Pensions Core Course 2013: Notional Defined-contribution Schemes
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This document summarizes pension reforms in Italy, Latvia, Poland, and Sweden that introduced notional defined contribution (NDC) pension systems. It outlines key features of the NDC designs such as individual accounts, contribution rates, retirement ages. It also discusses challenges faced by NDC systems including maintaining accurate individual account records, ensuring adequate replacement rates for low earners, and balancing pension costs with demographic changes. Overall the reforms aim to improve financial sustainability, fairness between generations, and transparency of pension benefits.
Pensions Core Course 2013: Notional Defined-contribution Schemes
- 1. Agnieszka Chłoń-Domińczak World Bank Pension Core Course, Washington, April 9th, 2013
- 2. Individual contributions are noted on individual accounts. ◦ NDC – contributions pay for benefits of current pensioners ◦ FDC – contributions are prefunded Accounts earn an “internal” rate of return: ◦ NDC – based on (nominal) covered per capita wage & covered labor force growth ◦ FDC – (nominal) financial market rate of return Retirement from any age after a minimum age. Life “annuity” based on individual’s account balance and cohort (unisex) life expectancy at retirement. Annuity rate of return (or indexation) ◦ NDC - based on (nominal) covered per capita wage & covered labor force growth ◦ FDC – based on the financial rate of return. 2
- 3. Individual accounts give transparency They state clearly the individual claim on aggregate liabilities. Intra-generational fairness A unit of contributions gives the same pension increment – same transfer of consumption from the present to the future - for all. Intergenerational fairness. Individuals in all generations pay the same rate on earned income into pensions. (The share of GDP going to pensions is the same over all generations.) Social policy through non-contributory rights e.g., for early years of childcare (financed with general revenues). Accounts can be shared between spouses/legal partners During the accumulation period and/or joint annuities can be created at retirement.
- 4. Basic equations At macro level: At individual level: 𝑃𝑒𝑛𝑠𝑖𝑜𝑛 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑒𝑛𝑠𝑖𝑜𝑛 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑎𝑔𝑒 × 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑛𝑠𝑖𝑜𝑛𝑒𝑟𝑠 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑤𝑜𝑟𝑘𝑒𝑟𝑠 𝑃𝑒𝑛𝑠𝑖𝑜𝑛 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 = 𝑖𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙 𝑝𝑒𝑛𝑠𝑖𝑜𝑛 𝑖𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙 𝑤𝑎𝑔𝑒 × 𝑝𝑒𝑟𝑖𝑜𝑑 𝑜𝑓 𝑟𝑒𝑡𝑖𝑟𝑒𝑚𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔
- 5. Italy, Sweden, Latvia and Poland
- 6. ◦ Two western European countries with: need to keep social expenditure under control with lower economic growth prospects population ageing ◦ Two transition economies with: the Latvian economy was turned upside down by the collapse of the Soviet system Inadequate and inefficient pension system inherited from the Soviet times, with widespread special conditions and early retirement provisions need to promote growth of the formal sector of the economy population ageing
- 7. Italy Latvia Poland Sweden Contribution rate on earnings 33% (employees) 20% (self-employed) 24% (atypical contracts) 20% 19.52% 18.5% NDC 33% (employees) 20% (self-employed) 24% (atypical contracts) 14% from 2012 12.22% From 2011: 17,22% 16.0% FDC Voluntary scheme 6% from 2012 7.3% From 2012: 2,3% going up to 3,5% 2.5% Occupational and voluntary schemes 20% of labour force in 2008 Yes, but very low coverage Yes, but very low coverage Yes, supplement under ceiling; whole benefit above Reform Overview - Overall DC framework and contribution rates
- 8. Credits for periods outside employment ◦ Differences in disability treatment ◦ Common recognition of unemployment, maternity and periods of care of younger children Inheritance gains (mortality credits) ◦ Sweden distributes to remaining active accounts ◦ Indirectly used to finance transition (to FDC, to cover for unbalanced PAYG expenditure) Notional interest rate ◦ Per capita wage in Sweden ◦ GDP growth in Italy ◦ Wage sum growth in Poland and Latvia
- 9. Country Oldest cohort covered Recognition of acrrued rights Italy initially mandatory for cohorts born after 1960, in 2010 expanded for older ones Two parts of pension: from old and new schemes Latvia all contributors covered from the beginning Re-computation of past contributions based on work histories Poland cohorts born after 1949 New pension calculated based on existing records, mixed old-new formula applied Sweden cohorts born after 1941 Initial capital based on old pension formula
- 10. Source: Jabłonowski and Müller (2013) based on 1% ZUS sample
- 11. Retirement age discussion continues… … but increase in participation rate expected. Continuing debate on retirement age: ◦ Italy: complex changes with final equal retirement age and increases linked to life expectancy ◦ Latvia: retirement age equalized at age 62 as a part of reform package. Present discussions of increase to 65. ◦ Poland: retirement age equalization and increase to 67 from 2013 to 2040 ◦ Sweden: incentives with NDC seem to help raising actual retirement age 0 5 10 15 20 25 Sweden EU27 Italy Poland 15-64 15-71 55-64 Source: Commission services, EPC. Estimated impact of pension reform on participation rates (2020), in percentage points
