Nonfinancial Defined Contribution Schemes in a Changing Pension

WorldEds.: Robert Holzmann, Edward Palmer & David Robalino

Edward Palmer

Swedish Social Insurance Agency and Uppsala University

Outline of the Talk

What is NDC NDC Countries The First Wave of NDC Reforms

- Paths to Reform- NDC at Work- Maintaining Financial Balance

What is NDC? Fixed contribution rate for all generations.

Individual contributions noted on personal accounts.

Rate of return based on (nominal) covered per capita wage & covered labor force growth.

Life “annuity” based on individual’s account balance and cohort (unisex) life expectancy at retirement + rate of return.

Minimum pension age – but can work & contribute after this age – part or full time.

Individual accounts give transparency – They state clearly the individual’s claim on future consumption.

Intra-generational fairness - Present value of a unit of contributions gives the same pension increment for all – i.e., no tax wedge.

Intergenerational fairness. - All generations pay the same rate on earned income (and % of GDP) into pensions.

Transparent social policy through non-contributory rights - e.g., for early years of childcare, periods with sickness, disability, unemployment (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.

Accounts can be combined with other insurance accounts

Distinguishing micro features of NDC

Financial sustainability - achieved through the internal rate of return and- integration of longevity changes into the pension formula

Labor supply incentives - Direct link between contributions and benefits- no tax wedge → neutral for labor supply decisions- encourages labor force formality- annuity construction provides an incentive to postpone retirement with improving longevity

Distinguishing macro features of NDC

NDC Countries The First Wave Countries

- Italy 1995- Latvia 1996- Poland 1999- Sweden 1999 (published model 1992, legislation from 1994)

Other NDC countries- Kyrgyzstan 1996 (for new entrants) - Russia 2002- Egypt 2013 (anthology chapter)

Other studies in the anthology with NDC focus:- Chile, China (2 chapters), Greece, Uruguay- Norway (implemented 2012 but didn’t go all the way)

The First Wave of NDC ReformsLatvia, Italy, Poland & Sweden

Paths to Reform in Four Countries Different histories Key issues: Separating disability (and survivor ?)

benefits from the NDC old age pension scheme Retirement age(s)

- minimum age for an NDC benefit- minimum age for a general budget financed guarantee; age for conversion of disability to old age

Transition – which cohorts are covered by the new scheme (overall reform strategy)

Administrative issues- contribution collection; development of administration; IT support; local office services; etc.

Communication of the reform to the public

NDC at Work in Four CountriesLatvia, Italy, Poland & Sweden

Coverage Integration with other pillars Transition Setting up individual accounts

- Notional rate of return- Inheritance gains- Social rights financed by general budget revenues

Annuities- Denominator - Indexation

Minimum pension guarantee (externally financed)

NDC in four countries - Individual outcomes Based on the OECD pension models

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

  1 year 2 years 3 years

Italy -1,4% -2,8% -4,2%

Latvia -1,8% -3,6% -4,2%

Poland -0,8% -1,7% -2,5%

Sweden -0,3% -0,5% -0,8%

Reduction of replacement rates of women For 1-3 years spent on out of the formal labor market with childcare.

Source. The OECD Pension Models.

Maintaining Long-Term Financial Balance

Choice of indexation Allocation of the systematic

mortality risk in annuities Creation of an NDC Bond Balancing mechanism

Country

2010 2020 2040 2060Change 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.

Thank you!