2 Pension models around the world Global pensions is proud to present you a summary of various pension models around the world. The document is split into three parts:I The World Bank pension model that is a framework to discuss the different pension systems in the worldII A detailed overview of pension systems of countries that are considered to be role models across the world. These systems can provide best practices for countries that are considering reforming their pension system.III Main characteristics of pension systems in countries that reforms have been recently launched, currently under reform or where changes are expected.This overview is based on the World Bank model.We realize the study is not yet comprehensive and would appreciate any additional comments or remarks. It will be further improved, however it can be used as a working document.
3 Table of contents I II III The World Bank model Leading role pension models compared to the World Bank model:ChileUSPoland**NetherlandsUKSweden *AustraliaMain characteristics of other country’s pension systemsIICountry pension system summarySystem characteristicsInvestment guidelineRegulation and supervisionMacro economic impact *System pros and cons**IIIAsiaChinaKoreaEuropeHungaryCzech RepublicSlovak RepublicRomaniaGreeceUkraineRussiaLatin AmericaMexicoBrazilPeru* Only applicable to countries recently reformed**Only applicable to *marked countries
4 The World Bank model (classic definition) Publicly funded schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangementsIIIIIISTATEMANDATORYVOLUNTARYGovernment is responsible for adequate safety net via Pillar IPrivate sector plays key role in building Pillars II and IIIGrowth will mainly be in Pillars II and IIIPublic/private partnership is essentialWhat actions are needed?Most important are macro-economic measures such as increase in labor market participation and increase in retirement ages; would help a lot, as numerous studies show.Still, pension reforms unavoidable; allow for sustainable financing.Governments can no longer bear the burden alone.Recommended by many respected institutions (world bank, European Commission, etc) is 3-pillar system.Proper balance between basic state security (pillar I), occupational company pensions (pillar II) and individual commercial solutions (pillar III)As part of 3 pillar system, important to reduce depency on 1st pillarExtension of 2nd pillar key in creating balanced pension systemIn EU, state still dominant source of pension provision (88%)Occupational pensions still relatively new concept in EuropeNL the exception: 2nd pillar pension = 36% pension benefits (vs. 7% for rest EU) Dutch 2nd pillar fully funded.
5 Pensions as economic growth engine Advantages of multi pillar-system:Proper financing of old age provisionBoosts economic growthContributions are invested back into the economyAccelerated development of local capital marketsShared responsibility by government, employers and individualsStrongly recommendedWorld Bank / OECDEuropean Union / ILOTax supportEETIIIIIISTATEMANDATORYVOLUNTARYThe advantages of a 3 pillar system: shared responsibility.Not everything is totaly depending on the stateThe EU Commission argues :a pension system should reflect a sustainable mix of mutually supporting pension pillars based on:legislation,collective labour agreementsand private contractsin a way that the state, social partners and individuals can share the reponsibility for retirement income.The support by the state can be different for each pillarState support can depend on:economic situation (public debt)need to reform tax system or subsidiesimprove the development of cpital marketsAlso the ILO and World Bank recommend strongly to develop a three pillar system.
6 A new perspective on World Bank pension model New definition on pension model, by World Bank (according to the study in February 2005Social pension functions as basic income re-distribution, extremely important for lifetime poor individuals as well as informal sector (income is not taxed)Role of private companiesOnly active in Pillar I, II & IIIPillar I: institutional asset management (potentially)Pillar II: pension fund managementPillar III: same as pillar IIPillarsZeroIIIIIIIVSocial pensionStateOccupational or personal(Mandatory)(Voluntary)Individual, informal financial and non-financialCharacteristicsBasic social assistance, universal or means testedAlso called “demogrant”Public pension plan, defined benefit or notional defined contributionOccupational or personal pension plans (fully funded defined benefit or defined contribution)Occupational or personal pension plans (partially or fully funded defined benefit or fully funded defined contribution)Informal support (family), other formal social program (health care), other individual financial or non-financial assets (homeowner)What actions are needed?Most important are macro-economic measures such as increase in labor market participation and increase in retirement ages; would help a lot, as numerous studies show.Still, pension reforms unavoidable; allow for sustainable financing.Governments can no longer bear the burden alone.Recommended by many respected institutions (world bank, European Commission, etc) is 3-pillar system.Proper balance between basic state security (pillar I), occupational company pensions (pillar II) and individual commercial solutions (pillar III)As part of 3 pillar system, important to reduce depency on 1st pillarExtension of 2nd pillar key in creating balanced pension systemIn EU, state still dominant source of pension provision (88%)Occupational pensions still relatively new concept in EuropeNL the exception: 2nd pillar pension = 36% pension benefits (vs. 7% for rest EU) Dutch 2nd pillar fully funded.Please note this new pension model is for reference only. In the remaining of the document, only the classic 3 pillars pension model will be discussed
7 Table of contents I II III The World Bank model Leading role pension models compared to the World Bank model:ChileUSPoland**NetherlandsUKSwedenAustraliaMain characteristics of other country’s pension systemsIICountry pension system summarySystem characteristicsInvestment guidelineRegulation and supervisionMacro economic impact *System pros and cons**IIIAsiaChinaKoreaEuropeHungaryCzech RepublicSlovak RepublicRomaniaGreeceUkraineRussiaLatin AmericaMexicoBrazilPeru* Only applicable to countries recently reformed**Only applicable to *marked countries
8 I. Chile Pension System compared to World Bank (summary) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)CHILEIIIIIISTATEMANDATORYVOLUNTARYPensionSystemOld State System (PAYG)Compulsory for the Armed Forces and old labor force without Past Service Bonus.Contribution levels higher than new private systemPrivate Pension System (AFPs)Compulsory for new labor force (since ): DC plan, employee’s contribute 10%, Past Service Bonus paid by the government at retirement age (if applicable since PSB being phased out)Optional for self-employed and old labor force: Past Service Bonus is still paid to the old labor force at retirement ageSelf employed and other groupsVoluntary retirement savings plans/products (APVs)Government subsidizes through tax reductionMajorIssuesNot applicable, pillar phasing outAlthough fully funded, not sufficient mandatory coverage‘Unnatural fit”: private companies with profit incentive managing system that is mandatory by gov’t (public interest)Mandatory disability coverage burdens AFP profitabilityLack of savings culture / high cash cultureLack of tax incentivesRecommenda tionsNot applicable, pillar phasing outIncrease the coverage and the investment range abroadMandatory contributions for self-employedSeparate disability and pensions coverageIntroduce savings alternatives (401Ks, APVs)Increase awareness and information available regarding the private system
9 II. System characteristics: reform in Chile On November 13th, 1980 the New Pension System was established by law.The New Pension System was launched in May 1981, replacing the old one (PAYG).Main features of the new system:Compulsory for the new labor force and optional change for the old labor force.The government assumes capitalization of contributions made in the old system through the issuance of “Recognition Bonds”.Many institutions, all private, manage pension funds, and compete on price, service levels and investment performance.Contribution-based funding of pensions, but complemented by a pay-as-you-go funding for disability and survival pensions.Freedom of choice. Freedom to change institutions.Same requirements for everyone. Benefits according to contributions paid and fund yield.Government sets rules, enforces, guarantees minimum pension and return on funds.During the first month, 11 competitors joined the industryAt the end of 1981, there were 12 competitorsThere are 3 types of competitors:National equityNational - Foreign equityTrade union equity
10 II. System characteristics: reform in Chile Simultaneously, other legal reforms were required for the success of the pension system reform:1. Capital Market - new legal framework for:Securities and financial marketStock companiesSuperintendence of Securities and InsuranceCustody of titles and securitiesIntroduction of fixed income securities able to compensate for inflation2. Investment Alternatives:State-issued securities for pension funds & insurance companiesPension funds were entitled to purchase fixed income instruments issued by banks and financial institutions and other private issuersPension funds were authorized to invest in stocks (1986)Pension funds were authorized to invest abroad (1994)3. Level of risk - prohibit investment in certain stocks and enforce diversification:IssuerTypes of instrumentsTermsRisk level and categoriesA Risk Assessment Commission was established
11 II. System characteristics CHILEPillar IOld State System (PAYG)Compulsory for the Armed Forces and old labor force without Past Service Bonus.Contribution levels higher than new private systemKey issuesNot applicable, pillar phasing out
12 II. System characteristics CHILEPillar IIMandatory pension funds (substituting Pillar I), which are privately managed and invested. AFPs in charge of underwriting and investing.Compulsory for new labor force (from ): DC plan, employee’s contribute 10%, Past Service Bonus paid by the government at retirement age (if applicable since PSB being phased out)Optional for self-employed and old labor force: Past Service Bonus is still paid to old labor force at retirement ageAlso coverage for Disability and Survivors PensionsLEGAL RETIREMENT:65 years for men and 60 years for womenThe pension amount is calculated based on:Accumulated Savings: Pension Fund + Past Service Bonus + Voluntary Savings Acc’tLife expectancy of the worker and of his family groupEARLY RETIREMENT:110% Legal Minimum Pension50% Inflation-adjusted income of last 10 years (August 2004, > 70%)Key issuesAlthough fully funded, not sufficient mandatory coverage‘Unnatural fit”: private companies with profit incentive managing system that is mandatory by government (public interest)Mandatory disability coverage burdens AFP profitability
13 II. System characteristics CHILEPillar IIISelf employed and other groupsVoluntary retirement savings plans/products (APVs). Government subsidizes through tax reductionKey issuesLack of savings culture / high cash cultureLack of tax incentives
