pension reform, international trends and future … · pension reform framework world bank...
TRANSCRIPT
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THE CHALLENGE OF AGEING
– PENSION REFORM, INTERNATIONAL
TRENDS AND FUTURE IMPERATIVES
Chris Daykin, UK Government Actuary
Chairman, PBSS Section of IAA
Nairobi, 7 June 2007
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GOVERNANCE OF SOCIAL SECURITY
Financial governance of social security> good overall governance and accountability> monitoring of income and expenditure> short, medium and long term projections> systems of control and audit> internal and public reporting> investment strategy and monitoring
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GOVERNANCE OF SOCIAL SECURITY
The role of the actuary in social security> demographic projections> estimates of future benefit outgo> estimates of future contribution income> long-term projections of financial balance> short/medium-term estimates of cash-flow> development of funding strategies> asset/liability management> actuarial control cycle> design and costing of pension reform proposals> transparency and disclosure of information about costs
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INCREASING LONGEVITY
Expectation of life at age 65 on cohort basis, E&W
10
14
18
22
26
1850 1900 1950 2000 2050
Year age 65 attained
Expe
ctat
ion
of li
fe (y
ears
)
10
14
18
22
26
FemalesMales
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EXPECTATION OF LIFE, AFRICAN MALES, 1950-2010
30
35
40
45
50
55
60
65
70
1950 1970 1990 2010
Eastern AfricaMiddle AfricaNorthern AfricaSouthern AfricaWestern Africa
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EXPECTATION OF LIFE, AFRICAN FEMALES, 1950-2010
30
35
40
45
50
55
60
65
70
75
1950 1970 1990 2010
Eastern AfricaMiddle AfricaNorthern AfricaSouthern AfricaWestern Africa
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DEPENDENCY RATIOS, 1970-2030 (nos. 65 & over per 1000 aged 15-64)
0
20
40
60
80
100
120
140
1970 1990 2010 2030
Eastern Africa
Middle Africa
Northern Africa
Southern Africa
Western Africa
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PENSION REFORM
What are the key objectives?> increase coverage and adequacy of benefits> reduce inequalities of provision between sectors> improve incentives for saving> ensure sustainability of structure and financing> avoid unaffordable increases in public expenditure> recognise the impact of future increases in longevity> reduce perverse incentives in labour market> improve retirement incentive structures
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PENSION REFORM
What is the role of actuaries in pension reform?> analysis of costs of existing arrangements> advice on design of alternative structures> modelling the transition> regulation of complementary schemes> modelling impact on individuals> impact on public expenditure/borrowing> modelling impact on investment markets
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SOCIAL SECURITY REFORM
Some alternative routes to reform national systems> individual accounts> notional defined contribution> modification of defined benefit> flat-rate demogrant> means-tested basic pension
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INDIVIDUAL ACCOUNTS
Individual account reforms> started in Chile in 1981> by now includes most countries in Latin America…> …also several countries in central and eastern Europe> competitive private sector investment vehicles> usually mandatory for formal sector workers> compulsory purchase of annuities at retirement
> or some form of programmed withdrawal
> promoted by World Bank in Averting the Old-Age Crisis
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INDIVIDUAL ACCOUNTS
Individual account reforms - evaluation> coverage is still a major problem…> …individual accounts are not enough of an incentive> transaction costs generally remain high…> …competition does not bring down the charges> churning and mis-selling have been an issue> pension levels may not be adequate…> …too many people will qualify for the minimum pension
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SOCIAL SECURITY REFORM
Alternatives> to achieve similar incentive effects to individual accounts> …without high transaction costs or mis-selling problems> …but maintaining fairness between generations> …passing on to individuals the risk of greater longevity> …and avoiding the cross-subsidies of defined benefit
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NDC PENSION REFORM
Notional Defined Contribution> structured as defined contribution…> … but on a PAYG basis rather than funded> clear link between contributions and benefits…> …but not subject to investment risk> targets lump sum at pension age…> with ‘notional’
purchase of an annuity
> permits flexibility of retirement age> passes on part of longevity risk
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SWEDEN
Swedish NDC> DB state scheme replaced by NDC> revalorisation of individual accounts by average wage> automatic economic regulator of pensions increase> annuity value responds to improving mortality> automatic balancing mechanism to maintain in balance…> …as otherwise both benefits and contributions are fixed
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SWEDEN
Automatic balancing mechanism (‘actuarial accounting’)Annual balance sheet for scheme:
Liabilities = present value of all future outlay for pensions in payment+ accumulated individual accounts for all persons not yet in
receipt of a pension
Assets =real assets in buffer fund + value of future contributions
Value of future contributions = contribution rate x wage mass x expected turnover duration
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SWEDEN
Expected turnover duration
0
20
40
0 5 10 15 20 25 30 35 43 50 55 60 65 70 76 85 90 95
Ste
ady
stat
e pe
nsio
n lia
bilit
y
(in y
ears
of c
ontri
butio
ns)
= turnover duration 33 years
Age group
Expectedincome-weighted
age of income earners Pay-in duration + Pay-out d.
