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
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
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
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
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.
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.
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.
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
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.
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.