Social Security Reform: Other Countries' Experiences Provide
Lessons for the United States (21-OCT-05, GAO-06-126).
Many countries, including the United States, are grappling with
demographic change and its effect on their national pension
systems. With rising longevity and declining birthrates, the
number of workers for each retiree is falling in most developed
countries, straining the finances of national pension programs,
particularly where contributions from current workers fund
payments to current beneficiaries--known as a pay-as-you-go
(PAYG) system. Although demographic and economic challenges are
less severe in the United States than in many other developed
countries, projections show that the Social Security program
faces a long-term financing problem. Because some countries have
already undertaken national pension reform efforts to address
demographic changes similar to those occurring in the United
States, we may draw lessons from their experiences. The current
and preceding Chairmen of the Subcommittee on Social Security of
the House Committee on Ways and Means asked GAO to study lessons
to be learned from other countries' experiences reforming
national pension systems. GAO focused on (1) adjustments to
existing PAYG national pension programs, (2) the creation or
reform of national pension reserve funds to partially prefund
PAYG pension programs, and (3) reforms involving the creation of
individual accounts. We received technical comments from SSA,
Treasury, the OECD, and other external reviewers.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-126
ACCNO: A40057
TITLE: Social Security Reform: Other Countries' Experiences
Provide Lessons for the United States
DATE: 10/21/2005
SUBJECT: Budgetary reserves
Comparative analysis
Economic analysis
Federal social security programs
Financial analysis
Foreign governments
Individual retirement accounts
Lessons learned
Pensions
Program management
Social security benefits
Social Security Program
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GAO-06-126
* Results in Brief
* Background
* Pension and Other Social Insurance Programs in OECD Countries
* Types of National Pension Reform
* Adjustments to Existing PAYG Programs Show Importance of
Sustainability, Safety Nets, and Incentives to Work and Save
* PAYG Adjustments Prove Key to Financial Sustainability
* Essential Reform Elements Include Maintenance of a Safety
Net and Work and Saving Incentives
* Successful Reform Requires Careful Implementation,
Administration, and Public Education
* Early Action and Effective Management Help Strengthen National Pension
Reserve Funds
* Early Action Matters
* Effective Management Can Contribute to Financial
Sustainability
* Individual Account Reforms Show the Importance of Funding Decisions
and Benefit Adequacy
* Approach to Funding Individual Accounts Affects Sustainability of
National Pension System
* Countries Balanced Opportunities to Realize High Expected
Returns with Provisions to Help Ensure Benefit Adequacy
* Effective Regulation, Implementation, and Education Can
Protect Individuals
* Concluding Observations
* Agency Comments
* Appendix I: Scope and Methodology
* Methodology
* Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
* Appendix III: GAO Contact and Staff Acknowledgments
* Glossary
*
* Add-on
* Adequacy
* Annuity
* Baby boomers
* Carve-out
* Consumer price index (CPI)
* Covered worker
* Deficit
* Defined benefit (DB)
* Defined contribution (DC)
* Dependency ratio
* Dependent
* Early retirement age
* Full retirement age (FRA)
* Full funding
* General revenue transfers
* Gross domestic product (GDP)
* Income adequacy
* Indexation
* Individual account
* Individual equity
* National pension reserve funds
* National saving
* Notional defined contribution (NDC) program
* Old-Age, Survivors, and Disability Insurance (OASDI)
* Pay-as-you-go (PAYG:)
* Payroll tax
* Price indexation (Compare with Wage indexation.)
* Rate of return
* Replacement rate
* Social insurance
* Social Security Administration (SSA)
* Solvency
* Sustainable solvency
* Transition costs
* Wage indexation
* Order by Mail or Phone
United States Government Accountability Office
Report to Congressional Requesters
GAO
October 2005
SOCIAL SECURITY REFORM
Other Countries' Experiences Provide Lessons for the United States
GAO-06-126
SOCIAL SECURITY REFORM
Other Countries' Experiences Provide Lessons for the United States
What GAO Found
All countries in the Organisation for Economic Co-operation and
Development (OECD), as well as Chile, have, to some extent, altered their
national pension systems, consistent with their different economic and
political conditions. While changes in one country may not be easily
replicated in another, countries' experiences may nonetheless offer
potentially valuable lessons for the United States. Countries' experiences
adjusting PAYG national pension programs highlight the importance of
considering how modifications will affect the program's financial
sustainability, its distribution of benefits, and the incentives it
creates. Also, how well new provisions are implemented, administered, and
explained to the public may affect the outcome of the reform. Most of the
countries GAO studied both increased contributions and reduced benefits,
often by increasing retirement ages. Generally, countries included
provisions to help ensure adequate benefits for lower-income groups,
though these can lessen incentives to work and save for retirement.
Countries with national pension reserve funds designed to partially
pre-fund PAYG pension programs provide lessons about the importance of
early action and sound governance. Some funds that have been in place for
a long time provide significant reserves to strengthen the finances of
national pension programs. Countries that insulate national reserve funds
from being directed to meet nonretirement objectives are better equipped
to fulfill future pension commitments. In addition, regular disclosure of
fund performance supports sound management and administration and
contributes to public education and oversight.
Countries that have adopted individual account programs-which may also
help prefund future retirement income-offer lessons about financing the
existing PAYG pension program as the accounts are established. Countries
that have funded individual accounts by directing revenue away from the
PAYG program while continuing to pay benefits to PAYG program retirees
have expanded public debt, built up budget surpluses in advance, cut back
or eliminated the PAYG programs, or taken some combination of these
approaches. Because no individual account program can entirely protect
against investment risk, some countries have adopted individual accounts
as a relatively small portion of their national pension system. Others set
minimum rates of return or provide a minimum benefit, which may, however,
limit investment diversification and individuals' returns. To mitigate
high fees, which can erode small account balances, countries have for
example capped fees or centralized the processing of transactions.
Although countries have attempted to educate individuals about reforms and
how their choices may affect them, studies in some countries indicate that
many workers have limited knowledge about their retirement prospects.
United States Government Accountability Office
Contents
Letter 1
Results in Brief 3 Background 5 Adjustments to Existing PAYG Programs Show
Importance of
Sustainability, Safety Nets, and Incentives to Work and Save 10 Early
Action and Effective Management Help Strengthen National
Pension Reserve Funds 16 Individual Account Reforms Show the Importance of
Funding
Decisions and Benefit Adequacy 20 Concluding Observations 30 Agency
Comments 31
Appendix I Scope and Methodology 33 Methodology 33
Appendix II Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
Appendix III GAO Contact and Staff Acknowledgments
Glossary
Tables
Table 1: Countries' National Pension Reforms-1970-2004 9 Table 2:
Countries Undertaking Selected Types of Adjustments to
their PAYG Pensions-1970-2004 12 Table 3: Background on OECD Countries and
Chile 37 Table 4: Information concerning Countries' National Pension
Systems 40 Table 5: Examples of Adjustments to PAYG Programs, 1970-2004 45
Table 6: National Pension Reserve Fund Reforms 52 Table 7: Individual
Account Reforms 54
Figure
F igure 1: National Pension Reserve Funds as a Percentage of GDP
Abbreviations
GDP gross domestic product
ILO International Labour Organization
NDC notional defined contribution
OECD Organisation for Economic Co-operation and Development
PAYG pay-as-you-go
SSA Social Security Administration
This is a work of the U.S. government and is not subject to copyright
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separately.
United States Government Accountability Office Washington, DC 20548
October 21, 2005
The Honorable Jim McCrery Chairman Subcommittee on Social Security
Committee on Ways and Means House of Representatives
The Honorable E. Clay Shaw, Jr. House of Representatives
Many countries, including the United States, are grappling with
demographic change and its effect on their national pension systems and
long-term fiscal posture. With increasing longevity and declining
birthrates, the number of workers for each retiree is falling in most
developed countries. These trends can strain the finances of national
pension programs, particularly those in which contributions from current
workers fund payments to current beneficiaries-a form of financing known
as pay-as-you-go (PAYG). Demographic and economic challenges are less
severe in the United States than in many other developed countries-the
birthrate is not as low, people are more likely to stay in the labor force
for a greater number of years, and immigration continues to provide young
workers. Yet projections show that the Social Security program faces a
significant long-term financing problem. Because some countries have
already undertaken national pension reform efforts to address demographic
changes similar to those occurring in the United States, their experiences
can provide lessons for U.S. policymakers.
To assist the Subcommittee in its deliberations concerning Social
Security's future, you asked us to review the experiences of other
developed nations and highlight lessons that can be learned from their
various approaches to national pension reform. Historically, developed
countries have had national pension systems that included some form of a
PAYG pension program. Countries have typically undertaken quite different
approaches to reforming their pension systems. These reforms fall into
three broad categories-adjustments to PAYG programs (decreased benefits or
increased contributions), 1 efforts to set aside funds
1
Generally, changes in contributions made to a national pension program
means changes in the tax rate on individuals or employers.
Page 1 GAO-06-126 Social Security Reforms Abroad
to help pay future benefits through a national reserve fund, and efforts
to prefund retirement income through contributions to individual accounts.
Accordingly, our objectives were to examine the lessons that can be drawn
from countries that have (1) adjusted their existing PAYG national pension
systems, (2) adopted national pension reserve funds to help finance their
national pension systems, and (3) adopted individual account reforms to
their national pension systems.
To address these objectives, we studied the experiences of the countries
that constitute the Organisation for Economic Co-operation and Development
(OECD), plus Chile, the nation that pioneered the use of individual
accounts. 2 As part of our analysis, we assessed both the extent to which
another country's circumstances are similar enough to those in the United
States to provide a useful example and the extent to which particular
approaches to pension reform were considered to be successful. 3 We
aligned our lessons with the criteria GAO developed for evaluating
domestic Social Security reform proposals-fiscal sustainability, adequacy
and equity, and implementation and administration of reform. 4 At the same
time, drawing lessons from other countries' experiences requires
recognition that countries have different starting points, including
unique economic and political environments, and that availability of other
sources of retirement income, such as occupational pensions, also varies
greatly. Therefore, reforms in one country may not be easily replicated in
another or may not lead to the same outcome.
Our review included interviews with, and analysis of materials provided
by, officials and interest group representatives in Washington, D.C.;
Paris; and London. We met with pension experts and country specialists at
the OECD as well as French and British experts. In addition, we drew from
interviews conducted by GAO with Chilean officials in 2002. We conducted
2
The OECD is a forum for the governments of 30 countries to work together
on economic, social, environmental, and governance issues through their
commitment to democratic government and the market economy. The OECD works
to promote economic growth, financial stability, trade and investment,
technology, innovation, and development cooperation.
3
For additional information concerning Social Security reform in the United
States, see GAO, Social Security Reform: Answers to Key Questions,
GAO-05-193SP (Washington, D.C.: May 17, 2005).
4
See GAO, Social Security: Criteria for Evaluating Social Security Reform
Proposals, GAO/T-HEHS-99-94 (Washington, D.C.: Mar. 25, 1999).
Results in Brief
our review between August 2004 and September 2005 in accordance with
generally accepted government auditing standards. For additional
discussion of our scope and methodology, see appendix I. We also include a
glossary of key terms in the back of this report.
With respect to adjustments to PAYG programs, the experiences of the
countries we studied highlight the importance of considering how
modifications will affect the program's financial sustainability, its
distribution of benefits, the incentives it creates, and the extent to
which the public understands the new provisions. To reconcile PAYG program
revenue and expenses, most OECD countries have both increased
contributions and reduced benefits, often in part by increasing retirement
ages. Although several countries have yet to make their programs
financially sustainable, some have come close to doing so. According to
OECD economists, some countries (Sweden and Italy, for example) have
succeeded in large part by automatically linking benefits to factors such
as worker contributions, changes in demographics, and growth in the
national economy. Generally, the countries that have come closest to
achieving sustainability have also undertaken other types of reform, such
as the individual account programs in Sweden and Australia. These reforms
may, however, substantially reduce benefits promised originally, leaving
future retirees with benefits that replace a lower portion of their
earnings than those provided to earlier generations or make them payable
beginning at a later age. Other countries' adjustments to their existing
PAYG programs have had mixed results for the programs' solvency, and
debate continues about additional reforms to reduce benefits or increase
revenue. This is the case in France and Germany, for example. Often
countries have included in their reforms provisions to help ensure
adequate benefits for lower-income groups. In certain cases, however, such
provisions lessen incentives to work and save for retirement, and can
weaken the country's economy over time. In addition, the way in which new
provisions are implemented, administered, and explained to the public
affects the outcome of the reform. For example, most countries phase in
changes to the national pension programs, such as changing the retirement
age over a certain period of time. Governments such as the United Kingdom
have had only limited success in efforts to educate workers about changes
in provisions that will affect their retirement income.
Where countries created national reserves to partially prefund PAYG
pension programs, many lessons can be drawn, including the importance of
early action and sound governance. In some countries where requirements
for prefunding through national reserves have been in place for a long
time and have been complemented by other reform measures, significant
amounts of money have already accumulated. 5 These are projected to help
make substantial contributions to the financial sustainability of national
pension programs. While acting early in setting up national reserve funds
helps maintain adequate benefits and distribute pension costs more
equitably across generations, governing these funds in the interest of
participants is also crucial. Countries that insulate national reserve
funds from being directed to meet nonretirement objectives are better
equipped to fulfill their future pension commitments. Some countries have
legislated specific starting dates for drawing down national funds to
resist demands for their immediate use. Effective governance of national
funds also requires that governments commit to making regular transfers
into these funds. Countries that count on budget surpluses to finance
their reserve funds will need strong and sustained budgetary discipline to
accumulate enough reserves to prepare for future pension spending
requirements. Moreover, where transfers to national funds are limited to
social security surpluses, reserve funds may not grow sufficiently to help
national pension systems become solvent. In addition, regular disclosures
of fund performance help achieve transparency in management and
administration and contribute to public education and oversight.
The countries adopting individual account reforms offer lessons about the
importance of addressing the financial solvency of existing PAYG pension
systems as the accounts are established. Countries adopting individual
accounts face the common challenge of how to pay for both a new funded
pension and an existing PAYG pension simultaneously. Some countries did
this by expanding public debt, building up budget surpluses, cutting back
or eliminating the PAYG system, or using some combination of these
approaches. Additionally, two countries, Australia and Switzerland, used
new sources of funding to add individual accounts to their existing
system. Because no individual account program can fully protect
individuals from investment risk, some countries protect the overall level
of benefits. For example, some have adopted individual accounts as a
relatively small portion of their national pension system. Others that
rely more heavily on
Asset allocation varies greatly across countries. The U.S. Social Security
Trust Fund, for example, is exclusively invested in nonmarketable
government securities; on the other hand, countries such as Canada and
Sweden invest a large fraction of their reserve fund assets in equities.