Expected pension weighted age of pensioners
Expected pension-capital-weighted average retirement age
1
00 5 10 15 20 25 30 35 43 50 55 60 65 70 76 85 90 95
= turnover duration 33 years
Age group
Expectedincome-weighted
age of income earners Pay-in duration + Pay-out d.
Expected pension weighted age of pensioners
Expected pension-capital-weighted average retirement age
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SWEDEN
Real individual accounts> mandatory funded individual accounts (PPM)> 2½% of earnings> contributions collected with NDC contributions of 16%> low administrative costs> choice of nearly 800 investment funds> default arrangements if no funds selected
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SWEDEN
Overall evaluation> hailed by many as a success> PAYG system made sustainable> cohort longevity risk passed on to individual members> dependency ratio risk passed to members through ABM> concern about expected fall in replacement ratios…> …and arbitrary effect of automatic balancing mechanism
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FINLAND
Improved targeting> basic pension used to be flat-rate and contributory > mandatory earnings-related scheme> industry-wide rather than individual employer schemes > basic pension turned into a minimum pension guarantee…> …measured against the earnings-related pension> …so no means-test or asset test> dramatically cut the cost of the basic pension…> …and focussed expenditure on lower paid
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FINLAND
Dealing with demographic ageing> objectives of recent reform of earnings-related scheme
> to postpone average age of retirement by 2 to 3 years> to adapt the pension system to increased expectations of life> to reduce pressures for future increases in contributions
> average of last 10 years → career average revalued> variable accrual rate
> 1.5% a year from 18 to 52> 1.9% a year from 53 to 62> 4.5% a year from 63 to 68
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FINLAND
Dealing with demographic ageing> introduction of “life expectancy coefficient”Life expectancy coefficient for year N (>2009) =
cohort life expectancy for those reaching 62 in 2009cohort life expectancy for those reaching 62 in N
Multiply pensions of those reaching 62 in N by life expectancy coefficient for year N
Thus adjusting a DB pension benefit for improving life expectancy
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GERMANY
Dealing with demographic ageing> still has earnings revaluation rather than prices but…> …revaluation is to net instead of gross wages> higher retirement age > reduced replacement rate at 65> contribution rate not to exceed 22% in 2030> “sustainability factor”
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GERMANY
Pension adjustmentChange in pensions =
Change in average income, net of contributionsx sustainability factor
Sustainability factor for year x = value for year x-1 ofNumber of active contributors
Number of pensioners
divided by corresponding value for year x-2
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NEW ZEALAND
Citizen’s pension> flat rate of benefit at or just above means-testing level> indexed to national average earnings> eligibility dependent on period of residence in NZ> individual entitlement, whether single or married> not dependent on pattern of working life> simple to understand and operate> no savings disincentive effects
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NEW ZEALAND
Kiwisaver> new, voluntary, work-based savings scheme> automatic enrolment for those starting new job> those in a job will be able to join if they wish> contributions from employees at 4% (or 8%)> contributions collected by Inland Revenue through PAYE> individual choice of scheme (with default)> employers can select a scheme –
but no need to contribute
> no withdrawal until age 65…> …except for deposit on a first home (after >3 yrs contns.)> existing DB or DC pension schemes can be exempted
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CANADA
Control based on steady state funding level> 1998 amendments to Canada Pension Plan> contributions increased from 6% to 9.9% from 1997 to 2003> small reduction in long-term benefit target> excess contributions to be invested in markets…> …under control of CPP Investment Board> three-yearly actuarial valuation…> …monitoring steady-state rate of contribution
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CANADA
Control based on steady state funding level> if steady state rate is higher than 9.9%...> …and if ministers cannot agree on what to do> then automatic adjustment mechanism is triggered:
> contribution rate is increased over 3 years by ½
of excess of steady state over 9.9% (subject to maximum increase of 0.2% a year)> benefits are frozen (i.e. not indexed any more)> after 3 years, situation is reviewed following new actuarial valuation
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UNITED KINGDOM
