Pension Analysis and the PER

1. Pension Analysis and the PER Richard P. Hinz, Adviser, HDNSP Anita M. Schwarz, Lead Economist, ECSHD April 2007

2. Objectives of a Pension System • Reduce poverty among the elderly • Smooth consumption between working years and retirement years • Implication: those who earn and consume more in working years will consume and earn more in retirement years • Very different from other public expenditure programs which ideally would be designed to allocate equal or greater share of expenditures to the poor

3. Pension Systems Usually Contributory • Historically contributory – part of the compensation package • Government provides a mechanism whereby employers and employees can save for old age in the absence of secure market-based instruments • Also makes pension reforms extremely different • People have acquired rights from the contributions they have made • Raises problems for redistribution analysis • Need to net out historical contributions from current expenditures • Only those who contribute get pensions; low income individuals often don’t contribute; so pension expenditure skewed toward higher income individuals as is pension revenue

4. Who is Covered Under the Pension System? • Contributors to the pension system can range from 5% of the labor force to 95% • Percentage of the elderly covered can be different from percentage of labor force covered • ECA, Brazil, Georgia • What programs exist to provide assistance to those not covered?

5. Coverage is Fundamental in How to Evaluate the Pension System • High coverage systems • Meaningful to include redistribution within system • Low coverage systems • Financing of the pension system should come from those who are covered • Low coverage system running a deficit results in highly regressive transfers from general revenues broadly collected to the few who are covered and generally have higher incomes • Redistribution within the pension system of secondary importance

6. Fiscal status of the pension system now and in the future • Is the system sustainable now and in the future? • Note that the relevant future for pension systems is usually 50-75 years into the future • Will promises being made to those beginning work today be kept? • Do proposed reforms improve sustainability? • Frequently do nothing in the short to medium term • With move to a funded system, reform can actually worsen the short and medium term position • Need measures like implicit pension debt

7. Implicit Pension Debt • What does the government owe pensioners and contributors as of today? • Pensioners are owed the present value of the current benefit (indexed as by law) for the remainder of their expected lifespan • Contributors are owed some prorated benefit to be received when they reach retirement age and to extend throughout the duration of their expected retirement period, prorated by the % of working career on which contributions have already been paid

8. Example of Fiscal Sustainability or Not in Context of Turkish Pensions • While Turkey starts out with a deficit, most countries will eventually show a deficit in the long run • Life expectancy increases while pension parameters are usually not automatically adjusted

9. Turkish Reform Proposal

10. Benefit Structure :Are Benefits Adequate? • How do we define adequacy? • Relative to poverty level • Relative to average wage – ideally net wage • Workers pay pension contributions, health insurance contributions • Note that inflation indexed pensions will result in a drop in the value of the pension relative to economy-wide average wage during one’s retirement period • Relative to pre-retirement wage • Relative to final salary or relative to average lifetime salary? • If average lifetime salary, how are salaries revalued to make them comparable? • Different measures can give very different results, but also provide different information

11. Example of Slovak Benefits

12. Benefit Structure (2):Are the Benefits Fair? • Individuals are making contributions and receiving pensions – are they getting good value for their money? • Benefits could be high, but costs could be high too • Internal rate of return • Fiscal link – if benefits are not perceived as fair, people stop contributing – drop in revenue

13. Internal Rate of Return for Different Individuals in Slovak Republic

14. Benefit Structure :How Redistributive is the Pension System? • Pension systems have multiple objectives: • Poverty reduction in old age • Consumption smoothing • Countries choose to weight these two objectives differently • Australia/New Zealand heavily weighted toward poverty alleviation • Austria, Sweden – strong link between contributions and benefits • No correct answer, but important to know what the system is actually achieving

15. Example from OECD countries, Pensions at a Glance

16. Pensions at a Glance

17. Tools • PROST model: • Fiscal analysis • SR and LR sustainability • Implicit pension debt • Individual level social analysis • Vary starting age, retirement age, starting wage, wage growth, work history, and mortality experience • Pensions as percentage of economy wide wage • Pensions as percentage of own final salary • Internal rate of return provided by pension system

18. PROST • Developed at the Bank; has been used for more than 85 countries • Available to all our client countries once counterparts are trained • Training programs and manuals available

19. Countries Using PROST Countries with PROST licenses as of July 2005

20. APEX methodology • Simulates pension benefits for individuals beginning work at age 20 and retiring at the retirement age for all different income levels • Shows what different individuals get in relation to what they earned, taking into account tax treatment and ceilings and floors on contributions and benefits

21. APEX model • Developed by Edward Whitehouse and AXIA Economics • Now the model of the OECD • In use for all OECD countries, Pensions at a Glance • Preliminary work on many of our countries as well

22. Benefit-Incidence Not That Useful