Moreover, several countries, such as New Zealand, diversify their
portfolios to include a significant portion of foreign shares.
Page 4 GAO-06-126 Social Security Reforms Abroad
Background
individual accounts, including Chile and Australia, set minimum rates of
return or provide a minimum benefit. While these provisions are intended
to protect individuals, they may also have unintended consequences. For
example, guaranteed rates of return imposed on fund managers in some
countries have been done in a way that may limit investment
diversification and variation in individuals' returns (in Chile and
Switzerland, for example). In addition, important lessons can be learned
regarding the administration of individual accounts, including the need
for effective regulation and supervision of the financial industry to
minimize investment risks that individuals face. To mitigate high fees
that can erode small account balances, some countries have capped the
level of administrative fees. Information about individual accounts should
be provided to help individuals make informed decisions about their
retirement savings. Some countries have done a better job than others in
providing information about their individual account programs.
Additionally, although studies in some countries indicate that many
individuals have only limited knowledge about their retirement prospects,
several countries have programs to provide information on investment
choices and retirement income options, such as annuities. The
effectiveness of these programs is unclear, however.
We received technical comments from the Social Security Administration,
the Department of Treasury, the OECD, and other external reviewers and
incorporated them where appropriate.
The U.S. Social Security program's projected long-term financing shortfall
stems primarily from the fact that people are living longer and having
fewer children. As a result, the number of workers paying into the system
for each beneficiary is projected to decline. A similar demographic trend
is occurring or will occur in all OECD countries. (See table 3 in app. II
for demographic and other characteristics of OECD countries and Chile.)
Although the number of workers for every elderly person (aged 65 and over)
in the United States has been relatively stable over the past few decades,
this ratio has already fallen substantially in other developed countries.
The number of workers for every elderly person in the United States is
projected to fall from 4.1 in 2005 to 2.9 in 2020 and to 2.2 in 2030. In
nine of the OECD countries, this number has already fallen below the
Pension and Other Social Insurance Programs in OECD Countries
level projected for the United States in 2020. 6 These decreases in the
projected number of workers available to support each retiree could have
significant effects on countries' economies, particularly during the
period from 2010 to 2030. These effects may slow growth in the economy and
standards of living, and increase costs for aging-related government
programs. Long run demographic projections are imprecise, however, due to
uncertainty about future changes in longevity, for example.
Although social security programs in all OECD countries and Chile provide
benefits for qualified elderly people, survivors, and the disabled, the
programs differ in many respects across the countries. In some countries,
"social security" refers to a wide range of social insurance programs,
including health care, long-term care, workers' compensation, unemployment
insurance, and so forth. To generalize across countries, we use "national
pensions" to refer to mandatory countrywide pension programs providing
old-age pensions. We use "Social Security" to refer to the U.S. Old-Age,
Survivors, and Disability Insurance Program, since that is how the program
is commonly known.
Although nearly all OECD countries use contributions from workers and
employers designated to finance pension benefits, most also use general
revenues as a funding source. Nearly all OECD countries, including the
United States, make pension benefits dependent on an individual's work
history, while several also provide benefits to all qualified residents
whether or not they have a work history. Countries' pension systems may be
financed differently, use different criteria for identifying qualified
beneficiaries, and calculate benefits in a different manner. Several OECD
countries finance benefits to the disabled or survivors with worker or
employer contributions designated for this purpose. Others use general
revenue to finance these benefits or have a single fund that provides
oldage pension benefits and benefits for the disabled and survivors. Some
OECD countries provide a universal benefit of a specified amount each week
or each month. Some adjust benefits based on time spent raising children,
or pursuing education, as well as years spent working. Some
6
The Social Security Administration (SSA) uses a somewhat different
ratio-the number of workers covered by the Social Security program for
each Social Security beneficiary. In 2004 there were 3.3 such workers for
each SSA beneficiary, and SSA projects that this ratio will decline to 2.1
in 2031, based on the intermediate assumptions of the 2005 trustees'
report. SSA's projections take into account the effects of gradual
increases in retirement age for those born after 1937, with a retirement
age of 67 for those born in 1960 or later.
Page 6 GAO-06-126 Social Security Reforms Abroad
Types of National Pension Reform
national pension programs, identified as "defined benefit" programs,
provide retirees a pension of a set amount per week or month or an amount
calculated based on such factors specified by law as their number of years
of work and the level of their earnings or contributions, and their age at
retirement. Other national pension programs, identified as "defined
contribution" programs, provide retirees income based on the accumulated
value of contributions and investment earnings on those contributions.
Many OECD countries have a pension system that includes a combination of
pension programs rather than a single program, providing many retirees
with more than one source of income. (See table 4 in app. II for
additional information concerning countries' national pension systems.)
Voluntary occupational pension programs are common in many OECD member
countries though the aggregate accumulated value of these pension funds
exceeds 25 percent of gross domestic product (GDP) in only seven
countries, including the United States, Canada, and Denmark. These include
programs sponsored by employers, trade associations, or trade unions and
regulated by governments; in some cases, the pensions provided by these
programs are to some extent insured by governmental entities-counterparts
to the Pension Benefit Guaranty Corporation in the United States. Tax laws
in many countries encourage participation in these voluntary programs.
Germany, for example, supplements its national pension system with
voluntary individual "Riester" accounts, supported by subsidies as well as
tax incentives. Our review, however, did not include these programs,
except in the United Kingdom, where workers' contributions to PAYG
national pension programs are reduced if they choose to participate. Where
these voluntary programs are prevalent, they can affect countries'
decisions about public pension reforms.
Historically, developed countries have relied on some form of a PAYG
national pension program. 7 Over time, countries have used a variety of
approaches to respond to demographic challenges and the ensuing increases
in expenditures for these programs. In many cases, these approaches
provide a basic or minimum benefit as well as a benefit based on the level
of a worker's earnings. Several countries are preparing to pay
7
Some countries, such as Germany, originally had pre-funded national
pension programs providing modest benefits, but pension reserves
diminished as they increased the level of benefits.
Page 7 GAO-06-126 Social Security Reforms Abroad
future benefits by either supplementing or replacing their PAYG programs.
For example, some have set aside and invested current resources in a
national pension reserve fund to partially prefund their PAYG program.
Some have established fully funded individual accounts. These are not
mutually exclusive types of reform. In fact, many countries have
undertaken more than one of the following types of reform (see table 1 for
the reforms OECD countries and Chile have undertaken): 8
o Adjustments to existing pay-as-you-go systems. Typically, these are
designed to create a more sustainable program by increasing
contributions or decreasing benefits, or both, while preserving the
basic structure of the system. Measures include phasing in higher
retirement ages, equalizing retirement ages across genders, and
increasing the earnings period over which initial benefits are
calculated. Some countries have created notional defined contribution
(NDC) accounts for each worker, which tie benefits more closely to
each worker's contributions and to factors such as life expectancy and
the growth rate of the economy.
o National pension reserve funds. These are set up to partially prefund
PAYG national pension programs. 9 Governments commit to make regular
transfers to these investment funds from, for example, budgetary
surpluses. To the extent that these contribute to national saving,
they reduce the need for future borrowing or for large increases in
contributions to pay scheduled benefits. Funds can be invested in a
combination of government securities and domestic as well as foreign
private sector securities. Because of differences in accounting
practices, some countries report reserve funds as part of national
budgets while others do not include them in federal figures. 10
o Individual accounts. These are fully funded accounts that are
administered either by employers, the government, or designated third
parties and are owned by the individual. The level of retirement
benefits depends largely on the amount of contributions made by, or on
behalf of, an individual into the account during his or her working
life, investment earnings, and the amount of fees individuals are
required to pay.
8
This list of types of reform is not comprehensive. Some countries, Norway,
for example, recently adopted legislation requiring employers to provide
pensions (usually defined benefit programs) for employees.
9
A fully prefunded pension program would no longer be a PAYG system.
10
The Netherlands, New Zealand, and the United States are examples of
countries that incorporate reserve funds into national budgets; Canada and
Finland, for instance, do not.
Page 8 GAO-06-126 Social Security Reforms Abroad
Table 1: Countries' National Pension Reforms-1970-2004
Groups of countries undertaking different types of reform
Adjustments to PAYG and Adjustments to PAYG and Adjustments to PAYG,
national Only adjustments to PAYG national pension fund individual
accounts pension fund, and individual accounts
Austria Belgium Australia Denmark
Czech Republica Canada Chileb Sweden
Italy Finland Hungary Switzerlandc
Germanyd France Icelande
Turkey Greece Mexico
Ireland Poland
Japan Slovak Republic
Luxembourg United Kingdomf
Netherlands
New Zealandg
Norway h
Portugal
South Korea
Spain
United States
Source: OECD, International Social Security Association, and Social
Security Administration.
a
The Czech Republic's defined contribution account program is not included
as an individual account reform as it is a voluntary supplementary
program. For a discussion of these accounts, see GAO, Social Security
Reform: Information on Using a Voluntary Approach to Individual Accounts,
GAO-03-309 (Washington, D.C.: Mar. 10, 2003), pp. 46-54.
bChile is not an OECD country, but was included in our study because it
pioneered individual account reforms.
cSwitzerland's mandatory occupation-based pensions provide individual
accounts that accrue credits at least at a minimum prescribed interest
rate. The program's requirements are phrased in terms of individual
accounts and the consulting actuaries must make an individual account
calculation applying the differing contribution rates per age bracket in
order to determine compliance with the law. But in fact many companies
offer plans that work like defined benefit pensions. Benefits are based on
the notional balance of the account at retirement.
d
Germany's Riester pension program is not included as an individual account
reform because it is a supplement to the mandatory national pension
program, rather than an alternative. For a discussion of these accounts,
see GAO-03-309, pp. 55-63.
e
Iceland's mandatory occupation-based pension program allows for the
creation of defined contribution individual accounts as a complement to
defined benefit pensions. However, in practice, employers have not yet
established these. Voluntary supplementary individual accounts are also
available.
fThe United Kingdom requires participation in either a state
earnings-related pension program or an approved alternative, including an
individual account.
gNew Zealand's national pension is technically not a PAYG program as it is
funded with general government revenue rather than workers' or employers'
contributions to the program.
Adjustments to Existing PAYG Programs Show Importance of Sustainability,
Safety Nets, and Incentives to Work and Save
h
Norway's Petroleum Fund is not, by law, dedicated exclusively to future
pension expenditures, but it is regarded as a fund to meet the future
expenses of an aging society, including pensions.
The countries that have adjusted their existing PAYG national pension
programs demonstrate a broad range of approaches for both reducing
benefits and increasing contributions in order to improve the programs'
financial sustainability. Their experiences also provide lessons about the
potential effects of some adjustments on the distribution of benefits,
including the maintenance of a safety net and incentives to work and save.
They also emphasize the care required in implementing and administering
reforms and ensuring that the public understands the new provisions.
PAYG Adjustments Prove Key to Financial Sustainability
To reconcile PAYG program revenue and expenses, nearly all the countries
we studied have decreased benefits, and most have also increased
contributions, often in part by increasing retirement ages. Generally
countries with national pension programs that are relatively financially
sustainable, based on estimated changes in spending on old-age pensions,
have undertaken a package of several far-reaching adjustments. 11 Most of
the countries we studied increased program revenue by raising contribution
rates, increasing the range of earnings or kinds of earnings subject to
contribution requirements, or increasing the retirement age. Most of these
countries increased contribution rates for some or all workers. Canada,
for example, increased contributions to its Canadian Pension Plan from a
total of 5.85 percent to 9.9 percent of wages, half paid by employers and
half by employees. Several countries, including the United Kingdom,
increased contributions by expanding the range of earnings subject to
contribution requirements.
Nearly all of the countries we studied decreased the promised level of
benefits provided to future retirees, using a wide range of techniques.
Some techniques reduce the level of initial benefits; others reduce the
rate at which benefits increase during retirement or adjust benefits based
on retirees' financial means.
11
OECD has assessed the financial sustainability of most OECD member
countries' pension systems by projecting the change in spending needed to
support the old-age pension programs through 2050. For details, see table
4 in app. II.
Page 10 GAO-06-126 Social Security Reforms Abroad
o Increased years of earnings. To reduce initial benefits, several
countries increased the number of years of earnings they consider in
calculating an average lifetime earnings level. France previously
based its calculation on 10 years but increased this to 25 years for
its basic public program. Austria is gradually increasing the number
of years from 15 to 40 years.
* Increased minimum years of contributions. Another approach is to
increase the minimum number of years of creditable service
required to receive a benefit. France increased the required
number of years from
* 37.5 to 40 years. Belgium is increasing its minimum requirement
for early retirement from 20 to 35 years.
o Changed formula for calculating benefits. Another approach to
decreasing the initial benefit is to change the formula for adjusting
prior years' earnings. Countries with traditional PAYG programs all
make some adjustment to the nominal amount of wages earned previously
to reflect changes in prices or wages over the intervening years.
Although most of the countries we studied use some kind of average
wage index, others, including Belgium and France, have adopted the use
of price indexes. The choice of a wage or price index can have quite
different effects, depending on the rate at which wages increase in
comparison with prices. The extent to which wages outpace prices
varies over time and among countries.
o Changed basis for determining year-to-year increases in benefits once
retirement begins. In many of the countries we studied, the rate at
which monthly retirement benefits increase from year to year during
retirement is based on increases in prices, which generally rise more
slowly than earnings. Others-including Denmark, Ireland, Luxembourg,
and the Netherlands-use increases in earnings or a combination of wage
and price indexes. Hungary, for example, changed from the use of a
wage index to the Swiss method-an index weighted 50 percent on price
changes and 50 percent on changes in earnings.
o Implemented provisions that adjust benefits in response to economic
and demographic changes. Adjustments, which link benefits to factors
such as economic growth, longevity, or the ratio of workers to
retirees, may contribute to the financial sustainability of national
pension systems. 12 Finland and Germany, for example, have adopted
adjustment mechanisms of this kind. In some countries, such as Italy
and Sweden, this approach
Increases in life expectancy, decreases in birth rates, or decreases in
real (inflation adjusted) interest rates can reduce the level of benefits
that a pension program can provide at a given tax (contribution) rate.
