Transcript Pension Analysis and the PER - Richard P. Hinz and

Pension Analysis and the
PER
Richard P. Hinz, Adviser, HDNSP
Anita M. Schwarz, Lead Economist, ECSHD
April 2007
Objectives of a Pension
System
 Reduce
poverty among the elderly
 Smooth consumption between working
years and retirement years
– Implication: those who earn and consume more in
working years will consume and earn more in retirement
years
– Very different from other public expenditure programs
which ideally would be designed to allocate equal or
greater share of expenditures to the poor
Pension Systems Usually
Contributory
contributory – part of the
compensation package
 Historically
– Government provides a mechanism whereby employers and
employees can save for old age in the absence of secure marketbased instruments
 Also makes pension reforms extremely different
– People have acquired rights from the contributions they have made
 Raises problems for redistribution analysis
– Need to net out historical contributions from current expenditures
– Only those who contribute get pensions; low income individuals
often don’t contribute; so pension expenditure skewed toward
higher income individuals as is pension revenue
Who is Covered Under the
Pension System?
 Contributors
to the pension system can
range from 5% of the labor force to 95%
 Percentage of the elderly covered can be
different from percentage of labor force
covered
– ECA, Brazil, Georgia
 What
programs exist to provide assistance
to those not covered?
Coverage is Fundamental in
How to Evaluate the Pension
System
 High coverage systems
– Meaningful to include redistribution within system
 Low coverage systems
– Financing of the pension system should come from those
who are covered
– Low coverage system running a deficit results in highly
regressive transfers from general revenues broadly
collected to the few who are covered and generally have
higher incomes
– Redistribution within the pension system of secondary
importance
Fiscal status of the pension
system now and in the future
 Is the system sustainable now and in the future?
– Note that the relevant future for pension systems is usually 50-75
years into the future

Will promises being made to those beginning work today be kept?
 Do proposed reforms improve sustainability?
– Frequently do nothing in the short to medium term
– With move to a funded system, reform can actually worsen the
short and medium term position
– Need measures like implicit pension debt
Implicit Pension Debt
 What
does the government owe pensioners
and contributors as of today?
– Pensioners are owed the present value of the current
benefit (indexed as by law) for the remainder of their
expected lifespan
– Contributors are owed some prorated benefit to be
received when they reach retirement age and to extend
throughout the duration of their expected retirement
period, prorated by the % of working career on which
contributions have already been paid
Example of Fiscal
Sustainability or Not in Context
of Turkish Pensions
 While
Projected Current Balance of Turkish Pension Funds, 20022075
% of GDP
Turkey starts
out with a deficit, most
countries will
eventually show a
deficit in the long run
 Life expectancy
increases while
pension parameters are
usually not
automatically adjusted
(2.0%)002
2
(4.0%)
07 12 17 22 27 32 37 42 47 52 57 62 67 72
20 20 20 20 20 20 20 20 20 20 20 20 20 20
(6.0%)
(8.0%)
Year
Turkish Reform Proposal
Implicit Pension Debt as % of GDP
Current Account Deficits as % of GDP
250.0%
200.0%
(3.0%)
Base Case
Reform Case
(4.0%)
(5.0%)
150.0%
Base Case
Reform Case
100.0%
50.0%
(6.0%)
Year
5
0
207
5
207
0
206
5
206
0
205
5
Year
205
0
204
5
204
0
203
5
203
0
202
5
202
0
201
(8.0%)
201
5
(7.0%)
200
% of GDP
(2.0%)
% of GDP
2073
2069
2065
2061
2057
2053
2049
2045
2041
2037
2033
2029
2025
2021
2017
2013
2009
(1.0%)
2005
1.0%
Benefit Structure :
Are Benefits Adequate?
 How do we define adequacy?
– Relative to poverty level
– Relative to average wage – ideally net wage


Workers pay pension contributions, health insurance contributions
Note that inflation indexed pensions will result in a drop in the value
of the pension relative to economy-wide average wage during one’s
retirement period
– Relative to pre-retirement wage

