over the low). <br />
<br />
“Consequently, it is argued that replacing tax deductions with tax credits may just help achieving the goal of increasing coverage among mid-to-low income individuals, as tax credits may reshuffle tax incentives toward individual with lower income.”<br />
<br />
Where employers are unhelpful or where an occupational scheme was uneconomic, coverage can be increased through greater use of ‘personal’ pension schemes. But then the employee will miss out on the attractions of an occupational scheme:<br />
“However, occupational plans provide an important incentive for enrolment over personal plans as it is through them that employers provide matching contributions. Additionally, investment and management fees are generally lower in the case of occupational plans thanks to scale, pooling, and the not-for-profit nature of occupational pension funds.”<br />
<br />
PensionReforms has a number of difficulties with the report:
<ol>
<li>How do we know that citizens in the subject countries are in fact under-saving for retirement? Just looking at their pension scheme entitlements or participation rates will only partly answer that question.</li>
<li>Labour market considerations are not the only difficulty with compulsory Tier 2 schemes – they are intrusive, expensive, complex, constantly changing and probably do not increase national saving though they certainly increase one form of saving.</li>
<li>The principles of behavioural finance may help retailers in their marketing/sales or even consumers to be more healthy but PensionReforms thinks they should not form part of public policy on retirement saving. That’s because they impose one person’s or institution’s view of what is appropriate on the whole population. If an employer wants, as part of its human resources strategy, to enrol more employees in its own scheme, that is one thing. However, PensionReforms suggests that the state should not have a view on how many of its citizens belong to voluntary Tier 3 schemes.</li>
<li>Tax breaks for retirement saving may be improved by shifting from a straight tax deduction to a tax credit but that would make them only slightly less bad. Tax breaks are expensive, complex, regressive, inequitable but, again, do not seem to increase saving. A tax credit still cannot avoid the difficulty that those who cannot afford to save subsidise those who can.</li>
<li>It’s unclear why employers should pay members of their subsidised occupational schemes more than those who choose not to join or cannot afford to join. If management fees are lower in occupational schemes, that is not necessarily a reason to encourage membership of those schemes – it may be better to focus on getting the fees charged by other alternatives down. There is no real reason for the difference in costs.</li>
</ol>
On the other hand, PensionReforms agrees with the idea of simplification of voluntary Tier 3 schemes. Getting rid of tax breaks would be a first major step in that direction. Also, any efforts to improve financial literacy both as a piece of public policy or in schools or the workplace should be encouraged and not just as part of retirement incomes’ policies. The same applies to regulation of all collective investment vehicles, including pensions.<br />
<br />
PensionReforms worries about international comparisons of ‘replacement rates’ and thinks they are not particularly helpful, certainly if they focus only on pension wealth rather than total wealth. It is total wealth at and in retirement that really matters. (File size 1.4 MB; 48 pp) 516<br />
http://www.oecd.org/dataoecd/23/0/41122606.pdfCoverage of Funded Pension Plans (2008)516Despite recent ‘reforms’ Thailand and Indonesian pensions are in a mess with either derisory DC or unrealistically high DB benefits. And the informal economy is large and growing. Both have “expensive, unsustainable and unjust” social security systems. 2012-01-08T06:07:162008<strong>PensionReforms’ summary and comments</strong><br />
Thailand and Indonesia have, for different reasons, arrived at similar points in their pension histories. This 2008 report concludes that “Sadly, both countries are now stuck with social security pension programmes that are expensive, unsustainable and unjust.”<br />
<br />
In brief, Thailand had, until recently, a contributory ‘social insurance’ age benefit that provided a pension of 20% of average earnings (measured over the last five years), subject to a retirement test (the recipient must not work). The pension is payable from age 55 with at least 15 years’ contributions (3% each from employers and employees). PensionReforms will look later at the 500 baht Universal Pension that started in April 2009 (there is a report <a href="http://www.ilo.org/gimi/gess/RessFileDownload.do?ressourceId=24378">here</a> about it).<br />
<br />
And Indonesia has a national provident fund (‘Jamsostek’) requiring contributions of 2% employees/3.7% employers. It is run by a central agency, the Employees Social Security System. The benefit is a lump sum from age 55 and there is no retirement condition.<br />
<br />
“It is difficult to find many positive aspects in Thailand and Indonesia’s recent pension reforms. In the case of Indonesia, the original reform bill appeared to promise much, but the reality was more complex. In fact, the bill which was approved was effectively a non-event, as far as pension provision is concerned. The existing system will be allowed to continue unchanged, despite the vague promise of a more extensive model at some unspecified future time.”<br />
