PENSION SECURITY IN THE USA

AND IN CHINA:CHALLENGES AHEAD

Kenneth Apfel

University of Maryland

College Park, MD

1

Two Pension Challenges That All Nations Face:

1. Sound administrative delivery systems: efficiency, stability, transparency and broad–based public legitimacy

2. Sound program model: benefit adequacy for individuals and sustainability for society

Core administrative functions of a successful public pension system:

1.collection of contributions and taxes; 2.payment of benefits; 3.secure financial management and

productive investment of assets; 4. effective communications and record

keeping mechanisms; 5.financial statements and reports,

providing reliable governance, fiduciary responsibility, transparency, and accountability.

Core programmatic elements of a successful public pension system:

1. Universal foundation of basic support in old age

2. Foundational benefit levels that are at least minimally “adequate”

3. Foundational benefit complemented with other retirement benefit “tiers”

4. A financing scheme with very long term stability

USA: KEY FEATURES

• Administratively efficient systems

• Some solid measures on improving transparency

• Universal benefit structure with portability

• Basic benefit adequacy

• But…..

USA’s Pension Challenges:

• An affluent society trying to deal with an aging population

• A trend over the 20th century toward retirement at earlier ages

• A well developed universal and multi-tiered retirement system, but a system facing real long term fiscal strains in all tiers

China’s Big Pension Challenges:

1. Underdeveloped (but strengthening) administrative systems

2. Very rapid aging population

3. Very low coverage levels (even in cities)

4. Relatively high retirement benefit levels for those covered

5. Retirement at a very early age for those covered

6. Decentralized system with very little portability

WHAT DOES ALL THIS ADD UP TO?

IN THE USA:

A

BIG

PENSION

CHALLENGE!!!

IN CHINA:

AN EVENBIGGER

PENSIONCHALLENGE!!!

PRESENTATION OUTLINE

1. OVERVIEW OF USA SYSTEM – MANY TIERS

2. USA’S FUTURE CHALLENGES

3. CHINA’S CHALLENGES

4. USA & CHINA OUTLOOK

USA has established generally solid administrative functions:

1.Reliable collection of contributions;

2.Reliable payment of benefits;

3.Basic security in employer pension fund assets and benefits;

4.Effective communication network, including development of accurate data and record keeping mechanisms;

5.Production of transparent financial statements and reports.

USA TRANSPARENCY:

FOR THE INDIVIDUAL: • STATEMENTS ON PRIOR TAX PAYMENTS AND

CONTRIBUTIONS AS WELL AS EXPECTED FUTURE BENEFIT PAYMENTS

• ACCESS TO ACCURATE INFORMATION

FOR POLICY MAKERS: • ANNUAL ACTUARIAL STATEMENTS ON THE LONG

TERM FISCAL OUTLOOK FOR PENSIONS

Source: U.S. Social Security Administration, Forthcoming. Income of the Population 55 or Older, 2002

Shares of Income from Specified Sources, 2002Married Couples and Unmarried Persons Aged 65 and Older

Public Pensions

9%

Social Security

39%

Other3%

Asset Income14%

Earnings25%

Private Pensions

or Annuities10%

Source: U.S. Social Security Administration, Forthcoming. Income of the Population 55 or Older, 2002

Shares of Income from Specified Sources by Income Level, 2002 Married Couples and Unmarried Persons Age 65 and Older

SSI10%Other

7%

Social Security

83%

Lowest fifth$9,720

Source: U.S. Social Security Administration, Forthcoming. Income of the Population 55 or Older, 2002

Shares of Income from Specified Sources by Income Level, 2002 Married Couples and Unmarried Persons Age 65 and Older

Social Security, 64%

Other, 4%

Income from Assets, 7%

Earnings, 7%

Pension, 15%

Middle fifth$15,180 - $23,880

Source: U.S. Social Security Administration, Forthcoming. Income of the Population 55 or Older, 2002

Shares of Income from Specified Sources by Income Level, 2002 Married Couples and Unmarried Persons Age 65 and Older

Other 2%

Pension19%

Social Security

19%Assets

24%

Earnings36%

Top fifth$40,980+

ELDERLY US POVERTY RATES

• 1930’s: 50+%• 1965: 35%• 1980: 15%• 2010: 9%

• If Social Security payments stopped tomorrow, 50% of elderly would be living in poverty.

FINANCING US GOVERNMENT

1962 1972 1982 1992 2002 2012 2022 2032 2042 2052 2062 2072 2082

0

10

20

30

40

Medicare and Medicaid

Actual Projected

Social Security

Other Spending (Excluding debt service)

2. Private Retirement Supports(OPERATED BY PRIVATE SECTOR - REGULATED BY PUBLIC SECTOR)

Employer defined benefit pensions:• Government “vesting” requirements• Government regulation of asset accumulation • Government insurance against default and bankruptcyEmployer and employee retirement savings:• Some government rules on accumulation and early

withdrawals

PRIVATE RETIREMENT SUPPORT?

PENSIONS AND HEALTH:• EMPLOYER PENSION AND HEALTH COVERAGE IS DECLINING,

SHIFTING MORE RISKS TO INDIVIDUALS

• EMPLOYER PROVIDED RETIREE HEALTH INSURANCE COVERAGE DROPPED FROM 66% TO 33% PAST 20 YEARS

RETIREE SAVINGS:• OLDER WORKERS AVERAGE ONLY $60,000 IN RETIREMENT

SAVINGS, AND MANY YOUNG “CASH OUT” FUNDS EARLY.

• US RETIREMENT SAVINGS ACCOUNTS LOST $3 TRILLION IN VALUE TWO YEARS AGO, CREATING REAL STRAINS ON RETIREES

ADD IT ALL TOGETHER, AND OUTLOOK IS RISKY.