14 III. Investment guidelines for the Pension Funds (AFPs) CHILEIII. Investment guidelines for the Pension Funds (AFPs)The AFPs must invest the pension funds’ resources as established by law (type of instruments and investment margins are regulated), and guarantee a minimum profitability and security for the participantsAFPs are stock companies with a target to manage 5 pension funds with different risk-return combinations (table 1)In order to invest their obligatory savings, affiliates can freely choose among the different five funds, except: (table 2)Participants with less than 10 years until retirement (at legal age) can not invest in Fund APensioners can not choose Funds A and BDefault allocation (when no choice made by the participant) will be as in table 3table 1Men: till 35 Women: till 35Men: Women: 36-50Men: from 56 Women:from 51PensionersABCDEAFP’s can not:Buy low liquidity assetsManage other portfoliosAct or fail to act in a manner required by lawIn general they cannot use, for themselves or on a third party’s behalf, information about investments of the pension funds managed by them, nor can they provide such information to people other than those who participate in the investment decision-making processtable 2Men: till 35 Women: till 35Men: Women: 36-50Men: from 56 Women:from 51PensionersABCDEtable 3
15 IV. Regulation and Supervision (1/2) CHILEREGULATION:Requirements of the pension funds:Minimum capital amounting to US $123,200 must be funded, subscribed and paid at the moment pension fund is granted a public deed of company formationShareholders’ equity must match some minimum capital requirement. This requirement depends on the number of members and ranges between US $123,200 to US $492,800. In practice, the capital and shareholders’ equity are much higher than the minimum amounts required.Governmental authority to operate, which is granted by the AFP Superintendence (Supervisory body)ResponsibilitiesEnroll new workers and accept members transferred from other AFP’sCollect monthly contributions from employersLegally enforce payment of unpaid contributionsIdentify/keep record of contributions of each memberCredit contributions to each member’s individual investment-based accountInvest pension fund assetsInform members every four months - and upon request- about their individual account status and about commissions charged
16 IV. Regulation and Supervision (2/2) CHILESUPERVISION:The AFP Superintendence supervises and controls the Fund Administration Companies (AFPs) as established by lawFunctions:Authorize AFP formation and keep record of themOversee AFP’s operations and the granting of benefits and services given to its membersOversee pension funds’ investment of assetsSet and provide interpretation of rules and regulations for the pension systemAdvise the executive power (via the Labor and Social Security Ministry) on pension-related issues and propose legal reforms leading to system enhancementApply sanctions upon AFP’s which may range from:Censure (reprimand)Fines amounting up to UF 15,000 (US $ 370,000)Repeal of the AFP’s authorization to existSettlement of the AFP and its funds, when applicable
17 V. Macro-economic impact CHILEV. Macro-economic impactImpact on the economy:Impact on the capital market:Initial estimates from industry said that in the mid-term, approx. US $3.5 billion would be transferred from fixed income to equity. (As of December 2003, the real increase in equity was US $11.8 billion )Higher amount invested in equity abroad.Local market receives investments depending on market conditions, liquidity and stock exchange performance. (ACD)Decrease in time deposit position (today 15% from pension funds)THE TOTAL ASSETS MANAGED BY PENSION FUNDS EQUALS:52% OF GDP100% OF TOTAL EXTERNAL DEBT2 TIMES TOTAL ANNUAL EXPORTS
18 I. US Pension System compared to World Bank (summary) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)USISTATEIIMANDATORYIIIVOLUNTARYPensionSystemState System (PAYG)First and current law: 1935 (with numerous amendments).Type of program: Social insurance systemNo mandatory systemEmployer related:DB and hybrid plansDC: 401K, 403B,457, SEP, Simple, SarsepPersonal savings:IRA – traditional, rothAnnutiesMutual FundsBrokerageMajorIssuesFunding issues under debate. New proposal under Bush reform looking at Individual Pension Accounts (similar to Chile/Lat Am)n/aDB: Declining due to move to individual funding, regulatory complexity and costDC: Continued expansion in competitive environment, with strong “takeover” elementExploding IRA marketImproving tax incentives for long term savings and investments
19 System characteristics: Pillar I USSystem characteristics: Pillar ICoverageGainfully occupied persons, including self-employed persons. Exclusions: Casual agricultural and domestic employment, and limited self-employment (when annual net income below $400), and some Federal employees hired before Voluntary coverage for employees of State and local governments, and clergy (mandatory coverage for employees of State and local governments not covered under a retirement system, effective July 1, 1991). Applies in U.S., Puerto Rico, Northern Mariana Islands, Virgin Islands, Guam, and American Samoa, and to citizens and residents employed abroad by U.S. employers. Special systems for railroad employees, Federal employees, and many employees of State and local governments.Source of FundsInsured person: 6.2% of earnings. Self-employed, 12.4%. Employer: 6.2% of payroll. Government: Cost of special monthly old-age benefit for persons aged 72 before 1968; whole cost of means-tested allowance. Maximum earnings for contribution and benefit purposes: $72,600 a year, automatically adjusted to wage levels.Qualifying ConditionsAge 65 (62-64 with reduction); gradually increasing to 67 over periodOld-Age BenefitsBased on covered earnings averaged over period after 1950 (or age 21, if later), and indexed for past wage inflation, up to age 62 (or death, if earlier) excluding 5 years with the lowest earnings. (Earnings in years outside this period may be substituted, if higher.) Available at age 62, but reduced for each month of receipt prior to age 65. No minimum benefit for workers reaching age 62 after Maximum $1,373 a month for workers retiring at age 65 in Increment for each month worker delays retirement at ages Increment amount depends on the year the worker reached age 62, and is 5.5% per year for those age 62 in Adjustment: Automatic cost-of-living adjustment.
20 System characteristics: Pillar I – Reform proposal USSystem characteristics: Pillar I – Reform proposalCurrent US system is not sustainable, i.e. the guarantee fund (PBGC) going into a deficit (September 30, 2004 growing from $11,2 bio to 23,3 bio). As of 2004 the cost of doing nothing to fix the US Social Security system had hit an estimated $10,4 trillion, according to the Social Security Trustees.The proposal of President Bush to reform pension focuses on 2 main areas:Individual investment accounts:Participation: benefits of anyone age 55 and older will not be changed. The accounts are voluntary. But participation would be phased in over three years according to age: the first year workers born from 1950 to 1965; the second year, workers born from 1950 to 1978; the third year, anyone born after 1950 could opt for an account.Contribution: workers would be permitted to invest up to 1/3 of the 12.4 percent payroll tax that they and their employers pay on their wages, into the individual investment accounts (Workers pay 6.2 percent and employers the other 6.2 percent.)Annual contributions would be capped at $1,000 in 2009 and thereafter rise slightly more than $100 per year.Investments: Workers would have a choice of five broadly diversified index funds and a lifecycle fund, in which the portfolio grows more conservative as the investor nears retirement. (i.e. when a worker turns 47 the account will automatically be invested in the lifecycle fund unless the worker and his or her spouse sign a waiver opting out)Pay out: Money in the accounts could not be taken out before retirement. At retirement, it's likely workers would have to annuitize a portion and only take out a lump sum if doing so would not result in the worker moving below the poverty line. Any unused portion of the account could be left to heirs.Administration: The accounts would be modelled on the Thrift Savings Plan - a 401-k type program already available to government employees - and centrally administered by the government. The accounts should not be eaten by Wall Street fees; low costs. It is estimated that the administrative cost per account will be 0.3 percentage points.Funding rules for defined pension plans will be strengthened.Funding targets will be based on meaningful measures of liabilitiesMarket values will be used for assets7 year amortization period for funding shortfallsEmployer can make additional deductible contributions in good yearsDisclosure to participants will be improvedPremiums will better reflect plans risks and restore the health of PBGCMain concerns:Transitional Cost: Payroll taxes are used to pay current retirees, so diverting a portion of them creates a shortfall in the ability to pay full benefits. The transition costs of diverting a third of payroll taxes to individual investment accounts have been estimated at around $2 trillion over the next 10 years. That assumes, though, that a third of payroll tax is diverted for each of the 10 years.
21 System characteristics: Pillar II USSystem characteristics: Pillar IICurrently no mandatory system in place
22 System characteristics: Pillar III USSystem characteristics: Pillar III14% Annuity7% Contributory IRA16% Defined Benefit20% Defined Contribution18% Rollover IRA17% State/Local Govt8% Federal Government1Estimates from Flow of Funds Accounts of the USDistribution of Retirement-Oriented Assets¹Employment Based:DBDC:401 (k)403 (b)457Non Employment based:IRA
23 System characteristics: Pillar III - DC USSystem characteristics: Pillar III - DC401(k) plan (as 403(b) and 457) allows employees to save for their own retirement. This type of plan was named for that section of the Internal Revenue Code, which permits employees of qualifying companies to set aside tax-deferred vehicle that offers a variety of investment options.$$$Pillar III - DCFixed Investments, Mutual Funds, Employer Stock, Stocks/Bonds, CashSponsorsDeductibility of contributions as an expenseCompetitive advantageAttracts quality employeesCost savings - retention tool (vesting schedules)Stimulate economic growth - promotes long term savingsSocially responsible to encourage retirement savingShifts responsibility for retirement to the employeeParticipantsPre-tax contributions - lowers current taxable loadTax deferred earningsDiversification of assetsEase investing and long-term savingsPotential matching employer contributionsNot taxable until distributed (normally at retirement when at a lower tax bracket)PortabilityOwnership of their retirement savingsCatch up contributions
24 System characteristics: Pillar III - IRA USSystem characteristics: Pillar III - IRAIRAs are tax-favoured retirement vehicles that individuals or workers can establish themselves. Unlike DC or DB, which can only be sponsored by er’s, IRAs provide tax –advantaged retirement savings plans for many ordinary wage earners without an employment-based retirement plan; self-employed, part-time workers; or even some individuals who are not in the labour force (such as nonworking spouses).The growth of IRAs in recent years has not been drive by regular annual contributions by IRA owners; rather, stock market gains and rollovers from other plans have accounted for the lion’s share of IRA growth. The experience so far shows that stock market gins/losses have a larger impact on total IRA assets than rollovers. Today, IRAs are used primarily as a vehicle to store retirement wealth that has been accumulated elsewhere in the retirement system, and not as a vehicle through which current retirement saving occurs.