<br />
Coverage in both countries by the time of the 1997 Asian financial crisis was low for the general working population: in Thailand, less than a quarter of the workforce but only 10% in Indonesia.<br />
<br />
“Taking Thailand and Indonesia together, pension funds either operate as defined contribution schemes whose benefits which will be derisorily small (JAMSOSTEK and to a lesser extent GPF) or as defined benefit schemes which promise unfeasibly large pensions (SSF, TASPEN and the Academic Paper’s first pension pillar). Stakeholders do not appear to be aware of these effects.”<br />
<br />
The gaps in coverage include the usual: workers in the informal sector and the “chronically unemployed”.<br />
<br />
The combined effect of the various systems in both countries is “…likely to redistribute towards better-paid, long-lived workers from poorly paid and non-formal sector colleagues.”<br />
<br />
The report suggests that neither country has heeded the lessons of Latin America which the report thought was “…surprising, given the involvement of international agencies such as the ILO and World Bank in the initial plans and consultations.”<br />
<br />
The current pension destination of each country is a function of their recent pasts. In one case (Thailand), the Tier 2 scheme started before the 1997 Asian financial crisis and, as with Chile in 1981, with a military-backed government. <br />
<br />
“The Indonesian reform occurred after the Asian Crisis (when more was being demanded of the state) at a time of democratic transition (generating optimism about a new social contract), explaining the grand ambitions of the draft reform bill. However, as interest groups began to mobilise, the limits of the new democratic regime’s commitment to meaningful reform became apparent.”<br />
<br />
Whatever the history, both countries are now burdened with systems that the report describes as “expensive, unsustainable and unjust”; doing “more harm than good”. Perhaps it is time to move away from systems that are linked to employment status.<br />
<br />
“Such an approach almost inevitably marginalises groups who do not have access to secure formal sector employment. Reliable labour market data are unavailable for either country, but rough estimates dating from before the 1997 crisis indicate that around a quarter of their workforces could be classified as formal sector employees.”<br />
<br />
This virtually rules out any system based on ‘contributions’:<br />
“Unfortunately, neither country is in a position to dismantle its current system of social security and replace it with social policies which genuinely meet the needs of their most needy citizens.”<br />
<br />
PensionReforms agrees. Even if a country’s systems of administration were able to capture all employees and all incomes, a system based on ‘contributions’ and ‘earned entitlements’ has serious flaws. Even if a country ‘knew’ all the income that every citizen earned, PensionReforms suggests it does not follow that old age pensions should be based on ‘contributions’ levied on that same income. The proof of that can be seen in poverty levels amongst the old in even developed countries.<br />
<br />
All countries, including ‘fully’ developed ones, have their own versions of the gaps described by the report in both Indonesia and Thailand; they just happen to be unmissable in those two countries. What seemed regrettable with both Indonesia and Thailand was that no-one wanted to discuss the real issue: poverty amongst the old. However, as mentioned, there has been a move in Thailand since the report with the emergence of the 500 Baht pension. PensionReforms will review that development later. (File size 453 KB; 29 pp) 515<br />
https://www.uea.ac.uk/polopoly_fs/1.73126.LATEST!dev%20wp%2003%20lloyd-sherlock%20and%20scroder-butterfill%202008.pdfSocial security pension "reforms" in Thailand and Indonesia: unsustainable and unjust (2008)515In 1998, Hungary swapped part of its public pension for a compulsory Tier 2 scheme. Membership was initially voluntary and 50% joined. Tier 2 didn’t ‘work’ and has been effectively nationalised and used to fund tax reductions. Time to reflect.<br />2011-12-22T14:51:062011<strong>PensionReforms’ summary and comments</strong><br />
Before 1998, Hungary had a Tier 2 Defined Benefit pension system that was inherited from its communist past. It “…provided the bulk of support in old age for the bulk of the pensioners.” The pension was as much as 80% of ‘average indexed earnings’ (since 1988) after 40 years’ contributions. There was a minimum pension after at least 20 years’ contributions.<br />
<br />
Hungary faced the usual ageing population coupled with a generous pension payable from age 60 (men) and 55 (women). By 1990, public pension expenditure had reached 10% of GDP. The transformation of the economy after the revolution dramatically increased the ‘system dependency ratio’ (all beneficiaries to all workers) from 51% in 1989 to 84% in 1995. The transition also produced double-digit inflation.<br />
<br />
