pension analysis and the per
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Pension Analysis and the PER
Richard P. Hinz, Adviser, HDNSPAnita 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
Historically contributory – part of the compensation package– Government provides a mechanism whereby employers and
employees can save for old age in the absence of secure market-based 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 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
Projected Current Balance of Turkish Pension Funds, 2002-
2075
(8.0% )
(6.0% )
(4.0% )
(2.0% )
Year
% of GD
P
Turkish Reform Proposal
Current Account Deficits as % of GDP
(8.0%)
(7.0%)
(6.0%)
(5.0%)
(4.0%)
(3.0%)
(2.0%)
(1.0%)
1.0%
2005
2009
2013
2017
2021
2025
2029
2033
2037
2041
2045
2049
2053
2057
2061
2065
2069
2073
Year
% of
GDP
Base Case
Reform Case
Implicit Pension Debt as % of GDP
50.0%
100.0%
150.0%
200.0%
250.0%
Year
% of
GDP
Base Case
Reform Case
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
0
50
100
150
200
Pre-ReformMale
PAYGmale CurrentMale FutureMale
High Income
Avg Income
Low Income
Pension Relative to Pre-Retirement Wage
0102030405060708090
Pre-ReformMale
PAYGmale CurrentMale FutureMale
High Income
Avg Income
Low Income
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
RepublicInternal Rates of Return for Different Individuals
00.5
11.5
22.5
33.5
4
Pre-ReformMale
PAYGmale CurrentMale FutureMale
% ra
te o
f int
eres
t
High income
Average Income
Low income
Benefit Structure :How Redistributive is the
Pension System? Pension systems have multiple objectives:
– Poverty reduction in old age– Consumption smoothing
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
Countries with Highly Redistributive Benefits
0
0.5
1
1.5
2
Wage Relative to Average Wage
Pen
sion
Rel
ativ
e to
Ave
rage
Wag
e
Canada
Germany
Ireland
Japan
New Zealand
United Kingdom
United States
Pensions at a GlanceCountries where Pensions are Closely Linked to Contributions
00.5
11.5
22.5
Wage Relative to Average Wage
Pen
sion
Rel
ativ
e to
Ave
rage
Wag
e
Finland
France
Italy
Netherlands
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 with PROST licenses as of July 2005
Countries Using PROST
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
Public System for Private Sector Workers
Public System for Federal Civil Servants
Decile TOTAL Active Workers
Pensioners Active Workers
Pensioners
1 0.9% 0.9 1.4 0.2 0.0 2 1.7% 3.3 2.2 1.2 0.0 3 4.7% 6.2 5.4 1.9 3.2 4 6.7% 7.8 8.2 4.7 3.1 5 7.2% 11.1 8.9 4.9 1.6 6 9.6% 11.3 10.3 7.8 6.7 7 11.7% 12.6 12.9 11.5 8.1 8 15.8% 14.1 15.5 14.9 16.8 9 17.9% 15.4 17.1 23.6 19.8 10 23.9% 17.3 18.0 29.2 40.6
URBAN 95.0% 93.4 94.5 91.4 97.9 RURAL 5.0% 6.6 5.5 8.6 2.1
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