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Business Development Global Pensions 2005

Business Development Global Pensions 2005. 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:

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Business Development Global Pensions 2005

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  1. Business Development Global Pensions 2005

  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 world II 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 • Europe • Hungary • Czech Republic • Slovak Republic • Romania • Greece • Ukraine • Russia I • The World Bank model • Leading role pension models compared to the World Bank model: • Chile • US • Poland** • Netherlands • UK • Sweden * • Australia • Main characteristics of other country’s pension systems II • Country pension system summary • System characteristics • Investment guideline • Regulation and supervision • Macro economic impact * • System pros and cons** III • Asia • China • Korea • Latin America • Mexico • Brazil • Peru • * Only applicable to countries recently reformed • **Only applicable to *marked countries

  4. The World Bank model (classic definition) Publicly funded schemes, social security schemes Employer sponsored schemes or private mandatory programs Additional voluntary arrangements I II III STATE MANDATORY VOLUNTARY • Government is responsible for adequate safety net via Pillar I • Private sector plays key role in building Pillars II and III • Growth will mainly be in Pillars II and III • Public/private partnership is essential

  5. Pensions as economic growth engine Advantages of multi pillar-system: • Proper financing of old age provision • Boosts economic growth • Contributions are invested back into the economy • Accelerated development of local capital markets • Shared responsibility by government, employers and individuals • Strongly recommended • World Bank / OECD • European Union / ILO • Tax support • EET I II III STATE MANDATORY VOLUNTARY

  6. A new perspective on World Bank pension model • New definition on pension model, by World Bank (according to the study in February 2005 • Social 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 companies • Only active in Pillar I, II & III • Pillar I: institutional asset management (potentially) • Pillar II: pension fund management • Pillar III: same as pillar II 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 • Europe • Hungary • Czech Republic • Slovak Republic • Romania • Greece • Ukraine • Russia I • The World Bank model • Leading role pension models compared to the World Bank model: • Chile • US • Poland** • Netherlands • UK • Sweden • Australia • Main characteristics of other country’s pension systems II • Country pension system summary • System characteristics • Investment guideline • Regulation and supervision • Macro economic impact * • System pros and cons** III • Asia • China • Korea • Latin America • Mexico • Brazil • Peru • * Only applicable to countries recently reformed • **Only applicable to *marked countries

  8. CHILE I. Chile Pension System compared to World Bank (summary) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) CHILE III I II STATE MANDATORY VOLUNTARY Pension System • Old State System (PAYG) • Compulsory for the Armed Forces and old labor force without Past Service Bonus. • Contribution levels higher than new private system • Private Pension System (AFPs) • Compulsory for new labor force (since 1.5.81): 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 age • Self employed and other groups • Voluntary retirement savings plans/products (APVs) • Government subsidizes through tax reduction Major Issues • Not applicable, pillar phasing out • Although 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 profitability • Lack of savings culture / high cash culture • Lack of tax incentives Recommenda tions • Not applicable, pillar phasing out • Increase the coverage and the investment range abroad • Mandatory contributions for self-employed • Separate disability and pensions coverage • Introduce savings alternatives (401Ks, APVs) • Increase awareness and information available regarding the private system

  9. CHILE 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 industry • At the end of 1981, there were 12 competitors • There are 3 types of competitors: • National equity • National - Foreign equity • Trade union equity

  10. CHILE 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 market • Stock companies • Superintendence of Securities and Insurance • Custody of titles and securities • Introduction of fixed income securities able to compensate for inflation 2. Investment Alternatives: • State-issued securities for pension funds & insurance companies • Pension funds were entitled to purchase fixed income instruments issued by banks and financial institutions and other private issuers • Pension 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: • Issuer • Types of instruments • Terms • Risk level and categories • A Risk Assessment Commission was established

  11. CHILE II. System characteristics Pillar I • Old State System (PAYG) • Compulsory for the Armed Forces and old labor force without Past Service Bonus. • Contribution levels higher than new private system Key issues • Not applicable, pillar phasing out

