Pension Debt Research Articles

Civil Services and Military Retirement Income Provision in Australia

*This paper documents developments in public sector pensions in Australia, and reports estimated unfunded liabilities associated with benefits promised to public sector employees. Australia’s experience with public sector pensions is unusual – currently, the defence forces and the judiciary apart, all new entrants to public sector schemes confront defined contribution (DC) plans. The transition from defined benefit (DB) to DC has taken place over the last 20 years. We argue that an important driver for this relatively rapid transition of public sector pensions is the broader retirement policy framework in Australia, in which the only nationally mandated earnings related retirement financing is based upon a compulsory DC contributory plan. While legacy costs from the now-closed public sector plans are significant at 15% of GDP, it is projected that this will fall to zero over the next 30 years, both through natural attrition and a series of initiatives designed to pay off the pension debt.

Funding in Public Sector Pension Plans: International Evidence

Most countries have separate pension plan for public sector employees. The future fiscal burden of these plans can be substantial as the government usually is the largest employer, pension promises in the public sector tend to be relatively generous, and future payments have to be paid out directly from government revenues (pay-as-you-go) or by funded plans (pension funds) which tend to be underfunded. The valuation and disclosure of these promises in some countries lacks transparency, which may be hiding potentially huge fiscal liabilities that are being passed on to future generations of workers.In order to arrive at a fair comparison between countries regarding the fiscal burden of their DB public sector pension plans, this paper gathers more evidence on public sector pension plans regarding the type of pension promise and quantifies the future tax burden related to these pension promises. The reported liabilities are recalculated using both a fair value approach (local market discount rates) and a common, fixed discount rate across all countries which reflects projected growth in national income. We also estimate for a number of plans from a sample of OECD countries the size of the net unfunded liabilities in fair value terms as of the end of 2008. This fiscal burden can also be interpreted as the implicit pension debt in fair value terms.

Is there any gain from social security privatization?

Abstract Increasing calls for a social security reform of switching from the pay-as-you-go (PAYG) system to a funded system has been seen in recent decades. This paper examines the effect of this reform on capital accumulation and the welfare of each generation. Three methods are used to finance the pension debt, government debt financing, tax financing, and government asset financing. With government debt or tax financing, the market equilibrium remains unchanged and all generations are as well off in the new system as in the PAYG system. Thus, switching from the PAYG system to a funded system is neutral. With government asset financing, the interest rate will decrease, private capital will increase, but the total output may either increase or decrease. The welfare effect is also ambiguous in general, depending on the rate of return of government assets. With plausible parameters, our simulation shows that the reform will lower the interest rate, increase private capital, and lower government capital in the short run, but raise government capital and increase output in the long run.

Funding in Public Sector Pension Plans: International Evidence

Most countries have separate pension plan for public sector employees. The future fiscal burden of these plans can be substantial as the government usually is the largest employer, pension promises in the public sector tend to be relatively generous, and future payments have to be paid out directly from government revenues (pay-as-you-go) or by funded plans (pension funds) which tend to be underfunded. The valuation and disclosure of these promises in some countries lacks transparency, which may be hiding potentially huge fiscal liabilities that are being passed on to future generations of workers. In order to arrive at a fair comparison between countries regarding the fiscal burden of their DB public sector pension plans, this paper gathers more evidence on public sector pension plans regarding the type of pension promise and quantifies the future tax burden related to these pension promises. The reported liabilities are recalculated using both a fair value approach (local market discount rates) and a common, fixed discount rate across all countries which reflects projected growth in national income. We also estimate for a number of plans from a sample of OECD countries the size of the net unfunded liabilities in fair value terms as of the end of 2008. This fiscal burden can also be interpreted as the implicit pension debt in fair value terms.

Estimation of Implicit Pension Debt in Russia

In the article the results of modeling the dynamics of insurance component of retirement pension in Russia are considered. The author outlines the current pension scheme and stresses the significance of implicit pension debt as an important tool for pension liabilities evaluation. Estimation results include computing the current value of pension liabilities in Russia, costs of pension reforms and dynamics of pension deficit for the future.

A Description of the Pension System in Uganda: Need for Reform

The current pension system in Uganda is similar to those in most Anglo-speaking countries in Sub-Saharan Africa. The system is fragmented lacking a policy framework for its efficient operation. Consequently, coverage is low, the public service schemes are unfunded and expensive and the governance of the mandatory pension scheme is unsatisfactory. Private pension schemes operate voluntarily without a law save for the common law principles of trusts and are not supervised. The system is ripe for fundamental reforms which should include the introduction of a supervisory framework, parametric reforms in the public service schemes in order to manage the ever rising implicit pension debt, introduction of best practice governance principles in both the National Social Security Fund and private occupational pension schemes. While pension reform is a major policy which the government should carefully consider, yet it is possible for the same to be developed in phases.