25 III. Investment guidelines USIII. Investment guidelinesUS Regulation of pension fund assetsMinimun diversification requirementsSelf-investment/ conflict of interestOther quantitative rulesOwnwership concentration limitsCurrency matchingDirect limits on foreign investmentsGeneral requirements for diversificationLimited to 10% for DB plansNoneNo info availableNo explicit rule
26 IV. Regulation and Supervision USThe United States has several agencies in charge of the supervision of private pension occupational schemes:The US Department of Labor, Pension and Welfare Benefits Administration (PWBA) primarily supervises the protection of employee benefit rights and fiduciary obligations for corporate and multi-employer voluntary pension plans.The Pension Benefit Guaranty Corporation (PBGC) provides protection for the termination of defined benefit schemes.The Internal Revenue Service (IRS), overseen by the United States Department of Treasury, operates and supervises the tax treatment related to pensions and, in that role, is responsible for the registration (tax qualification) of pension plans.NASDSECState Insurance DepartmentState Attornies GeneralDue to the large number of pension plans in the US, the voluntary nature of the pension plan system, the great variety of plans, and the limited amount of resources allocated to the governmental agencies charged with supervising pension plans, a significant emphasis on the part of government has been on voluntary compliance, through educational outreach programs and voluntary compliance programs for plan sponsors and plan fiduciaries who have discovered violations and want to correct them. Both the Department of Labor and the IRS have sophisticated programs for identifying likely areas of non-compliance with the law and targeting examinations at those areas. Through these programs, the agencies have made significant recoveries of money for plans and have imposed plans to correct deficiencies in their operations.
27 I. Poland Pension System compared to World Bank (summary) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)POLANDIIIIIISTATEMANDATORYVOLUNTARYPensionSystemPAYG schemeHowever, benefit consists of 2 components:a. Notional accumulation of contributions in individual accountsb. The accrued DB pension right (at the time of reform) is converted into a notional lump sum value and “credited” to the individualContribution is 19.52%, equally split by employers and employeesOnly 12.22% is contributed to Pillar I, if individual is eligible and elects to join a pillar II fundRemaining 7.3% is contributed to pillar IIMandatory, open end pension fundsManaged by private pension fund companiesAt retirement, accumulated benefit will be transferred to annuityFirst benefit payout is expected to be in 2009Members have free choice of pension fund providerTransfer between funds are permitted, but only one pension fund at a timeA custodian bank has to be used, for which 10 – 12 bps is paidFor self employed, a minimum contribution required and can be split between pillar I and IIVoluntary, additional employer contribution to corporate pension fundLimited take up rate as employers view this is an extra labour cost7% payroll tax deductionMarket perception that tax incentive too lowIndividual retirement account (IKE)Tax qualified long term savings productsEarly withdraw tax penalty appliedLife insurers, mutual fund managers, banks and brokerage firmsMajorIssuesZUS, an effective, centralised administration system, however, room for improvementDelayed customer data retrieval as a result of slow and unorganised system (member data delay up to 2 months)System introduced in 2004 and initial sign up for IKE successful, but long term success still remains to be seen
28 II. System characteristics: from mono to multi pillar systems in 1999 POLANDII. System characteristics: from mono to multi pillar systems in 1999Mandatory, reformed PAYG, DC systemPAYG: current pensions are financed by current contributions paid by employees and employersIndividual account, DC system: previously accrued defined benefit pension rights “credited” to a notional individual defined contribution accountContribution is paid by employeeOld age pension contribution is part of the social security contribution, of which19.52% of earnings paid to old age pensions – equal contribution from employer and employees13% for disability – equal contribution from employer and employees1.93% work injury, 100% paid by employer2.45% sickness, 100% paid by employeeOld age pension contribution is split into 2 parts12.22% is paid to finance the current retirees7.3% is for individual account (II Pillar)Benefit 2 componentsPillar I: accrued DB benefits before reform + accrued DC benefits on 12.22% contribution, both are notionalPillar II: accrued assets from individual account, DCPension reform bill passed by parliament in 1998, scheduled for implementation in January 1999Actual implementation started 1 March 1999Before pension reform, state pension liability is 462% of GDP2004, pension liability is 194% of GDP2010, system is projected to be in surplusPension reform does not bring additional cost to employers nor to employees (Government made the social security system transparent)Employers aggregated contribution was reduced and employees, in the mean time, receive additional salary that equals the employer contribution reduction
29 II. System characteristics - general POLANDII. System characteristics - generalMandatory, funded systemEligibility:Compulsory to all employees born after 1969Born before 1949 had to remain in the old systemBorn between 1949 – 1969, have a choice of joining pillar I or IIFree member choice of fundEmployers were not allowed to influence the choice of fund (Partially the reason Tied Agents were a successful distribution model)Fund managers and agents are not allowed to offer inducement to customers to join a fundEffectively only 7.3% is contributed to the individual accountOpen-ended pension funds, managed by private pension fund managers16 private pension funds, top 3 has over 65% market share (PZU, ING, Commercial Unions)11.7 million members, however, approximately 2 million members are effectively non-contributory accountsTotal assets: +€ 11 billion, end June 2004Insurance companies, banks, security / brokerage firms can apply licence to set up pension fund entityPension fund manages the assets, but needs a custodian bank to handle the asset administration (10 – 15bps commission fee)Insurance companies hold 88% of total assets (too concentrated)
30 II. System characteristics - Administration POLANDII. System characteristics - AdministrationOne centralised administration body – ZUSEmployer pays both employee and employers contribution to ZUSIndividual account:ZUS allocates employee(er) contributions to Pillar I,Pillar II, it matches contributions with employee fund choices and distributes the money to the funds’ custodians and advises the fundsCollect information / money reconciliations a. pass money to custodians; b. information to fund managersKey issuesToo short preparation time: legislation passed in 1998, actual implementation 1 March 1999Inaccurate form completion by employers resulted in unmatched contributionsEducation for employers took over a year
31 III. Investment guidelines (1/2) POLANDIII. Investment guidelines (1/2)Majority of investments to domestic capital marketRegulation sets maximum 5% limit on off shore investmentIn practice, only 1% assets invested off shore, due to many hidden “obstacles”, ie., waiver on custodian service fee, stamp duties etc.Maximum asset management fees: < 0.6%Market players set the fee (ING, being 1 of top 3 players with approx. 20% market share, has strong influence in fees)Asset management fees: upfront fees + management feesUpfront fee – maximum for contribution based fees is 5.8% of annual contribution, includes administration fees (0.8% to ZUS), supervision, custodian etc.Average 50 bps per annum, if assets above Zloty 8 bln, management fees will be reduced (sliding scale)An open pension fund can only offer one fundFor customer & agent, restriction simplified the choice and education processHowever, from fund managers’ point of view, this restriction limits the investment returnFund managers keep record of accounts for each member, member information access through:Internet, call center, ATM or SMS
32 III. Investment guidelines (2/2) POLANDIII. Investment guidelines (2/2)Investment restrictions (to protect the members’ rights):Up to 95% of assets in bonds or shares on domestic capital markets< =5% off shore investment (limited to OECD countries)Restriction applies to open end pension fund40% in quoted stocks10% in secondary stock10% in treasury bills10% in NIFs15% in municipality bonds10% in close ended investment funds15% in open ended investment funds20% in banks and bank groupsAn industry guaranteed fund to recover losses from fund managers, in the event of bankruptcyEffectively, the fund managers are paying for the industry lossesNo investment in real estateNumerous diversification requirements, ie.,no more than 10% of assets to be invested in a single kind of securitiesInvestment in bonds, or stocks should be <=5% of assets in one issuerAsset allocation (June 31, 2004)Bonds: 60%Equity: 31%Treasury bills: 4%Bank, securities and deposits: 3%Others: < 1%Key issues:Pension funds hold about 25% domestic capital marketIncreasing demand for IPO to increase the size of the market
33 IV. Regulation and supervision POLANDIV. Regulation and supervisionInsurance and Pension Funds Supervisory Commission supervise:Open pension fundsEmployee pension fund (non-profit)The commission consists of 5 members:Chairman of the commission appointed by Prime MinisterDeputy Chairman appointed by Ministry of Finance and Ministry of LabourMember of the commission: chairman of the security and exchange commission or his deputyMember of the commission: chairman of the competition office or his deputyGovernment intended to amend the law in following aspects:Cost of system development (remove limitation)Competition (intensify)Investment (increase effectiveness)Finance burdens of funds and of members (liquidation)(Reduce) power of big 3 pension fundsNew draft law yet to be sent to parliament
34 IV. Regulation and supervision POLANDClear division of rulesCustodian, administration and pension fund managersMember information clear and easy accessible published regularly in the newspapers as net of feesPension fund manager is regulated to protect members:If market average return is 8%, underperforming fund managers have to make up the difference in order to equal half of the average (i.e. at least provide 4%)Effectively, it resulted in fund managers all investing in a similar way
35 V. Macro economic impact POLANDV. Macro economic impactReduced pension liabilitiesUntil 2005: before reform, 462% of GDP vs. after reform, 150% of GDP2050, pension expenditure will drop from one of the highest in Europe to one of the lowestTransfer of a portion of contributions to funded pension scheme is not a costIt reveals a portion of the implicit debtIt reduces future public finance obligationsIncreased funding requirements can be offset by higher debt, purchased by pension fundsPension funds assets invested into equities stimulate investment and economic growthIt is better to turn a portion of pension liabilities into savings now than to have much greater problems with redeeming such obligations in the futureExpenditure and revenue of the pension system2049, pension system surplusDependency ratio(d)GDPR/GDPPrimary surplus needed to keep pension debt at 2000 level20002050changeFrance27.250.823.622.214.171.124.9Germany26.653.211.8126.96.36.199Spain27.165.738.69.417.48.04.8Sweden29.446.3188.8.131.52.61.0Poland20.4184.108.40.206-2.5-1.0
36 VI. Polish pension reform pro’s and con’s POLANDVI. Polish pension reform pro’s and con’sPro’sCon’sMandatory, big bang pension reformSimple & transparent:Individual account makes it easier to understand– amount an retiree receives equals to accumulated contribution value, enhances personal interest and accountabilitySeparate old age pension from other social security contribution – transparent and easy to understand for individualDefined contribution system makes it easier for people to understand increase the confidence levelOne investment fund per pension fund makes it easier to understandFew, but smart regulations to protect member rightsMaximum asset based fees, no contribution feeIndustry average investment return as a benchmark, low performer has to pay penaltyDis-encouraged to take high risk investmentOne centralised administration system allows efficient collection and administration, also saves costMedia attention and support helped people to understandLack of investment options to sustain a long term high rate of returnLimited solutions to channel pension fund assets into long term investmentPension fund investment over reliance on domestic capital marketLimited investment option when the capital market is small (limited supply of financial instruments and resources) and illiquidOver complicated regulations and international charges limited pension fund overseas investment
