Pensions Core Course 2013: Diagnostic Process & Conceptual Framework

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Pensions Core Course 2013: Diagnostic Process & Conceptual Framework

  1. 1. Pensions Diagnostic Assessment and Conceptual FrameworkPensions Core CourseMark DorfmanThe World BankApril 1, 2013
  2. 2. Slide 2April 1, 2013Organization1. Diagnostic assessment process2. Conceptual framework – design typology
  3. 3. Diagnostic Assessment
  4. 4. Slide 4April 1, 2013Diagnostic Assessment (1) – Evaluation Process & CriteriaEnablingenvironment(Motivatingreform, framing &constrainingreform options)•Existingdesign•Demographicprofile•Macro-economicenvironment•InstitutionalCapacity•Financialmarket status•PoliticaleconomyInitialConditions &InheritedSystem•Demand -consumptionsmoothing &elderlypovertyprotection•Supply -mandatory &voluntarypension &socialsecurityschemes•Family &communitysupportReformobjectives•Primary:improvingcoverage,adequacy, &sustain-ability for thelong-term•Secondary:improvinglabor markets,macro/fiscalposition, &contributingto financialmarketdevelopment.Reform Design&ImplementationOptions•Design reforms-introduce newschemes,parametric &structuralreforms•Governance,Institutionaland regulatoryreforms•Strengtheninginstitutions &implementation
  5. 5. Slide 5April 1, 2013Diagnostic Assessment (2) – Data, Indicators and ToolsInformation/ DataElderlyincomes,vulnerability & povertyInitialconditionsMandatory& voluntarypensionsystems &socialsecurityschemesTools• Country HH survey data• ADEPT-SP x/country dataEnvironment –• UN Population Projections• Country admin data• Financial market data• Macro & fiscal data (country/IMF)System design –• Admin data/country laws• WB database comparatorsPerformance –• Admin data/country laws• WB database comparators• HH survey data• Administrative data from socialwelfare schemes, housing, healthprovision.• HH survey data.AdditionalstatesupportIndicatorsEnvironment• Demographic• Economic• Financial• Informal Support • ADEPT-SP• Apex• PROST• ASPIRE &ext. x-countrydataDesign• Structure of pensionsystem• Qualifying conditions• ParametersPerformance• Coverage• Adequacy• Financial sustainability
  6. 6. Slide 6April 1, 2013Diagnostic Assessment (3) IndicatorsIndicatorsPerformance IndicatorsCoverage Contributors/labor force orworking-age population Recipients (% total & % age65+)Adequacy Replacement rates Pension income/elderlyexpenditures Elderly incomes Elderly poverty (before & afterbenefits)Sustainability Pension spending (% GDP) PV of financing gap (% GDP) PV spending/PV contributions(%)EnvironmentDemographic• Old-age & systemdependency ratios(historical & projected)• Life expectancy atretirement age (projected)• Fertility (historical &projected)Economic• Labor force participation• Public & Publicly guaranteeddebt (% GDP)Financial & Institutional• Financial sectordevelopment indicatorsGovernment effectiveness• Informal support• Co-residence ratesDesignStructure• Pillars (benefit design,financing, institutionalstructure)• Civil service (integrated vs.separate)Qualifying conditions• Eligibility ages• VestingParameters• Pension contribution rates +caps• Social insurancecontribution rates• Target replacement rates• Target pension wealth
  7. 7. Slide 7April 1, 2013Diagnostic Assessment – 4. ToolsToolsAPEXEvaluation ofindividual levelbenefits acrossinstruments +for differentincome groups.IndividualreplacementratesReplacement ofaverage wagePension wealthADEPT-SP Elderly welfare Elderly poverty Co-residence Elderly incomegeneration Comparisons ofwelfare, povertyacross elderly, non-elderly & householdtypes.PROST• Baseline. Long-termprojections of financinggap for existingschemes + replacementrates for current andfuture retirees• Reform scenarios.Long-term projectionsfinancing gap +replacement rates forparametric and/orstructural reforms• Outputs to simulateother instruments(social pensions,voluntary savings)WB Database &External X-CountryDataCross-countrycomparisons Demographics Coverage Adequacy Affordability Sustainability
  8. 8. Conceptual Framework – Design Typology
  9. 9. Slide 9Design typology – A Multi-pillar designObjectiveMandatory savingsto smoothconsumptionVoluntary savings tosmooth consumptionMandatory co-insurance againstconsumption shocksElderly povertyprotectionInstrumentProtection againstpoverty &consumption shocksThird pillar - Voluntaryoccupational & individualpension arrangementsSecond pillar – Mandatorycontributory earnings-related pension savingsFirst pillar – Mandatorycontributory earningsrelated pension insuranceZero pillar – Non-contributory elderly socialassistanceFourth pillar - otherassistance programs (eg.health or housing) assistingelderly income protectionMandatoryPensionInsuranceElderly SocialAssistanceMandatoryPensionSavingsOther Assistance ProgramsVoluntaryPensionSavings
  10. 10. Slide 10Stylized illustration of one type of multi-pillar designIndividual Wage as a % of Average Wage LevelBenefit Level (% ofAverage Wage)Mandatorycontributorysavings and/orsocial insuranceMeans-TestedSocial PensionVoluntaryoccupationalor individualpensionsavings