Page 11 GAO-06-126 Social Security Reforms Abroad
takes the form of a notional defined contribution program. Italian and
Swedish workers have "notional" accounts in that both the incoming
contributions and the investment earnings exist only on the books of the
managing institution. At retirement, the accumulated notional capital in
each account is converted to a stream of pension payments using a formula
based on factors such as life expectancy at the time of retirement.
Most of the countries we studied undertook more than one of these types of
reforms as indicated in table 2. See table 5 in appendix II for additional
information concerning adjustments to PAYG programs.
: Countries Undertaking Selected Types of Adjustments to their PAYG
Pensions-1970-2004
Change in Other adjustment years of Change in mechanisms Increase in
earnings Change in indexation for linking initial level contribution
Increase in considered in indexation for benefits of benefits to Other
rates or retirement benefit calculation of during demographic or decrease
in
a
Country coverage age calculation initial benefit retirement economic
factors benefits
Australia X
Austria X X X
Belgium X X X
Canada X X X
Chile X X
Czech Republic X X
Denmark X
Finland X X X X
France X X X X X
Germany X X X X X
Greece X X X
Hungary X X X
Iceland
Ireland X
Italy X X X X X X X
Japan X X X X
Luxembourg X X
Mexico X X
Netherlands X X X
New Zealand X
Norway X
Poland X X
Change in Other adjustment
years of Change in mechanisms
Increase in earnings Change in indexation linking initial
for level
contribution Increase considered indexation benefits of benefits Other
in in for to
rates or retirement benefit calculation during demographic decrease
of or in
Country coverage age a calculation initial retirement economic benefits
benefit factors
Portugal X X X
Slovak X X X X
Republic
South Korea X X X
Spain X X X X
Sweden X X
Switzerland X X
Turkey X X X
United X X X X X
Kingdom
United
States X X X X X
Essential Reform Elements Include Maintenance of a Safety Net and Work and
Saving Incentives
Source: OECD, International Social Security Association, and individual
government sources.
aGenerally, increasing the retirement age both increases lifetime
contributions and decreases lifetime benefits, as people remain in the
workforce for a longer period and spend a shorter period in retirement,
without changes in monthly contribution rates or benefit amounts.
Several countries, such as Sweden and the United Kingdom, have undertaken
one or more of these adjustments to their PAYG programs and have achieved,
or are on track to achieve, relative financial sustainability. Other
countries, including France, and Germany, may need to take additional
action to finance future benefit commitments. Generally, the countries
that have come closest to achieving sustainability are those that have
undergone more than one type of national pension reform.
All of the countries we studied that reformed their PAYG pension programs
by reducing projected benefits included provisions to help ensure adequate
benefits for lower-income groups and put into place programs designed to
ensure that all qualified retirees have a minimum level of income. 13 Most
did so by providing a means-tested program that provides more benefits to
retirees with limited financial means. Two countries-Germany and
Italy-provide retirees access to general social welfare programs that are
available to people of all ages rather than providing programs with
different provisions for elderly people.
13
The adequacy of pension benefits can be evaluated both in terms of their
minimum level and the extent to which they replace earnings. For more
information on projected replacement rates for OECD pensions systems, see
table 4 in app. II.
Page 13 GAO-06-126 Social Security Reforms Abroad
Twelve countries use another approach to providing a safety net: a basic
retirement benefit. The level of the benefit is either a given amount per
month for all retirees or an amount based on years of contributions to the
program (but not the level of earnings during those years). In Ireland,
for example, workers who contribute to the program for a specified period
receive a flat-rate pension equal to about 167 euros a week in 2004-
approximately one-third of average earnings. 14 According to the Social
Security Administration (SSA), Chile set a minimum pension for those
younger than age 70 at 62.7 percent of the minimum wage in 2004. The
United Kingdom and Belgium give low-income workers credit equivalent to
the minimum level contribution even though their earnings were too low to
require a contribution. Several countries give workers credit for years in
which they were unemployed, pursued postsecondary education, or cared for
dependents. Establishing a safety net requires a careful consideration of
costs and incentives for working and saving. Costs can be high if a
generous basic pension is provided to all eligible retirees regardless of
their income. On the other hand, means-tested benefits can diminish
incentives to work and save. The United Kingdom provides both a basic
state pension and a means-tested pension benefit. Concern about the
decline in the proportion of preretirement earnings provided by the basic
state pension has led some to advocate making it more generous. Others
argue that focusing safety net spending on those in need enables the
government to alleviate pensioner poverty in a cost-effective manner.
Prior to 2003, retirees in the United Kingdom received a means-tested
benefit that brought their income up to a guaranteed minimum retirement
income level. This benefit left those retirees with low to moderate
incomes no financial incentive to work or save, because additional income
was offset by equal reductions in the means-tested benefit. 15 To help
remedy this, the United Kingdom introduced the savings credit, which
provides a supplementary benefit equal to a portion of an individual's
additional income within a range near the guaranteed retirement income
level. This new benefit increases, but does not fully restore, the
incentive to work and save because a portion of the additional income is
lost through reductions in pension income. If, for example, a retiree with
pre-benefit income of
14
This was the equivalent of about $203 a week in mid-2004. To qualify for
this basic benefit, the retiree must have 260 weeks of paid contributions,
with an annual average of at least 48 weeks of paid or credited
contributions.
15
The lack of a financial incentive applies up to the point at which the
retiree has sufficient income or assets that they no longer qualify for
the benefit.
Page 14 GAO-06-126 Social Security Reforms Abroad
Successful Reform Requires Careful Implementation, Administration, and
Public Education
$700 a month increases this income to $800 a month, his or her total
retirement income including these means-tested benefits would increase by
$60, from $892 to $952. The proportion of United Kingdom pensioners
eligible for these means-tested benefits is expected to rise. The United
Kingdom Pensions Commission projects that unless current pension rules are
changed, almost 65 percent of retiree households will be eligible for
these means-tested benefits by 2050, because the increases in the Basic
State Pension are linked to prices, but increases in other components of
the United Kingdom's pension system are linked to earnings.
The extent to which new provisions are implemented, administered, and
explained to the public may affect the outcome of the reform. Although
many adjustments to PAYG programs are not difficult to implement and
administer, some more complex reforms, such as the development of a
notional defined contribution program, can be challenging. Poland, for
example, adopted NDC reform in 1999, but the development of a data system
to track contributions has been problematic. As of early 2004, the system
generated statements documenting contributions workers made during 2002,
but there was no indication of what workers had contributed in earlier
years or to previous pension programs. Without knowing how much they have
in their notional defined accounts, workers may have a difficult time
planning for their retirement. Additionally, countries typically phase in
certain changes, such as increasing the retirement age. This could help to
provide workers with enough time to understand how the changes to the
pension program will affect their retirement income.
To educate workers about how PAYG programs and PAYG reforms affect them,
countries including Canada, Sweden, the United Kingdom, and the United
States, send workers periodic statements concerning the program, the
record of their contributions to it, and the benefits they are projected
to receive. 16 To increase the likelihood that recipients will read and
understand them, the United Kingdom provides different messages tailored
to workers of different ages. Nonetheless, the United Kingdom has had
limited success in efforts to educate workers about changes in provisions
that will affect their retirement income. For example, a survey of women
in the United Kingdom showed that only about 43 percent of women who will
be affected by an increase in the retirement age knew the
16
For a discussion of the understandability of benefit statements in Canada,
Sweden, the United Kingdom and the United States, see GAO, Social Security
Statements: Social Security Administration Should Better Evaluate Whether
Workers Understand Their Statements, GAO-05-192 (Washington, D.C.: Apr. 1,
2005).
Page 15 GAO-06-126 Social Security Reforms Abroad
Early Action and Effective Management Help Strengthen National Pension Reserve
Funds
age that applied to them. A large proportion (70 percent) of younger women
indicated that they expect to retire before their state pension
eligibility age-65 years. 17
Another measure often found in reform packages is the accumulation of
reserves in national pension funds with the aim of partially prefunding
PAYG pension programs. With public centralized prefunding, governments set
aside resources in the current period to safeguard the financing of their
PAYG pension programs in the future. Typically invested in various
combinations of bonds and equities, these reserve funds are in some cases
meant to remain untouched for several years before being channeled into
the public pension system, in particular to maintain adequate pension
levels for the baby boom cohort. Pension reserve funds can contribute to
the system's financial sustainability, depending on when they are created
or reformed, as well as how they are invested and managed. Countries that
took action early have had time to amass substantial reserves, reducing
the risk that they will not meet their pension obligations. Effective
management of reserve funds has also proved important, as a record of poor
fund performance has led some countries to put reserve funds under the
administration of a relatively independent manager with the mandate to
maximize returns and minimize avoidable risk. 18
Early Action Matters
Establishing reserve funds ahead of demographic changes-well before the
share of elderly in the population increases substantially-makes it more
likely that enough assets will accumulate to help meet future pension
obligations. In countries such as Sweden and Denmark, which have had long
experience with partial prefunding of PAYG programs, important reserves
have already built up. Combined with long-term policies aimed at ensuring
sound public finances, raising employment rates, and adjusting pension
program provisions, these resources are expected to make significant
contributions to the long-term finances of
17
In contrast only 7 percent of the women who were not affected by the
increase expected to retire before they reached the state pension age that
applied to them (60 years).
18
While some investment risks are unavoidable, other kinds of risks can be
minimized by diversifying the portfolio among asset classes, for example
stocks, bonds, and real estate, and within asset classes.
Page 16 GAO-06-126 Social Security Reforms Abroad
Effective Management Can Contribute to Financial Sustainability
public pension programs. 19 For example, Denmark's reserve fund, set up in
1964, had assets equivalent to about 25 percent of GDP in 2000. Sweden's
reserve fund, created in 1960, was around 24 percent at the end of 2003.
Other countries that have recently created pension reserve funds for their
pension programs have a shorter period in which to accumulate reserves
before population aging starts straining public finances. In particular,
the imminent retirement of the baby boom generation is likely to make it
challenging to continue channeling a substantial amount of resources to
these funds. France, for example, relies primarily on social security
surpluses to finance its pension reserve fund set up in 1999. Given its
demographic trends, however, it may be unable to do this beyond the next
few years. Similarly, Belgium and the Netherlands plan on maintaining
budget surpluses, reducing public debt and the interest payments
associated with the debt, and transferring these earmarked resources to
their reserve funds. However, maintaining a surplus will require sustained
budgetary discipline as a growing number of retirees begins putting
pressure on public finances. Some countries have set specific starting
dates for drawing down national funds to resist demands for their
immediate use.
Though the Irish National Pensions Reserve Fund was established in 2001,
as of 2004 it had already amassed substantial assets, nearly 10 percent of
GDP. Its resources are projected to support the financial sustainability
of the pension program for two main reasons. First, Ireland enjoys
relatively favorable demographics. Its aging problem is expected to
increase in severity at a later date than those of other Western European
countries; thus, it has in effect created its pension fund relatively
early, with more time for returns to accumulate. Second, Ireland provides
somewhat less generous public pensions to their beneficiaries than other
OECD countries; its pension spending is, therefore, relatively low.
Examples from several countries reveal that prefunding with national
pension reserve funds is less likely to be effective in helping assure
that national pension programs are financially sustainable if these funds
are also used for purposes other than supporting the PAYG program. Some
countries have used funds to pursue industrial, economic, or social
19
If however, policymakers increase deficit spending or decrease surpluses
in the rest of the government's budget in response to the accumulation of
pension reserves, the prefunding benefits of the reserve will be offset.
Page 17 GAO-06-126 Social Security Reforms Abroad
objectives. For example, Japan used its reserve fund to support
infrastructure projects, provide housing and education loans, and
subsidize small and medium enterprises. 20 As a result, Japan compromised
to some extent the principal goal of public prefunding, which is to save
in advance and accumulate assets so as to continue providing adequate
benefits to retirees while keeping contribution rates of workers stable.
Japan has since implemented a series of reforms. The latest wave, which
became effective in 2001, refocused the fund's objective in the interests
of participants, rather than those of the general public. Measures
introduced include management improvements and more aggressive investment
strategies with the aim of maximizing returns.
Past experiences have also highlighted the need to mitigate certain risks
that pension reserve funds face, in addition to the risks that are
inherent in investment of any pension funds. One kind of risk has to do
with the fact that asset buildup in a fund may lead to competing pressures
for tax cuts and spending increases, especially when a fund is integrated
into the national budget. 21 For instance, governments may view fund
resources as a ready source of credit. As a result, they may be inclined
to spend more than they would otherwise, potentially undermining the
purpose of prefunding. For example, according to many observers, the
United States' Social Security trust fund, which is included in the
unified budget and invested solely in U.S. Treasury securities that cannot
be bought or sold in the open market, may have facilitated larger federal
budget deficits. Ireland sought to alleviate the risk that its reserve
fund could raise government consumption by prohibiting investment of fund
assets in Irish government bonds. Some economists argue in favor of
similar limits on the share of domestic government bonds the fund
portfolio can hold.
Additionally, pension reserve fund investments in private securities can
have negative effects on corporate governance. There is the danger that if
the government owns a significant percentage of the stocks of individual
companies and as a result controls their corporate affairs, the best
interest
20
Apart from a national fund for pension reserves, with a balance equal to
about 28 percent of GDP as of 2003, Japan has accumulated savings through
Japan Post, a national corporation with a large savings program. Japan
Post's assets (50 percent of GDP in fiscal year 2003) included postal
savings and life insurance.
21
The fact that reserve funds are sometimes accumulated separately from the
budget does not entirely relieve the pressure to use them for current
consumption. So far, no country has managed to completely "wall off" its
fund from at least the pressure to divert some of the proceeds for program
priorities or tax cuts.
of shareholders may not be upheld because of potential conflicts of
interest. Limiting the government's stock voting rights by investing
national pension resources in broad index funds may provide a safeguard
against this type of risk.
Another risk is that groups may exert pressure to constrain fund managers'
investment choices, potentially lowering returns. For example, Canada and
Japan have requirements to invest a minimum share of their fund portfolios
in domestic assets, restricting holdings of foreign assets to stimulate
economic development at home. In contrast, Norway chose to invest its fund
reserves almost exclusively in foreign assets. 22 The funds of Ireland and
New Zealand also have large shares of foreign investments. 23 Investing a
significant share of reserves in foreign assets may not be a realistic or
viable option for large economies with mature financial markets, such as
the United States. Funds in several countries have also faced pressure to
adopt ethical rather than purely commercial investment criteria, with a
possibly negative impact on returns. 24 In recent years, some countries
have taken steps to help ensure that funds are managed to maximize returns
and minimize avoidable risk. Canada, for example, has put its fund under
the control of an Investment Board operating independently from the
government since the late 1990s. Several countries, including New Zealand,
have taken steps to provide regular reports and more complete disclosures
concerning pension reserve funds which may help achieve transparency in
management and administration and contribute to public education and
oversight. 25 (For additional information concerning national pension
reserve programs, see fig. 1 and table 6 in app. II.)