37 I. Dutch Pension System compared to World Bank (summary 1/2) NetherlandsI. Dutch Pension System compared to World Bank (summary 1/2)WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)HollandIIIIIISTATEMANDATORYVOLUNTARYPensionSystemBasic old age pension (AOW)PAYGUniversal: system applicable to all residents and flat rate benefitMinimum guarantee to prevent poverty (70% of minimum wage)Build up phase: 15 – 65 yearsIn case of a person who resides outside Netherlands during the accumulation phase and the total retirement income is less than 70& of minimum wage, this person is entitled to receive social assistanceEmployer sponsor, occupational pension schemes, voluntaryHowever, +90% employed participated in an occupational pension schemeIncluding AOW benefit, the total replacement ratio is aimed at 70% of individual final, or average salary)Pension payoutEarly retirement is possible4 types of pension fundsIndustry-wideCompanyInsurance contractPension funds for self employed professionalsDB (88%) and DC plansMajorIssuesAgeing population created future pension deficit in Pillar IAn AOW savings fund created to finance part of the (AOW) expenditure in futureGovernment deposits tax revenue to the fund on annual basisOver funding requirements (strict solvency) by regulatory commission puts pressure on industry playersCurrent solvency margin still healthy (at 110%), however, is historically low compared to before crisis (at 150%)RecommendationsAllow pension funds time for recovery – short term underfunding, long term financial sustainability
38 I. Dutch Pension System compared to World Bank (summary 2/2) NetherlandsI. Dutch Pension System compared to World Bank (summary 2/2)WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)HollandISTATEIIIIIMANDATORYVOLUNTARYPensionSystemBasic old age pension (AOW)PAYGUniversal: system applicable to all residents and flat rate benefitMinimum guarantee to prevent poverty (70% of minimum wage)Build up phase: 15 – 65 yearsIn case of a person who resides outside Netherlands during the accumulation phase and the total retirement income is less than 70& of minimum wage, this person is entitled to receive social assistanceIndividual pension arrangementAnnuity and endowment insurancePremium contribution tax deductibleAnnuity benefit tax incentive is caped at 70% of a person’s final pay (incl. benefits from AOW and Pillar II occupational scheme); contribution deduct from taxable income (€ 1,036 per annum)Endowment with 15+ years policy duration: interest tax free, principal tax free up to a ceilingMajorIssuesAgeing population created future pension deficit in Pillar IAn AOW savings fund created to finance part of the (AOW) expenditure in futureGovernment deposits tax revenue to the fund on annual basisTax legislation is very influentialBoth Pillar II & III applies EETRecommendations
39 II. System characteristics NetherlandsHollandII. System characteristicsSource: OECD,Please note: OECD definition is used in this table: 2 pillar reflects employer sponsored pension schemes
40 II. System characteristics: Pillar I old age pension (AOW) NetherlandsHollandII. System characteristics: Pillar I old age pension (AOW)Funding:Statutory pension contribution is set at 18.25%, in 2003, however, is set at 17.9% or up to €28,850 per annumContribution are collected through tax bureau for which the tax bureau will automatically transfer the money to SVBIn case of funding deficits, government will grant tax revenue (to which pensioners contribute as well)An AOW savings fund established. Funding source is government tax money. Expected to reach €135 billion in 2020 & share 12% AOW expenditure in 2030Administration: Social Verzekerings Bank (SVB)An central administrative body set by the governmentNon-profit organisationDay-to-day operation independent from the governmentBoard of Directors manages SVB, in consultation with board of advisorsSVB responsibility: collect premiums and distribute to individual (amongst others, old age pension benefits)Supervisory body and processMinistry of Social Affairs and Employment (SZW) appoints members of SVB Board of Directors & Board of AdvisorsSZW supervises SVB through regular inspectionsInvestment:Currently, minimum capital surplus, hence NO investment managementHowever, AOW savings fund is managed by Ministry of Finance
41 II. System characteristics: Pillar III Occupational pension scheme NetherlandsHollandII. System characteristics: Pillar III Occupational pension schemeAt this moment pension funds in the Netherlands are managing close to five million employees, the immense amount of around 390 billion euros. This means 120% of the yearly Dutch GNP. In 2040 the pension fund assets will be risen to 195% of GNP.3 types of pension schemes:Branch pension funds (Industry wide)81 out of 103 funds are made mandatory14% of all the branch funds are fully re-insuredUsually insurance companies or large specific sector based pension funds provide administrationSector based pension funds refer to, for instance, civil servants pension funds (ABP) or health sector (PGGM)Company pension fundsLarger enterprises usually administer own company pension fundThe company pension fund is not allowed to invest more than 5% of the assets in the employer’s companyPresently, 44% of these funds are fully reinsuredInsurance companies (direct insurance)Through group or individual contractAdministered by life insurance companiesThe Dutch pension marketNumber of funds/schemesNumber of active participantsTotal assents(billions of euro’sBranch pension funds103300Company funds87680.00090Directly insured schemes+/30
42 NetherlandsHollandIII. InvestmentFollow prudent man rule – pension fund investment has to according to prudent pension principalPension regulator (PVK) judges each pension individually on its investment policyIn case reserve shortage, PVK sets the rule to repair the shortage, See regulation slide for further explanationNo quantitative regulations on investmentWorries that it will penalise the providers’ profitHowever, Financial Testing Framework applied to each pension fund to achieve required security both affordably and efficientlyEach fund being judged on individual basisFree to invest in any asset classFree to invest off shoreTraditionally very strict solvency rule (150%)However, due to recent stock market developments, the solvency ratio has been reduced to 119%
43 NetherlandsHollandIV. Regulation and supervision: applicable laws & main issues addressed by law (1/2)Regulation and supervision framework:Ensure all employees have access to a supplementary pension scheme+91% of all employees are coveredGovernment safeguards accrual of supplementary pension entitlements and offer tax relief in both Pillar II and Pillar III pension schemesRegulatory frameworkPension and Savings Fund Act (PSW)Act on Mandatory Participation in a branch pension fund 2000 (Act Bpf 2000)PSW:Pension contributions must be placed outside the employer’s company by either joining a branch pension fund, or establishing a company pension fund, or concluding an agreement with an insurance companyLaid down institutional framework for pension schemesAct Bpf 2000A branch pension fund may request the government to impose an obligation to its employers and employees to participate in the branch fundA branch pension fund is set up through employers’ organisations and trade unions
44 IV. Regulation and supervision (2/2) NetherlandsHollandIV. Regulation and supervision (2/2)One super-regulatory powerRecently merged supervision activities of banking, insurance and pension fundFormer Pensions & Insurance Supervisory Board (PVK), currently a division under super-regulator, supervises / regulates pension funds and direct insuranceRegulatory principalPension reserve adequacy level (Solvency) to ensure long term financial sustainabilityMinimum reserve required by law: 100% assets divided by value of pension commitments discounted by a factor of 4%However, regulatory requirement and industry standards: 119%Stock market shock wave 2001 – promoted new regulation:Minimum level of guarantee for equity - at 40% below the highest point in the last 48 monthsMinimum level of guarantee for bond - at 10% below the lowest in the last 10 monthsShould a pension fund capital reserve is below the benchmark, the pension fund has 2 – 8 years to recover
45 I. UK Pension System compared to World Bank (summary 1/2) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)UKISTATEIIIIIMANDATORYVOLUNTARYPensionSystem3 components: basic state pension, State Second Pension (S2P)* & pension CreditEmployees (not self-employed) may chose “contracted-out” SSP into private occupational pension scheme, or “opt out” into Approved Personal PensionsMinimum income guarantee, gross replacement only 37% of average earningsPension age man: 65, woman 60. Equalise at 65 from 2010Employer sponsored pension planOccupational pension schemes, non mandatory for both employer and employee.However, it is very common, especially so in the larger companiesMajorissue44 years in workforce needed for full basic pensionProvide least income to prevent poverty at age of retirementGross replacement rate very low: 37% at average earning in UK (same as the US), NL: 70%, Sweden: 76%, France: 71%In a shift towards international accounting standard, more pension plans move from DB to DC, likely result in a reduced level of premium contributionEarning related pension on top of being 20% of revaluated average earningsContracted out because of occupational pensions* S2P previously is called State Earnings Related pension Scheme (SERPS)
46 I. UK Pension System compared to World Bank (summary 1/2) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)UKIIIISTATEIIMANDATORYVOLUNTARYPensionSystemIndividual pension plansTraditional personal pensions, defined contribution schemes25% can be taken as a lump sum on retirement, rest as an annuityMaximum contribution is € 5,450 a yearVoluntary contributions to private pensions based on occupational schemes (stakeholder pensions scheme)Huge tax relief on voluntary pensionsVery large privately funded pension sector is available so difference between different income groups is very big. Mostly DBMajorissue* S2P previously is called State Earnings Related pension Scheme (SERPS)
47 II. System characteristics: general UKII. System characteristics: generalFour tiers pension systems:State social security benefits for pensioners, which consist of a basic flat rate state retirement pension and a state earnings related pension scheme (SERPS)Occupational pension schemes, offered by employersThird pillar pension schemes established by private insurance companiesUnderpinning all the above, a state minimum guarantee, which any pensioner will be topped up to by the state if his or her pension income falls below the minimum.Challenge:Growth in income inequality among pensioners, due toToo many people have difficulty adding on to their flat rate basic state old age pensionSERPS does not fundamentally solve the problems that low wage earners ending up with small pensionsOccupational and private pensions have tended to benefit the better off mostGovernment solution:To making savings during the career more desirable and possible, and to protect those who cannot save because of low earnings or other circumstances with a "State Second Pension" (S2P)The S2P will provide more generous additional pensions for low and moderate earners, certain careers and people with a long-term illness or disability.2003 the existing Minimum Income Guarantee (MIG) for pensioners, available to those whose total income falls below a level set each year by Parliament, will be replaced by the "pension credit" which should provide extra help to the poorest pensioners and reward those with low or modest incomes (for example from occupational pension schemes).The cost associated with the new measures will have minimum increase on pension spendingsTaxation of pensioners:A progressive income tax structure applies to all pensioners.A single person under 65 has an income tax allowance of GBP 4,615 per year in 2002 – 03Age 65 – 74 years old, GBP 6,100 income tax allowance per yearAge 75 plus, GBP 6,370 income tax allowance per yearIf total income exceeds GBP 17,900, additional allowances are withdrawn at 50% of the expenses
48 II. System characteristics – pillar I, state pension UKII. System characteristics – pillar I, state pension3 components:Basic State Pension:Flat rate paymentFull benefits only applicable for 44 years contributionBasic pension for a single person is GBP79.60 per week in The amount is set annually and consumer price indexed.State Second Pension (S2P):Introduced in 2002, to replace the old state earnings related pension schemeAim is to provide a more generous scheme for low and moderate income groupS2P is for employee only, a quasi-occupational systemAbility to contract out87% scheme were contract outIf opt for contract out, employee national insurance contribution drop by 1.6%, for employer the rate drop by 3.5%Lower contribution to the national insurance means lower PAYG paymentPension credit:Means tested benefit for pensioners , only meant for pensioners without other adequate sources of income or assets. Guaranteed minimum level is GBP per week for a single personKey issue:State pension become less generous:1998 / 1999, replacement ratio for man is 34% for a full social security contributions and 37% for wormanIt declined to 25 – 28% in 2030“Savings gap” is rising
