Discussion Question (250-300 words long) Describe the princip.docx
AT751 Pension
1. AT 751 Group Presentation 11/19/2014
Pension Plan
--A Comparison of China and Chile
Yifan Zhao
Lu Zhang
Yun Wan
Natalia Easton
2. AT 751 Group Presentation 11/19/2014
Types of Pension Plan
Pay-As-You-Go
Defined Contribution (DC)
Most common now in US [401(k) & 403(b)], China and Chile
Defined Benefit (DB)
Unit benefit per year of service
Less common
“Hybrid” plans
3. AT 751 Group Presentation 11/19/2014
Key Characteristics
Pay-as-you-go is highly sensible to deficits due to
demographic changes, business cycles, fiscal irresponsibility
DC does not guarantee any level of pension. If the worker does
not save enough, his pension will be low.
DC are sensible to the quality of the labor market (more labor market
restrictions make people less productive and that lower the future
pensions)
The employee bears the investment risk.
Examples: Europe, US, China and Chile fall in some place in
between these two systems.
4. AT 751 Group Presentation 11/19/2014
Key Characteristics
DB pension plan promises to pay you a certain
amount of retirement income for life.
Predetermined by a formula based on the employee's
earnings history, tenure of service and age
Examples: Some governmental and public entities
5. AT 751 Group Presentation 11/19/2014
How to evaluate?
Main Indicators
Efficiency
The replacement rate
How much is your pension compared to your average wage
(generally accepted: 70% or more )
Sustainability
will the system incur in deficit today or in the future
6. AT 751 Group Presentation 11/19/2014
Chinese Pension System Structure
7. AT 751 Group Presentation 11/19/2014
Non-Governmental
• Life Expectancy
• Retirement Age
• Hybrid System
8. AT 751 Group Presentation 11/19/2014
China’s System – Calculation of Benefit
Must contribute >=15 years
Contribution(0.6 - 3) :
Individual: 8% of salary base-> Personal Account
Company: 20% of current employee’s salary base-> Pooled
Fund
Benefit:
Personal Account + Pooled Fund
9. AT 751 Group Presentation 11/19/2014
China’s System – Calculation of Benefit
Benefit = Personal Account + Pooled Fund
Personal Account (constant):
= Amount in account when retired
Number of months to receive the pension
Pooled Fund (varying):
= (Avg Salary + Salary Base)/2 * N years contribute *1%
10. AT 751 Group Presentation 11/19/2014
Number of Months to Receive Pension
Age Months Age Months Age Months
40 233 51 190 61 132
41 230 52 185 62 125
42 226 53 180 63 117
43 223 54 175 64 109
44 220 55 170 65 101
45 216 56 164 66 93
46 212 57 158 67 84
47 208 58 152 68 75
48 204 59 145 69 65
49 199 60 139 70 56
50 195
11. AT 751 Group Presentation 11/19/2014
China’s System – Calculation of Benefit
A man joined the retirement plan at age 25 and retired at
age 60. His average salary is 8000/m. The average salary
in his province last year is 3500/m. What’s the benefit
for him per month this year (assume: i=0)?
Solution:
Personal Account = Amount in account when retired
Number of months to receive the pension
= (60 - 25)*12 * 8000 * 0.08 = 1933.81
139 months
12. AT 751 Group Presentation 11/19/2014
China’s System – Calculation of Benefit
A man joined the retirement plan at age 25 and retired at
age 60. His average salary is 8000/m. The average salary
in his province last year is 3500/m. What’s the benefit
for him per month this year (assume: i=0)?
Solution:
Pooled Fund
= (Avg Salary + Salary Base)/2 * N years contribute *1%
= (3500+8000)/2 * (60 - 25) * 0.01
= 2012.5
13. AT 751 Group Presentation 11/19/2014
China’s System – Calculation of Benefit
A man joined the retirement plan at age 25 and retired at
age 60. His average salary is 8000/m. The average salary
in his province last year is 3500/m. What’s the benefit
for him per month this year (assume: i=0)?
Solution:
Total Benefit = Personal Account + Pooled Fund
= 1933.81+ 2012.5 = 3946.31
14. AT 751 Group Presentation 11/19/2014
China’s System – Evaluation
Efficiency: Replacement Rate
Average Pension/m 1516.68
Average Salary/m 3537.67 (Yr 2011)
ILO suggests a replacement rate greater than 55%.
Government’s target replacement rate was 58.5%.
