Reforming Social Security: Lessons from Thirty Countries

Studies | Social Security

No. 277
Thursday, June 09, 2005
by Estelle James


Notes

  1. Workers with very low earnings were often excluded, to avoid the high administrative costs associated with small accounts.
  2. Most defined benefit plans in the United Kingdom are closed to new members. In Australia the new plans are all defined contribution and many old plans have been transformed as well. In Switzerland, even when the plan is described as defined benefit, it must meet certain defined contribution criteria (the accumulation at the end must be at least as great as would be achieved by a contribution rate and interest rate that is specified by law). In the Netherlands, which is one of the last strongholds of defined benefit plans, employers are beginning to actively consider a switch to defined contributions.
  3. See Estelle James and Sarah Brooks, “Political Economy of Structural Pension Reform,” in Robert Holzmann and Joseph Stiglitz, eds., New Ideas about Old Age Security (Washington, D.C.: World Bank, 2001).
  4. In Kosovo, an add-on contribution was used and the new system is mandatory, but this is because the old system was left behind in Serbia. In Sweden the new system raised the total contribution rate — it is now 18.5 percent of wages — with the agreement that 2.5 percent would go to the account. Some influential parties would not have agreed to 18.5 percent without the accounts. In that sense, the Swedish agreement was an add-on/carve-out hybrid that might be relevant to the United States.
  5. In the United Kingdom, switching back and forth is permitted, which has the perverse effect that it becomes financially advantageous for workers to switch back into the state defined benefit system as they age — and that seems to be happening now. New entrants to the labor force can also choose between the public and private systems. This adds cost and uncertainty to the public plan. Switching to the accounts for existing as well as new workers was mandatory in Bolivia, Kazakhstan and Mexico. However, in Mexico workers were given the right to switch back to the old system upon retirement, if this raises their pension.
  6. A worker who contributes 4 percent of wages for 40 years and retires for an expected lifetime of 20 years, with wage growth 1.5 percent and rate of return 4.5 percent per year, will be able to purchase an annuity that provides 23 percent of his final wage, with his retirement accumulation. Given the progressivity of our defined benefit system, the proportion of total benefits coming from the accounts would be smaller for low earners and larger for high earners. This is desirable because high earners are more able to cope with the volatility of account investment returns.
  7. If a person pays a year-end fee at the end of the year that is 20 percent of first-year contributions and retires immediately afterwards, that fee equals 20 percent of his year-end assets. But if he keeps that money in the system for 40 years, it will have the same effect on final pension as an asset-based fee that is only 0.6 percent of his year-end assets, for each of the 40 years. If he contributes every year for 40 years, paying a 20 percent fee on each new contribution, all these fees together are equivalent to an annual fee of 1 percent of assets per year. This will reduce his final pension by 20 percent. See Estelle James et al., “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); a revised version was published in Private Pension Systems: Administrative Costs and Reforms (Paris: Organization for Economic Cooperation and Development, 2001). Also see Estelle James et al., “Mutual Funds and Institutional Investments: What is the Most Efficient Way to Set Up Individual Accounts in A Social Security System?” in John Shoven, ed., Administrative Costs and Social Security Privatization ( Chicago: University of Chicago Press, 2000).
  8. See Table II.
  9. See Pension Reforms: Results and Challenges (Santiago, Chile: Federacion Internacional de Administradoras de Fondo de Pensiones, 2003).
  10. James et al., “Administrative Costs and the Organization of Individual Account Systems.”
  11. See Estelle James, Alejandra Cox Edwards and Rebecca Wong, “The Gender Impact of Pension Reform,” Journal of Pension Economics and Finance, 2003, and “The Impact of Social Security Reform on Women in Three Countries,” National Center for Policy Analysis, Policy Report No. 264, November 2003.
  12. Or $1,000 monthly for a couple. See the poverty guidelines of the U.S. Department of Health and Human Services.
  13. See Estelle James and Dimitri Vittas, “Annuities Markets in Comparative Perspective: Do Consumers Get Their Money’s Worth?” in Private Pension Systems: Administrative Costs and Reforms.
  14. At present, annuitants get an income of $7,200 annually for a $100,000 premium. In the future, they will get $6,800.
  15. The Chilean Pension System (Santiago, Chile: Superintendencia de Administradoras de Fondos de Pensiones, 2003).
  16. Ibid.

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