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Public Pension Problems an International Issue

For all the dire predictions about the fiscal health of the U.S. Social Security system?see "Social Security 101" elsewhere in Stable Times?the program is in better shape than many of its counterparts in other parts of the world. Italy, for example, has an unfunded retirement plan liability equal to about 400 percent of its gross domestic product. Much of Europe is in similar straits. By comparison, the unfunded liability of the U.S. Social Security systems is about 150 percent of GDP, according to Richard Hinz, a pension advisor for the World Bank and former director of the Office of Policy and Research for the U.S. Department of Labor's Pension and Welfare Benefits Administration. Thanks to the widespread problems, he says pension reform has become a worldwide phenomenon. And while some common approaches have emerged, he says different countries have experienced much different outcomes.

Hinz told the SVIA Forum that typical problems with public pension systems around the world include an inability to deliver the expected benefits, uneven and unfair distribution of costs and benefits, and poor management of assets, particularly in the developing world. Successful reforms are important, he said, not only because of moral imperatives but because the burden of meeting the needs of the elderly can make other social objectives unaffordable and lead to macroeconomic instability, as it did in Brazil in 1998.

At the root of many countries' pension problems, Hinz said, are rising life expectancy rates and declining birthrates that are converging to replacement levels. With more elderly and fewer people of working age, it becomes increasingly difficult to sustain pension systems, especially those like Social Security which operate on a pay-as-you-go, or PAYGO, model, meaning that current workers pay for the benefits of today's retirees.

Several types of reforms are options for troubled retirement systems, Hinz says. They include changing the provisions of the existing system, which he calls the "facelift" of pension reform?pushing out the retirement date, for example, or reducing benefits. Other reforms including transforming from a PAYGO defined benefit system, such as the Social Security system, to a defined contribution type of plan; privatizing some elements of the plan, such as asset management or recordkeeping; and diversification of the plan into multiple "pillars," each representing a different level or type of benefit. Such pillars might include non-contributory social assistance for the lifetime poor; a publicly financed and managed pay-as-you-go system to provide basic income protection; a mandatory funded individual account system with a direct link between contributions and benefits; voluntary retirement savings, either individual or occupational; and family and intergenerational support for the elderly. Different combinations of pillars can work, Hinz said, depending upon the characteristics of the country involved.

Australia, which has one of the developed world's best-funded (though not debt-free) pension systems, offers a means-tested minimum benefit to provide a retirement safety net for the country's poor, and requires employers to make mandatory contributions to a defined contribution plan set up for workers. With no explicit licensing process, many types of investment funds are available in that country: employer-sponsored funds, individual or collective arrangements and retail funds.

Sweden, which also has a relatively healthy national retirement system, several years ago replaced its PAYGO defined benefit system with a PAYGO "notional defined contribution" or NDC system in which 16 percent of workers' wages are credited to individual retirement accounts. Another 2.5 percent of wages goes to fund individual retirement account. Benefits are paid out as annuities. Other countries that have reformed or are reforming their retirement programs, Hinz said, include Kazakhstan, Poland, Mexico, Hong Kong, the United Kingdom, China, Russia, Brazil, India and Nigeria.

Hinz said the changes rippling through the pension world present opportunities for the global pension industry, though some will be challenging. For example, he says, there are few passively managed index funds for emerging markets, but only because developing them in thin and volatile markets is difficult. Similarly, many countries have pension systems that don't allow for retail products such as those developed in the US for 401(k) plans; instead, asset managers will have to develop wholesale products which may be sold only through a competitive licensing process. In addition, many countries have undertaken reforms that require the issuance of full or partial annuities at retirement age, but do not have markets in place to provide them. He also noted that it will be a challenge for annuity providers to get a handle on mortality rates in many developing countries. In developing countries, fixed-income instruments with durations beyond three to five years are also rare.

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