old age income support in the 21st century robert holzmann sector director social protection n.
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Old Age Income Support in the 21st Century Robert Holzmann Sector Director, Social Protection

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  1. Old Age Income Support in the 21st CenturyRobert HolzmannSector Director, Social Protection The Financial Sector Post-Crisis: Challenges and Vulnerabilities Brookings Institution, April 26-27, 2005

  2. Road Map • Background of Bank Report • Conceptual Underpinnings (excerpt) • Key components of reform direction • Goals of pension system and reforms • Criteria of for evaluation of reform proposals • The (net) benefits of funding • Design and Implementation Issues (excerpt) • Costs and fees – how to contain? • Readiness of financial market and minimum conditions? • How to regulate private and funded pillars? • How to provide retirement products? Enhancing Job Opportunities in ECA

  3. Key Components of Reform Direction • Type of Reform Necessity, such as • Short and long term fiscal pressure • Social-economic changes • Challenges and opportunities of globalization • Reform Design Options, such as • Parametric reform of existing system(s) • Fully market-based approach • Non-financial or notional defined contribution system • Public pre-funding of existing/reformed system • Multi-pillar reform • Enabling Environment, such as • Economic stability • Fiscal and administrative capacity • Readiness of financial sector • Commitment by government and main stockholders Enhancing Job Opportunities in ECA

  4. Goals of a Pension System and Reform • Primary goals: To provide adequate, affordable, sustainable and robust old-age income • Adequate refers to both the absolute and relative level (i.e. poverty alleviation and income replacement) • Affordable refers to the financing capacity of individuals and the society • Sustainable refers to the financial soundness of the scheme, now and in the future • Robust refers to the capacity to withstand major shocks, coming from economic, demographic and political risks • Secondary goals: To create developmental effects • by minimizing negative impacts (e.g. labor market) • by leveraging on positive impacts (e.g. financial market development) Enhancing Job Opportunities in ECA

  5. Enhancing Job Opportunities in ECA

  6. Criteria for Evaluation of Reform Proposal • Four primary content criteria • Does the reform make sufficient progress toward the goals of a pension system, and meet distributive concerns? • Is the macro and fiscal framework capable of supporting the reform? • Can the administrative structure operate the new (multi-pillar) pension system? • Have steps been prepared to establish to regulatory and supervisory arrangements and institutions to operate a funded pillar? • Three primary process criteria • Is there a credible commitment by government • Is there local buy-in and leadership • Does it include sufficient capacity building for implementation Enhancing Job Opportunities in ECA

  7. The (net) Benefits of Funding • Role of financial sector in growth, and role funding for pensions remains area of dispute • Scenario considerations to determine (net) benefit • Mature system operating (large) funded pillar (e.g. Australia, Netherlands, Denmark) • Mature system operating (large) PAYG (e.g. Germany, France, Italy, Japan) • Immature system with low coverage (as most developing countries) Enhancing Job Opportunities in ECA

  8. Mature system operating large funded pillar • Would these countries be better off by reducing their funded for an unfunded pillar? • Enhancing output (potential main benefit 1/3) • Through higher aggregate saving? • Seems to depend on mandating and institutional set-up • Narrow versus broad funding • Better inter-temporal government fiscal position? • Through improved labor markets? • Through contribution to financial sector development? • Dealing with population aging • Funding no panacea for aging but facilitates adjustment • Enhancing individual welfare • Better isolation against political risks (after Argentina?) • Individual choices (at which price?) • High rate of return (risk adjusted?) Enhancing Job Opportunities in ECA

  9. Mature and large PAYG system • Potential benefits still valid, but limited, while the transition costs may be too high for full reversal • Implicit pension debt (accrued to date liability) is some 20-30 times annual expenditure of GDP • But countries are reducing the public generosity, implicitly relying on two reactions by individuals: longer working and more saving Enhancing Job Opportunities in ECA

  10. Immature Systems with Low Coverage • Potential benefits are very high, in particular through labor market, savings and financial sector development effects • Coverage and hence implicit debt is relatively low in percent of GDP (but not in tax capacity) • But capacity to deliver on primary objectives may also be restricted Enhancing Job Opportunities in ECA

  11. Costs and Fees: How to contain? • High fees– irritation for supporter and central argument for opponents of funded schemes • Cost and fees seem to falling over time, but often still amount to a reduction in pension level of 30 and more percent (i.e. 150 on more basis points on assets) • Savings on administrative expenses (economies of scale and scope) through use of central clearing house (such as in Sweden) • Limiting of marketing costs through blind accounts or switching constraints • Limiting of asset management fees by restrictions on individual choice and, passively managed accounts, employers choice in provider, or competitive bidding of restricted number of asset managers • Decreasing costs, however, may no be sufficient as individuals seem to have a very low price elasticity of demand while providers (pension funds) seem to form oligopolistic structures (Chile has now 6 PF compared to prior 24). How to create regulated arbitrage? Enhancing Job Opportunities in ECA

  12. Readiness and Minimum Conditions • Not all countries are ready for funded provisions, but ideal conditions may not be needed • Polar cases of yes and no easily established, but more difficult for large grey zone • Which main criteria should be applied? • Level of per capita income as indicator for demand • Macroeconomic stability and credible macro policy • Sound banking system, government debt market, and? • Capacity and willingness to regulate pension institutions and products • How should the criteria be measured? Enhancing Job Opportunities in ECA

  13. How to Regulate and Supervise Private and Funded Pillars? • Experience in LAC and ECA in addition to OECD indicates less and more controversial regulation • General support for from “Draconian Rules” to gradual relaxation • Basic and largely uncontested regulation to be applied from the beginning, such as • Appropriate licensing and capital requirements • Full segregation of pensions assets from other activities • Use of external custodian and transparent asset valuation rules • More controversial rules include • Market structure and portfolio choice • Minimum funding standards for DBs • Minimum rate of return guarantees Enhancing Job Opportunities in ECA

  14. Regulation and Supervision - II • Non-controversial rules of supervision, e.g. • Need of independent, proactive, well-financed and professional staff in supervisory body • Vetting of application for licensing • Off-site surveillance and on-site inspection • More controversial rules and questions, e.g. • Single purpose (pioneered in Chile) or integrated supervisory agency • How to guarantee the independence of the supervisory • How to accomplish oversight and accountability of the supervisor Enhancing Job Opportunities in ECA

  15. How to Provide Retirement Products? • Focus so far on accumulation phase gives way to investigating the capacity of private sector to deliver appropriate retirement products (phased withdrawal, annuities, ?) • Work program of Financial Sector and Social Protection to review conceptual issues and experience • Is there a demand-side problem to explain annuity puzzle such as • Underestimating (remaining) life expectancy • Strong bequest motive • Incomplete insurance markets for other risks increase the marginal value of traditional (non-insurance) assets Enhancing Job Opportunities in ECA

  16. Retirement Products - II • Is there a supply side problem due to investment or longevity risk as appropriate assets to hedge these risks do not exist? • Can private sector fully insure investment and longevity risks at reasonable/competitive prices? • Is there a need to share the risk between individual and provider? • Does the government need to assume both main risks and be the final provider of annuities? • What type of providers should be allowed to offer annuities? • What kind of products should be allowed? • When must the private annuity market be ready? • Should there be price indexation of annuities? Enhancing Job Opportunities in ECA