  12. CHILE II. System characteristics Pillar II • Mandatory pension funds (substituting Pillar I), which are privately managed and invested. AFPs in charge of underwriting and investing. • Compulsory for new labor force (from 1.5.81): 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 age • Also coverage for Disability and Survivors Pensions • LEGAL RETIREMENT: • 65 years for men and 60 years for women • The pension amount is calculated based on: • Accumulated Savings: Pension Fund + Past Service Bonus + Voluntary Savings Acc’t • Life expectancy of the worker and of his family group • EARLY RETIREMENT: • 110% Legal Minimum Pension • 50% Inflation-adjusted income of last 10 years (August 2004, > 70%) Key issues • Although 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. CHILE II. System characteristics Pillar III • Self employed and other groups • Voluntary retirement savings plans/products (APVs). Government subsidizes through tax reduction Key issues • Lack of savings culture / high cash culture • Lack of tax incentives

  14. CHILE III. 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 participants • AFPs 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 A • Pensioners can not choose Funds A and B • Default allocation (when no choice made by the participant) will be as in table 3 table 1 • AFP’s can not: • Buy low liquidity assets • Manage other portfolios • Act or fail to act in a manner required by law • In 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 process table 2 table 3

  15. CHILE IV. Regulation and Supervision (1/2) REGULATION: 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 formation • Shareholders’ 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) Responsibilities • Enroll new workers and accept members transferred from other AFP’s • Collect monthly contributions from employers • Legally enforce payment of unpaid contributions • Identify/keep record of contributions of each member • Credit contributions to each member’s individual investment-based account • Invest pension fund assets • Inform members every four months - and upon request- about their individual account status and about commissions charged

  16. CHILE IV. Regulation and Supervision (2/2) SUPERVISION: • The AFP Superintendence supervises and controls the Fund Administration Companies (AFPs) as established by law • Functions: • Authorize AFP formation and keep record of them • Oversee AFP’s operations and the granting of benefits and services given to its members • Oversee pension funds’ investment of assets • Set and provide interpretation of rules and regulations for the pension system • Advise the executive power (via the Labor and Social Security Ministry) on pension-related issues and propose legal reforms leading to system enhancement • Apply 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 exist • Settlement of the AFP and its funds, when applicable

  17. CHILE V. Macro-economic impact 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) Impact on the economy: • THE TOTAL ASSETS MANAGED BY PENSION FUNDS EQUALS: • 52% OF GDP • 100% OF TOTAL EXTERNAL DEBT • 2 TIMES TOTAL ANNUAL EXPORTS

  18. US I. US Pension System compared to World Bank (summary) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) US III I II STATE MANDATORY VOLUNTARY Pension System • State System (PAYG) • First and current law: 1935 (with numerous amendments).Type of program: Social insurance system • No mandatory system • Employer related: • DB and hybrid plans • DC: 401K, 403B,457, SEP, Simple, Sarsep • Personal savings: • IRA – traditional, roth • Annuties • Mutual Funds • Brokerage Major Issues • Funding issues under debate. New proposal under Bush reform looking at Individual Pension Accounts (similar to Chile/Lat Am) • n/a • DB: Declining due to move to individual funding, regulatory complexity and cost • DC: Continued expansion in competitive environment, with strong “takeover” element • Exploding IRA market • Improving tax incentives for long term savings and investments

  19. US System characteristics: Pillar I • Coverage • Gainfully 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 1984.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 Funds • Insured 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 Conditions • Age 65 (62-64 with reduction); gradually increasing to 67 over period 2000-27. • Old-Age Benefits • Based 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 1981.Maximum $1,373 a month for workers retiring at age 65 in 1999.Increment for each month worker delays retirement at ages 65-69.Increment amount depends on the year the worker reached age 62, and is 5.5% per year for those age 62 in 1999.Adjustment: Automatic cost-of-living adjustment.

  20. US System characteristics: Pillar I – Reform proposal Current 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 - 2009 - 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 liabilities • Market values will be used for assets • 7 year amortization period for funding shortfalls • Employer can make additional deductible contributions in good years • Disclosure to participants will be improved • Premiums will better reflect plans risks and restore the health of PBGC Main 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. US System characteristics: Pillar II • Currently no mandatory system in place

  22. US Distribution of Retirement-Oriented Assets¹ 14% Annuity 7% Contributory IRA 16% Defined Benefit 20% Defined Contribution 18% Rollover IRA 17% State/Local Govt 8% Federal Government 1Estimates from Flow of Funds Accounts of the US System characteristics: Pillar III • Employment Based: • DB • DC: • 401 (k) • 403 (b) • 457 • Non Employment based: • IRA