Relative to final salary or relative to average lifetime salary?
– If average lifetime salary, how are salaries revalued to make them comparable?
 Different
measures can give very different results,
but also provide different information
Example of Slovak Benefits
Average Male Pension as % of Economywide Average Wage
200
150
High Income
100
Avg Income
Low Income
50
0
Pre-Reform
Male
PAYGmale
CurrentMale
FutureMale
Pension Relative to Pre-Retirement Wage
90
80
70
60
50
40
30
20
10
0
High Income
Avg Income
Low Income
Pre-Reform
Male
PAYGmale
CurrentMale
FutureMale
Benefit Structure (2):
Are the Benefits Fair?
 Individuals
are making contributions and
receiving pensions – are they getting good
value for their money?
– Benefits could be high, but costs could be high too
 Internal
rate of return
 Fiscal link – if benefits are not perceived as
fair, people stop contributing – drop in
revenue
Internal Rate of Return for
Different Individuals in Slovak
Republic
% rate of interest
Internal Rates of Return for Different Individuals
4
3.5
3
2.5
2
1.5
1
0.5
0
High income
Average Income
Low income
Pre-Reform
Male
PAYGmale
CurrentMale
FutureMale
Benefit Structure :
How Redistributive is the
Pension System?
 Pension systems have multiple
– Poverty reduction in old age
– Consumption smoothing
objectives:
 Countries
choose to weight these two objectives
differently
– Australia/New Zealand heavily weighted toward poverty
alleviation
– Austria, Sweden – strong link between contributions and benefits
 No
correct answer, but important to know what the
system is actually achieving
Example from OECD countries,
Pensions at a Glance
2
Canada
1.5
Germany
1
Ireland
0.5
Japan
0
Wage Relative to Average Wage
3
2.7
2.4
2.1
1.8
1.5
1.2
0.9
New Zealand
0.6
0.3
Pension Relative to Average
Wage
Countries with Highly Redistributive Benefits
United Kingdom
United States
Pensions at a Glance
Pension Relative to Average
Wage
Countries where Pensions are Closely Linked to Contributions
2.5
2
1.5
Finland
France
1
0.5
0
0.3
Italy
Netherlands
5
5
.
0
0.8
5
0
.
1
1.3
5
5
.
1
1.8
5
0
.
2
2.3
Wage Relative to Average Wage
5
5
.
2
2.8
Tools
 PROST model:
– Fiscal analysis
SR and LR sustainability
 Implicit pension debt

– Individual level social analysis
Vary starting age, retirement age, starting wage, wage
growth, work history, and mortality experience
 Pensions as percentage of economy wide wage
 Pensions as percentage of own final salary
 Internal rate of return provided by pension system

PROST
Developed
at the Bank; has been used
for more than 85 countries
Available to all our client countries
once counterparts are trained
Training programs and manuals
available
Countries Using PROST
Countries with PROST licenses as of July 2005
APEX methodology
 Simulates
pension benefits for individuals
beginning work at age 20 and retiring at the
retirement age for all different income levels
 Shows what different individuals get in
relation to what they earned, taking into
account tax treatment and ceilings and
floors on contributions and benefits
APEX model
Developed
by Edward Whitehouse and
AXIA Economics
Now the model of the OECD
In use for all OECD countries,
Pensions at a Glance
Preliminary work on many of our
countries as well
Benefit-Incidence Not That
Useful
Decile
TOTAL
1
2
3
4
5
6
7
8
9
10
URBAN
RURAL
0.9%
1.7%
4.7%
6.7%
7.2%
9.6%
11.7%
15.8%
17.9%
23.9%
95.0%
5.0%
Public System for
Private Sector Workers
Active
Pensioners
Workers
0.9
1.4
3.3
2.2
6.2
5.4
7.8
8.2
11.1
8.9
11.3
10.3
12.6
12.9
14.1
15.5
15.4
17.1
17.3
18.0
93.4
94.5
6.6
5.5
Public System for
Federal Civil Servants
Active
Pensioners
Workers
0.2
0.0
1.2
0.0
1.9
3.2
4.7
3.1
4.9
1.6
7.8
6.7
11.5
8.1
14.9
16.8
23.6
19.8
29.2
40.6
91.4
97.9
8.6
2.1