World Bank sees shift to funded DC from PAYG

IRELAND - The main trend in worldwide pension reform is the shift from pay-as-you-go defined benefit to funded defined contribution, said Richard Hinz of the World Bank at the World Pension Association conference in Dublin.

This involves moves from “large first-pillar public systems to multi-pillar models. From single assets to a diversified portfolio. This is something the World Bank has been a strong advocate of,” Hinz said. “Many current pensions systems are unsustainable at the level of demographic change we are now facing.”

An increase in life expectancy of 25% after the age of 60 had occurred since 1970. Such changes bring a disproportionate change in the pension cost of perhaps 50-60%. The more that is invested in health care the greater the impact in pension cost provision, he said. “There are some difficult tradeoffs here.” Even the lower income countries are seeing significant increases in life expectancy. “Birth rates are converging around the world to replacement rate,” he said.

The typical PAYG system was not designed to cope with such demographic trends. “Most countries would require more than double their contribution rate. As currently these are in the range of 15-30% of payroll, they could go to 50%. This is not just sustainable.”

Unless retirement ages could be increased by 10 years there could be an “apocalyptic reaction”.

One of the key features of population ageing is the effect on the labour and capital markets, Hinz said, adding that one of the future problems for growing the economy will be future labour shortages. And the greater the tax disincentive to work, the greater the proportion of unused labour capacity.

Some innovative work was being undertaken in public systems, he said. “Latvia and Poland are moving to the so-called ‘notional defined contribution systems’, a hybrid a hybrid of DC and DB. Hinz described this move as “somewhat controversial” adding they have been dubbed some was a ‘virtual pensions’”. The jury was still out about this development, he said.

There also had been interesting developments in Europe on the administration of pension, with the use of centralised clearing-house administration for the collection of contributions. He said that the Swedish use of a clearing-house is one of the more fascinating reforms which used the concept of managed competition. This meant private management of the assets, with distribution to the market controlled by a clearing-house approach.

We are seeing “interest developments” in payroll deduction and use of employers to collect contributions. This is probably the most efficient way to collect them, he said.

The role of employers throughout the world “in the places with strong occupational schemes employers are withdrawing from their role and taking less responsibility for guaranteeing benefits. They are acting more as financial intermediaries, collecting contributions and organising investments.”

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