- 12. Close link between earnings and benefits – deviation at bottom and top of wage distribution Despite different role of pillars – relatively similar outcomes Italy Latvia Poland Sweden 0.30 0,99 1,08 0,96 1,04 0.50 0,75 0,80 0,74 0,79 0.75 0,75 0,80 0,75 0,67 1.00 0,75 0,77 0,75 0,64 1.50 0,77 0,73 0,75 0,81 2.50 0,78 0,70 0,77 0,88 Net replacement rates in the future by wage level Based on the OECD pension models
- 13. Source: The OECD Pension Models. -0.06 -0.04 -0.02 0.00 0.02 0.04 1 year 2 years 3 years Italy gross loss compensation -0.06 -0.04 -0.02 0.00 0.02 0.04 1 year 2 years 3 years Latvia gross loss compensation -0.06 -0.04 -0.02 0.00 0.02 0.04 1 year 2 years 3 years Poland gross loss compensation -0.06 -0.04 -0.02 0.00 0.02 0.04 1 year 2 years 3 years Sweden gross loss compensation
- 15. ◦ Latvia Reduced FDC contribution Reduced newly granted early retirement pensions ◦ Poland – good economic performance with maintained small GDP growth but high budget deficit Social Insurance Fund deficit covered with commercial loans and state budget loan – SIF can also borrow from Demographic Reserve Fund Demographic Reserve Fund finances part of expenditure Reduced FDC contribution Increase of retirement ages as a long-term change agenda ◦ Sweden Automatic balancing mechanism initiated Negative indexation of benefits ◦ Italy No specific adjustment Risk of future ad hoc measures?
- 16. Source: Jabłonowski and Müller (2013)
- 17. Source: Jabłonowski and Müller (2013)
- 18. Source: Jabłonowski and Müller (2013)
- 20. NDC formula uses life expectancy for the entire population Risk of bias if the system covers only the part of workforce ◦ Deficit in the financing if actual life expectancy of the covered group is higher than for the entire population
- 21. DC systems both nonfinancial and financial have strong link between lifetime earnings and pensions Risk of low pensions for people with shorter working careers and low wage levels
- 22. NDC system requires maintenance of individual accounts ◦ For the entire working population ◦ For long periods of work ◦ Contributions that are not assigned and not registered and do not increase individual’s pension rights. This requires: ◦ Prepared social security administration ◦ Well-designed communication channels between all stakeholders: social security institutions, employers, banks and individuals ◦ Good quality unique ID numbers Revision of existing numbers (if exist) Establishing a new one (costly and complicated)
- 23. Regularly revised life expectancy information Indexation information: ◦ Wage growth and labour force growth Record keeping
- 24. Quality of information must be assured All participants are equally responsible for adequate performance of the system Computer system is important…. …. as well as system managers Proper identification should be ensured Procedures should be designed to avoid errors
- 25. 70% 80% 90% 100% Septem ber2001 D ecem ber2001M arch 2002 June 2002 Septem ber2002 D ecem ber2002M arch 2003 June 2003 Septem ber2003 D ecem ber2003M arch 2004 June 2004 Identification of employers Identification of employees Formal control Identification of payments Overall efficiency
- 26. Simple and understandable message to individuals Annual pension statements On-line access to the OA account
- 28. Country 2010 2020 2040 2060 Change 2010-2060 Italy 15,3 14,5 15,6 14,4 -0,9 Latvia 9,7 7,3 6,3 5,9 -3,8 Poland 11,8 10,9 10,3 9,6 -2,2 Sweden 9,6 9,6 10,2 10,2 0,6 EU27 11,3 11,3 12,9 12,9 1,5 Source: 2012 Ageing Report, European Commission.
- 29. 0 100 200 300 400 500 600 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Simulation: value of OA pension for 100 000 currency unitis for 65-year old in Poland OA Pension Reduction due to life expectancy change Source: own calculation based on GUS data
- 30. Source: Orange report 2011
- 31. Source: 2012 Ageing Report, European Commission.
- 32. Source: 2012 Ageing Report, European Commission. -3 -2 -1 0 1 2 3 4 2010-2020 2020-2030 2030-2040 2040-2050 2050-2060 Italy Dependency ratio contribution Coverage ratio contribution Employment effect contribution Benefit ratio contribution
- 33. In the long-run the NDC pension system reaches financial balance (as expected in DC system) Strong link between contributions and benefits in the NDC encourages participation, but requires long working lives and stable wages NDC offers transparency and stable financing, but needs high coverage, long working lives and good administration
- 34. Chlon-Dominczak, Franco and Palmer (2012), The First Wave of NDC Countries – Taking Stock Ten Plus Years Down the Road - Sweden, Poland, Latvia and Italy in: Holzmann, R., E. Palmer and D. Robalino. 2012, eds. NDC Pension Schemes in a Changing Pension World, Volume 1: Progress, Issues, and Implementation. Washington D.C.: The World Bank & Swedish Social Insurance Agency. Jabłonowski, J. and Müller, C. (2013), 3 sides of 1 coin – Long-term Fiscal Stability, Adequacy and Intergenerational Redistribution of the reformed Old-age Pension System in Poland , National Bank of Poland European Commission (2012), Ageing Report 2012.