22
Although the Norwegian Government Petroleum Fund is not a pension fund per
se, its assets are designated to deal with the impact of population aging.
23
Investing abroad also helps lower the risk that funds will distort
domestic capital markets. On the other hand, there is a risk that changes
in exchange rates will decrease the value of foreign investments.
24
New Zealand and Sweden are examples of countries stating explicitly that
ethical considerations must be taken into account in investment policy.
25
Maintaining high standards of transparency and disseminating accurate
information contribute to public education and oversight, providing some
degree of discipline to fund management.
Individual Account Reforms Show the Importance of Funding Decisions and
Benefit Adequacy
Figure 1: National Pension Reserve Funds as a Percentage of GDP Percentage
of GDP Norway
Japan Sweden Luxembourg
United States Korea Ireland Finland Portugal Spain Canada New Zealand
France
0 10 20 30 40 50 6070
Source: OECD and individual government sources.
Note: The figure for Finland excludes the statutory pension funds (58.3%
of GDP). Figures as of 2003, except as follows: as of December 31, 2000,
for Portugal, as of December 31, 2004, for Spain, Ireland, the United
States, and Norway.
Countries that have adopted individual account reforms-which may also help
prefund future retirement income-offer lessons about financing the
existing PAYG pension program as the accounts are established. To manage
this transition period these countries have expanded public debt, built up
budget surpluses in advance of implementation, reduced or eliminated the
PAYG program, or used some combination of these approaches. Another
important consideration for countries that have individual account
programs is how to balance achieving high rates of
Approach to Funding Individual Accounts Affects Sustainability of National
Pension System
return while ensuring individuals receive an adequate level of benefits.
Measures such as limits on how the funds are invested and the level of
fees and charges may help to ensure that benefits will be adequate, but
should not be so restrictive that they unduly harm individuals or pension
fund managers. In addition, administering individual accounts requires
effective regulation and supervision of the financial industry to protect
individuals from avoidable investment risks. Educating the public is also
important as national pension systems become more complex.
The experiences of other countries demonstrate the importance of
considering how individual accounts may affect the long-term and shortterm
financing of the national pension system and the economy as a whole. In
the long-term, individual accounts can contribute to sustainability by
providing a mechanism to prefund retirement benefits that could be less
subject to demographic booms and busts than a PAYG approach. Individual
accounts prefund benefits in private accounts rather than government
accounts. If governments are unable to save through national pension
reserves, private accounts may facilitate pre-funding that would not occur
otherwise. 26 If, however, such accounts are funded through borrowing, no
such prefunding is achieved. In the short-term countries adopting
individual accounts face the common challenge of how to pay for both a new
funded pension and an existing PAYG pension simultaneously. The cost of
the transition from a PAYG program to individual accounts depends on
whether the individual accounts redirect revenue from the existing PAYG
program, the amount of revenue redirected, and how liabilities under the
existing PAYG program are treated.
The countries we studied vary in the amount of revenue diverted from their
PAYG programs to fund their individual accounts, resulting in a range of
related transition costs. Australia and Switzerland used new sources of
funding to add individual accounts to their existing, relatively modest,
26
The extent to which individual account programs can contribute to national
saving is not yet clear, however. Some studies of Chile's individual
account program have concluded that it has contributed to national saving
rates. Other studies provide less clear evidence that individual account
programs contribute to national saving rates, in part because saving in
individual accounts can displace other forms of saving. Accounting issues
also cloud the evidence.
Page 21 GAO-06-126 Social Security Reforms Abroad
national pension systems. 27 Transition costs were not an issue, because
no resources were diverted from paying current benefits. Nonetheless, new
financing was needed to both fund the new program and to support the
existing program. (For additional information concerning these "add-on"
programs and other countries' individual account programs, see table 7 in
app. II.) Some countries diverted revenue from the existing PAYG program
to the individual accounts, a "carve out," resulting in shortfalls that
reflect, in part, the portion of the PAYG program being replaced with
individual accounts. For example, transition costs may be less in
countries such as Sweden where the contribution to individual accounts is
2.5 percent of covered earnings, than for Poland or Hungary, which have
contribution rates of 7.3 percent and 8 percent, respectively.
In addition to the level of transition costs resulting from redirecting
PAYG revenue, how a country manages these costs also affects the success
of the reform. All of the countries we reviewed also made changes that
were meant to help finance the transition to individual accounts, such as
increasing contributions to or decreasing benefits from their PAYG
programs. In addition, Chile built a budget surplus in anticipation of
major pension reform, and Sweden had large budget surpluses in place prior
to establishing individual accounts. Some countries transferred funds from
general budget revenues to help pay benefits to current and near retirees,
expanding public borrowing. Where they financed individual accounts
through borrowing, these countries will not positively affect national
saving until the debt is repaid, as contributions to individual accounts
are offset by increased public debt. 28 For example, Poland's debt is
expected to exceed 60 percent of GDP in the next few years, in part
because of its public borrowing to pay for the movement to individual
accounts.
Countries sometimes had difficulty predicting their transition costs. In
particular, countries that allowed workers to opt in or out of individual
account programs had difficulty estimating costs. For example, more
workers in the United Kingdom, Hungary, and Poland responded to incentives
to contribute to individual accounts than originally anticipated, leaving
the existing PAYG programs with less funding than planned.
27
Australia's national PAYG program consistently replaces approximately 25
percent of average wages (23 percent in 2005); Switzerland's national PAYG
program replaced approximately 36 percent of average wages in 2005.
28
Additionally, increased government debt may crowd out private-sector
access to lending markets and dampen the economic growth individual
accounts are meant to generate.
Page 22 GAO-06-126 Social Security Reforms Abroad
Countries Balanced Opportunities to Realize High Expected Returns with
Provisions to Help Ensure Benefit Adequacy
Hungary's short-run fiscal concerns resulted in a slower increase in
contribution rates to individual accounts than originally planned.
Regardless of whether workers have a choice of participating in the
program, individual accounts may also affect the long-term costs to the
government. For example, if income from substitute accounts leaves
particular individuals with less retirement income than if they had not
participated, some may qualify for benefits from other means-tested
programs. On the other hand, to the extent that the accounts increase
retirement incomes, costs for such programs may fall. Under a voluntary
approach, such effects could depend partly on the rate of participation.
The actual effect of countries' individual account programs on other
programs as they relate to government spending will not be clear for years
to come, when cohorts of affected workers retire.
Countries adopting individual accounts as part of their national pension
systems have had to make trade-offs between giving workers the opportunity
to maximize expected returns in their accounts and helping assure that
benefits will be adequate for all participants. Some countries set a
guaranteed rate of return to reduce certain investment risks and help
ensure adequacy of benefits. Guaranteed rates of return may be relative,
that is, related to other funds' returns, as in Chile, or fixed-a
guaranteed percentage rate return, as in Switzerland. In Chile workers
with individual accounts are guaranteed a minimum rate of return set at 2
percentage points below the average return for funds of the same type
during a 3-year period. 29 In Switzerland, account holders were assured a
minimum rate of return of 2.25 percent in 2004. 30 This type of guarantee
may, however, result in limited investment diversification or conservative
investment decisions, resulting in lower rates of return overall. In
Chile, for example, the guaranteed return may have resulted in a "herding"
effect, creating an incentive for fund managers to hold similar portfolios
and reducing variation in returns. To help ensure that individuals receive
at least a benefit based on the guaranteed rate of return, several
countries require
29
Previously, Chile's rate of return guarantee was calculated over a
12-month period. The Chilean association of the fund managers reported
that the average annual real (inflationadjusted) rate of return on funds
in the individual accounts, before deducting administrative fees, was 10.3
percent during the 24 years since the inception of the program.
30
Switzerland originally set its minimum return guarantee at 4 percent.
However, because of funding problems from lower than expected yields on
investments, it gradually lowered its rate to the current 2.25 percent.
fund managers to have reserve funds to pay benefits at the guaranteed
return level. A number of these countries have further provisions that the
government will provide benefits if all of the fund reserves are used.
Another measure to ensure retirees will have at least a minimally adequate
level of income is to provide some form of minimum guaranteed benefit. All
countries with individual accounts that we reviewed provide such a
benefit. This can be increasingly important as individuals assume risks
with the investment of funds in their individual accounts. Some experts
believe that a minimum pension guarantee could encourage investors to
select riskier investments or spend their assets more quickly. For
example, in countries with a large flat-rate pension, individuals may make
risky investment decisions because they can rely on the guarantee if their
risk taking brings poor results. In countries where additional benefits
are added on to the individual account payment to meet a minimum standard
("top-up" benefits) individuals may minimize their voluntary contributions
in order to receive a higher benefit from the government. There is some
belief that this may occur in Chile, where low-income workers might try to
stop making contributions after meeting the contribution year requirement.
Individuals in countries with a means-tested benefit may spend down their
retirement assets quickly to qualify for the benefit. This has occurred in
Australia, and as result, that country plans to increase the age when
individuals can access their individual account funds from 55 to 60
between 2015 and 2025. In any of these cases, the government could incur
increased costs because it ensures that individuals have at least a
certain level of income. The financial risk to the government will be
greater in countries that have a larger guarantee. However, the protection
of individuals against poverty could also be greater in these countries.
Outside of providing a minimum pension guarantee, countries have taken
additional measures to help ensure an adequate retirement income. 31 To
prevent fees from eroding small account balances, some of these countries
also exclude low-income workers from participation requirements in the
individual account program. Another approach to help protect low-income
In addition to the measures discussed in this section, other factors, such
as regulations on investments, administrative and marketing costs, and
fees (including those during payout), can affect the amount of retirement
income individuals will receive and subsequently the adequacy of their
benefits. Countries' use of these measures is discussed in the following
section.
Page 24 GAO-06-126 Social Security Reforms Abroad
Effective Regulation, Implementation, and Education Can Protect
Individuals
workers occurs in Mexico, where the federal government provides a flatrate
contribution on behalf of workers. 32
It is important to consider the payout options available from individual
accounts, as these can also affect income adequacy throughout retirement.
For example, an annuity payout option can help to ensure that individuals
will not outlive their assets in retirement. 33 However, purchasing an
annuity can leave some people worse off if, for example, premiums are high
or inflation erodes the purchasing power of benefits. Several countries
also allow for phased withdrawals, sometimes with restrictions, helping to
mitigate the risk of individuals outliving their assets and becoming
dependent on the government's basic or safety net pension. Some countries
offer a lump-sum payment under certain circumstances. For example, Chile
and Mexico allow lump sums for persons who have account balances above a
certain amount. 34 Australia allows a full lumpsum payout for all retirees
age 55 and above (age 60 and above by 2025).
Countries also protect individuals by regulating how the funds in their
accounts can be invested. Initially, several countries offered individuals
choices among a limited number of investment funds and often restricted
the portion of assets that could be invested in certain products, such as
publicly traded equities, private equities, and foreign securities. Later,
however, the options were expanded in most countries to allow more
investment diversification, but they still include some restrictions.
Additionally, as investment options have expanded, some countries have
incorporated other protections. For example, Chile and Mexico have
incorporated investment options that take into account individuals' ages
and risk tolerance. Chile requires each pension administrator to offer
four
32
The Mexican government makes a contribution to individuals' accounts of
5.5 percent of minimum wage (a contribution of about $0.24 per workday in
Mexico City).
33
The countries we reviewed require a range of annuity options, including,
for example, inflation-indexed, joint and survivor, and gender-neutral.
Different types of annuities will help to protect against certain risks;
however, they may not be the best option for certain individuals. Certain
annuities, such as those with joint and survivor or guarantee period
provisions provide an opportunity for individuals to leave some benefits
to their heirs. Other annuities do not provide such an opportunity.
34
Chile allows a lump sum of the amount by which the account balance exceeds
a specified level-the amount needed to pay a pension equivalent to 70
percent of pensionable salary and at least 120 percent of the minimum
pension. Mexico allows a lump sum of the remaining balance if the
individual account will pay a pension at least 30 percent more than the
minimum guarantee.
types of funds with varying degrees of risk, including a higher risk fund
and a fund invested in fixed-rate instruments. Pension administrators may
offer a fifth higher risk fund, available to workers more than 10 years
from the age of retirement. Mexico recently allowed pension fund managers
to offer more than one investment fund and included options to help
provide workers with an adequate rate of return at acceptable risk. Sweden
limits individuals to selecting at most five funds from among all the
qualified investment funds that choose to participate-over 650 funds as of
2004. Some experts have suggested that having such a large number of funds
available may discourage active choice. About two-thirds of participants
made an active investment choice in 2000. Since 2001, however, about 85
percent of new entrants have left their money in the default fund-a
separate fund for those who do not wish to make a fund choice. 35 This
default option can be an important safeguard. However, depending on who
makes the default decisions, it may be open to some of the same issues as
pension fund reserves, such as political pressures for certain investment
criteria in order to meet other social objectives.
To further protect individuals, most of the countries with individual
accounts have some sort of limit on the fees that fund managers can
charge. Nonetheless, it is unclear how these restrictions may affect an
individual's account balance and returns. Chile allows funds to charge
fees on new accounts, and individual account contributions, and for phased
withdrawals of funds during retirement. In addition to imposing this type
of limit, Poland has a ceiling on the amount of some types of charges.
Sweden has variable ceilings on charges, and the United Kingdom has a
fixed ceiling charge on its stakeholder pension. 36 Sweden uses a formula
to calculate the size of fees that are permitted to help ensure that fees
are not too high. Additionally, it plans to spread certain fixed costs
over the first 15 years of the program, helping avoid high fees in the
early years. Limits on the level of fees can also affect fund managers. In
the United Kingdom, for example, regulations capping fees may have
discouraged some providers from offering pension funds.
35
Sweden is undergoing a study that may include a discussion on the idea of
decreasing the number of funds in which accounts are directed-from over
650 to about 20.
36
Stakeholder pensions provide individuals with the option of contracting
out of the national second tier social security system to participate in
the tax-relieved defined contribution individual pension accounts.