The Liabilities and Risks of State-Sponsored Pension Plans

As of December 2008, state governments had approximately $1.94 trillion set aside in pension funds for their employees. How does the value of these assets compare to the present value of states' pension liabilities? Just as future Social Security and Medicare liabilities do not appear in the headline numbers of the U.S. federal debt, the financial liability from underfunded public pensions does not appear in the headline numbers of state debt. If pensions are underfunded, then the gap between pension assets and liabilities is off-balance-sheet government debt. We show that government accounting standards require states to use procedures that severely understate their liabilities. We then discuss the true economic funding of state public pension plans. Using market-based discount rates that reflect the risk profile of the pension liabilities, we calculate that the present value of the already-promised pension liabilities of the 50 U.S. states amount to $5.17 trillion, assuming that states cannot default on pension benefits that workers have already earned. Net of the $1.94 trillion in assets, these pensions are underfunded by $3.23 trillion. This “pension debt” dwarfs the states' publicly traded debt of $0.94 trillion. And we show that even before the market collapse of 2008, the system was economically severely underfunded, though public actuarial reports presented the plans' funding status in a more favorable light.

Welfare, Inequality and Financial Consequences of a Multi-Pillar Pension System - A Reform in Peru

The distributional impact of the structural pension reform in Latin American countries has been largely absent in the economic debate. However, this reform may widen inequality in old-age and reduce welfare. In this paper we study the consequences of implementing a multi-pillar system in one of these countries. We take advantage of available administrative records for Peruvian workers to estimate inequality in pensions, pension debt and welfare. Overall, our results show that the pension debt and inequality can be substantially reduced without welfare losses.

The Actuarial Model for Implicit Pension Debt of China

Based on the basic principles of actuarial, with the latest provisions of pension system reform of china, using the individual cost method, implicit pension debt of China in 2009 can be calculated with the model.

Pension Reform Modeling and Implicit Pension Debt Evaluation

The paper reviews major foundations of pension schemes, their classification, prerequisites and reasons for pension reforms. Also the issue of pension reform modeling and analysis of financial consequences of pension scheme restructuring from the government budget point of view are considered. Special attention is paid to the implicit pension debt as the toolbox for estimating future obligations of the government. Main principles of implicit pension debt estimation and short review of its implementation practice are discussed.

Reforming pensions: Principles, analytical errors and policy directions

AbstractThis article, sets out a series of principles for pension design rooted in economic theory: pension systems have multiple objectives, analysis should consider the pension system as a whole, analysis should be framed in a second‐best context, different systems share risks differently, and systems have different effects by generation and by gender. That discussion is reinforced by identification of a series of widespread analytical errors — errors that appear in World Bank work, but by no means only in World Bank work: tunnel vision, improper use of first‐best analysis, improper use of steady‐state analysis, incomplete analysis of implicit pension debt, incomplete analysis of the impact of funding (including excessive focus on financial flows, failure to consider how funding is generated, and improper focus on the type of asset in trust funds), and ignoring distributional effects. The second part of the article considers implications for policy: there is no single best pension design, earlier retirement does little or nothing to reduce unemployment, unsustainable pension promises need to be addressed directly, a move from pay‐as‐you‐go towards funding in a mandatory system may or may not be welfare improving, and implementation matters — policy design that exceeds a country's capacity to implement it is bad policy design. We illustrate the ranges of designs of pension systems that fit the fiscal and institutional capacity constraints typical at different levels of economic development. The potential gains from simplicity imply that a country capable of implementing an administratively demanding plan does not necessarily gain from doing so. New Zealand has a simple pension system through choice, not constraint.

Pension Privatization and Country Risk

This paper explores how privatizing a pension system can affect sovereign credit risk. For this purpose, it analyzes the importance that rating agencies give to implicit pension debt (IPD) in their assessments of sovereign creditworthiness. We find that rating agencies generally do not seem to give much weight to IPD, focusing instead on explicit public debt. However, by channeling pension contributions away from the government and creating a deficit of resources to cover the current pension liabilities during the reform's transition period, a pension privatization reform may transform IPD into explicit public debt, adversely affecting a sovereign's perceived creditworthiness, thus increasing its risk premium. In this light, accompanying pension reform with efforts to offset its transition costs through fiscal adjustment would help preserve a country's credit rating.

Proč přechod průběžného penzijního systému na fondový nijak nesouvisí s demografickým vývojem?

The paper deals with a wide-spread myth that a switch from a PAYG to a funded pension system might solve adverse consequences of the population aging. It is shown, that under additional assumptions the pension debt (which is created during the process of the switch) is exactly equal to the value of assets that the pension funds accumulate. These additional assumptions are following: government imposes additional taxes, which are equal to the difference between the contributions to the former PAYG system and the contributions to the pension funds. Therefore workers contribute less to the pension funds but if the additional taxes are taken into account, they continue paying the same amount. It is shown, that if the additional taxes were permanently lower than what is supposed, the pension debt would grow beyond any limits. The other additional assumption made is that the interest rate paid by government from its pension debt is the same as the interest rate reached by the funds. If this assumption is relaxed, the qualitative conclusions do not change. Hence, demographic development cannot be used as an argument in favour of a switch of the pension system.