42.9% =
15. AT 751 Group Presentation 11/19/2014
China’s System – Evaluation
Sustainability: Pension Deficit?
Pension deficits would appear in 2030, and the
accumulated shortfall would amount to 90% of
China’s GDP by 2050. (CASS)
Pay-as-you-go System
Aging Population:
The proportion of population over 65 is projected to grow
to 24% by 2050. (UN Population Division)
16. AT 751 Group Presentation 11/19/2014
China’s System – Discussion
Raise Retirement Age
Many have advised raising standard retirement ages by five
years for both women and men.
MHRSS means to raise the retirement age and will definitely
introduce the plan before 2020.
Increase Return Rate of Pension Fund
Bank and government bond -> Other investment
Adjust Civil Servant’s Retirement Plan
Increase contribution or decrease benefit
17. AT 751 Group Presentation 11/19/2014
The Chilean Privatized DC System
Each worker contributes to his own pension by a
mandatory saving of 10% of his monthly wage
Survivors benefits
Tax deductible and unseizable
Voluntary contributions up to USD 75,000 (annual) free of
taxes
The contribution management and the annuities
are entirely provided by private institutions
6 AFP and annuity providers companies (Life Ins.)
Each person decides his optimal portfolio mix
AFP invests in every asset around the world (5 funds)
Source: Superintendence of Pensions, Chile; Superintendence of
Securities and Insurance, Chile; Inland Tax Service, Chile
18. AT 751 Group Presentation 11/19/2014
Chile achieves higher replacement rates than
developed countries…
Source: OECD (2012), OECD Pensions Outlook 2012, OECD
Publishing.
19. AT 751 Group Presentation 11/19/2014
… with no government contribution to its pension
system
Source: OECD (2013), Pensions at a Glance 2013: OECD and G20
Indicators, OECD Publishing.
20. AT 751 Group Presentation 11/19/2014
How the Chilean system works?
A •(100/0)
B
E •(0/100)
C
D
AFP
+10%+10%
65 / 60
PENSION
MARKET
AFP Life Ins.
Comp.
Fixed/Level
Whole Life
Annuity
-Guaranteed
period
-Deferred
period
Varying
Annuity
(PR)
- Recalculated
each year
Source: Superintendence of Pensions, Chile; Superintendence of
Securities and Insurance, Chile.
21. AT 751 Group Presentation 11/19/2014
Example: Fixed/Level Whole Life Annuity
Suppose a man going to retire now who works and
make nonstop monthly contributions from age 25 to
age 65. Suppose he has no family group and he want to
buy a whole life annuity without any guaranteed or
deferred period:
Monthly Interest Rate 0.22%
Monthly Pension (USD) 524.83
PENSION MARKET
USD 524.83 = 68.60%
USD 765.07
Replacement RateUSD
Average Monthly Wage 765.07
Monthly Contribution (10%) 76.51
Monthly Return Rate 0.34%
Acc. Value at age 65 92,767.80
Source: SCOMP
22. The Chilean Pension
System is privately run
with no government
involvement
6 AFP and insurance co.
The system achieves high
replacement rates for
those who contribute as
planned
Failing to contribute as
planned results in low
pensions
Thanks, Mr. Piñera!
José Piñera (Phd in Economics, Harvard;
BU Assistant Professor, 1974)
Summary: Chilean DC System
23. AT 751 Group Presentation 11/19/2014
Bibliography
Superintendence of Pensions, Chile
Superintendence of Securities and Insurance, Chile
Inland Tax Service, Chile
The System and Pensions Level in Chile: Proposals for their Improvements, K. Schmidt-
Hebbel
Social Security, Nolan et al.
UN Population Division
ILO (International Labor Organization)
CASS (Chinese Academy of Social Sciences)
MHRSS (Ministry of Human Resources and Social Security)
Paying for the Gray – The Economist
Why Time is Running Out on China’s Social Security System – Yueran Zhang, TeaLeafNation
http://hi.people.com.cn/n/2014/0311/c231190-20748018.htm
OECD (2012), OECD Pensions Outlook 2012, OECD Publishing.
OECD (2013), Pensions at a Glance 2013: OECD and G20 Indicators, OECD Publishing.
McGill D M, Brown K N, Haley J J, Fundamentals of private pensions(2009)
There are several types of Pension Plan:
1. Pay-As-You-Go
the current workforce contribute to the pension fund that pays for current retirees
2. Defined Contribution (DC)
--define in advance what participants and plan sponsors will contribute each year.
contributions are paid into an individual account for each member.