  23. US • System characteristics: Pillar III - DC Sponsors • Deductibility of contributions as an expense • Competitive advantage • Attracts quality employees • Cost savings - retention tool (vesting schedules) • Stimulate economic growth - promotes long term savings • Socially responsible to encourage retirement saving • Shifts responsibility for retirement to the employee 401(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 - DC Fixed Investments, Mutual Funds, Employer Stock, Stocks/Bonds, Cash • Participants • Pre-tax contributions - lowers current taxable load • Tax deferred earnings • Diversification of assets • Ease investing and long-term savings • Potential matching employer contributions • Not taxable until distributed (normally at retirement when at a lower tax bracket) • Portability • Ownership of their retirement savings • Catch up contributions

  24. US • System characteristics: Pillar III - IRA • IRAs 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. US III. Investment guidelines • US Regulation of pension fund assets

  26. US IV. Regulation and Supervision • The 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. • NASD • SEC • State Insurance Department • State Attornies General • Due 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. POLAND I. Poland Pension System compared to World Bank (summary) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) POLAND III I II STATE MANDATORY VOLUNTARY Pension System • PAYG scheme • However, benefit consists of 2 components: • a. Notional accumulation of contributions in individual accounts • b. The accrued DB pension right (at the time of reform) is converted into a notional lump sum value and “credited” to the individual • Contribution is 19.52%, equally split by employers and employees • Only 12.22% is contributed to Pillar I, if individual is eligible and elects to join a pillar II fund • Remaining 7.3% is contributed to pillar II • Mandatory, open end pension funds • Managed by private pension fund companies • At retirement, accumulated benefit will be transferred to annuity • First benefit payout is expected to be in 2009 • Members have free choice of pension fund provider • Transfer between funds are permitted, but only one pension fund at a time • A custodian bank has to be used, for which 10 – 12 bps is paid • For self employed, a minimum contribution required and can be split between pillar I and II • Voluntary, additional employer contribution to corporate pension fund • Limited take up rate as employers view this is an extra labour cost • 7% payroll tax deduction • Market perception that tax incentive too low • Individual retirement account (IKE) • Tax qualified long term savings products • Early withdraw tax penalty applied • Life insurers, mutual fund managers, banks and brokerage firms • ZUS, an effective, centralised administration system, however, room for improvement • Delayed 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 Major Issues

  28. POLAND II. System characteristics: from mono to multi pillar systems in 1999 • Mandatory, reformed PAYG, DC system • PAYG: current pensions are financed by current contributions paid by employees and employers • Individual account, DC system: previously accrued defined benefit pension rights “credited” to a notional individual defined contribution account • Contribution is paid by employee • Old age pension contribution is part of the social security contribution, of which • 19.52% of earnings paid to old age pensions – equal contribution from employer and employees • 13% for disability – equal contribution from employer and employees • 1.93% work injury, 100% paid by employer • 2.45% sickness, 100% paid by employee • Old age pension contribution is split into 2 parts • 12.22% is paid to finance the current retirees • 7.3% is for individual account (II Pillar) • Benefit 2 components • Pillar I: accrued DB benefits before reform + accrued DC benefits on 12.22% contribution, both are notional • Pillar II: accrued assets from individual account, DC • Pension reform bill passed by parliament in 1998, scheduled for implementation in January 1999 • Actual implementation started 1 March 1999 • Before pension reform, state pension liability is 462% of GDP • 2004, pension liability is 194% of GDP • 2010, system is projected to be in surplus • Pension 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. POLAND II. System characteristics - general • Mandatory, funded system • Eligibility: • Compulsory to all employees born after 1969 • Born before 1949 had to remain in the old system • Born between 1949 – 1969, have a choice of joining pillar I or II • Free member choice of fund • Employers 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 fund • Effectively only 7.3% is contributed to the individual account • Open-ended pension funds, managed by private pension fund managers • 16 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 accounts • Total assets: +€ 11 billion, end June 2004 • Insurance companies, banks, security / brokerage firms can apply licence to set up pension fund entity • Pension 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. POLAND II. System characteristics - Administration • One centralised administration body – ZUS • Employer pays both employee and employers contribution to ZUS • Individual 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 funds • Collect information / money  reconciliations  a. pass money to custodians; b. information to fund managers • Key issues • Too short preparation time: legislation passed in 1998, actual implementation 1 March 1999 • Inaccurate form completion by employers resulted in unmatched contributions • Education for employers took over a year