By 1995, there was a “broad consensus” that a compulsory, Tier 2 scheme should partially ‘privatise’ the state’s retirement income obligations. Also, the State Pension Age would increase and become unified at age 62 for males and females by 2008.<br />
<br />
The new scheme started in 1998. The amounts needed for contributions came from employee contributions that would otherwise have gone to the state system (about one quarter or 8% of gross pay with the remaining 23%, including all the employer’s contributions, going to the state system). So-called ‘social insurance contributions’ to pay for disability insurance, other non-retirement benefits and current beneficiaries were the remaining 1.5% employee and the whole of the employer’s contributions.<br />
<br />
Workers chose their ‘private pension association’, a closely monitored regime of providers. Benefits were available after 15 years’ membership with compulsory annuities supplied on terms that matched the state pension (including inflation-proofing).<br />
<br />
Initially, transfer to the new scheme was voluntary (and 50% so chose) but became compulsory from 30 June 1998. The rules tried to direct mainly younger workers to shift. The transition costs were relatively high at 1-2% of GDP as existing entitlements continued but were not officially recognised until 2004.<br />
<br />
Over the 13 year life of the new Tier 2 scheme, much conspired against it, including the other spending habits of the government. That put pressure on all spending, including pensions. There were enhancements to the public leg of the pension system by adding a 13th month of pension. Entry to the EU in 2004 required the government to reduce deficits. A new government in 1998 froze contributions at 6% and then allowed members to shift back to the old system. That was reversed with a new government in 2002.<br />
<br />
However, the design of the new arrangements contributed because they tried, unrealistically, to ‘join’ private and public pensions. Tier 2 proved expensive to administer and assets concentrated into the hands of the six largest providers. A net real return of zero for the period 1998-2004 did not help.<br />
<br />
Then there were negative real returns between 2007-2010 – older members were again allowed to return to the old system but apparently only half of them chose to do so.<br />
<br />
The global financial crisis meant that “conditional loans of the EU and the International Monetary Fund (IMF) … saved the country from a complete financial meltdown.” And the conditions involved significant reductions in pension entitlements. Then, a new government in 2010 announced significant personal tax cuts that had to be financed. In late 2010, contributions to Tier 2 were first suspended and then effectively abolished though members were offered Hobson’s choice about remaining:<br />
“In the end, 3 per cent of the membership decided to remain in the pure second pillar, most of them deciding at the last minute. Since most remaining members are young, they may believe that they have enough time to wait for the eventual reversal of the law.”<br />
<br />
The government even took the precaution of curtailing the jurisdiction of the Constitutional Court to avoid a legal challenge:<br />
“The government has sacrificed the future on the altar of the present. Once more, the future of the Hungarian pension system looks dark.<br />
<br />
The report’s conclusions?<br />
<br />
The reforms seemed popular, at least initially and PensionReforms suggests that, in the absence of high costs, negative returns and the global financial crisis, they may still have been popular.<br />
<br />
“Individuals, however, may not understand fully the disadvantages of joining the mixed system – in Hungary, those who joined the pension associations voluntarily ceded one quarter of their previously-gained pension rights.”<br />
<br />
Hungary’s experience shows what happens when governments seem not to understand what they are doing and back themselves into a public policy corner. Far from reducing political risk (an argument often made in favour of a ‘private’, prefunded Tier 2), Hungary shows how reform can increase that risk.<br />
<br />
And, once the government was backed into a fiscal corner by a combination of the global financial crisis and the ensuing debt crisis, it had few alternatives:<br />
“However, governments can also target the accumulated capital of pension funds as a source of finance to bankroll projects without having to raise personal income tax rates or reduce public expenditures. This temptation may be especially strong in times of crises when short-terms needs overshadow long-terms objectives.” <br />
<br />
PensionReforms agrees with the report’s final point:<br />
“From this perspective, Hungary is a typical case how not to do pension reforms and counter-reforms.”<br />
<br />
Indeed. A “broad consensus” on the apparent solutions to an acknowledged problem wasn’t enough. Hungary provides a graphic lesson of what is possible and what not; of a failure to identify the real problem and so an example of applying the wrong solution. Instability was as inevitable as the ultimate destination. (File size 201 KB; 23 pp) 514<br />