49 UKII. System characteristics: pillar III – occupational private sector pension (1/4)Four type of schemesOccupational salary related (employer sponsored DB scheme)Occupational money purchase (employer sponsored DC scheme)Group personal pensionIndividual personal pensionLow participation11.3 million employees out of 25.6 million population in work did not contribute to any private pension scheme (See following slide for reference)Shift from DB to DCActive membership of DB scheme has fallen by 60% since 1995In addition, a small but increasing % of scheme are now closed to benefit accruals for existing members (DB)Average level of pension provision on a continuous declineContribution level at DB: 16 – 20% vs DC: 7 – 11%Pension protection fund established to provide guarantees retirement payment in an event of bankruptcyLegal contract is in between individual and insurance pension providers
50 UKII. System characteristics: pillar III – occupational private sector pension (2/4)Characteristics of occupational pension schemesNon-mandatory contributionHowever, most large companies have pension schemesMembership in mid-2000 is: 10.1 million,5.7 million in private sector4.5 million in public sectorThe fall in private sector has been significant due to number of employees working in the private sector has been increasing, but the membership has been declined from 6.2 million in 1995 to 5.7 million in 2002Since 2001, mandatory for employers with 5 or more employees to offer stakeholder pension schemeEmployer contribution is not requiredTake-up has been slow till nowTraditional schemes have been DB, guaranteed level related to final pensionable salary90%, or 4.6 million out of 5.7 million members are in DB scheme in 2000However, a strong tendency shifting from DB to DC since 2000, as an effort from employer to:Contain costs and risksFunding difficulties after the downturn of the equity marketAccounting issuesLongevity risk no longer bearableTo date, 36% DB plans are closed for new entrants, DC plans insteadIf DC, contribution is much lowered (from 16% - 20% to 7% - 11%)
51 UKII. System characteristics: pillar III – occupational private sector pension (3/4)Tax rules (to be implemented in April 2006)A universal lifetime allowance on aggregate value of tax favourable benefits,Plus a universal maximum accrual contribution in any yearThe lifetime allowance at GBP 1.5 million and annual allowance at GBP 215,000Any excess will be levied with 40% income taxNo limit on tax relief on employer contributionPersonal contributions will get tax relief up to 100% of earnings or on a gross contribution of up to GBP 3,600 per yearAlso, early withdraw can begin between age 50 and 75Fund must be externally funded to gain maximum tax advantageInsurance or pension fund can administered the fund
52 UKII. System characteristics: pillar III – occupational private sector pension (4/4)Pension funds and insurance schemes are set up under trust law as separate legal entity and the legislation for both is similarMost large companies sponsor their own pension plansIndustry wide pension plans not commonSmall employers favour insurance schemesLarge companies generally use self administered funds without using insurance, although lump sum death in service benefits are usually insuredPension funds (self- administered plan)Obligatory to appoint investment manager and a custodianInvestment manager is restricted thathas to be authorised under the Financial Services Act 1986Formally appointed by trustees6% manages pension fund fully in-houseTax treatmentTax relief for employees are 15% of income, if the plan is tax qualifiedInsurance schemesAn employee can establish individually with an external providers a pension plan, in the form of annuity or other type of insurance productsIt can also be a vehicle to contract out S2PGroup contact is on the rise due to flexibility and cost effectiveness
53 II. System characteristics – pillar III, individual private pensions UKII. System characteristics – pillar III, individual private pensionsPersonal pension plans, introduced in 1988Majority sold by insurance companiesBank, building societies and other financial institutions can also provide the plans, but remain smallMore investment choice with personal pension plans25% male and 17% female fully time employees have personal pension plansBenefits is based on DC principalUpon retirement, 25% lump sum tax free withdraw, remaining balance is used to purchase an annuityBenefits are taxed as incomeStakeholder pensionsCheap, flexible and can be held as a company pension or personal pensionCharges are caped at 1% per annum of the value of each members’ fundMember are able to transfer into and out of the scheme at any time and to stop and restart contribution payments without additional costs or penaltiesNo guaranteed minimum benefits, entirely DC approachWithdraw as of age 5025% tax free lump sum withdraw, the balance is to purchase annuityThe scheme is run by trustees or scheme managers who are responsible for determining the investment options and are authorised by Financial Services Authority
54 III. Investment guidelines UKIII. Investment guidelinesTrustee responsible for pension fund investmentTrustee allow prudent man rule“A fiduciary must discharge his / her duties with the care, skill, prudence and diligence that a prudent person acting in a like capacity would use in the conduct of an enterprise of like character and aims”Implication to the pension fund investment“Trust” function separates pension fund assets from “other monies”Provide legal obligation to seek to minimize potential divergence of interest in relationships where one party is particularly vulnerably to anotherPrudent man rule is based on the UK common lawTrust is to perform due diligence when it comes to pension fund selectionNo restrictions on asset allocation or off shore investmentAs a result, the traditional equity exposure close to 70% of total pension fund assetsMinimum funding required for occupational DB plan, largely follow European Pension Fund Directive – statutory funding objective to cover technical provisionsA pension bill is expected to pass:Requires trustees and employers to agree on a funding strategy appropriate for their circumstanceHowever, this will subject to satisfying the European Pension Fund Directive
55 IV. Regulation and supervision UKIV. Regulation and supervisionPension regulator formed on April 6, 2005, former regulatory body is Occupational Pension Regulatory AuthorityStatutory objectives:To protect member benefitsTo promote good administrationTo reduce risk of situations that may lead to claims of compensation from pension protection fundResponsibility: Trustee, administrators, employers,Investing schemes through data collectionschemes, including details of membership, sponsoring employers, trustees, advisers, administration, funding and investment.provide practical guidelines for trustees, employers, administrators and others on complying with the requirements of pensions law; andset out the standards of conduct and practice that we expect.Proactive approach on risk management:inadequate funding;incomplete or inaccurate record-keeping;lack of knowledge or understanding on the part of trustees about their role and duties; orpossible dishonesty or fraud.
56 I. Sweden Pension System compared to World Bank (summary 1/2) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)SwedenIIIISTATEIIMANDATORYVOLUNTARYPensionSystemPension reform introduced in 1999, applies to people aged 45 or under at the time of reform2 components: PAYG elements and pre-funded elementsTotal 18.5% contribution, mandatory.16% contribution to notional account2.5% to individual DCNotional account is indexed every year. Contribution is used to pay current retirees benefit (PAYG elements)Annuity payout is required upon retirementGuarantee pension is provided by the government at rate of 33% of average earnings.Voluntary contribution, but has universe coverage - pension plan based on collective agreement between employers and Unions.Two different schemes:White collar workers (ITP), mostly DB schemesComplementary occupational pension (ITPK) – DC plans above certain ceilingPart that is DC plan: 13,4% of salaryBlue collar workers (AMF), DC scheme and offers employees some degree of investment choiceDC plan: 3.5% of salaryManaged by banks and insurance companiesAdministered by AMF centralMajorIssuesPayout is depending on years active in working force.Over 700 type of funds available for individual to chose for the investment of 2.5% contribution – too complicatedNotional DC fund 16% of earnings, the concept of notional accounts means that the PAYGO character is retained, however the size of contributions is registered on individual account
57 I. Sweden Pension System compared to World Bank (summary 2/2) WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)SwedenIIIISTATEIIMANDATORYVOLUNTARYPensionSystemPension reform introduced in 1999, applies to people aged 45 or under at the time of reform2 components: PAYG elements and pre-funded elementsTotal 18.5% contribution, mandatory.16% contribution to notional account2.5% to individual DCNotional account is indexed every year. Contribution is used to pay current retirees benefit (PAYG elements)Annuity payout is required upon retirementGuarantee pension is provided by the government at rate of 33% of average earnings.Private pension plan is provided by insurance, bank or a similar institutionTax incentive provided for pension contribution€2,178 per annumHigher income group may able to contribute up to 5% of salary, max €4,356 per annumAge 55 withdraw is possibleSalary reduction schemes gain importance over the last yearsTax effective as no tax is payable on contribution – regardless of the amountMajorIssuesPayout is depending on years active in working force.Over 700 type of funds available for individual to chose for the investment of 2.5% contribution – too complicatedNotional DC fund 16% of earnings, the concept of notional accounts means that the PAYGO character is retained, however the size of contributions is registered on individual account
58 II. System characteristics: the reform SwedenII. System characteristics: the reformFaced by largely the same demographic challenges as other OECD countries, Sweden opted in 1992/1994 for a radical reform of its national old-age pension system, a process supported by five parties and some 85% of members of Parliament.In effect, Sweden moved from a traditional income related defined-benefit system, to two types of defined-contribution systems. The old system was financed more or less on a pay-as you-go basis. In the new system, an individual will put 2.5% contribution into an individual financial account under the financial defined-contribution system (FDC), another 16% of pensionable income is on a notional account and the real money will be channelled into the new pay-as-you-go system. Financial accounts are managed by a variety of private funds chosen by the individual.The equivalent of 16% of each individual’s annual pensionable income will be credited yearly to his or her notional account under the Notional Defined Contribution System (NIC). The corresponding amount is transferred on monthly installments to the system’s Buffer Fund, similar to the Trust Fund of the United States’ federal pension system, which finances pension payments. Recently significant liberalisation has been introduced in the investment rules for the funds, 70% of which can now be invested in equities.The new system has no formal age of retirement. Pension credits will always be earned and added to the notional (as well as financial) accounts if the individual has pensionable income, regardless of age. Pension credits are given for all social insurance benefits in the nature of income replacement, such as sickness, unemployment, disability, and maternity/paternity benefits. In addition pension credits will also be given for some "activities" such as childcare years, university studies and compulsory national service. Pensions from the pay-as-you go-system are calculated at the time of retirement by dividing the notional-account balance by a life expectancy at retirement. Those with insufficient contributions throughout their careers will be entitled to a minimum guaranteed pension, paid for by general taxes. The guaranteed-pension is indexed by the change in the Consumer Price Index.Because of the commitment to keep the contribution rate fixed, the new system will accommodate demographic and economic developments by adjusting the value of the pensions. The automatic balance mechanism legislation, the final piece of pension reform legislation adopted in May 2001, ensures this. The mechanism provides for a switch in indexation basis for pensions from growth in the average income to the internal rate of return of the NDC system if liabilities in the system should exceed assets. The pension level is automatically re-established, as is the growth in average income as the basis of indexation, as soon as this is possible without undermining the financial balance of the system.