The participant in a defined contribution plan bears the investment risk, for better or for worse.
Most common now in US [401(k) & 403(b)], China and Chile
A 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers, cooperative hospital service organizations, and self-employed. It has tax treatment similar to a 401(k) plan
3. Defined Benefit (DB)
--use a formula to determine in advance the amount of the retirement benefit
a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns
--A common benefit is a unit benefit per year of service.
4. A hybrid plan provides benefits based on the greater of a defined benefit formula and a defined contribution formula.
Pay-as-you-go
Current politicians have incentives to benefit current retirees in detriment of future retirees.
If you are a worker, there is no certain way to know how much your pension is going to be
DC:
You know exactly how much your pension is going to be (based on mortality assumptions)
Examples: Many governmental and public entities, as well as a large number of corporations, provided defined benefit plans,
Replacement Ratio:-- is the ratio of the income you receive from your pension once retired, to the salary you were receiving just before retirement.
For example, if your pensionable salary just before you retire is 10,000 per month and your replacement ratio is 80%, you might expect to receive 8,000 per month in retirement.
It is generally accepted that replacement ratios of 70% or more should be adequate for the average person. This takes into account that your lifestyle and spending patterns change as you get older.
Rural – agricultural workers in the countryside, around 50% of the Chinese population.
Pension coverage rates:
Urban pension system:50%
Rural pension system: 9%
CASS (Chinese Academy of Social Studies) reported in 2012 that annual pension benefits for retired urban works were 20900 RMB compared with 859 RMB for retired agricultural workers. Where the official poverty threshold was 2300 RMB. A budget report submitted to China’s legislature March 2014 trumpeted a 10% rise in urban pensions to 22800 RMB annually but didn’t mention any increases for pensioner in the countryside.
Dual-Track Systems /Two Schemes
SOEs – State Owned Enterprise and state related organizations
Those who work in public sectors and other sectors financed by public expenditure are exempt from the system. Their pensions are paid for by government spending – or in other words, all taxpayers – rather than their own previous payments. Moreover, the payment standard they enjoy is much higher than that os the social pension system.
According to CASS, 92.3 percent of retirees in public sectors receive monthly payments higher than 4000 RMB while 75.4 percent of retireees covered by the social pension system receive monthly payments lower than 2000 RMB.
Life expectancy was 45 years old in 1950s but was 75 years old in 2010.
However, the retirement age is not changed. 50-55 for women and 60 for men.
The current social pension system, founded in 1997, is a hybrid of two traditional models adopted by most countries:
The pay-as-you-go system, in which the current workforce contribute to the pension fund that pays for current retirees
A fully-funded system, in which every worker saves for his or her own pension and every retiree gets paid by what he or she saved while working.
8% of income is required to be saved in the individual account and when you retire, you get back all the money and the interest it accumulated during your career.
20% of income is contributed to the social pension fund pays every retiree a “basic pension” which is weighted to average incomes in a given province. The “basic pension” is only paid to retirees who have contributed pension payments for longer than 15 years.
The total pension you receive is the sum of the accumulated individual account and the “basic pension”.
If less than 15 years, can make a supplementary lump sum contribution or just return your personal account.
The salary base cannot be less than 60% of the average salary in your province or higher than 300% of the average salary in your province.
Before 2006, 3% from company will go to personal account, but now all go to pooled fund.
It can be slightly different by province. eg. SH 22%, BJ 20%.
Retirement Age: Male: 60; Female: 50/55.
Benefit is paid by month.
Number of months is calculated by the government: retired earlier -> number larger -> less pension each month; not linear: eg. 50-195, 55-170, 60-139
Pooled Fund is varying based on the average salary in the province (last year).
The salary base of contribution, usually your original salary.
You can get 1% more if you contribute one more year.
The percentage of a worker's pre-retirement income that is paid out by a pension program upon retirement.
ILO: International Labour Organization
The largest for any category of investor ahead of mutual funds, insurance companies, currency reserves, sovereign wealth funds, hedge funds, or private equity.(Stock Market)
![AT 751 Group Presentation 11/19/2014
Types of Pension Plan
Pay-As-You-Go
Defined Contribution (DC)
Most common now in US [401(k) & 403(b)], China and Chile
Defined Benefit (DB)
Unit benefit per year of service
Less common
“Hybrid” plans](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)