Key Social Security Policy Choices in Thailand

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Key Social Security Policy Choices in Thailand

• by
• Estelle James

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Key policy choices that affect sustainability,
equity, growth

• Structure
• Pay-as-you-go (PAYG) or funded (FF)?
• Defined benefit (DB) or defined contribution
  (DC)?
• Public or private management?
• Substance
• What is the target replacement rate?
• What is the normal retirement age?
• How much and what kind of redistribution?
• How much coverage?

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1. Pay-as-you-go (PAYG) v. Funding (FF)

• Most industrialized countries have PAYG systems
  Workers (W) contribution today is used to pay
  pensioners (P) today.
• Required CR (RR)/(W/P) where CR contribution
  rate, RR replacement rate, W/P support ratio

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Example of PAYG

• Assume
• promised benefit (RR) 40 wage
• System is new populations young, W/P 8.
• So each point of CR yields 8 points RR.
• Then 40 RR requires 5 CR (Thailand today has
  even higher W/P, lower CR--new system)
• But
• As populations and system age, W/P 2.
• So each point of CR yields 2 points RR.
• Then 40 RR requires 20 (Thailand 2030?)
• In long run W/P lt 2, each point CR yields lt 2

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Advantage of PAYG system

• Low contribution rate needed in early years. Easy
  to pay current generation of retirees, and they
  get benefits that far exceed their contributions

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Problems with PAYG systems

• Non-sustainable Initial low CR is deceptive
  because few retirees, but high contribution rate
  needed as system matures and populations age.
• Equity first cohorts get large redistribution
  (BgtC), later cohorts lose
• Security Overly generous benefits promised at
  first, but high political risk promises may not
  be kept in future because of high costs

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PAYG Problems (Contd) Impact on economic growth

• High payroll tax later may decrease formal sector
  employment and income
• Initial transfer decreases national saving
• Hidden implicit pension debt (IPD)
  accumulates--present value of obligations to
  workers (figure)
• Future burden may be shifted to governments
  budget, less resources for other services

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Implicit Public Pension Debt, 1990
Explicit debt
Canada
Implicit public pension debt
France
Germany
Italy
Japan
United States
0
50
100
150
200
250
300
Percentage of GDP
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Fully funded systems

• Assets are accumulated to match liabilities, and
  earn interest, so no IPD, unaffordable promises
  or inter-generational transfers
• Can be used to increase sustainability, national
  savings and growth
• Requires higher CR initially, much lower CR
  later that is why many countries are moving
  toward pre-funding
• But financial market risk--so fund management
  and investment choice is crucial

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Example FF system

• If funds earn 5 interest, each point of CR
  yields 6 points of RR, so 40 RR requires only 7
  CR while PAYG in long run would require gt 20 CR
• Rate of return is crucial Suppose worker works
  40 years, retires 20 years, wage growth2,
  CR10.
• Then If r 2, RR 25,
• 4 44
• 5 60
• Each interest point raises RR 10-15 percentage
  points
• If r gt 2, FF costs less or gives higher benefits
  than PAYG in long run

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Contribution rate required to pay replacement
rate 40 under PAYG funding
Contribution rate
Workers/pensioners
Assumptions rate of wage growth 2 r net rate
of return for funded plan Pension is
indexed worker works 40 years, retires for 20
years
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2. Defined benefit (DB) v. Defined contribution
(DC)

• In DB benefit depends on number of years worked
  and wages per year, according to formula
• In theory--benefits are guaranteed
• but in practice promises too generous, not kept
• In theory--could penalize early retirement
• but in practice usually doesnt
• In theory--provides safety net to low earners
• but in practice high earners often benefit the
  most
• DB pillars in L. America, Ireland, Switzerland,
  HK redistribute to low earners in different ways

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Defined contribution plans (DC)

• Contribution is specified retirement income
  depends on accumulated savings interest
• Close link between benefits and contributions
• No hidden redistributions to high earners
• but other safety net is needed for low earners
• Rate of return determines accumulation, pension
• so high rate of return important, benefit
  uncertain
• For company plans--DC more portable than DB
• Provident funds in Thailand are DC What is rate
  of return? expected benefit? Are funds portable?
  are annuities available? Where is social safety
  net?