59 II. System characteristics: pillar III – occupational pension system SwedenII. System characteristics: pillar III – occupational pension systemOccupational pension covers almost all employees in the countryConditions are determined by nation wide collective labour agreement4 pension schemesITP – white collar workers, 1.5 million employees, DB mainly, managed by insurance company AlectaSAF-LO – blue collar workers, 1.8 million employees, DC mainly (established in 1996), managed by AMFCivil servants plan: 700,000 employees, DBEmployees from municipalities: 1 million employees, DC mainly3 funding methods:Pension fund: DB, although risk benefits are fully insured (majority of ITP plans are using pension fund)Book – reserves: DB, same as pension fund, risk benefits are insuredPension insurance: mostly DC, common in small enterprises and dominating occupational pension plans for blue collar workersCompany segmentation:Small enterprises uses pension insurance, hence DC schemeLarge companies participate in ITP plans, usually use book reserve in combination with credit insurance for securing pension liabilitiesPension foundations are increasingly popular among large companiesTaxEmployer contribution tax deductible up to 35% of the plan member’s salaryA ceiling of 10 times the price base amount applies - € 43,556 in 2005Employer contribution are not considered taxable income to the employeeBenefits paid from occupational pension schemes are taxed as ordinary incomeInvestment income is taxed – average interest on government loans in the preceding year to determine the investment income
60 II. System characteristics: pillar III - administration SwedenII. System characteristics: pillar III - administrationPension funds – commonly used in ITP plans and other DB plansSet up as a separate legal entity but are affiliated with the companyPension funds have to participate in credit insurance which guarantees the pension paymentsPension insurance – group insurance contractsInsurance contracts can be used for all types of plansITP, SAF-LO and voluntary plansHowever, ITP and SAF-LO can only be administered by Alecta and AMF respectivelyAlecta responsible for the administration, collection, distribution and investment of the ITP plansAMF administers, collects and distributes premium to investment vehicle like bank or insurance company, chosen by the employees (if no decision made by employees, assets remain in AMF)Endowment insurance contracts - can be used, seen as a legal form for securing a pension promise if the contract is pledged to the employee.Pension insurance is the most common form for small enterprises and is dominate form for blue-collar workersBook reserves – only applicable to DB schemeIn case pension scheme under ITP plan is using book reserve method: -Mandatory to participate in credit insurance system - FPG (re-insurance)Pension payment and calculation of pension liabilities is done by a special institution - PRIInsurance companies hold up to 60% of pension assets
61 III. Investment guidelines SwedenIII. Investment guidelinesNOT required by law to appoint investment managerExternal asset managers become increasingly a market practiceNo specific investment restrictions besides the Prudent Person Rule and solvency margin in case no re-insurance (FPG)Funds can invest up to 80% of assets in equities
62 IV. Regulation and supervision SwedenIV. Regulation and supervisionFinansinspektionen (FI) is the primary supervisory agency for all financial institutions, including friendly societies, but excluding the pension foundationsObjective of Finansinspektionen is“promotion of financial stability and efficiency in the financial sector and promotion of consumer protection goals.”Pension foundations are monitored by the parties to the agreements.Counties’ administrative boards may supervise pension foundations according to the region where they are located.Since there are twenty four counties in Sweden, the supervision rules and practices can be significantly different.A general legal framework is the Act: safeguarding of pension obligationsLegal framework to require the pension funds to buy credit insurance systemCredit insurance is provided by FPGFPG guarantees pension payment in case an employer become insolvent0.2% of pension liabilities is paid to FPG for insurance premiumNo legal requirements regarding minimum funding (solvency margin)Pension liabilities are re-insured through FPG
63 V. Macro economic impact - the reform helped the economy SwedenV. Macro economic impact - the reform helped the economyBudgetary savings. Partial privatization, combined with reform of the government-run, pay-as-you-go portion of the retirement system, is expected to result in a fiscally sustainable system. Future expenditures will be significantly lower, protecting Swedes from higher taxes, higher spending, and large deficits.Higher retirement income. The ability to invest privately over a working lifetime will allow Swedish workers to benefit from compounding returns. The average blue-collar worker, for instance, should enjoy 40 percent more old-age income. Swedish retirees will have a safer and more comfortable retirement.Economic growth. By reducing the payroll tax rate and creating a direct link between lifetime income and pension benefits, Swedish pension reform will increase incentives to work. Moreover, the shift to a funded system will boost national savings, thus providing capital for future growth.
64 V. Macro economic impact: benefits of the new system SwedenV. Macro economic impact: benefits of the new systemGreater incentive to work. In the new system, pensions are determined by lifetime income, which means that each year of gainful employment will have a positive impact on future pension benefits. Because pension rights will be recorded in real and notional individual accounts, workers will have much less reason to hide, shelter, and underreport their income. The new system will also discourage workers from dropping out of the labor force.Increased national savings. Replacing a tax-and-transfer entitlement system with a partially funded pension system will increase national savings, particularly as the new system matures. Some recent empirical evidence from Swedish household sector data, for instance, indicates that reform will result in a net increase in savings.Flexible retirement age. The new system neither penalizes nor rewards early retirement. Workers can retire as early as age 61 or stay in the workforce as long as they choose. Early retirement no longer burdens taxpayers since workers who choose to retire early do so in exchange for a smaller pension. Moreover, the new system does not penalize workers who remain in the workforce since they receive a larger pension or, if they so choose, earn income and collect a smaller pension at the same time. These benefits are possible because a worker’s notional account becomes an annuity based on life expectancy at the time of retirement. Since the annuities do not reflect differences in life expectancies for men and women, however, women receive more from the new system than men.Lower taxes and less government spending. The new pension system will yield large fiscal benefits over time. The Swedish government calculated that the payroll tax rate necessary in order to perpetuate the old system would have reached 36 percent by This tax rate— and the level of government spending implied by such a tax burden—would have been an enormous weight on the Swedish economy. Even the 16 percent tax in the new system is too high, though the creation of notional accounts minimizes the adverse impact on labor supply.