  31. POLAND III. Investment guidelines (1/2) • Majority of investments to domestic capital market • Regulation sets maximum 5% limit on off shore investment • In 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 fees • Upfront 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 fund • For customer & agent, restriction simplified the choice and education process • However, from fund managers’ point of view, this restriction limits the investment return • Fund managers keep record of accounts for each member, member information access through: • Internet, call center, ATM or SMS

  32. POLAND III. 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 fund • 40% in quoted stocks • 10% in secondary stock • 10% in treasury bills • 10% in NIFs • 15% in municipality bonds • 10% in close ended investment funds • 15% in open ended investment funds • 20% in banks and bank groups • An industry guaranteed fund to recover losses from fund managers, in the event of bankruptcy • Effectively, the fund managers are paying for the industry losses • No investment in real estate • Numerous diversification requirements, ie., • no more than 10% of assets to be invested in a single kind of securities • Investment in bonds, or stocks should be <=5% of assets in one issuer • Asset 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 market • Increasing demand for IPO to increase the size of the market

  33. POLAND IV. Regulation and supervision • Insurance and Pension Funds Supervisory Commission supervise: • Open pension funds • Employee pension fund (non-profit) • The commission consists of 5 members: • Chairman of the commission appointed by Prime Minister • Deputy Chairman appointed by Ministry of Finance and Ministry of Labour • Member of the commission: chairman of the security and exchange commission or his deputy • Member of the commission: chairman of the competition office or his deputy • Government 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 funds • New draft law yet to be sent to parliament

  34. POLAND IV. Regulation and supervision • Clear division of rules • Custodian, administration and pension fund managers • Member information clear and easy accessible published regularly in the newspapers as net of fees • Pension 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. POLAND V. Macro economic impact • Reduced pension liabilities • Until 2005: before reform, 462% of GDP vs. after reform, 150% of GDP • 2050, pension expenditure will drop from one of the highest in Europe to one of the lowest • Transfer of a portion of contributions to funded pension scheme is not a cost • It reveals a portion of the implicit debt • It reduces future public finance obligations • Increased funding requirements can be offset by higher debt, purchased by pension funds • Pension funds assets invested into equities stimulate investment and economic growth • It is better to turn a portion of pension liabilities into savings now than to have much greater problems with redeeming such obligations in the future • Expenditure and revenue of the pension system • 2049, pension system surplus

  36. POLAND VI. Polish pension reform pro’s and con’s Pro’s Con’s • Mandatory, big bang pension reform • Simple & transparent: • Individual account makes it easier to understand– amount an retiree receives equals to accumulated contribution value, enhances personal interest and accountability • Separate old age pension from other social security contribution – transparent and easy to understand for individual • Defined contribution system makes it easier for people to understand  increase the confidence level • One investment fund per pension fund makes it easier to understand • Few, but smart regulations to protect member rights • Maximum asset based fees, no contribution fee • Industry average investment return as a benchmark, low performer has to pay penalty • Dis-encouraged to take high risk investment • One centralised administration system allows efficient collection and administration, also saves cost • Media attention and support helped people to understand • Lack of investment options to sustain a long term high rate of return • Limited solutions to channel pension fund assets into long term investment • Pension fund investment over reliance on domestic capital market • Limited investment option when the capital market is small (limited supply of financial instruments and resources) and illiquid • Over complicated regulations and international charges limited pension fund overseas investment

  37. Netherlands I. Dutch Pension System compared to World Bank (summary 1/2) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) Holland III I II STATE MANDATORY VOLUNTARY • Basic old age pension (AOW) • PAYG • Universal: system applicable to all residents and flat rate benefit • Minimum guarantee to prevent poverty (70% of minimum wage) • Build up phase: 15 – 65 years • In 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 assistance • Employer sponsor, occupational pension schemes, voluntary • However, +90% employed participated in an occupational pension scheme • Including AOW benefit, the total replacement ratio is aimed at 70% of individual final, or average salary) • Pension payout • Early retirement is possible • 4 types of pension funds • Industry-wide • Company • Insurance contract • Pension funds for self employed professionals • DB (88%) and DC plans Major Issues • Ageing population created future pension deficit in Pillar I • An AOW savings fund created to finance part of the (AOW) expenditure in future • Government deposits tax revenue to the fund on annual basis • Over funding requirements (strict solvency) by regulatory commission puts pressure on industry players • Current solvency margin still healthy (at 110%), however, is historically low compared to before crisis (at 150%) Recommendations • Allow pension funds time for recovery – short term underfunding, long term financial sustainability