http://econ.core.hu/file/download/mtdp/MTDP1112.pdfThe Mandatory Private Pension Pillar in Hungary: An Obituary (2011)514The challenges of New Zealand’s ageing population are examined in a cost-benefit framework. Greater intervention by the government seems indicated, including expanding private saving schemes and increasing tax breaks as the Tier 1 pension reduces. 2011-12-22T14:43:312011<strong>PensionReforms’ summary and comments</strong><br />
All OECD countries have schemes that help people manage their retirement income issues. Some of these schemes are mandatory, and are implemented through the tax system; others are voluntary but receive substantial subsidies. There is considerable variety across countries.<br />
<br />
The report says that OECD countries typically have a three-tiered system:<br />
“Tier 1: publicly provided pension schemes; <br />
Tier 2: mandatory personal retirement savings schemes; and <br />
Tier 3: voluntary personal retirement savings schemes.”<br />
<br />
The report expands on this brief classification and, in describing the internationally unusual mix in New Zealand, suggests that the absence of a Tier 2 scheme means that “average retirement benefits are low by OECD standards, even though the basic retirement pension is generous.”<br />
<br />
The report uses the New Zealand case to look at why governments might worry about the way citizens plan for their retirement incomes:<br />
“This note provides an overview of the reasons why governments intervene to help people manage their retirements, and the costs of these interventions. It then uses this cost-benefit framework to discuss the main options facing New Zealanders if they wish to change New Zealand’s retirement schemes as life expectancy increases.”<br />
<br />
There seem to be three issues with respect to individuals’ behaviour that governments of developed countries try to address with their retirement income systems:<br />
“(i) they believe many people will solve the problems badly if left to their own devices;<br />
“(ii) they can provide investment products that are poorly provided by the private sector, such as annuities; and <br />
“(iii) they can provide insurance protection to ensure people have some resources in retirement even if they suffer catastrophic investment returns.”<br />
<br />
The key policy levers are regulation of financial service providers, information, subsidies and compulsory saving schemes. New Zealand’s relatively low level of intervention seems to suggest that New Zealanders can largely resolve these issues themselves.<br />
<br />
So, why do many countries use Tier 2 schemes to force a particular kind of behaviour on their citizens? There seem to be four main reasons:<br />
“(i) They ensure people save a minimum amount for their retirement, because many people find it difficult to correctly calculate the amounts they should save, or find it difficult to discipline themselves to save this amount. <br />
“(ii) They solve the moral hazard problem that some people would deliberately under-save while working in order to take advantage of a government provided welfare benefit when retired…<br />
“(iii) They protect individuals and whole cohorts against catastrophic investment outcomes by forcing them to invest in a particular way….<br />
“(iv) Tier 2 schemes solve the moral hazard problem that some people will adopt unduly risky investment strategies in anticipation that they keep the bulk of the returns should an investment do well, and a government welfare benefit in old age if it does not.”<br />
<br />
How that turns out depends on the way the Tier 2 scheme is designed. There are costs and benefits of such schemes: the costs include the fact that people are forced to save at ‘inconvenient’ times; that they are forced to save in ways that do not suit them and finally that employees may want to avoid the costs of the Tier 2 scheme by not participating in the paid workforce. These costs have different impacts at different stages of employees’ working lives and can be mitigated by private behaviours or even by the design of the scheme itself (such as age-related contribution rates or choice of investment strategy for the Tier 2 scheme’s assets).<br />
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“There are several reasons why New Zealand may wish to modify its current retirement saving schemes. These range from concern that neither individuals nor the nation as a whole is saving or investing adequately, through concern that the current schemes are an inefficient means for the country (and its people) to achieve their goals, to concern that the current scheme was designed for an earlier time when life expectancy was low, and will not perform adequately in a future period when life expectancy is longer.”<br />
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The report uses a cost/benefit framework to look at possible interventions to resolve this ‘problem’. The aim should be to deal with longevity with “the greatest increase in benefits for the smallest increase in costs.” Six possibilities are analysed from the status quo through possible changes to the design of the Tier 1 scheme and then the addition of Tier 2 arrangements.<br />
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In summary, the report canvasses reducing the cost of the Tier 1 ‘New Zealand Superannuation’ (NZS) by increasing the State Pension Age, age-related tax increases, a ‘save-as-you-go’ pre-funded NZS (re-starting contributions to the New Zealand Superannuation Fund), encouraging New Zealanders to replace ‘lost’ NZS entitlements through tax-subsidised, voluntary Tier 3 savings (such as through ‘KiwiSaver’) and changing the tax incentives towards the internationally favoured EET model. Then there is the possibility of a compulsory Tier 2 for which tax incentives would not be needed.<br />