Pension Privatization and Country Risk

This paper explores how privatizing a pension system can affect sovereign credit risk. For this purpose, it analyzes the importance that rating agencies give to implicit pension debt (IPD) in their assessments of sovereign creditworthiness. We find that rating agencies generally do not seem to give much weight to IPD, focusing instead on explicit public debt. However, by channeling pension contributions away from the government and creating a deficit of resources to cover the current pension liabilities during the reform's transition period, a pension privatization reform may transform IPD into explicit public debt, adversely affecting a sovereign's perceived creditworthiness, thus increasing its risk premium. In this light, accompanying pension reform with efforts to offset its transition costs through fiscal adjustment would help preserve a country's credit rating.

On the financial sustainability of earnings-related pension schemes with ‘pay-as-you-go’ financing and the role of government-indexed bonds

AbstractIn this paper we reconsider the idea of an earnings-related pension system with reserves invested in indexed government bonds as a mechanism to both ensure financial sustainability and improve security. The paper starts by reviewing the characterization of the sustainable rate of return of an earnings-related pension system with pay-as-you-go financing. We show that current proxies for the sustainable rate, including the Swedish ‘gyroscope’, are not stable and propose an alternative measure that depends on the growth of the buffer-stock and the pay-as-you-go asset. Using a simple one-sector macroeconomic model that embeds a notional account pension system we then show how GDP-indexed government bonds, if combined with the right measure for the sustainable rate of return on contributions, could be used to generate a sustainable and secure earnings-related pension system, without becoming a fiscal burden. The proposal is particularly attractive for countries considering reforms to earnings-related systems that have accumulated a large implicit pension debt. In this case, the government bonds allow the financing of this debt in a transparent way. The proposed mechanism can also facilitate the transition to a fully funded pension system when the government bonds are allowed to be traded.

Pension Liabilities and Public Finances in Bolivia: Evidence from a Reformer Country

In 1996 Bolivia undertook a radical pension reform, switching from an unfunded to a fully funded privately managed system. This paper analyzes the impact of the pension reform and post-reform pension policies (1997-2003) on public finances; it shows initial estimates for the transition cost, analyzes the main factors that increased the financial burden for the Treasury to unexpected levels, presents some public accounting considerations, and examines post-reform linkages between the Treasury and the new pension system. It concludes that the effect of the pension reform and post-reform pension policies on public finances has been two-fold: increasing considerably pension net liabilities, and inducing a higher fiscal deficit for the explicit report of the pension debt.

Defeasing Legacy Costs*

The authors propose a new way to defease the legacy costs of America's defined benefit pension system that will help ensure its viability. The proposal would allow companies to exchange their legacy pension debt for another liability with more attractive terms—to the benefit of the sponsor, the Pension Benefit Guaranty Corporation (PBGC), and the plan participants. The transparency gained by separating the past from future liabilities will give better insight into sponsors' balance sheets. And it could take the PBGC out of the impossible position of insuring against events over which the insured have considerable control.

Pensions, Public Opinion, and the Graying of China

An analysis of popular beliefs and attitudes regarding pensions, pension reforms, and the future of retirement savings in China reveals that the strong belief in state-funded pensions held by many Chinese at or near the retirement age, especially given the large pension debt already acquired by the Chinese government, will exacerbate the current "guns vs. butter" debate in China and may even threaten social stability.

Options and impact of China's pension reform: a computable general equilibrium analysis

A serious obstacle to China's economic reform is the lack of a sustainable pension system. Using a newly designed computable general equilibrium (CGE) model that differentiates 7 productive activities and 22 age and gender groups, this study compares various options for financing the implicit pension debt and estimates the effects of pension reform on the sustainability of the system and on economic growth. Simulation results show that the current pay-as-you-go system is not financially sustainable and the implicit pension debt is estimated at around 46 to 64 percent of GDP in 2000. The paper proposes to use value-added tax revenue to finance the transition cost, which would make the new multi-pillar system financially sustainable. Journal of Comparative Economics 32 (1) (2004) 105–127.

La réforme des retraites en Chine : enjeux, options et conséquences

China’s pension reform : challenges, options and impacts China’s population has been aging rapidly, and the burdens of supporting the elderly are distributed unevenly across regions and sectors. This study discusses the current reform efforts, compares various options for financing the implicit pension debt and estimates the effects of pension reform on the sustainability of the system. Simulation results show that the current pay-as-you-go system is not financially sustainable and the implicit pension debt is estimated at around 46 to 63 percent of GDP in 2000. The public pillar becomes financially sustainable if tax revenues will be injected to finance the transition cost. The paper proposes to use value-added tax revenue to finance the transition cost, which would make the new multipillar system financially sustainable without damping economic growth. JEL classification : H55, D58, O53, P52