Page 26 GAO-06-126 Social Security Reforms Abroad
Countries have also taken steps to lower administrative costs that
contribute to the fees participants are charged. For example, regulations
regarding how often individuals are permitted to move assets from one
investment fund to another can also protect program participants by
helping contain program costs that arise when people switch funds
frequently. Many countries restrict the number of times an individual can
switch. Mexico reportedly has lower administrative costs than some other
Latin American countries, in part because it limits individuals to annual
switching. Chile permitted people to switch fund managers three times a
year, but later restricted switching to two times a year to help lower
costs. Poland provides an incentive for individuals to stay with a pension
fund manager for at least 2 years by requiring fund managers to charge
lower fees for these contributors. Sweden does not restrict the number of
times individuals can change their investments. To help keep costs low,
however, Sweden aggregates individuals' transactions to realize economies
of scale. 37
Some countries' experiences highlighted weaknesses in regulations on how
pension funds can market to individuals. 38 Poland's and the United
Kingdom's regulations did not prevent problems in marketing and sales.
Poland experienced sales problems, in part, because it had inadequate
training and standards for its sales agents, which may have contributed to
agents' use of questionable practices to sign up individuals. The United
Kingdom had a widely-publicized "mis-selling" scandal that resulted in
over a million investors opening individual accounts when they would more
likely have been better off retaining their occupation-based pensions.
Insurance companies were ordered to pay roughly $20 billion in
compensation. In contrast, Sweden protects individuals from excessive
marketing by not allowing pension funds access to information about
individuals' investments. Instead, funds rely on mass advertising and
provide reports and disclosures to investors through a clearinghouse.
37
Designers of an individual account program must make critical decisions
about who would assume the new administrative and recordkeeping
responsibilities, how much choice or discretion individuals would have in
selecting and changing their investment options, and how workers would
receive their benefits. For additional information concerning options for
administering individual account programs, see GAO, Social Security
Reform: Administrative Costs for Individual Accounts Depend on System
Design, GAO/HEHS-99-131 (Washington, D.C.: June 18, 1999).
38
Marketing also contributes to the overall program costs, and a portion of
these costs are often passed on to participants.
Countries' individual account experiences reveal pitfalls to be avoided
during implementation. For example, Hungary, Poland, and Sweden had
difficulty getting their data management systems to run properly and
continue to experience a substantial lag time in recording contributions
to individuals' accounts. Sweden purchased a new computer system after the
program it intended to use proved insufficient for managing individual
accounts, resulting in an unexpected cost of $25 million. Once a
recordkeeping system is in place, however, problems may persist. For
example, Poland had some difficulty matching contributions with
contributors because it allowed two different identification numbers to be
used for reporting purposes. In such cases, workers' contributions were
not being credited to their accounts. Additionally, Poland experienced
problems with its computer system that resulted in a backlog. The
government was required to make interest payments to funds for delays in
contribution transfers. According to a report from the International
Labour Organization (ILO), the government initially failed to make 95
percent of the transfers to private funds and as of 2002 was still unable
to make 20 percent to 30 percent of required monthly transfers. 39
In countries where workers have a choice of whether to participate in the
individual account program, it is important that policymakers make timely
decisions about other details concerning the administration and
implementation of the program, so that workers can make informed choices.
Hungary and Poland reportedly implemented their individual account systems
without having made such decisions, including those concerning annuities.
Both countries required annuity payouts, but the markets did not have the
appropriate type of annuity available. For example, inflation-adjusted and
gender-neutral annuities were not available in Hungary. Experts suggest
that while these decisions may not have seemed important initially, the
lack of information could make it difficult for workers to decide whether
to participate in the individual account program and to assess their
potential retirement security.
Not only is information important to help workers make initial decisions
about participation in an individual account program, but it should be
provided on an ongoing basis. It is also of increasing importance as
International Labour Organization, Pension Reform in Central and Eastern
Europe, Vol. 1: Restructuring with Privatization: Case Studies of Hungary
and Poland. (Budapest, International Labour Office, 2002). For a general
discussion of such implementation issues, see GAO, Social Security Reform:
Implementation Issues for Individual Accounts, GAO/HEHS-99-122
(Washington, D.C., June 18, 1999).
Page 28 GAO-06-126 Social Security Reforms Abroad
national pension systems become more complex. Several countries require
disclosure statements about the status of a pension fund. 40 The inclusion
of fees charged on these disclosure statements could help individuals to
make more informed decisions when choosing a fund manager. Some countries
have done a better job than others of providing fund performance
information. For example, Australia requires its fund providers to inform
members through annual reports clearly detailing benefits, fees and
charges, investment strategy, and the fund's financial position. In
contrast, Hungary reportedly did not have clear rules for disclosing
operating costs and returns, making it hard to compare funds'
performances. Other more general information about individual account
savings is also important. In the United Kingdom, individuals must decide
whether they should participate in the state earnings-related pension
program, their employer-sponsored pension plan, or an individual account.
To help individuals make this decision, the Financial Services Agency
publishes decision trees on its Web site. Decision trees in the United
Kingdom ask basic questions about pension arrangements to help individuals
make their own choices. Individuals may find that these are somewhat
complicated, however, in part because the United Kingdom's system is
complex. In Mexico, a government entity provides information to workers on
the mandatory pension system and includes information about the importance
of reviewing commissions and returns when making a pension fund choice.
While countries have made efforts to inform the public about the
individual account program and the different options they will have
available, little research on the effectiveness of these campaigns has
been conducted. There has been research, however, looking at the overall
financial literacy of individuals across many OECD countries. The OECD
recently conducted a study on financial literacy and found that most
respondents to financial literacy surveys in member countries have a very
low level of knowledge concerning finances, often seeming to think that
they know more about financial issues than they really do. 41 For example,
about two-thirds of Australian respondents to a survey indicated that they
40
Some countries also provide annual statements that include information
about different pieces of an individual's retirement benefits, such as the
PAYG and individual account benefits.
41
OECD, Directorate for Financial and Enterprise Affairs, Committee on
Financial Markets, Financial Education Report: Overview and Analysis of
Selected Non-School Financial Education Programmes: Executive Summary,
DAF/CMF(2005)6/REV2, (Paris: June 23, 2005).
Concluding Observations
understand the concept of compound interest. However, only 28 percent
correctly answered a question using the concept. 42 Countries have
realized the growing need for more financial literacy, and several
countries provide or are planning to provide general information about
pensions and savings for retirement.
Demographic challenges and fiscal pressure have necessitated national
pension reform in many countries. Though the reform efforts we examined
all had the common goal of improving financial sustainability, countries
adopted different approaches depending on their existing national pension
systems and the prevailing economic and political conditions. That is why
reforms in one country are not easily replicated in another, or if they
are, may not lead to the same outcome. Countries have different emphases,
such as benefit adequacy or equity; as a result, what is perceived to be
successful in one place may not be viewed as a viable option somewhere
else. Although some pension reforms were undertaken too recently to
provide clear evidence of results, the experiences of other developed
countries do suggest some lessons for U.S. deliberations on Social
Security's future.
Some of these lessons are common to all types of national pension reform
and are consistent with findings in previous GAO studies. Restoring
longterm financial balance invariably involves reducing projected
benefits, raising projected revenues, or both. Additionally, with early
reform, policymakers are more likely to avoid the need for more costly and
difficult changes later. Countries that undertook important national
pension reform well before undergoing major demographic changes have
achieved or are close to achieving, financially sustainable national
pension systems. Others are likely to need more significant steps because
their populations are already aging.
No matter what type of reform is undertaken, the sustainability of a
pension system will depend, in large part, on the long-term health of the
national economy. As the number of working people for each retiree
declines, average output per worker would have to increase in order to
sustain average standards of living. Reforms that encourage employment
42
Roy Morgan Research, ANZ Survey of Adult Financial Literacy in Australia:
Final Report. (Melbourne, Australia, May 2003). This study included a
telephone survey of 3,548 adults and in-person interviews with 202, but
the report did not indicate response rates.
Page 30 GAO-06-126 Social Security Reforms Abroad
Agency Comments
and saving, offer incentives to postpone retirement, and promote growth
are more likely to produce a pension system that delivers adequate
retirement income and is financially sound for the long term.
Regardless of a country's approach, its institutions need to effectively
operate and supervise the different aspects of reform. A government's
capacity to implement and administer the publicly managed elements of
reform and its ability to regulate and oversee the privately managed
components are crucial. Good public understanding of pension issues is
needed to provide reasonable assurance that people plan ahead to have
adequate income in retirement and to help ensure that pension reforms have
enough public support to be sustainable. In addition, education of the
public becomes increasingly important as workers and retirees face more
choices and the national pension system becomes more complex. This is
particularly true in the case of individual account reforms, which require
high levels of financial literacy and personal responsibility.
In nearly every country we studied, debate continues about alternatives
for additional reform measures. It is clearly not a process that ends with
one reform and often requires more than one type of reform. This may in
part be true because success can only be measured over the long term, but
problems may arise and need to be dealt with in the short term. The
positive lessons from other countries' reforms may only truly be clear in
years to come.
We provided a draft of this report to the Social Security Administration,
the State Department, and the Department of the Treasury. SSA and Treasury
provided technical comments on the draft; the State Department did not
provide comments. We also provided copies of the draft to OECD staff and
other external reviewers, who provided technical comments. In response to
these technical comments, we modified the draft where appropriate.
We are sending copies of this report to the Commissioner of Social
Security, the Secretary of State, and the Secretary of the Treasury. We
will also make copies available to others on request. In addition, the
report will be available at no charge on GAO's Web site at
http://www.gao.gov/.
If you or your staff have any questions about this report, please contact
me at (202) 512-7215 or [email protected]. Contact points for our Offices
of Congressional Relations and Public Affairs may be found on the last
page of this report. GAO staff who made major contributions to this report
are listed in appendix III.
Barbara D. Bovbjerg, Director Education, Workforce, and Income Security
Issues
Appendix I: Scope and Methodology
Methodology
We reviewed national pension reforms that occurred since 1970 in all 30
Organisation for Economic Co-operation and Development (OECD) countries
and Chile. We included Chile in our study because it was the first country
to undertake national pension reform that resulted in individual accounts.
On the basis of our preliminary research, we identified three types of
reform-adjustments to the existing pay-as-you-go (PAYG) program, national
pension reserve funds, and individual account programs-that illustrate a
variety of circumstances and experiences with national pension reform
across these countries. 1 While we reviewed each type of reform separately
for this report, we do indicate when countries have undergone more than
one of these types of reform.
We did not conduct an evaluation or audit of any country's national
pension program or its reform efforts; rather, we relied on the work of
officials in individual countries and international organizations with
expertise in this area. We did, however, draw some lessons based on our
review, as well as including the lessons that others have drawn. We
attempted to report the most current status of a country's reform by using
the most recently available data. Some countries may have undergone
changes to their systems subsequent to the publication of the literature
we reviewed, however. In many countries reforms are implemented over an
extended period of time, so the results are yet to be apparent. We also
contacted supreme audit institutions or reviewed their Web sites to see if
they have done similar work. However, much of their work was of the audit
nature and not relevant for our study.
To obtain information on other countries' national pension reforms, we
reviewed the types of reforms undertaken in OECD countries and Chile. We
selected the OECD countries in part because they are most comparable to
the United States. Additionally, the OECD has relatively comparable data
for its member countries. We conducted background research and interviews
to identify the types of reforms, if any, the selected countries had
undertaken. We primarily used information from the following sources to
identify countries' reforms and characteristics of national pension
systems: the Social Security Programs Throughout the World publications,
provided through a cooperative effort by the Social
1
This list of types of reform is not comprehensive. Some countries, Norway,
for example, recently adopted legislation requiring employers to provide
pensions (usually defined benefit programs) for employees.
Page 33 GAO-06-126 Social Security Reforms Abroad Appendix I: Scope and
Methodology
Security Administration and the International Social Security Association;
publications from the International Social Security Association and
updates from its Social Security Worldwide database; and publications from
OECD, World Bank, International Monetary Fund, and the European Union's
Economic Policy Committee.
After identifying the countries to be reviewed and the types of reform
they had undertaken, we conducted a review of relevant literature on these
countries' national pension reforms, including the following sources:
o OECD Economic Surveys;
o OECD publications on national pension reform and other related issues;
o World Bank's Pension Reform Primer;
o Relevant government agency publications and Web sites from selected
countries;
o Reports from U.S. and international policy groups; and
o Reports from U.S., international, and country-specific experts.
We also interviewed officials and interest group representatives in
Washington, D.C.; Paris; and London. We met with pension experts and
country specialists at the OECD, the World Bank, and French and British
experts, officials, and interest group representatives, as well as
international pension experts in the United States. We formulated the
lessons learned in our report from those identified by experts and
officials and based on our own analysis of countries' reforms. Generally,
we aligned our lessons with GAO's criteria for evaluating national pension
reform, identifying key lessons related to fiscal sustainability, adequacy
and equity, and implementation and administration of reform.
We relied mainly on OECD data for information on country demographics,
economics, and information related to the national pension programs. OECD
collects much of its data from its member countries and validates its
reports with these countries. For example, OECD recently published a
description of each OECD member country's mandatory pension system,
including the results of modeling that projects the net replacement rates
expected from old-age pension benefits once all reforms enacted through
Appendix I: Scope and Methodology
2002 have been fully implemented. 2 OECD has also undertaken studies of
the projected level of public spending on national old-age pension
programs through 2050 based on national estimates and common OECD economic
assumptions. 3 In cases where national governments have completed more
recent estimates, we cited those rather than the earlier OECD estimates.
Also, we do not make a link between specific national pension reforms and
changes in the economy or of any specific reform measure and the
sustainability of the program. This is because most countries have
undergone more than one type of reform at different points in time, making
causes and effects difficult to determine.
To assess the reliability of the data on countries' national pension
systems, we (1) interviewed officials at the OECD including those in the
Statistics Directorate and the Economics Department responsible for
compiling these data based on information provided by government officials
in OECD member countries, and (2) performed some basic reasonableness
checks of the data against other sources of information. We determined
that the data are sufficiently reliable for the purpose of making broad
comparisons of the United States' and other countries' pension systems. To
ensure the reliability of its data, OECD also compares and investigates
alternative sources of data, uses an internal peer and supervisory review
process, and a process through which draft reports are reviewed and
validated by member governments prior to publication. Nonetheless, OECD
officials note several limitations in the data, including the fact that
the data are largely self-reported by each country and are affected by
differences in exchange rates, methods for analyzing national account data
and tracking price inflation, as well as different methods used to predict
longevity and economic growth. OECD works to develop comparable data by,
for example, developing purchasing power parity factors, harmonized price
indexes, and projections of old-age pension spending based on common
economic assumptions. Because of, these limitations, we were unable to
determine the reliability and precision of estimates for each country. We
conducted our review from August 2004 through September 2005 in accordance
with generally accepted government auditing standards.