Continuous pension reform since 1975> State earnings-related pension (1975)> contracting out (1975)> basic pension linked to RPI (1980)> personal pensions for contracting out (1987)> cut back of SERPS (1988)> equalisation of pension age at 65 (by 2020) (19950> State Second Pension replaced SERPS (2002)> pension credit with an earnings link (2003)> trend to more dependence on means-testing> longevity risk offset by revaluation and rising pension age
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UNITED KINGDOM
Expenditure from National Insurance Fund as % of GDP
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060
Past data and future price uprating Future earnings uprating
1950
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UNITED KINGDOM
Pensions by year of award as % of earnings (at average earnings levels)
0%
5%
10%
15%
20%
25%
30%
35%
40%
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2 060
Basic Serps Increase due to S2P
1950
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UNITED KINGDOM
Issues to be addressed> declining value of BP (and S2P)> shift to dependence on means-tested benefits> residual problem of coverage for older women> declining significance of defined benefit plans> defined contributions generally low> individuals shouldering more of the risk
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UNITED KINGDOM
White Paper proposals (May 2006)> restore earnings link for basic pension> raise pension age to 68 by 2046> individual accounts with auto-enrolment> reform contribution conditions (30 years needed)> abolish DC contracting-out
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UNITED KINGDOM
Proposals now being enacted (May 2007)> restore earnings link for basic pension (from 2012 or later)> raise pension age to 68 by 2046
> 65 → 66 between 2024 and 2026> 66 → 67 between 2034 and 2036> 67 → 68 between 2044 and 2046
> invested individual accounts with auto-enrolment
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PENSION REFORM
Goals of a pension system
Primary goals> To provide adequate, affordable, sustainable and robust old-age incomeSecondary goals> To create developmental effects by
> minimizing negative impacts> leveraging on positive impacts
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PENSION REFORM FRAMEWORK
World Bank framework (1994)
1st
PillarMandatory unfunded public defined benefit social security2nd
PillarMandatory funded and privately managed defined contribution3rd
PillarVoluntary savings retirement plan (or occupational pension plans)
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PENSION REFORM FRAMEWORK
World Bank framework (2005)Pillar zeroNon-contributory scheme providing minimal level of protection1st
PillarMandatory unfunded publicly managed DB or NDC providing some longevity insurance2nd
PillarMandatory funded and privately managed DC (or DB)3rd
PillarVoluntary savings plans –
regulated and privately managed
4th
PillarInformal intergenerational financial and non-financial support
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SOME GENERAL LESSONS
Increasing coverage> use of demogrant
(citizenship pension)
> simpler than means-testing> but more expensive to give benefits to everyone> general budget financing
> keep universal pension at very low level (pillar zero)> supplement with social insurance for employed workers> flat-rate benefits on DB basis> …supplementary savings through individual accounts> …or occupational pension schemes
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SOME GENERAL LESSONS
Sharing longevity risk1. target lump sum at retirement…
> …and convert to pension using current annuity value> …funded individual accounts or NDC
2. index retirement age based on cohort expectation of life...> …or maintain ratio between working and retired life periods
3. raise retirement age at intervals to offset rising cost4. overall adjustment mechanism such as
> life expectancy coefficient> sustainability factor> automatic balancing mechanism
5. risk-sharing between contributors and pensioners
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CONCLUSIONS
Wide range of solutions – DC favoured> everywhere has a different solution> but all are starting from different points> DC widely favoured for its incentive structure…> …but lacks basic characteristics of protection> …unless in with-profits form or with strong underpin> many national DC systems have a minimum pension
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CONCLUSIONS
Wide range of solutions – new DB thinking> DB mostly moving to career-average revalued…> …which is equivalent to a type of DC> NDC is really a DB structure dressed up as DC> focus on fund at retirement facilitates longevity solutions> cash balance is another alternative DB/DC hybrid…> …or perhaps revisit with-profits DC> reconsider survivorship in light of individual entitlement
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CONCLUSIONS
Wide range of solutions – efficient savings> mandatory DC necessary to achieve full coverage…> …or almost mandatory> contributions should be collected centrally> avoid insurance wrappers> don’t have too much choice of investment funds> guaranteed minimum should underpin state pension only
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THE END
Questions and discussion