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Encouraging private provision to replace ‘lost’ NZS would be cheaper:<br />
“Consequently, it will be much less costly to provide a subsidised KiwiSaver scheme in response to increasing longevity than it will be to maintain the current structure of New Zealand Superannuation. The benefits to lower lifetime-income people will not necessarily be as large, however.”<br />
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More radical changes to NZS - means-testing; reducing its real value; adding a ‘social security benefit’ - such as other countries practise, are also canvassed.<br />
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“This note has outlined the main costs and benefits of interventions aimed at helping people manage their retirement. The benefits largely stem from assisting people to solve the savings and investment problems, while the timing, portfolio and workforce disincentive costs reflect the deadweight losses associated with the interventions.”<br />
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The report notes that care must be exercised when promoting another country’s arrangements but the improvement in pensioner longevity “…suggests that maintaining the current payment level and age of eligibility for New Zealand Superannuation will increase costs by more than benefits as longevity increases, making it increasingly unsuited to the needs of younger cohorts and future cohorts.”<br />
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In summary, the report suggests that change is inevitable but that there has been “relatively little systemic analysis of how the costs and benefits of [possible reforms] are likely to stack up in an age when longevity is noticeably higher than it is now.”<br />
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PensionReforms agrees that New Zealand must start a discussion about these issues sooner, rather than later. However, it seems that some of the report’s suggestions raise the risk of importing the difficulties of alternative regimes that need themselves to be addressed. One of the great virtues of New Zealand’s regime is its simplicity. With that comes great, potential flexibility that may be needed once New Zealanders get the chance to have a full look at the impact of their changing population shape. However, PensionReforms thinks it should be for tomorrow’s taxpayers (not today’s) to decide what proportion of tomorrow’s economic output is distributed to older citizens on whatever basis they decide.<br />
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A government’s primary responsibility is to reduce or even eliminate poverty in old age and it seems to PensionReforms that New Zealand’s present perhaps ‘unbalanced’ model (by reference to other developed countries’ alternatives) manages that much more successfully than regimes where the government pays close attention to the ‘private’ behaviour of individuals and their employers. In that context, it remains unclear to PensionReforms why New Zealand ended up with KiwiSaver.<br />
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With NZS Tier 1’s largely delivering on the ‘elimination of poverty’ objective, it is also unclear to PensionReforms why a government might be directly concerned about its citizens’ private saving and investment decisions in a retirement income context. The government should help out with good regulation and effective information/education programmes but it seems that the outcomes of the moral hazards identified in the report should rest with individuals rather than the state. (File size 2.3 MB; 16 pp) 513<br />
http://www.motu.org.nz/index.php?/publications/detail/motu_note_6_mandatory_retirement_income_schemes/Mandatory Retirement Income Schemes, Saving Incentives, and KiwiSaver (2011)513Pre-funded pensions become more expensive with lower interest rates. PAYG, wage-indexed, state pensions are also indirectly affected as an analysis of the pension challenges faced by Cyprus shows. Shifting to prices-based indexation will help protect the Cypriot economy. 2011-12-14T11:01:452008<strong>PensionReforms’ summary and comments</strong><br />
The cost of pre-funded, Defined Benefit pensions are sensitive to at least two main drivers: improving mortality rates and investment income. The longer a pensioner lives, the more pension payments there are and so the more money is needed at the outset to pay for the cost.<br />
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Investment income is the other main driver. The provider of a fully pre-funded, Defined Benefit pension must have sufficient capital to meet all of the expected payments, allowing for investment income on the retained balance. So, prevailing interest rates have a significant effect on the cost of those benefits: the lower those rates, the more costly the promises. <br />