  38. Netherlands I. Dutch Pension System compared to World Bank (summary 2/2) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) Holland III I II STATE MANDATORY VOLUNTARY • Basic old age pension (AOW) • PAYG • Universal: system applicable to all residents and flat rate benefit • Minimum guarantee to prevent poverty (70% of minimum wage) • Build up phase: 15 – 65 years • In 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 assistance • Individual pension arrangement • Annuity and endowment insurance • Premium contribution tax deductible • Annuity 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 ceiling Major Issues • Ageing population created future pension deficit in Pillar I • An AOW savings fund created to finance part of the (AOW) expenditure in future • Government deposits tax revenue to the fund on annual basis • Tax legislation is very influential • Both Pillar II & III applies EET Recommendations

  39. Netherlands Holland II. System characteristics Source: OECD, Please note: OECD definition is used in this table: 2 pillar reflects employer sponsored pension schemes

  40. Netherlands Holland II. 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 annum • Contribution are collected through tax bureau for which the tax bureau will automatically transfer the money to SVB • In 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 2030 • Administration: Social Verzekerings Bank (SVB) • An central administrative body set by the government • Non-profit organisation • Day-to-day operation independent from the government • Board of Directors manages SVB, in consultation with board of advisors • SVB responsibility: collect premiums and distribute to individual (amongst others, old age pension benefits) • Supervisory body and process • Ministry of Social Affairs and Employment (SZW) appoints members of SVB Board of Directors & Board of Advisors • SZW supervises SVB through regular inspections • Investment: • Currently, minimum capital surplus, hence NO investment management • However, AOW savings fund is managed by Ministry of Finance

  41. Netherlands Holland II. System characteristics: Pillar III Occupational pension scheme • At 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 mandatory • 14% of all the branch funds are fully re-insured • Usually insurance companies or large specific sector based pension funds provide administration • Sector based pension funds refer to, for instance, civil servants pension funds (ABP) or health sector (PGGM) • Company pension funds • Larger enterprises usually administer own company pension fund • The company pension fund is not allowed to invest more than 5% of the assets in the employer’s company • Presently, 44% of these funds are fully reinsured • Insurance companies (direct insurance) • Through group or individual contract • Administered by life insurance companies

  42. Netherlands Holland III. Investment • Follow prudent man rule – pension fund investment has to according to prudent pension principal • Pension regulator (PVK) judges each pension individually on its investment policy • In case reserve shortage, PVK sets the rule to repair the shortage, See regulation slide for further explanation • No quantitative regulations on investment • Worries that it will penalise the providers’ profit • However, Financial Testing Framework applied to each pension fund to achieve required security both affordably and efficiently • Each fund being judged on individual basis • Free to invest in any asset class • Free to invest off shore • Traditionally very strict solvency rule (150%) • However, due to recent stock market developments, the solvency ratio has been reduced to 119%

  43. Netherlands Holland IV. 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 covered • Government safeguards accrual of supplementary pension entitlements and offer tax relief in both Pillar II and Pillar III pension schemes • Regulatory framework • Pension 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 company • Laid down institutional framework for pension schemes • Act Bpf 2000 • A branch pension fund may request the government to impose an obligation to its employers and employees to participate in the branch fund • A branch pension fund is set up through employers’ organisations and trade unions

  44. Netherlands Holland IV. Regulation and supervision (2/2) • One super-regulatory power • Recently merged supervision activities of banking, insurance and pension fund • Former Pensions & Insurance Supervisory Board (PVK), currently a division under super-regulator, supervises / regulates pension funds and direct insurance • Regulatory principal • Pension reserve adequacy level (Solvency) to ensure long term financial sustainability • Minimum 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 – 20002 promoted new regulation: • Minimum level of guarantee for equity - at 40% below the highest point in the last 48 months • Minimum level of guarantee for bond - at 10% below the lowest in the last 10 months • Should a pension fund capital reserve is below the benchmark, the pension fund has 2 – 8 years to recover