2
OECD, Pensions at a Glance: Public Policies across OECD Countries (Paris:
2005).
3
See, for example, Thai Than Dang, Pablo Antolin, and Howard Oxley, Fiscal
Implications of Ageing: Projections of Age-Related Spending,
ECO/WKP(2001)31 (Paris: OECD, Sept. 19, 2001), and, OECD, Sustainable
Development in OECD Countries: Getting the Policies Right, (Paris: 2004).
Page 35 GAO-06-126 Social Security Reforms Abroad
Appendix II: Information on OECD Countries and Chile, Their Pension Systems, and
Reforms
Below are tabular data concerning OECD countries and Chile. Table 3
provides background information concerning each country's demographics,
economy, and political structure. Table 4 provides basic information about
each country's national pension system, including information about
spending on mandatory old-age pension programs, contribution rates, the
extent to which mandatory pensions replace workers' earnings, and the size
of voluntary supplementary private and occupational pensions. Table 5
provides examples of various adjustments to PAYG pension programs. Table 6
provides information on national pension reserve funds for countries that
have established such funds. Table 7 provides information on individual
account programs that countries have adopted as part of their mandatory
national pension systems.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms
Table 3: Background on OECD Countries and Chile
Percentage of
Number of people elderly people
in the workforce for receiving less than
every person aged half the median
65 or over income
Estimated Percentage
of
population population GDP
in aged 55-64 per Aged 66 Aged 76 and Government
millions, employeda capitab to 75 over structure c
Country July 2005 2005 2050
Australia 20 3.9 1.6 50 $30,700 21 29 Democratic,
federal-
state system
recognizing
the
British
monarch as
sovereign
Austria 8 2.9 1.3 30 31,300 8 12 Federal
Republic
Belgium 10 2.5 1.5 28 30,600 11 19 Federal
parliamentary
democracy
under a
constitutional
monarch
Canada 33 4.2 1.9 53 31,500 4 5 Confederation
with
parliamentary
democracy
Chile 16 Not Not Not 10,700 Not Not Republic
available available available available available
Czech 10 3.5 1.2 42 16,800 1 4 Parliamentary
Republic democracy
Denmark 5 3.4 2.0 61 32,200 4 9 Constitutional
monarchy
Finland 5 3.3 1.5 50 29,000 7 16 Republic
France 61 2.7 1.3 37 28,700 10 11 Republic
Germany 82 2.6 1.5 39 28,700 10 11 Federal
republic
Greece 11 2.0 1.2 42 21,300 22 28 Parliamentary
republic
Hungary 10 2.6 1.0 29 14,900 6 5 Parliamentary
democracy
Iceland 0.3 4.8 2.5 87d 31,900 Not Not Constitutional
available available republic
Ireland 4 4.3 1.9 49 31,900 31 43 Republic
Italy 58 2.2 0.9 30 27,700 15 16 Republic
Japan 127 2.5 1.1 62 29,400 20 24 Constitutional
monarchy with
a
parliamentary
government
Percentage of
Number of people elderly people
in the workforce for receiving less than
every person aged half the median
65 or over income
Estimated Percentage
of
population population GDP
in aged 55-64 per Aged 66 Aged 76 and Government
millions, employeda capitab to 75 over structure c
Country July 2005 2005 2050
Luxembourg 0.5 3.2 1.7 28d $58,900 4 9 Constitutional
monarchy
Mexico 106 6.8 2.3 54 9,600 24 37 Federal republic
Netherlands 16 3.8 2.2 44 29,500 2 2 Constitutional
monarchy
New Zealand 4 4.2 1.7 64 23,200 0.4 0.5 Parliamentary
democracy
Norway 5 3.6 2.1 69 40,000 6 20 Constitutional
monarchy
Poland 39 3.1 1.0 29 12,000 4 5 Republic
Portugal 11 3.1 1.2 51 17,900 25 35 Parliamentary
democracy
Slovak 5 4.0 1.0 25 14,500 Not Not Parliamentary
Republic available available democracy
South Korea 48 4.5 0.9 58 19,200 Not Not Republic
available available
Spain 40 2.7 1.3 41 23,300 15 9 Parliamentary
monarchy
Sweden 9 2.8 2.0 69 28,400 5 12 Constitutional
monarchy
Switzerland 7 3.4 2.1 66 33,800 10 13 Federal republic
Turkey 70 5.1 1.4 33 7,400 17 15 Republican
parliamentary
democracy
United 60 3.2 1.8 56 29,600 11 19 Constitutional
Kingdom monarchy
United 296 4.1 2.3 60 40,100 20 30 Constitution-based
States federal republic
Source: OECD, Central Intelligence Agency (CIA), Social Security
Administration.
a
For 2003, unless otherwise noted. Amounts are rounded to the nearest whole
number.
b
For 2004, based on purchasing power parity.
cGovernment structure definitions from the United States' CIA. For
definitions of the government structures see, The World Factbook, 2005 on
the CIA's webpage,
http://www.cia.gov/cia/publications/factbook/index.html, guide to country
profi les section- government type.
d
Figure for 2002.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms
Table 4: Information concerning Countries' National Pension Systems
Projected funding for national pension system as a
percentage of GDP Employee/employer contributions
Projected increase in
spending on old-age
pensions from 2000
to 2050 as a Average contributions as Annual ceiling for Country
percentage of GDPa 2000 2050 a percentage of earningsb contributions in
U.S. dollars
Australia 1.6 3.0 4.6 9.0f $87,900
Austria 2.2 9.5 11.7 22.8 51,800
Belgium 3.3 8.8 12.1 16.4 No ceiling
Canada 5.8 5.1 10.9 9.9 29,100
Chile NA NA NA 10.0 16,900 (as of Jan. 2003)
Czech Republic 6.8 7.8 14.6 28.0 No ceiling
Denmark 2.7 6.1 8.8 1.9g No ceilingg
Finland 4.8 8.1 12.9 22.9 to 33.0 No ceiling
France 3.9h 12.1 16.0h 16.4 37,100
Germany 5.0 11.8 16.9 19.5 77,300
Greece 10.0i 12.5 22.5 20.0 29,400j
Hungary 1.2 6.0 7.2 26.5 3 times gross average earnings
Iceland NA NA NA 15.6k No ceiling
Ireland NA NA NA 16.8l No ceiling
Italy -0.3 14.2 13.9 32.7 105,500m
Japan 0.6 7.9 8.5 13.6 67,500
Luxembourg 1.9n 7.4n 9.3n 16.0 105,200
Mexico NA NA NA 11.3 No ceiling
Netherlands 4.8 5.2 10.0 25.8 36,900
New Zealand 5.7 4.8 10.5 0.0p Not applicable
Norway 8.0 4.9 12.9 21.9 No ceiling
Poland -2.5q 10.8 8.3 32.5 18,400
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
Projected net replacement rates as a percentagec,d
Assets of voluntary
Half of Average Two times supplementary pension funds as
average earnings earnings average earnings a percentage of GDP, 2002e
77 52 36 Not available (NA)
91c 93c 79c 4.4
83 63 43 5.6
89d 57d 31d 47.6
NA NA NA NA
88 58 35 3.3
96d 54d 36d 28.5
91 79 78 NA
98 69 59 NA
62 72 67 3.8
100 100 100 NA
87 90 93 5.2
96 66 57 100.5
63 37 22 NA
89 89 89 2.0
80 59 44 NA
125 110 104 NA
50c 45c 44c 4.9
82 84 84 106.0o
77 40 22 15.1
86 65 50 4.6
70c 70c 70c 4.4
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms
Projected funding
for national pension
system as a
percentage of GDP Employee/employer contributions
Projected
increase in
spending on old
age pensions
from 2000 to 2050
as a Average Annual ceiling
percentage of contributions as for
GDPa a percentage of contributions in
Country 2000 2050 earnings b U.S. dollars
Portugal 4.5r 8.0r 12.5r 23.1 No ceiling
Slovak Republic NA NA NA 26.0 No ceiling
South Korea 8.0 2.1 10.1 9.0 37,100
Spain 8.0 9.4 17.4 28.3 41,000s
Sweden 1.6t 9.2 10.8 18.5 46,700u
Switzerland NA NA NA 16.8 to 27.8v No ceiling
Turkey NA NA NA 20.0 23,100u
United Kingdom -0.7 4.3 3.6 23.8 1% rate applies above
$55,300
United States 1.8 4.4 6.2 12.4 87,000w
Projected net replacement rates as a percentagec,d
Assets of voluntary
Half of Average Two times supplementary pension funds as
average earnings earnings average earnings a percentage of GDP, 2002e
116 80 86 13.4
58 60 66 NA
65 44 34 2.2
89 88 83 6.0o
90 68 74 4.2
71c 67c 41c 125.5
113 103 84 NA
78d 48d 30d 73.3o
61d 51d 39d 57.2
Source: OECD and Social Security Administration.
aNational estimate of increase needed to fund projected benefits using
national models and common OECD economic and demographic assumptions as
published by OECD in 2005, except as noted.
bTotal of employer and employee contributions for old-age, survivor, and
disability coverage, except as noted. In many cases these rates apply to a
specified range of earnings rather than all earnings. As of 2004 for
Europe, Asia, and the Pacific; as of 2003 for the Americas, except as
noted.
cIn some countries estimates for men and women differ. In these cases the
values shown are for men. Specifically, the estimates for women in Austria
are 86 percent, 85 percent, and 72 percent for half average earnings,
average earnings, and twice average earnings, respectively. The estimates
for women in Mexico are 50 percent, 30 percent, and 28 percent. The
estimates for women in Poland are 62 percent, 49 percent, and 49 percent.
The estimates for women in Switzerland are 72 percent, 68 percent, and 42
percent. The estimates for women in Turkey are 111 percent, 101 percent,
and 82 percent, respectively.
dIn some countries voluntary pension programs play an important role and
substantially increase net replacement rates. In Canada estimated net
replacement rates, including voluntary schemes, are 109 percent, 95
percent, and 69 percent for half average earnings, average earnings, and
twice average earnings, respectively. In Denmark comparable estimates are
125 percent, 82 percent, and 67 percent. In the United Kingdom the
estimates are 90 percent, 70 percent, and 58 percent. In the United States
the estimates are 106 percent, 92 percent, and 84 percent, respectively.
e
Aggregate supplementary private and occupational voluntary pension fund
assets as a percentage of GDP in 2002 unless otherwise noted.
f
Mandatory employer contribution to superannuation program. General
government revenue funds PAYG program.
gUp to 2,682 kroner per year per employee for labor-market supplementary
pension ATP plus 1 percent for Special Pension without a ceiling, but
Special Pension contributions were suspended in 2004 through 2007.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
hEstimate for 2040; 2050 estimate not available. In contrast, official
reports suggest a 4.4 percent increase on unchanged labor market policies
for the period 2000 to 2040.
i
National projection forecasts an increase of 12.2 percentage points.
j
No ceiling for workers first insured after January 1, 1993.
k
Includes maternity/paternity, work injury, and unemployment benefits as
well as old-age, survivor, and disability coverage.
l
For weekly earnings above 356 euros, about $445. Percentage rate depends
on level of earnings. Includes sickness, maternity, work injury,
unemployment, and adoptive benefits. mNo ceiling for workers first insured
before January 1, 1996. nFrom an estimate published by European Union's
Economic Policy Committee in 2001. oAs of 2001. pCosts of most programs
covered by general fund revenue.
qAssumes 2 percent growth in the revaluation factor. rEstimate published
by OECD in 2001, noting that this estimate is less comparable than
estimates for other countries.
sCeiling of $114 per day for some occupational classes.
t
Assumes a 1.6 percent revaluation factor. uCeiling for employee
contributions.
v
Rate depends on age and gender.
w
$90,000 as of 2005.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
Table 5 provides examples of adjustments to national PAYG pension programs
undertaken by OECD countries and Chile. The table primarily includes
examples of reforms that increased contributions to the programs or
decreased benefits. It does not provide a comprehensive list of such
reforms.