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This 2008 report looks at a long-run, indirect effect of lower interest rates on PAYG pension promises in Cyprus (that is a ‘small open economy’ or SOE). The report starts with the assumption that world interest rates will decline because of global ageing. That’s because of the weight of investment money from baby boomers in their peak saving period; also the demand for investment money is expected to decline as baby boomers retire.<br />
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The report suggests that SOEs like Cyprus will be adversely affected. It uses an overlapping generations (OLG) model that tries to “capture the key institutional features of the Cypriot pension system, including the different regimes for private and public employees. It also captures the effect of aging on health care spending.”<br />
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Cyprus is of interest in the European context as its PAYG pension costs are expected to have the highest increase over the next 40 years. (+12.9% of GDP by 2050, according to the European Commission).<br />
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“This paper shows that long-run declines in world interest rates will impinge on a SOE’s ability to cope with its own demographic shock. In a nutshell, lower interest rates will induce higher capital-labor ratios and thereby increased wages. Higher wages, in turn, will boost pension benefits, exacerbating aging-related fiscal pressures. This pass-through effect will be stronger if pension benefits, and past wage earnings used to compute these benefits, are indexed to nominal wages rather than prices.”<br />
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The report suggests that, without reform, the cost of pensions is likely to increase by 7.5% of gross national income by 2050. Amongst other suggestions, the report recommends a shift from wage-indexation of pensions to a price-related basis to “… provide macroeconomic insurance against long-run declines in world interest rates.” In other words, this kind of change is not just about reducing the cost of pensions but also about partly protecting the economy of Cyprus against changes in the world’s economic environment.<br />
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“In an unreformed system, a decrease of 100 basis points in world interest rates increases pension expenditures by 4.8 percentage points of GNI compared to the baseline scenario with constant interest rates. In contrast, when the pension system is “fully” reformed, this increase is limited to 2.1 percentage points of GNI.”<br />
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The report suggests that simply changing indexation from wages to prices will not be enough for Cyprus but the ‘insurance’ aspect of that reform might justify that change on its own.<br />
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PensionReforms continues to have difficulties with OLG models of the kind used in the report (with a 160 year time-frame – 1957-2117). The underpinning assumptions have to be little short of heroic to make the model ‘work’. For example, Cypriot households are assumed to be entirely ‘public’ or ‘private’ during their working lives (that has significance for their pension entitlements); labour markets are “characterized by perfect competition and substitutability of private and public households’ labor” etc.<br />
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However, there is a wider point here. PensionReforms suggests that a widespread shift to prices-based indexation, as the report recommends for Cyprus, will provide countries with ‘relief’ (as well as the insurance-related protection) for only a relatively short period. Countries will eventually face the difficulties the UK has had with its Basic State Pension that, in recent decades, has declined against wages (though not against prices). That’s because pensioners will look at relative standards of living to assess whether they are being ‘fairly’ treated. Real wages are a way in which living standards are measured over time so there will be a perception of a lack of equity in the distribution of a nation’s wealth where one group is consistently treated less well than others. The UK government has recently had to bow to pressure caused by a halving of the Tier 1 Basic State Pension from about 25% of average wages over the last 30 years.<br />
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PensionReforms agrees that the long-term implications of interest rate changes are certainly of significance but, if a country concludes that a wage-based indexation looks unaffordable in the long-run because of interest rates, the more honest approach is to change the starting value of the pension (through the pension age and/or the annual amount payable) rather than gradually deflate the real value over time (measured against wages). That might work for a while (as in the UK) but PensionReforms suggests it cannot last over the very long term. (File size 1.2 MB; 42 pp) 512<br />
http://www.imf.org/external/pubs/ft/wp/2008/wp0898.pdfGlobal Aging and Declining World Interest Rates: Macroeconomic Insurance through Pension Reform in Cyprus (2008)512People are generally healthier at older ages and so ‘should’ be working longer. However, US data suggests that averages need analysis. The less well-educated, lower-paid have significantly lower healthy life expectancy averages and may not be able to work until the State Pension Age. 2011-12-14T10:55:162008<strong>PensionReforms’ summary and comments</strong><br />
