Pension Analysis and the PER

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Pension Analysis and the PER

• Richard P. Hinz, Adviser, HDNSP
• Anita M. Schwarz, Lead Economist, ECSHD
• April 2007

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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

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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 dont contribute so
  pension expenditure skewed toward higher income
  individuals as is pension revenue

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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?

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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

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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

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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

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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

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Turkish Reform Proposal
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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 ones 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

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Example of Slovak Benefits
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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

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Internal Rate of Return for Different Individuals
in Slovak Republic
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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

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Example from OECD countries, Pensions at a Glance
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Pensions at a Glance
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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

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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

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Countries Using PROST
Countries with PROST licenses as of July 2005
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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

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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

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Benefit-Incidence Not That Useful