  11. 11. Slide 11April 1, 2013Redistribution in Pensions – OECD Illustrations (1)•0•.5•1•1.5•2•2.5•Grossrelativepension•level•0 •.5 •1 •1.5 •2 •2.5 •3•Individual earnings, multiple of economy•-•wide average•Canada•Denmark•Australia•United Kingdom0.511.522.5Grossrelativepensionvalue0 .5 1 1.5 2 2.5 3FinlandLuxembourgAustriaSwedenIndividual earnings, multiple of economy-wide averageItaly NL0.511.522.5Grossrelativepensionvalue0 .5 1 1.5 2 2.5 3FranceJapanUnited StatesSwitzerlandIndividual earnings, multiple of economy-wide averageGermany
  12. 12. Slide 12April 1, 2013A. Design options – Non-Contributory SchemesBenefit ParametersQualification criteria - eligibilityage, means testingBenefit levelIndexationClawback or other benefitadjustmentsInstrument Types1. Elderly social assistance• Universal• Pensions-tested• Resource/means tested• Subsidized minimum socialinsurance benefit2. Household social assistance
  13. 13. Slide 13April 1, 2013A. Design considerations – non-contributory schemes• Universal vs. targeted• Integration w/contributory schemes – minimum benefit• Elderly assistance vs. household social assistance• Targeting methods – weighing targeting effectiveness• Benefit level considerations• Reconciling coverage vs. adequacy & fiscal envelope• Fiscal affordability w/aging.• Incentive effects of different designs & benefit levels
  14. 14. Slide 14April 1, 2013B. Design options – Earnings-related Contributory SchemesInstitutionalDesignCentralizedaccount andfinancialmanagementDecentralizedaccount andfinancialmanagementBenefit DesignEarnings related1. Defined benefitConventional DBPoints2. Definedcontribution3. HybridNon-earningsrelatedFinancingPay-as-you goPartially fundedFully fundedContributionsMandatoryQuasi-voluntaryVoluntary
  15. 15. Slide 15April 1, 2013B. Weighting the Advantages & Disadvantages of PAYG DB & FDC SchemesAdvantages DisadvantagesSimplicity of designLimited information and infrastructurerequirementsParameters need to be adjusted over time to respondto and anticipate demographic changes. Changes inparameters can result in an effective partial default inpension promises.Longevity risks covered by plan sponsor;indexation risks may be covered in benefitformulaUnsustainable benefit promises invite both partialdefault in pension promises and severe fiscal burdens.Scaled premium financing enables moregenerous benefits for the current generationthan would be the case for an immaturescheme.Poorly designed DB schemes have weak incentives forworking longer and can inequitably provide somewhatregressive benefits for higher income workersCan compensate for risks of individualmyopia, inappropriate planning, and financialmarket risks.Central management can contribute to weak disclosureand participant accountability, poor service standardsand weak investment returns.PAYG Defined Benefit Schemes
  16. 16. Slide 16April 1, 2013B. Weighing the Advantages and Disadvantages of PAYG DB vs FDC Schemes (2)Advantages DisadvantagesAddress population aging (compared to PAYG-DB) Transitioning requires the payment of both current benefits andcontributions on behalf of current workers resulting in afinancing challenge for “transition costs”Can improve benefits for retirees if returns after feesgreater than wage growth.Administrative costs of individual choice materially affectpension benefits.Can insulate members from political risk - ensure thatpension benefits are fully deliveredRequirements for sufficient enabling conditions - fiscalconditions; depth, breadth and contestability of financialmarkets; regulation and supervision of financial markets &pension providers.Eliminates a contingent fiscal obligation to make goodon pension claimsSignificant institutional requirements including informationsystems, regulation and supervision.Strong incentives for work and contributions as benefitslinked to contributions and life expectancy.Incentives for strong investment and account manage-ment through consumer choice & regulation.Subjects participants to financial market volatility and risk yetunder a mandatory regime. Regulators generally need toconstrain the investment choices of membersCan assist in achieving secondary objectives of labormarket efficiency and financial market developmentFunded Defined Contribution Schemes
  17. 17. Slide 17April 1, 2013B. Weighting the Advantages & Disadvantages of PAYG DB & FDC Schemes (3)Hybrid approach of 1st & 2nd pillars can diversify risks toindividuals.Well designed PAYG DB schemes & NDC schemes can• align contributions & benefits• ensure appropriate indexation• ensure long-term sustainability• establish automatic adjustment mechanisms.Yet PAYG schemes still• Require substantial buffer funds & pre-funding (aging + ensurepayment in the face of shocks)• Face challenges of adequacy in the face of aging
  18. 18. Slide 18April 1, 2013Weighing the Tradeoffs in Pension DesignSustainability &long-termaffordability(Long-termcontribution rate& fiscal costs)Adequacy(TargetReplace-ment Rate)Work-retirementbalance(RetirementAge)14% Employer/Worker ContributionRate nd est.20.1% ContributionRate from StateSubsidy42% ReplacementRate? (Manworking 26 years)Life expectancy atage 60 (2010) 17.6years (men), 21.9years (women).