Table 5: Examples of Adjustments to PAYG Programs, 1970-2004
Change in Change in
years
Increase in of earnings Change in indexation Economic and
for
contribution Change in considered indexation benefits demographic
in for
rates or retirement benefit calculation during adjustment Other
coverage age a calculation of initial retirement mechanisms decrease in
Country benefitb benefits
Australia None 60 to 65 None None None None Means
identified for identified identified identified identified testing
women reintroduced
in
mid 1980s
Austria 9.0% to 9.5% None 1993: 10 to None 1993: new None Reduced
15 identified identified access
beginning in identified years for adjustment to early
full
1989 and to retirement; formula retirement
based with
10.25% for 2003: 15 to on net later age
employees by 40 years by wages requirement,
2004 2028; 1997: reduced
15 to 18 benefits,
and
incentives
years for for delayed
early retirement
retirement
Belgium None 60 to 65 20 to 35 Adoption None None Minimum work
identified for years for of identified identified
women early price life for
retirement index early
retirement
increased
from
24 to 35
years;
age limit
for early
retirement
increased
from
55 to 58
Canada 5.85% to None All years Valorization None None Means
9.9% less identified identified testing for
phased in identified 15% of low based on ratio basic flat
benefit
beginning earning years of the earning at high
in income
1998 year's levels
maximum
pensionable
earnings c
Chile Increased to 60 to 65 None None None None None
for identified identified identified identified identified
average of men; 55
to
50% of 60 for
covered wages women
by 1974; later
reduced to
33%, then 20%
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms Appendix II: Information on OECD
Countries and Chile, Their Pension Systems, and Reforms Appendix II:
Information on OECD Countries and Chile, Their Pension Systems, and
Reforms Appendix II: Information on OECD Countries and Chile, Their
Pension Systems, and Reforms Appendix II: Information on OECD Countries
and Chile, Their Pension Systems, and Reforms
Change in Change in Change in
years of indexation indexation Economic and
earnings for for demographic
Country Increase in Change in considered calculation benefits adjustment mechanisms
contribution rates retirement in benefit of initial during Other decrease in
or coverage age a calculation benefitb retirement benefits
Czech None 60 to 63 None Move to None None None
Republic identified for men; identified price identified identified identified
57 to 63 indexation
for women, plus
but lower increases
depending of at least
on the one-third
number of of real
children wage growth
raised
Denmark Increased by 1% of wages None None identified None identified
recently-other increases in past; gradual identified Imposed actuarially fair
increase in pension contribution rates None adjustment for retiring early,
from 0 to 9% from 1993 to 2004, 5% to 9% identified decreasing cost to government
for blue collar workers effective 2004 and benefits to early retirees
None identified None identified Finland From wages to 80% prices and 20%
Worker contributions to employmentbased of wages, but no adjustment in
pensions introduced, then increased 0.7% 1994 Pension benefits linked to
to 2.2% of wages, and 3.7% of wages above life expectancy beginning in
a set level 63 to 65 4 to 10, then to 2009 Lower accrual rates for
whole work life early retirees; and minimum age
for early retirement raised from
58 to 60, then to 62 years; flat
monthly base benefit eliminated
in favor of a pension-tested
benefit
France New tax None 10 to 25 From From wages Point None
for years for wages to system for identified
to
pensions: identified calculation prices prices; no calculating
1% and
of all 37.5 to 40 adjustment earnings
incomes years in
required 1994 related
benefits
contributions
Change in Change in Change in
years of indexation indexation
Increase in earnings for for Economic and
contribution Change in considered calculation benefits demographic
rates or retirement in benefit of initial during adjustment Other decrease
Country coverage age a calculation benefitb retirement mechanisms in benefits
Germany Successive 60 to 65 None None From gross Point system Adopted
increases, for women identified identified to net for calculating penalties for
e.g., 1991 by 2004 wages, earningsrelated early
increase of then benefits in retirement and
2.5% and 1.7% prices supplementary incentives for
in 1994; schemes, later
upper including a retirement
earnings demographic
limit indexed factor
to wages
Greece Major 60 to 65 Minimum None None None identified Benefit
increase in for women years 13.5 identified identified calculation
1992 to 15 factor 80% to
years, 1990 60%
Hungary None 60 to 62 Increase in None From wages None identified Increased
identified for men; number of identified to half penalties for
56 to 62 years for wages and early
for women early and half retirement by
full prices raising the
retirement minimum age
benefit and increasing
the minimum
number of
years for
early
retirement
Iceland None None None None None None identified Flat-rate
identified identified identified identified identified component of
the basic
pension was
abolished and
replaced with
a wholly
income-related
benefit
Ireland Earnings cap None None None None None identified None
on employer identified identified identified identified identified
contributions
eliminated
(effective
April 2001)
Change in years Change in
Increase in of earnings Change in indexation Economic
for and
contribution Change in considered in indexation benefits demographic
for
rates or coverage retirement age benefit calculation during adjustment Other decrease in
a calculation of initial retirement mechanisms benefits
Country benefitb
Italy Increase in 60 to 65 for Increased Earnings From minimum NDC plan Minimum years
1995-97 men; 55 to minimum number growth to wage to adopted required for
prices; 1995,
period; from 60 for of years for moving partial but to be benefit 15 to 20
24.5% to women seniority average of suspension of phased in years, but reset
32.7% of gross through pension and nominal GDP price slowly to 5 years for
indexation
earnings, but 1995, old-age growth over NDC
5
in part this under new pension years
reflected re- NDC: age
labeling other 65, but
contributions early
as social retirement
security as early as
Japan contributions 57 60 to 25 to 40 None Gross wages In 2004 Accrual rate for
17.35% to 18.3% by 65 for men in 1986 identified to net legislation earnings-related
2017 government and 59 to reform wages introduced pension from 1%
share to increase 65 for (1994), automatic per year to
from one-third to women then from adjustment to 0.7125%;
one-half of cost; wages to benefits in benefits to be
also extended prices, response to reduced 20% by
contributions base then prices macroeconomic 2025; increased
to include bonuses less changes in penalties for
(1994) demographic the working early
and age retirement,
longevity population incentives for
adjustments and life later retirement
projected expectancy
to be 0.6%
and 0.3%
per annum
Luxembourg Contribution rates None None Higher, not None None Increases in
are identified identified lower, identified identified benefits, not
increased revaluation decreases:
based on actuarial factors for supplements,
review every 7 prior years' higher accrual
years earnings rates
Mexico 20% None 10 to 25 None None None None
to years of identified identified identified identified
26%
identified contributions
required for
minimum
benefit
Change in Change in Change in
years of indexation indexation
Increase in earnings for for Economic and
contribution Change in considered calculation benefits demographic
rates or retirement in benefit of initial during adjustment Other decrease
Country coverage age a calculation benefitb retirement mechanisms in benefits
Netherlands Increase in None Shift from None Indexing None Imposed taxes
1995-1997 identified calculation identified suspended identified on
period and based on temporarily quasimandatory
2002 to 2004 final in late occupationbased
salary to 1980s pension early
one based retirement
on average benefits to
salary increase
penalties for
early
retirement and
achieve
actuarial
neutrality
New Zealand No employer/ 62 to 65 None None None None The link to 80%
employee identified identified identified identified of average
contributions wages (for
to PAYG couple)
abolished;
relative value
is now below
70%
Norway Generally Retirement None None None None 45% to 42% of
each May age identified identified identified identified base times
Parliament lowered average pension
increases from 70 to points; maximum
contributions 67 in 1973 points per year
by increasing 8 1/3 to 7
the base
amount used
to set
taxable wages
(no
indexation).
Poland None None None None Indexation NDC reform None identified
identified identified identified identified suspended adjusts
2005; benefits to
scheduled reflect
to be contributions,
adjusted longevity, and
every 3 growth in
years; wages;
earlier if replacement
inflation rate expected
is 5% or to drop from
more 73% to 24% by
2050
Change in years Change in
Increase in of earnings Change in indexation Economic and
for
contribution Change in considered in indexation benefits demographic
for
rates or retirement benefit calculation during adjustment Other
coverage age a calculation of initial retirement mechanisms decrease
benefitb in
Country benefits
Portugal None 62 to 65 From best 10 None None None Accrual
identified for of identified identified identified rate will
women last 15 years be reduced
to from
entire work 2.2% to 2%
life;
Increase in
minimum
contribution
period
Slovak Increase in 60 to 62 Highest 5 of None None Adoption of a None
for last identified identified identified
Republic 1995-1997 men; 53 to 10 years to points system
point
period 62 for system with
women considering adjustments
for
working life point values
South Korea Increase in 60 to 65 15 years in None None None None
by 1990, identified identified identified identified
1995-1997 2033 then 10
years,
period and then lifetime
continued earnings in
point
gradual system
increases
through 2025
Spain Various Closed 8 years of None None None Reduced
identified identified identified early
ceilings on earlier contributions retirement
plan to
contributions with last 15 years benefits
raised to the retirement
highest level age 60 to
new
entrants;
new
entrants
retire at
age 65
Sweden None Increase None None None NDC reform None
identified identified identified identified identified
from 65 to adjusts
benefits
66; to reflect
decrease contributions,
to
61 with longevity, and
actuarial economic
penalty performance
Switzerland None 62 to 65 None None None Demographic None
identified for identified identified identified identified
women conversion
factor reduced
from 7.2% to
6.65% by 2016
Turkey None 55 to 60 Minimum None None None Reduction
identified for identified identified identified in
men; 50 to contributions benefits
for
58 for 5,000 to recipients
7,000 who
women days work
Change in years Change in
Increase in of earnings Change in indexation Economic and
for
contribution Change in considered in indexation benefits demographic
for
rates or retirement benefit calculation during adjustment Other decrease
coverage age a calculation of initial retirement mechanisms in benefits
Country benefitb
United Employees' 60 to 65 From 20 best None Basic None Earnings-related
for identified state identified
Kingdom contributions women years to all pension pension reduced
9% to 10%; from 2010 working years indexed to from 25% of best
for
also rates to 2020 earnings-related prices, 20 years
1980
increased by pension earnings to 20%
1 percent for of lifetime
employers and earnings
employees on
earnings
above a
threshold
United 10.8% to 65 to 67 None identified Wage index Delayed None Cut windfall
the identified
States 12.4% amended to June 1983 benefits to
cost those
include of-living with benefits
deferred adjustment from employment
until
compensation December not covered by
1983
beginning in the program
1991
(increases
benefits)
Source: OECD, International Social Security Association, SSA, World Bank,
and country publications.
a
Changes in retirement age generally both increase contributions and
decrease benefits. Workers contribute for a longer period and receive
benefits for a shorter period if they work longer.
bThis is the index used for adjusting earlier years' earnings when
calculating an initial earnings-related pension benefit. In the United
States, for example, earnings in a given year under age 60 are adjusted to
reflect the increase in average wages from that year to the year in which
the worker reaches age 60. Earnings from age 62 to age 67 are adjusted
using a price index.
cThis is indexed to growth in average earnings during the 3, then 4, then
5-year period ending at retirement.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms
Table 6: National Pension Reserve Fund Reforms
Reserve as Restrictions on
percentage of class of De-accumulation
Country Year GDP Reserve Fund investments trigger or date
management
Belgium Established Not Silver Fund 100% in None identified
available
2001 (NA) government
securities
Canada Established 2.3%a Canadian Pension 30% limit on None identified
Plan Investment foreign
1997 Board (CPPIB) securities
beginning
in 2001
Denmark Established 25%b Arbejdsmarkedets The Board None identified
Tillaegspension annually
1964 (ATP)-corporation sets
with board investment
appointed by guidelines
various employee
&
employer
associations
Finland Implemented 4.5%a None None identified
Identified
1999
France Implemented 1.2%a Pensions Reserve Equities of 2020
Fund (Fonds de firms
2004 Reserve des headquartered
Retraites, FRR)
outside
European
Economic Area
limited to
25%
Greece Established NA NA None None identified
Identified
2002
Ireland Established 9.6%c Autonomous National None of the 2025
Pensions assets
2001 Reserve Fund can be
Commission invested in
(NPRFC) Irish
government
securities
Japan Established 28.2%a Government Pension Minister set None
1942, reformed Investment Fund requirement identified
(GPIF)d that
2001 holdings of
domestic
bonds must
be
greater than
foreign
bonds;
foreign
equities
must
represent
less than
two-thirds
of
domestic
equity
investments;
and
holdings in
foreign
stocks must
be
greater than
foreign
bonds None None
Korea Established 13.0%a National Pension Fund identified identified
1988
Luxembourg Late 1980s 23.6%a NA None identified None
identified
Netherlands Established NA AOW-spaarfonds None identified 2020
(AOWSF)
1998
Reserve as Restrictions
percentage Reserve Fund on class of De-accumulation
Country Year of GDP management investments trigger or date
New Established 1.6%a Guardians of None 2020
Zealand 2001 New Zealand legislated,
Superannuation investment
Fund policy set
and reviewed
annually
Norway Established 65%c Norwegian 100% in None identified
1990 Government foreign
Petroleum Fund securities
(NGPF)c
Portugal 3.4%b Fundo de None None identified
Established Estabilizac,ao identified
1989, Financeira da
reformed Seguranc,a
2002 Social, FEFSS
Spain Established 1997 2.6%c None None
identified
Sweden Established 23.6%a Autonomous A limit of 5 None
1960, reformed AP-fonden percent in identified
1999 (APF) boards unlisted
securities; no
one of the 4
funds can hold
more than 2% of
the
value of equities
in a single
company; No more
than 40% in
investments with
unhedged foreign
currency
exposure; At
least 30% in
highly rated
fixed income
securities
United Reformed 14.1%a Old-Age and 100% in Shortfall in
States 1983 Survivor's Insurance
Trust Fund trustees government program cash
flows
securities; no
foreign
securities
Source: OECD, World Bank, and annual reports for specific funds. aAs of
2003. bAs of 2000.
c
As of December 31, 2004. dAlso known as the Investment Fund of Social
Security Reserves or (IFSSR).
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms Appendix II: Information on OECD Countries and Chile,
Their Pension Systems, and Reforms
Table 7: Individual Account Reforms
Mandatory or
voluntary Funded with revenue
for new
Year redirected Transition costs
entrants to to accounts
or
Country implemented workforce? new funding Contribution
revenue? rates
Mandatory No
Australia 1992 employer- New revenue transition 9% (employer)
costs
based plan
Chile 1981 Mandatory Redirected Built budget 10%
surpluses in (employee)
advance of
reform:
raised
taxes on
consumption,
sold
state-owned
enterprises,
and
borrowed
from the
public
Denmarkd No 1% gross
2002 Mandatory New Revenue transition income,
costs
but
contributions
suspended for
2004
through 2007
Hungary 1998 Mandatory Redirected Central 8% (employee)
revenue, budget
parametric
changes to
decrease
PAYG
liabilities
Mandatory No
Icelande 1997 employer- New Revenue transition Varies
costs
based plan
Mexico 1997 Mandatory Redirected General 6.5%f
government
budget
Poland 1999 Mandatory Redirected Public 7.3%
borrowing (employee)
Slovak 2005 Mandatory Redirected Sale of 10.0%
nationalize
Republic companies to
the private
sector
In part
Sweden 1999 Mandatory Redirected through 2.5%
reductions
in PAYG
benefits
with
adoption of
NDC
Switzerlandh Mandatory No 14%-36%i
1985 employer- New revenue transition
costs
based plan
United 1988 Voluntary Redirected General Varies by age
opt-out revenue from
Kingdom 2.1% to 5.25%
over
middle
earnings
range
Who Total Administrative
amount costs
invested
Who in the
administers manages the accounts and charges-
the at the
individual individual Minimum rates of end of reduction in
account 2004 as final
program? accounts? return guarantees Payout percentage capital and
options of GDP pension a
Centrelink Annuity, lump 76%
through 401 Employer No sum, estimated 26%
as of
customer phased September
service withdrawal 2004
centers
Pension fund Pension Relative Annuity, 59% 16%
managers funds rate of programmed or
returnb phased
withdrawal,
or a combination c
The Board of No Installments 3% NA
Labor-Market over 10
Supplementary Directors years, lump
Pension and sum for
Institution, Council small
an accounts
independent representing
organization
headed by a the Social
bipartite
board of Partners
directors (ATP)
Pension funds Pension No-abolished Annuity, 2% NA
funds in lump sum if
2002 less than
180 months
of contributions
Independent Pension None Annuity NA NA
pension funds Identified
funds
Social Pension
Insurance funds No Annuity, phased NA 22%
Institute
withdrawal (based
on
life expectancy)
Social Pension Relative
Insurance funds rate of Annuity 6% 14%
Institute
returng
Social Private Relative Annuity,
Insurance asset rate of phased NA NA
Institute
managers return withdrawal
Premium Pension No Annuity 7% 15%
Pension funds
Agency
Occupational Jointly by 2.5% Annual payment 117% NA
Pension (reduced (2000)
Institutes employers from 4%) equal to 7.2%
and of
employees accumulated
funds,
with interest
The Pensions Variety of No 25% can be a lump NA 19%j
Regulator
private sum; annuity
required
pension by age 75
providers
Source: OECD, SSA, World Bank, and country publications.