  45. UK I. UK Pension System compared to World Bank (summary 1/2) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) UK III I II STATE MANDATORY VOLUNTARY • 3 components: basic state pension, State Second Pension (S2P)* & pension Credit • Employees (not self-employed) may chose “contracted-out” SSP into private occupational pension scheme, or “opt out” into Approved Personal Pensions • Minimum income guarantee, gross replacement only 37% of average earnings • Pension age man: 65, woman 60. Equalise at 65 from 2010 • Employer sponsored pension plan • Occupational pension schemes, non mandatory for both employer and employee. • However, it is very common, especially so in the larger companies • In a shift towards international accounting standard, more pension plans move from DB to DC, likely result in a reduced level of premium contribution • Earning related pension on top of being 20% of revaluated average earnings • Contracted out because of occupational pensions • 44 years in workforce needed for full basic pension • Provide least income to prevent poverty at age of retirement • Gross replacement rate very low: 37% at average earning in UK (same as the US), NL: 70%, Sweden: 76%, France: 71% Major issue * S2P previously is called State Earnings Related pension Scheme (SERPS)

  46. UK I. UK Pension System compared to World Bank (summary 1/2) WB Publicly financed plans, social security plans Employer sponsored plans or private mandatory programs Additional voluntary arrangements (possibly sponsored by Employer) UK III I II STATE MANDATORY VOLUNTARY • Individual pension plans • Traditional personal pensions, defined contribution schemes • 25% can be taken as a lump sum on retirement, rest as an annuity • Maximum contribution is € 5,450 a year • Voluntary contributions to private pensions based on occupational schemes (stakeholder pensions scheme) • Huge tax relief on voluntary pensions • Very large privately funded pension sector is available so difference between different income groups is very big. Mostly DB Major issue * S2P previously is called State Earnings Related pension Scheme (SERPS)

  47. UK II. System characteristics: general • Four 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 employers • Third pillar pension schemes established by private insurance companies • Underpinning 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 to • Too many people have difficulty adding on to their flat rate basic state old age pension • SERPS does not fundamentally solve the problems that low wage earners ending up with small pensions • Occupational and private pensions have tended to benefit the better off most • Government 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 spendings • Taxation 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 – 03 • Age 65 – 74 years old, GBP 6,100 income tax allowance per year • Age 75 plus, GBP 6,370 income tax allowance per year • If total income exceeds GBP 17,900, additional allowances are withdrawn at 50% of the expenses

  48. UK II. System characteristics – pillar I, state pension • 3 components: • Basic State Pension: • Flat rate payment • Full benefits only applicable for 44 years contribution • Basic pension for a single person is GBP79.60 per week in 2004. The amount is set annually and consumer price indexed. • State Second Pension (S2P): • Introduced in 2002, to replace the old state earnings related pension scheme • Aim is to provide a more generous scheme for low and moderate income group • S2P is for employee only, a quasi-occupational system • Ability to contract out • 87% scheme were contract out • If 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 payment • Pension credit: • Means tested benefit for pensioners , only meant for pensioners without other adequate sources of income or assets. Guaranteed minimum level is GBP105.45 per week for a single person • Key issue: • State pension become less generous: • 1998 / 1999, replacement ratio for man is 34% for a full social security contributions and 37% for worman • It declined to 25 – 28% in 2030 • “Savings gap” is rising

  49. UK II. System characteristics: pillar III – occupational private sector pension (1/4) • Four type of schemes • Occupational salary related (employer sponsored DB scheme) • Occupational money purchase (employer sponsored DC scheme) • Group personal pension • Individual personal pension • Low participation • 11.3 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 DC • Active membership of DB scheme has fallen by 60% since 1995 • In 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 decline • Contribution level at DB: 16 – 20% vs DC: 7 – 11% • Pension protection fund established to provide guarantees retirement payment in an event of bankruptcy Legal contract is in between individual and insurance pension providers

  50. UK II. System characteristics: pillar III – occupational private sector pension (2/4) • Characteristics of occupational pension schemes • Non-mandatory contribution • However, most large companies have pension schemes • Membership in mid-2000 is: 10.1 million, • 5.7 million in private sector • 4.5 million in public sector • The 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 2002 • Since 2001, mandatory for employers with 5 or more employees to offer stakeholder pension scheme • Employer contribution is not required • Take-up has been slow till now • Traditional schemes have been DB, guaranteed level related to final pensionable salary • 90%, or 4.6 million out of 5.7 million members are in DB scheme in 2000 • However, a strong tendency shifting from DB to DC since 2000, as an effort from employer to: • Contain costs and risks • Funding difficulties after the downturn of the equity market • Accounting issues • Longevity risk no longer bearable • To date, 36% DB plans are closed for new entrants, DC plans instead • If DC, contribution is much lowered (from 16% - 20% to 7% - 11%)

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