  19. 19. Slide 19April 1, 2013C. Voluntary Occupational & Individual Schemes – Policy ConsiderationsOccupational schemes - important for formal sector employees – compensate design rigidities of other schemes enables deferred compensation which supports investments inhuman capitalIndividual schemes - important role for middle and upper incomeself-employed Both entail financial and agency risks resulting from privatepension management Strong regulation essential Tax incentives requires income limitations.
  20. 20. Slide 20April 1, 2013C. Occupational Schemes for Civil Servants – Policy Considerations Harmonization & integration with national schemes forlabor mobility - portability losses and labor market effects Fiscal cost. Often substantial deferred compensation with ahigh fiscal cost the expense of other critical fiscal priorities.Consider in context of compensation review. Final pay schemes - weak incentives & higher effectiveincome replacement for the highest paid workers. Weak/discretionary indexation leaves retireesinsufficiently protected. Technical issues – commutation, annuity factors, wagebase.
  21. 21. Slide 21April 1, 2013D. Institutional IssuesAdministrative Infrastructureand InstitutionalArrangementsGovernance andAccountabilityLegal andRegulatorySupervisionNon-contributorypensions orold ageassistance Unique identification Means-testing infrastructure Application and eligibilitycertification Record-keeping and datamanagement Disbursement mechanisms Rules, roles and controls. Transparent disclosure Complaint redress External audit andevaluation Periodic independentassessment M&E evaluationprocesses1st PillarMandatoryDefined-benefitscheme Unique ID Record-keeping and datamanagement Funds managementinfrastructure and governance Contribution and disbursementmechanisms + payment systems.Above+ Governing body &policies for managinginstitutionsLegal frameworkspecifying the rights& resp. ofcontributors,beneficiaries,employers, agents,managers etc. External oversight ofmanaging institutionuseful. External audit andaccountabilityprocesses.2nd PillarfundeddefinedbenefitschemeAdministrative systems +infrastructure for competitiveindividual choice of fundmanagers & custodians• Governance policies &oversight to addressprinciple-agent issues• Accounting, audit andvaluation infrastructure.• Depth, breadth andcontestability for pensionfund investments.“ Competent, empowered& independent pensionsupervisory authorityauthorizing & supervisingall necessary agents,instruments andprocesses.
  22. 22. Slide 22April 1, 2013E. Combining Multi-Pillar Design Options (1)Multi-pillared pension systems - elements with varying riskcharacteristics.Portfolio approach can accommodate the diversity of societalneeds and economic characteristics. Multiple instruments canoptimize desired individual and societal benefits while minimizingrelative risks.Mix of instruments (& pillars) depends upon: Objectives (income replacement & poverty protection) Inherited policies and institutions Environmental conditions (demographic, fiscal, admin systems,financial markets) Policy choices who bears what risks
  23. 23. Slide 23April 1, 2013E. Combining Multi-Pillar Design Options (2) Earnings-related 1st & 2nd pillar schemes generally only beeneffective for formal sector workers with wages or in countries withstrong tax net coverage Occupational schemes (3rd pillars) generally cover establishedfirms & often the least poorest workers Individual schemes (3rd pillars) considered for workers of allincomes (formal & informal) though often only cover workers withrelatively high and/or stable incomes. Non-contributory schemes (Zero pillars) generally aim to assist atleast the poorest elderly.
  24. 24. Conclusions
  25. 25. Slide 25April 1, 2013ConclusionsDiagnostic assessment – existing programs, reform needs & reformscenarios based on: Coverage Adequacy SustainabilitySimulation and modeling tools are employed to ensure an evidence base forpolicy evaluation including ADEPT, PROST and APEX; comparative data isalso reviewed.Menu of mandatory and voluntary pensions savings and insuranceinstruments - appropriate to its needs and enabling conditions.Elderly social assistance – can address gaps in coverage but needs to beconsidered against other needy populations.

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