65 I. Australia Pension System compared to World Bank (summary) WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeAustraliaIIIISTATEIIMANDATORYVOLUNTARYPensionSystemPAYG - “Age pension”, universal, means test benefit paymentMeans tested: in accordance with income or assets, whichever determines the lower pension rateBenefit payment from general revenue (government tax income)Retirement age: man – 65 years of age, woman – 61.5Compulsory, earnings relatedSuperannuation guaranteeEstablished since 1992As of July 2002, minimum contribution level 9%, paid by employer (phased approach from 1992 – 2002)Contribution tax deductibleFully funded individual account, defined contributionFew investment restrictionsNo early withdrawRetirement age: 55 (60 by 2025)Choice of lump sum, pension, annuity with tax transfer incentiveAll employees aged 18 – 65Self employed not coveredVoluntary member superannuation contributionsTax preferredContribution usually made by members of superannuation funds, above the compulsory superannuation contribution or, a person is not eligible for compulsory superannuationKey characteristicsAll superannuation funds accept both mandatory and voluntary contributionsFund income (contribution and earnings) and benefits taxed at concessionary ratesTax: employer contribution tax deductible, superannuation funds taxed at 15%, benefits are taxed depend on type of benefit and its size
66 II. System characteristics: introduction of superannuation guarantee AustraliaII. System characteristics: introduction of superannuation guaranteeBefore reform2 pillars:Age pension, means testedVoluntary retirement savings1990: Superannuation guarantee introducedMandatory, employment related
67 II. System characteristics: Australia superannuation industry Superannuation funds operate as trusts and managed by boards of trusteesCorporate fundsSponsored by a single or group of related employersMembership is restricted to employees of the employerIf fund rules allowed, contribution may also be made on behalf of the employee’s spouse or partnerRepresent 6% individual membersApproximately 13% of the assets in the marketIndustry fundsMembers from a large number of employers across a single industryRepresent 30% of individual members10% of total assetsPublic sector fundEmployer sponsor is a government agencyOr, business enterprise that is majority government ownedRepresent 12% individual membersApprox. 20% of total assetsRetail fundsPublic offered superannuation funds, include master trust*Members are either self employed or additional voluntary contribution by members of other employment based superannuation arrangementsRepresent 50% of individual members34% of total assetsSmall funds< 5 members, mostly family owned company with family members as trusteeRepresent 2% of individual members* Non related individuals or companies to operate superannuation under a single trust deed
68 II. System characteristics: Role of trusteeship and service providers AustraliaII. System characteristics: Role of trusteeship and service providersAll plan assets must be held in trust“Trust” ensures pension scheme assets are separated from employerTrustee can be a person or superannuation fund but are separated from the pension schemeTrustee may engage or authorise service providers to act on their behalfService providers include: external fund administrator, actuaries, lawyers and investment managersBank, life insurance and investment management companies may be appointed as service providers offering investment service, custodianship of assets, administration of records etc.Universal licensing will be issued in 2 – 3 yearsCurrent trustee licensing procedure expected to be changed
69 III. Investment guidelines AustraliaIII. Investment guidelinesInvestment strategy follows “prudent man” principalNo limit on asset category / quantitative rulesIe., asset allocation in bonds, deposits or equityNo limit on minimum diversification requirementNo limit on foreign investmentsNo limit on ownership concentrationOnly restriction: loans or financial assistance to members not permittedAsset allocation, as % of total assets, reference Sep. 2004Cash & deposits: 8%Loans: 4%Interest bearing securities: 16%Equities and units in trusts: 49%Land and buildings: 5%Overseas: 17%Other: 2%
70 IV. Regulation and supervision AustraliaIV. Regulation and supervisionRegulation principal: prudent manNo rate of return or asset requirementsAustralian Prudential Regulation Authority (APRA)Integrated financial sector regulatory bodyPrimary responsibility: prudential regulation of superannuation, insurance and bankingAdministers superannuation industry supervision act (SIS Act)SIS Act is principal legislation relating to prudent management of superannuation entitiesSupervisory approach:Risk based (through internal risk rating), consultative and in line with international practicesRecognize management and boards are primary responsible for financial solutionsAustralian Securities and Investment Commission (ASIC)Responsible for market integrity and consumer protectionResponsibility across the financial system, including areas of superannuationAustralian Tax Office (ATO)Responsible for regulation of self-managed superannuation fundsGeneral: Information sharing among the parties APRA, ASIC and ATO is regulated through Memoranda of Understanding (MOU)Objective of the MOU is to reduce duplication and compliance costs for industry
71 Table of contents I II III The World Bank model Leading role pension models compared to the World Bank model:ChileUSPoland**NetherlandsUKSwedenAustraliaMain characteristics of other country’s pension systemsIICountry pension system summarySystem characteristicsInvestment guidelineRegulation and supervisionMacro economic impact *System pros and cons**IIIAsiaChinaKoreaEuropeHungaryCzech RepublicSlovak RepublicRomaniaGreeceUkraineRussiaLatin AmericaMexicoBrazilPeru* Only applicable to countries recently reformed**Only applicable to *marked countries
72 Hungary Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)HUNGARYIIIIIISTATEMANDATORYVOLUNTARYPensionSystemPAYGCovers the entire labour force18% employer contribution to PAYG8.5% employee contribution to PAYG (However, in certain circumstance, 0.5% ee contribution to PAYG; 8% to Pillar II)Benefit: replacement ratio: first pension/final pay may vary between 25%-80%Mandatory occupational pension, individual account. Free choice of the employeeHalf of the workforce is covered. Career starters are obliged to joinRemark:Single investment portfolio per fund;Not really 2nd pillar, a recent study of Pragma Consulting called this (along with the Polish system) 1st pillar bis.Voluntary pension funds, individual retirement savingsTax incentive paid either by the employee or the employeeEmployer should treat employees equal by providing equal amounts or equal percentage of the pay as a contribution.Employees are free to chose between funds, employer can not restrict, however informally does.One pension fund can offer different investment portfoliosMajorIssuesStrong degression in the system, including a cap on income forming basis of the pension rights (This will disapper until 2012 or 2020)Further decline of the average replacement ratioII AND IIIAlliance of major funds is lobbying for change:Funds legal structure (self governance) is not appropriate for funds with several hundred thousands members. Multinationals run reputation risk without formal controll and ownership.Clients can switch fund too frequently (6 months) following short term yield changes, supported by a very low cap on exit fees. We would prefer being able to tie the client to the fund (on a voluntary basis) e.g. by offerring lower fees.Recommenda tionsLobby for legislation, supervision change: MPF investment portfolios, administration ease, ownership – on going along with the competitorsLobby for more public / private partnership: expect a raise in 8%/18.5% in favour of MPF. MPF is a more important market than VPF (faster growth, more stable income)Investment regime – not prohibiting at this stage
73 Czech Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeCzechISTATEIIIIIMANDATORYVOLUNTARYPensionSystemTwo part system:Flat rate basic amount for allEarnings related portion related to employmentPAYGO mechanismContribution 21,0% by employer 7,0% by employeeNon – existence in our definitionVoluntary DC pension funds by employer / ee and state (minimum sponsoring). AuM: € 3 blnAlso voluntary pension arranged by insurance companies. AuM € 1.5 bln>50% workforce participated25% employee have additional contribution by employerTax incentiveMajorIssuesNo political consensus on future pension systemLow fertility rateFunding for transitional period uncertainGovernment election ahead, no major decision to be made prior electionHighly consolidated market: 12 pension fund owned by 10 groupsToo low contribution: benefit is less than3% of avg. gross wageRecommenda tionsAdvice government to establish mandatory pillar II business with meaningful tax incentiveIncrease contribution rate, possibly introduce mandatory schemeAcquire extra planholders (grow from 25% to40%) for additional contribution by employerIncrease tax incentives for employers and direct subsidies for individualsProduct / investment solution
74 Slovak Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeSlovakIIIISTATEIIMANDATORYVOLUNTARYPensionSystemPAYG, DB28.5% mandatory contributionAfter reform, individual can chose contribution rate to be reduced to 19.5%Current pension expenditure: 7% of GDPReplacement ratio 45.2% (net pension / gross wage)Mandatory contribution for all new employees entering work force; Voluntary for people in current workforceIndividual account with 9% contribution, with minimum 10 years commitmentVoluntary pension plan (DDP)AuM < 1% GDPMajorIssuesAgeing populationSustainability of quite generous benefits of I. pillar after reformGood participation rateTo be transformed to align with second pillarRecommenda tionsDevelop the third pillar more extensively
75 Romania Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeRomaniaISTATEIIIIIMANDATORYVOLUNTARYPensionSystemPAYG state pensionCurrently already 10% of GDPNon existent in practiceCurrent new law approved in 2004 not sufficiently worked out yet; changes expected to be made by the new governmentOccupational pension law was issued in 2004, but not implemented yetLaw in process of ammendment, to be implemented in 2006 with tax benefits;Very small at the moment, only pension products labeled like this and offered by life insurance co.MajorIssuesPensions unfundableLooking into pension reformCurrent drafts very unclearHigh inflation and pension not indexed according to the cost of living – retired persons most affectedFollowing Polish model but contributions are too low from 2% to 6% in 8 yearsThe categories of eligible persons and the low contribution make it unattractive for business; changes expectedIncrease incentives, currently there are not deductible for the individuals and dis-incentivised for the employer;State sector institutions and companies not allowed to have pension schemesRecommenda tionsUse copies of other pension reformsUse co operation between public and private sector to arrange a optimal systemSet fees at a rate that is acceptable for private parties to invest in RomaniaIncrease the contribution, increase the potential eligible persons for the private systemTax incentives are keyReview the eligible companies that can create occupational pension schemes;Leave it to the market forces the level of fees
76 Greece Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeGreeceISTATEIIIIIMANDATORYVOLUNTARYPensionSystemVery diffuse first pillar, very fragmented and financially unbalancedBased on occupational linesThree tiers all based on PAYGOTotal spending already 12,5% of GDPVery high replacement ratio of 107%Non existingVery low number of AUMMost payouts are in lump sumMajorIssuesTotally unaffordable and unsustainable systemUnclear systemNo big tax reliefRecommenda tionsHuge reform neededInefficient systems should be improvedImprove benefitsPayout in annuities
77 Russian Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeRussiaISTATEIIIIIMANDATORYVOLUNTARYPensionSystemPAYGO systemLarge coverageLabor pensionsSocial pensions1996: individual personified accounts introduced in State PF2003: Choice of opting out to Asset Management Company2004: Choice of opting out to Non-state Pension FundNon state pension funds; life insuranceNSPF through employer, with possibility of joint financing and additional individual contributionsMajorIssuesNon sustainableVery low pensions; non indexedFlawed introduction of monetization of pension benefits led to up rise amongst populationReforms neededStill relatively new concept and as a result lack of awarenessSo far only about 8-10% of eligible population has opted outNo awareness campaign; practical difficulties for opting outRules of the game constantly changingRecommenda tionsHigher pension ageUnambiguous political support for pension reformsAwareness campaign for populationCreate level playing field for all providersAbolish social security tax on pension contributionsIntroduce further tax incentives for individualsMore stable legal and fiscal environment; more predictable and professional supervision