Appendix II: Information on OECD Countries and Chile, Their Pension
Systems, and Reforms
aEstimates include fees on investments, record-keeping services,
marketing, and profits. Data from Estelle James, Gary Ferrier, James
Smalhout, and Dimitri Vittas, Administrative Costs and the Organization of
Individual Account Systems: A Comparative Perspective, in Robert Holzmann
and Joseph Stiglitz, eds., New Ideas About Old Age Security (Washington,
D.C.: World Bank, 2001), except as noted.
bThe minimum rate of return is no less than 2 percentage points below the
average for all pension funds of the same type.
cCombinations may be a phased withdrawal with deferred annuity, or
immediate annuity with phased withdrawal.
d
This row covers Denmark's Special pension savings scheme (SP) as amended
in 2000. SP contributions in 1999 and 2000 were redistributed among
workers to help equalize benefits. Denmark also provides a Labor Market
Supplementary Plan (ATP) based on deferred annuities. The amount of
contributions is based on the number of hours worked rather than earnings.
The level of benefits is based in part on the rate of return in the
centrally managed investment fund. Since 2002 the accrual of pension
rights has been based on a guaranteed interest rate of 2 percent, but if
actual returns are higher, the level of benefits can be increased.
eIceland made its occupation-based pension system, with a defined benefit
structure, compulsory in 1974. In 1997, Iceland passed legislation that
codified the principle of a mandatory payment of at least 10 per cent of
wages and salaries in order to acquire pension rights, and it also allows
for the occupation-based pension program to create defined contribution
individual accounts as a complement to defined benefit pensions. However,
in practice, employers have not yet established these. Voluntary
supplementary individual accounts are also available. The occupation-based
pensions have a contribution rate of 10 percent of an employee's wages. A
minimum pension of at least 56% of lifetime average salary is paid for a
contribution period of 40 years (equivalent to 1.4% of average lifetime
salary per contribution year) and is paid for life.
f
The employer, employee, and government together contribute 6.5 percent,
and the employee contributes an additional 5 percent contribution to an
individual housing account (a scheme known as Infonavit) which reverts to
the retirement account when it is not used.
gThe minimum rate of return is either 50 percent of the average rate or 4
percent lower than the average for all funds during 24 consecutive months,
whichever is lower.
h
The 1985 mandatory employer-based pensions built upon the pre-existing
voluntary occupational plans.
i
Employee contributions vary based on age and gender, ranging from 7
percent to 18 percent on earnings between about $19,900 and $59,800.
Employers have to at least match these contributions.
j
Estimate from OECD, OECD Economic Surveys 2004: Poland (Paris: June 2004).
Appendix III: GAO Contact and Staff Acknowledgments
Barbara D. Bovbjerg (202) 512-7215 or [email protected]
GAO Contact
In addition to the contact named above, Alicia Puente Cackley, Assistant
Director; Benjamin P. Pfeiffer; Joseph Applebaum; Thomas A. Moscovitch;
Nhi Nguyen; Nyree M. Ryder; Roger Thomas; Seyda G. Wentworth; Corinna A.
Nicolaou; Lise Levie; and Pat Elston made key contributions to this
report.
Glossary
Add-on Individual accounts supplement Social Security benefits and would
draw contributions from new revenue streams.
Adequacy (See Income adequacy.)
Annuity An insurance product that provides a stream of payments for a
preestablished amount of time in return for a premium payment-the amount
being converted into any annuity. For example, a life annuity provides
payments for as long as the annuitant lives. Only insurance companies can
underwrite life annuities in the United States. Other financial
intermediaries, such as banks and stock brokerage firms, may sell
annuities issued by insurance companies.
Baby boomers Cohort of people born after World War II. This includes
Americans born from 1946 through 1964; 76 million strong, they represent
the longest sustained population growth in U.S. history. Other countries
generally use the term "baby boomers" to describe this generation.
Carve-out Individual accounts that would result in some reduction of or
offset to Social Security benefits because contributions to those accounts
would draw on existing Social Security revenues.
Consumer price index A measure of the change over time in the prices,
inclusive of sales and
(CPI) excise taxes, paid by urban households for a representative market
basket of consumer goods and services. The CPI is prepared by the U. S.
Department of Labor and used to compute Social Security cost of living
adjustment (COLA) increases.
Covered worker A worker in covered employment, that is, a job through
which the worker has made contributions to Social Security.
Deficit The amount by which the government's spending exceeds its revenues
in a given period, usually a fiscal year. The federal deficit is the
shortfall created when the federal government spends more in a fiscal year
than it receives in revenues. To cover the shortfall, the government sells
bonds to the public.
Page 58 GAO-06-126 Social Security Reforms Abroad Glossary
Defined benefit (DB)
A type of retirement plan that guarantees a specified retirement payment
and in which the plan's sponsor assumes the risk of providing these
benefits. Defined benefit plans promise their participants a steady
lifetime retirement income, generally based on years of service, age at
retirement, and salary averaged over some number of years. Defined benefit
plans express benefits as an annuity but may offer departing participants
the opportunity to receive lump-sum distributions. Defined benefit plans
are one of two basic types of employer-sponsored pension plans.
Defined contribution (DC) A type of retirement plan that establishes
individual accounts for employees to which the employer, participants, or
both make periodic contributions. Defined contribution plan benefits are
based on employer and participant contributions to and investment returns
(gains and losses) on the individual accounts. Employees bear the
investment risk and often control, at least in part, how their individual
account assets are invested.
Dependency ratio An estimate of the number of dependents per worker,
generally defined as the ratio of the elderly (ages 65 and older) and/or
the young (under age 15) to the population in the working ages (ages
15-64) or to the projected size of the labor force.
Dependent A person who is eligible for benefits or care because of his or
her relationship to an individual. Under the Social Security Act,
"dependent" means the same as it does for federal income tax purposes;
i.e., someone for whom the individual is entitled to take a deduction on
his personal income tax return, generally an individual supported by a tax
filer for over half of a calendar year.
Early retirement age The age at which individuals qualify for reduced
retirement benefits if they choose to collect benefits before the normal
retirement age; the current early retirement age for Social Security is
62. Individuals who choose to take retirement benefits early will have
their monthly benefits permanently reduced, based on the number of months
they receive checks before they reach full retirement age.
Full retirement age (FRA) (Also called normal or statutory retirement
age.) The age at which individuals qualify for full, or unreduced,
retirement benefits from Social Security and employer-sponsored pension
plans. The normal retirement
Page 59 GAO-06-126 Social Security Reforms Abroad Glossary
age for Social Security was 65 for many years. For workers and spouses
born in 1938 or later and widows/widowers born in 1940 or later, the
normal retirement age increases gradually from age 65 until it reaches age
67 in the year 2022. Among OECD countries, based on full implementation of
laws enacted as of 2002, the retirement age ranges from 60 (in France and
Korea) to 67 (in Iceland, Norway, and the United States).
Full funding A pension system that is fully funded is one in which
sufficient contributions have been put aside so that assets accumulated to
date are equal to the value of benefits accrued to date. Defined
contribution pensions and individual retirement accounts are fully funded
by definition.
General revenue transfers Funds moved from the General Fund of the
Treasury to other programs that are usually funded with earmarked revenue,
sometimes to maintain the solvency of those programs. General funds,
constituting about twothirds of the budget, have no direct link between
how they are raised and how they are spent. General fund receipts include
income and excise taxes.
Gross domestic product (GDP)
A commonly used measure of domestic national income. GDP measures the
market value of output of final goods and services produced within a
country's territory, regardless of the ownership of the factors of
production involved, i.e., local or foreign, during a given time period,
usually a year. Earnings from capital invested abroad (mostly interest and
dividend receipts) are not counted, while earnings on capital owned by
foreigners but located in the country in question are included. GDP may be
expressed in terms of product-consumption, investment, government
purchases of goods and services, and net exports-or it may be expressed in
terms of income earned-wages, interest, and profits. It is a rough
indicator of the economic earnings base from which government draws its
revenues.
Income adequacy
Helping workers maintain living standards during retirement by replacing
income from work at an adequate level and to prevent destitution in old
age. The U.S. Congress expected that Social Security benefits would
eventually provide more than a "minimal subsistence" in retirement for
full-time, full-career workers. Various measures help examine different
aspects of this concept, but no single measure can provide a complete
Page 60 GAO-06-126 Social Security Reforms Abroad Glossary
picture. Such measures include poverty rates, replacement rates, and the
proportion of the population that depends on others for income support.
Indexation (See Price indexation, Wage indexation.)
Individual account These are fully funded accounts that are administered
by either employers, the government, or designated third parties and are
owned by the individual. The level of retirement benefits depends largely
on the amount of contributions made by, or on behalf of, an individual
into the account during his or her working life, investment earnings, and
the amount of fees the individual is required to pay.
Individual equity The relationship of benefits to contributions-for
example, implicit rates of return on Social Security contributions or
money's worth ratios.
National pension reserve funds These are set up to partially prefund PAYG
national pension programs. Governments
commit to make regular transfers to these
investment funds
from, for example, budgetary surpluses. To
the extent that these
contribute to national saving, they reduce
the need for future borrowing or
for large increases in contributions to pay
scheduled benefits. Funds can
be invested in a combination of government
securities and domestic as
well as foreign private sector securities.
Because of differences in
accounting practices, some countries report
reserve funds as part of
national budgets, while others do not
include them in federal figures
National saving Total saving by all sectors of the economy: personal
saving, business saving (corporate after-tax profits not paid as
dividends), and government saving (the budget surplus or
deficit-indicating dissaving-of all government entities). National saving
represents all income not consumed, publicly or privately, during a given
period. Net national saving is gross national saving less consumption of
fixed capital (depreciation).
Notional defined PAYG pension programs in which "notional" accounts track
both incoming contribution (NDC) contributions and investment earnings,
but these exist only on the books program of the managing institution. At
retirement, the accumulated notional capital in each account is converted
to a stream of pension payments using
Page 61 GAO-06-126 Social Security Reforms Abroad Glossary
a formula based on factors such as life expectancy at the time of
retirement.
Old-Age, Survivors, and The two U.S. Social Security programs-Old-Age and
Survivors Insurance Disability Insurance (OASI) and Disability Insurance
(DI)-that provide monthly cash benefits (OASDI) to beneficiaries and their
dependents when the beneficiaries retire, to
beneficiaries' surviving dependents, and to disabled worker beneficiaries
and their dependents.
Pay-as-you-go (PAYG:) System of financing in which contributions that
workers and/or employers make in a given year are used to fund the
payments to beneficiaries in that same year, and the system's trust funds
are kept to a relatively small contingency reserve. 1
Payroll tax
Tax imposed on some or all of workers' earnings that can be imposed on
employers, employees, or both. In the United States, payroll taxes are
used to finance the Social Security and Medicare programs. Employers and
employees each pay Social Security taxes equal to 6.2 percent of all
employee earnings up to a cap and pay Medicare taxes of 1.45 percent, with
no cap. Payroll taxes are also known as FICA (Federal Insurance
Contributions Act) taxes or SECA (Self-Employment Contributions Act), if
the taxpayer is self-employed. All OECD countries except New Zealand levy
payroll taxes to support their pension programs, though the rates and the
shares borne by employers and employees vary, as do the minimum and
maximum level of earnings subject to the tax and the kinds of programs
funded.
Price indexation (Compare with Wage indexation.)
A method by which benefits are adjusted at periodic intervals by a factor
derived from an index of prices; some Social Security reform proposals in
the United States would price-index earnings to compute benefits, instead
of using wage indexing. Over time, increases in wages have been greater
and are expected to continue to be greater than increases in prices.
Indexing earnings to prices instead of wages would, therefore, reduce the
1
By comparison, the federal budgetary term "pay-as-you-go" (PAYGO) refers
to a requirement that all direct spending and tax legislation for a fiscal
year must be deficitneutral in the aggregate.
Page 62 GAO-06-126 Social Security Reforms Abroad Glossary
average lifetime earnings used in the formula, which, in turn, would
reduce benefits.
Rate of return Usually expressed annually, the rate of return is the gain
or loss generated from an investment, expressed as a percentage of the
value at the time of the initial investment.
Replacement rate The ratio of retirement benefits (from Social Security or
employersponsored plans) to preretirement earnings. Analysts often compare
current benefits with a recipient's previous wages to judge the adequacy
of Social Security payments.
Social insurance Under a social insurance program, the society as a whole
insures its members against various risks they all face, and members pay
for that insurance at least in part through contributions to the system.
Social insurance programs, including Social Security, are designed to
achieve certain social goals.
Social Security The federal agency that administers all Social Security
related programs, Administration (SSA) including the Supplemental Security
Income (SSI) and the Disability Insurance (DI) programs.
Solvency For Social Security, a condition of financial viability in which
the program can meet its full financial obligations as they come due.
Specifically, the ability to pay full benefits using existing revenue
sources and trust fund balances. When a program does not meet these
conditions, it is said to be insolvent.
Sustainable solvency
For Social Security, sustainable solvency means the ability to pay
benefits, based on current law projections of revenue and outlays, beyond
Social Security's Board of Trustees' 75-year forecast and make Social
Security permanently solvent. Also defined as having a stable and growing
trust fund ratio with program revenues increasing faster than outlays at
the end of the 75-year period. The European Union and OECD have examined
the fiscal sustainability of national pension systems based in part on
projections of the change in the percentage of countries' GDP to be spent
on old-age pensions from 2000 to 2050 under current law.
Glossary
Transition costs
Refers to the additional revenue required to implement substitute
individual account plans. Under some individual account plans, portions of
Social Security contributions would be diverted to the accounts. However,
under Social Security's pay-as-you-go financing, some of those
contributions would also be needed to pay for current benefits. Making
account deposits while also meeting current benefit costs requires
additional revenue, which we refer to as transition costs.
Wage indexation (Compare Price indexation.) A method by which benefits are
adjusted at periodic intervals. Under its current formula, SSA uses the
national average wage indexing series to index a person under age 60's
lifetime earnings when computing that person's Social Security benefits.
Earnings from age 62 to age 67 are adjusted using a price index.
(130403)
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