Pension systems around he world are facing up to the good news/bad news story about mortality and morbidity statistics. On the one hand, people are on average living longer with more years of ‘healthy life expectancy’. On the other hand, a longer life means more years of pension payments. The answer at the moment is to increase the State Pension Age and that’s what the US is doing (along with many others). The US has already increased from 65 to 66 and after a spell, will resume increasing to age 67 by 2027. The report questions whether looking at just average mortality/morbidity numbers tell us all we need to know about this important piece of public policy.<br />
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In the US, the median retirement age for men is currently (2011) age 63.<br />
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The report uses the National Health Interview Survey of about 100,000 people that has been conducted annually since 1959. It focuses on men aged 50-64 and makes a number of findings:<br />
“First, on average, a 50-year-old man could expect almost three more years of healthy life in 2000 than in 1970.” That’s an increase of more than one year for each of the three decades to 2000.<br />
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“Second, healthy life expectancy varies significantly by race and education. In 2000, a white with less than high school could expect another 13 years and a white college graduate 23 years. Third, – with the exception of college graduates – little improvement has occurred within each race-education group.” The report notes that these gaps have been widening <br />
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What seems to be happening is that men have been getting more education, particularly at the high (secondary) school level. That significantly improves health outcomes but the differences diminish with age.<br />
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“Fourth, when collapsing the race and educational groups into quartiles of the population, healthy life expectancy averages 14 years for the lowest quartile, 18 to 19 years for quartile two and three, and 23 years for the highest quartile.”<br />
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The report then suggests that “…healthy life expectancy may not continue to improve in the future, given that the percent of men graduating from high school and from college appears to have leveled off and that obesity may slow or reverse health gains.”<br />
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Under the US Social Security system, more years of work and contributions means a higher pension and, as the value of the age pension is reducing (with the increasing State Pension Age), workers will probably need to work longer in order to maintain their previously expected entitlements. Much the same applies to Tier 3 occupational retirement saving schemes; also to other private provision at Tier 3: the longer the saving period, the greater the savings with the added advantage (by comparison with public provision) that they will have to last for a shorter the period in retirement.<br />
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The policy implications of the report’s findings are potentially significant as those who are most at risk from a benefit perspective of an increasing State Pension Age are those who are least well equipped to work longer (lack of education; physical jobs with adverse health impacts). <br />
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“Finally, policymakers should be cautious about expecting continued gains in healthy life expectancy, since these gains are due primarily from movement up the education ladder, and that movement has stalled. Changes that affect the retirement age should be based on the notion that the level and dispersion in healthy life expectancy that we have today may be with us for a long time to come.”<br />
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PensionReforms thinks that an increase in the State Pension Age should be accompanied by a carefully designed support system for those who cannot work for health (or economic) reasons. As the report notes, many can expect to work longer and enjoy longer periods of healthy life expectancy. The signal sent by the increasing age in the US is softened to an extent by the option to take the pension early. However, again, the vulnerable group identified in the report might be even more disadvantaged as they are, by definition, more dependent on the state pension than other, more independent groups. Taking a reduced earlier pension increases their chances of poverty in old age.<br />
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The greater flexibility in this regard of the US Social Security benefit might contain a lesson for countries, like the UK and Ireland, that are simply increasing the State Pension Age with no particular regard for the individual circumstances of those who cannot work until the new, higher age. (File size 257 KB; 40 pp) 511<br />
http://crr.bc.edu/images/stories/Working_Papers/wp_2008-11.pdfWill People be Healthy Enough to Work Longer? (2008)