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Questions for new Thai plan

• SustainabilityThailand recognizes need for
  pre-funding. New DB system is partially funded
  at first--but becomes PAYG as soon as workers
  start to retire. By 2020s system will run
  deficit.
• How much will contribution rate rise in future,
  how much will benefit rate fall?
• Equity How much will present generations gain,
  future generations lose?Where is social safety
  net?
• Growth What is impact on employment,
  formal-informal sectors, retirement age, long
  term saving? Will large IPD build up, become govt
  burden?

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3. Public v. private management?

• Crucial question if funds are accumulated, how
  will they be managed and invested?
• Empirical evidence shows private competitive
  management earns higher return than public
  management--portfolios are diversified, economic
  rather than political criteria determine
  investments
• New plans in Latin America, Hong Kong use private
  management Ireland is trying to insulate public
  funds from political control

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Funded plans in Thailand

• Crucial question for Thailand--how will provident
  funds, public employees pension fund and
  partially funded DB plan be invested?
• Will they maximize return and productivity?
• How will private funds be regulated?
• How will public funds be insulated from political
  manipulation?
• Dilemma build-up of funds in new DB plan and GPF
  can reduce required CR in future, but increase
  political manipulation. Can private competitive
  management prevent this?

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International experience

• In next few days we will discuss how many
  countries --Hong Kong, Singapore, Malaysia, Latin
  America, Switzerland--have handled questions of
  funding v. PAYG and how to manage
  funds--advantages and problems of each system--to
  help analyze what is best system for Thailand

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4. What is the target replacement rate?

• Replacement rate (RR) tells how large pension is
  compared with wage level
• Higher RR requires higher CR--so trade-off
  between consumption when young and old
• Young have children, work expenses
• Rule of thumb mandate 40-50 RR, those who want
  more can save more, redistribute to poor. Many
  countries pay pensioners more, but this costs
  more when young

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Replacement rate in Thailand

• New DB system provides RR 35 for worker with
  35 years contributions
• This is modest benefit but in medium term will
  require gt20 CR if PAYG
• Below poverty for low earners
• Should RR be raised, espec for low earners?
• Or should PAYG part be reduced and part of burden
  shifted to funded plan? If PAYG RR were 20 and
  funded plan provided 20, this would cut long run
  CR to 14 instead of 20.
• Funded part second pillar of multi-pillar
  system--we will discuss further.

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5. Normal retirement age

• Retirement age has big effect on pension fund and
  economy
• Impact on required CRSuppose PAYG, stable
  population, people start work at age 20, die at
  80, RR 40
• if retirement age 60, W/P 2/1, CR 20
• if retirement age 65, W/P 3/1, CR 15
• Later retirement age decreases CR, increases
  experienced labor force, GDP, growth

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Retirement age in Thailand

• Currently retirement age in Thai system is 55, no
  actuarial penalty for early retirement or reward
  for postponed retirement. This raises dependency
  rate, CR, lowers RR
• Workers in formal sector, covered by social
  security, live longer than average
• Does Thailand want to keep low retirement age, or
  to raise benefits, or to cut long run
  contribution rate instead? Early retirement is
  very costly, to the system and economy

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6. What kind of redistribution?

• Should social security be redistributive or tie
  benefits to contributions? If redistributive,
  toward whom?
• Most analysts say close benefit-contribution link
  (DC) reduces work disincentives but safety net
  for low earners should also be provided (well
  structured DB)
• In new Thai DB plan chief gainers are high
  earners, early retirees, first cohorts to retire
  no safety net
• Noncontributory means-tested scheme targeted
  toward rural poor
• Is this the redistribution you want?

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7. Coverage by contributory system--how fast to
increase?

• Currently only 25 of labor force covered
• Important to expand. How fast? Expand when
• Inclusion will make workers better off, not worse
  off low earners may be better off with more
  take-home pay, family system for old age
• System is sustainable, equitable, good return
• Government has capacity to monitor
  compliance--avoid culture of evasion
• Public program wont crowd out family system

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Policy choices for Thailand

• Aging rapidly, needs economic growth
• How high total replacement rate and how much from
  PAYG v. funded, DB v. DC, public v. private
  management?
• How should pension funds be invested?
• How can public funds be insulated from political
  manipulation?
• How should private funds be regulated?
• What should normal retirement age be, how to
  discourage early retirement?
• How to target redistributions and how fast to
  increase coverage?
• Answers determine sustainability, equity, growth