78 Ukraine Pension System compared to World Bank WBPublicly financed schemes, social security schemesEmployer sponsored schemes or private mandatory programsAdditional voluntary arrangements + individual retirement incomeUkraineISTATEIIIIIMANDATORYVOLUNTARYPensionSystemPAYGO system effective since 2004Principles of solidarity and subsidization -everyone has to contribute to Pension Fund of Ukraine (PFU)34% of wage fundOld age pensions, disability pensions, survivor’s pensionsActive from January 1, 2007Personal accounts7% of wage contributionPayout lump sums or annuitiesBetween 2007/2018 managed by PFU and asset management companies. In 2018 pension funds get access to managementEffective since January 1, 2004Open funds, corporate funds, professional funds; voluntary participation - employers/ employeesTax benefitsThe banks participation declared via accumulation accountsMajorIssuesThe pension level remains inadequate even after increaseA lot of privileges in contributions payment to the PFU from different economy sectorsPFU is non sustainableReforms neededThe issue of privileged pension is not resolvedCriteria for the asset management companies is the focus for legislative controversyTotally new concept: market just started upLegislative contradictions existProblems with investments of pension assetsRecommenda tionsMake it attractive for private parties with international experience to enter the marketBring related effective laws in the line with current pension legislationHigher pension ageReduce privileges in payment of contributions to PFU; set up allocations within State Budget expenditures to compensate for privileges; ensure complete separation of sources for fundsResolve legislative problems/contradictionsLaunch ad-hoc propaganda of Non State Pension SystemDevelop reliable investment options for pension assets* Laws still have to be implemented by bylaws
79 Table of contents I II III The World Bank model Leading role pension models compared to the World Bank model:ChileUSPoland**NetherlandsUKSwedenAustraliaMain characteristics of other country’s pension systemsIICountry pension system summarySystem characteristicsInvestment guidelineRegulation and supervisionMacro economic impact *System pros and cons**IIIAsiaChinaKoreaEuropeHungaryCzech RepublicSlovak RepublicRomaniaGreeceUkraineRussiaLatin AmericaMexicoBrazilPeru* Only applicable to countries recently reformed**Only applicable to *marked countries
80 Mexico Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)MEXICOIIIIIISTATEMANDATORYVOLUNTARYPensionSystemPAYGFacing out:Employees before ‘92 who did not change to new individualized system (SAR & AFORE)Civil servants (ISSTE) -- although currently issuing law to transfer them to Afore (estimation 2 mln civil servants)AFORES & SAR SystemMandatory contribution of 6.5% salary and possibility of voluntary contributionsOffered via large agent networkAuM: 46 bln EuroParticipants: 32 mlnPrivate sector employees:DB driver = Termination Indemnity (11,6 bln Euro*)Some additional DC plans (mainly multinationals and corporate 500+). Mostly as hybrid system (1,45 bln E)Individuals:Voluntary contribution to AFOREOther individually acquired plans / savingsMajorIssuesUn-fundedIf ISSTE civil servants are transferred, PAYG will be completely facing out in due timeAlthough fully funded, not sufficient mandatory coverage.‘Unnatural fit” between privately run system (high profit), mandatory by Gov. (lowering costs) >overregulatedInformal economyProviders fee structureTransfers warPrivate sector employeesLack of regulation enforcing retirement age (DB driver = Termination Indemnity)Lump sum at pay outIndividualsLow awareness and informationNo tax incentivesRecommenda tionsFinally transfer of ISSTE employees to Afore systemEnlarge the coverage and increase the investment range abroadIncentivise formal economySet retirement ageMandatory contributions for independent workersPrivate sector employeesTermination indemnity should not be retirement-terminationIncentivise via taxesIndividualsTax incentivesProduct and investment options
81 Brazil Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)BRAZILISTATEIIIIIMANDATORYVOLUNTARYPensionSystemPAYGMandatory, minimum benefit defined by constitutionLarge deficit caused by imbalance and ageing of populationCivil servants’ pension unified with private sector employees and so capped recentlyPrivate sector employeesNon-existing, government not interested in discussion so farClosed corporate pension funds, open corp. pension plans & individual plansShort-term saving so far (change to long-term products; recently proposed new product family should be in place as of 2005)Tax incentives availableDominated by banksMajorIssuesIn-transparent system mixing different social&health payments togetherInformal economyNot a feeling for acute changes at the momentNot in placeCrucial for overall pension reformBrings substantial assets for boosting national economyShort-term products onlyHeavily regulated including ban on penalties for early withdrawalTransformation of the closed pension funds to the open plansOutsource plans to professional providersRecommenda tionsStep-by-step change to be startedDifferentiate clearly the obligation (now mixed in one social system)Increase of transparency and move to fully funded system in the long-termIncentivise formal economyMake the system less generous for the state civil servantsIntroduce this pillar !The Vision: “Mandatory scheme ran by professional pension providers and asset mangers with long term commitment”Active participation in formulation of the second pillarIndividual & CorporateIntroduce truly long-term products while keeping tax incentives for individuals as well as for corporate sponsorsProduct optionsInvestment options
82 Peru Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)PERUIIIIIISTATEMANDATORYVOLUNTARYPensionSystemNational System competes with Private SystemPublic system: PAYGO, mandatory (if you don’t enter to private system), 13% employees contribution, lump sum payment at retirement age.State guarantee minimum pension: S/ 415Private sector (AFP): new industry of pension fund managers, strictly regulated by State, mandatory (if don´t enter public system), 11.19% monthly fees contribution.Not maximum top-cap for contributions increase final pension for affiliateFully fundedOnly 3.5mln of the 12mln economically active population is affiliated to an AFPOther voluntary pension arrangementsCould be added as voluntary contributions to the AFP, although will imply restrictions on withdrawalsVery smallNo tax incentivesLacks to complement benefits from the mandatory pillarsMajorIssuesUn-fundedIn Peru exist an elderly population which misses social assistance benefits. (In 2003 only 26% of elderly were receiving pensions, WB recommends the establishment of a “Zero Pillar”Broken systemUnfair and bias pensionsHigh proportion of National Budget used in pension paymentsNot sufficient coveragePolitical pressure to reduce pricesMultiple Pensions FundsNew transfer regulationNot tax benefits for employers and employeesNew player in system.Low awareness and informationNo tax benefitsRecommenda tionsIn the short run, reduce gap between different pension regimes (20530 and )In the short run, reduce resources directed to pensionsIn the long run, close public system for < 45 years in order to switch from pay-as-you-go to define contribution and stop entrance of new labour forceIn the long run, commission should be based as percentage of AUMTax incentives in order to increase contributions ratesTax incentives for companiesTax incentives for individualsSpread private pension system benefits to all the labour forceIncrease awareness and informationProduct optionsInvestment optionsTax benefits (EET)
83 Table of contents I II III The World Bank model Leading role pension models compared to the World Bank model:ChileUSPoland**NetherlandsUKSwedenAustraliaMain characteristics of other country’s pension systemsIICountry pension system summarySystem characteristicsInvestment guidelineRegulation and supervisionMacro economic impact *System pros and cons**IIIAsiaChinaKoreaEuropeHungaryCzech RepublicSlovak RepublicRomaniaGreeceUkraineRussiaLatin AmericaMexicoBrazilPeru* Only applicable to countries recently reformed**Only applicable to *marked countries
84 China Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)CHINASTATEIIIIIIMANDATORYVOLUNTARYPensionSystemBasic old age pension consists of 2 components:Ia. Social pool pension – Employer contributes 15% (in some cases 17%) to finance current retirees. Defined benefit at 20% of (local) average wage1b. Individual account – Employer contributes 5% (in some cases 3%) and employee contributes another 6% - 8% (8% applicable if employer contribution is 3%). Benefit based on 11% contributionCorporate annuity is voluntary, but perceived as 2 pillar corporate pension.Legislation announced, implementation is scheduled in 20064 types of players: trustee, custodian, plan administrator and asset managerEmployer receives 4% (up to 10%, depend on the region and provincial / municipality decision) tax benefit on pension contributionIndividual receives no tax benefitVoluntary Personal savings (life annuity) smallMajorIssuesRapid aging population created a bigger pension gap as 15% of employer contribution was not enough to pay 20% at retirementLife expectancy increased from 49 years in 1949 to 71 years now. In urban area, the rate is even higherOne child policyDue to insufficient funding, some of the 1b individual account asse.ts being used to pay off the social pool benefit. As a result, individual account is more of a notional account.Economic inequality (between the rural and urban, or costal and inland) resulted in differences in some regions have better pension funding than other. Hence, pension problem has to be dealt with on regional basisLack of tax incentives (tax system is not yet in place) Voluntary contribution in a market where pension is still a new concept, this effectively lead to limited subscriptionLack of long-term investment instruments complicates participation of commercial life companies (Bank deposit = 2%, max. 10-year duration bonds available, no international investments are allowed)Individual voluntary savings is almost non-existentLow individual awareness
85 Korea 1.) Current Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)KOREAIIIISTATEIIMANDATORYVOLUNTARYPensionSystemNational pension scheme, compulsory for all employees (Civil servants, teachers and armed force arranged separately)9% wage contribution, equally divided er/eeBenefits related to number of years employment and also earnings. Relative generous benefit with currently 60% replacement ratioRetirement age : 60, to be raised to 65Current NPS funded with a surplus of 140 trillion won, approx. 15% of GDPRetirement allowance system equals to severance pay (ESP)Retirement insurance contract (RI) or trust structure (RT) used to externalise liabilities under ESPInsurance companies have over 90% market share in RIRI do not grow in recent years due to unfavourable accounting standards to employer and weak economic conditionsEmployer pays all contribution, contribution tax deductibleLump sum or pension benefit at age 55All financial institutions provide personal pension plansHigh tax incentive, plan can withdrawal as early as 5th yearMajorIssuesHowever, demographic developments as well as low return lead to structural imbalance of the fundsUnfavourable performance of the fund due to tight investment restrictions - currently part of funds outsourced to int’l fund managers (ING - Kookmin is one of the fund managers)Public lack of confidence in NPSSelf employed, account for a quarter of working population, NOT covered by NPSRetirement allowance covers all employees work in companies with 4+ people. However, it represents only 30% of economically active populationBenefits used as annual bonus or lump sum payment to meet cash flow needs -> insufficient income for retirement. Benefits NOT meaningful even for members with 35 years contribution and no early withdrawal before age of 55System severely under fundedCompanies under funding lead to slow shift to new RPSPremature withdrawal by many people as too favourable tax structure for individualsFierce competition among financial institutions which erodes margins for service providersRecommendationsStructured loan arrangements can help transition (from RAS to RPS)
86 Korea 2.) reformed Pension System compared to World Bank WBPublicly financed plans, social security plansEmployer sponsored plans or private mandatory programsAdditional voluntary arrangements (possibly sponsored by Employer)KOREAIIIISTATEIIMANDATORYVOLUNTARYPensionSystemSame as previous slide3 different sub-markets exist after ERISARetirement allowance systemRetirement pension systemIRA (for job switchers and companies with < 10 employees)Contribution: 8.3% annual salaryBenefit: pension payout or lump sum payout (only applicable if member has <10 years contribution)Early withdrawal possible if meets certain criteria, ie., first time house purchasingTax benefit unclearSame as previous slideMajorIssuesToo many options (old system remain)Members (employers too) obliged to join a system, but it is up to the member to choose from new or old systemNot clear incentive for individual and employer to switch to new retirement pension system