USA Average Retirement Age of Men

1910: 741940: 701960: 661985: 62

2010: 63+?

LIKELY USA PENSION SCENARIO

• PUBLIC SPENDING WILL RISE BY ABOUT 1.0-1.5% of GDP FOR PUBLIC PENSIONS

• PUBLIC PENSION BENEFITS WILL BE REDUCED FOR UPPER INCOMES

• LATER RETIREMENT WILL BE ENCOURAGED AND/OR MANDATED

• EMPLOYER PENSIONS WILL CONTINUE TO DECLINE

• MORE RETIREMENT SAVINGS WILL BE ENCOURAGED

ALL TOUGH CHOICES, BUT MANAGEABLE!

IN CHINA:

PENSIONS ARE A

BIGGER

CHALLENGE!!!

IMF: PENSION ADMINISTRATION

“The Chinese pension system is highly fragmented due to the decentralized nature of the Chinese economy…and the tradition of trial programs for the development of social pension policies. As a result, financing, administration, and parameters are often defined at the provincial or municipal levels.”

“Pension fund governance practices and standards in the Basic Old Age Insurance system are virtually undocumented. This is explained by the decentralized and autonomous manner in which provinces, cities and other municipalities have so far developed and implemented pension policies.”

China’s Big Pension Challenges:

1. Underdeveloped (but strengthening) administrative systems

2. Very rapid aging population

3. Very low coverage levels (even in cities)

4. Relatively high retirement benefit levels for those covered

5. Retirement at a very early age for those covered

6. Decentralized system with very little portability

WHAT DOES ALL THIS ADD UP TO?

IMF: PENSION REPORTING

“Basic information on governance standards, investment rules, implementation of strategic asset allocation and performance is not publicly available. This lack of public disclosure can seriously limit accountability and jeopardize the policy of pre-funding pension liabilities.”

“No reliable projections exist for the Chinese pension system liabilities. This raises concerns about the adequacy of the resources managed by the NSSF to absorb the demographic transition.”

China ages much faster than USA

% of POPULATION 60+ (UN)

1950 1990 2010 2030 2050

CHINA 7 8 12 24 30

USA 12 16 17 24 27

“China will effectively be shouldering the old age burden of a high-income economy with the resources of a middle-income economy.” (Watson-Wyatt)

LIFE EXPECTANCY AT BIRTH: AT AGE 60:

VIETNAM 70 78

CHINA 72 79

MEXICO 75 81

INDIA 64 76

USA 77 82

KEY CHINA/USA STATISTICS

• % of labor force receiving pension coverage: China is 20% (USA is 94%)

• Replacement rates for those covered: China is 67% (USA is 40%)

• Normal Pension age: China is 60 men, 55 women (USA is 67)

• Early Pension age: China is 55 men, 50 women (USA is 62)

EXPECTED NUMBER OF YEARS IN RETIREMENT

VIETNAM 18

PHILLIPINES 16

CHINA 19

KOREA 17

USA 17

Pension Coverage Rates (as Share of Population Aged 15-65)

VIETNAM 11%

CHINA 17%

INDIA 6%

PHILLIPINES 19%

THAILAND 18%

KOREA 55%

USA 73%

OECD 60%

A large share of Chinese still depend on theextended family for support in old age

• 54% of Chinese Rural Elderly Primary Income Source Is the Extended Family

• 37% of Chinese Urban Elderly Primary Income Source Is the Extended Family

But family support networks will be under intense demographic stress

• Average number of surviving children of women turning 65:

• In early 2000’s:

2.2 urban

4.5 rural

• In early 2020’s:

1.3 urban

3.5 rural

OECD• The Chinese pension system appears to be marked by

relative generosity to a narrow share of older population. The relatively low number of contributors as a percentage of the labor force has meant that the contributions required to finance these benefits are relatively high, compared to other world regions.

• China has set a goal to achieve universal coverage by the year 2020. The key is to design an adequate, affordable and sustainable system for migrant and rural workers. Equally important is the capacity to provide basic protection to those who have not been employed and have never participated in any old-age insurance plan.

Men’s Net Pension Wealth by Earnings

(Multiple of individual annual earnings) Half of Average Average Twice Average

China 21 16 14

India 10 6 4

USA 8 6 5

OECD 11 8 7

WHY ONLY HALF URBAN COVERAGE LEVELS IN CHINA?

• MIGRANT WORKERS MOSTLY UNCOVERED

• SOME WORKERS & EMPLOYERS OPT OUT

• ADMINISTRATIVE COMPLEXITIES AND FREQUENCY OF CHANGES PRESENT OBSTACLES TO EMPLOYERS

• LIMITED TRANSPARENCY AND TRUST OF SYSTEM (PENSION SCANDALS!)

• RESTRICTIONS ON PENSION PORTABILITY

Major Problems!

•  China lacked in a comprehensive law to regulate its social security system and safeguard the management and operation of the social security system.

•   Some employers refused to insure their employees or deliberately defaulted paying insurance fees for their employees.

• Because Social Security was not portable, migration of labor was hindered.

• The Social Security system was not providing basic income security for most people.

KEY QUESTIONS ABOUT CHINA PENSIONS

• How to strengthen management systems and expand transparency?

• How to ensure a foundation of public support -- with portability -- for all?

• Can provinces and municipalities provide the basis for the basic pension benefit?

• How much of China’s economy can/should be devoted to pension security?

CHINA’S NEW SOCIAL INSURANCE LAW

• A universal right: basic social security, medical insurance, and employment injury, unemployment and maternity insurance.

• Law allows employees to transfer their basic endowment insurance accounts from one residence to another and establishes a new system for rural residents.

• The law overcomes many of the obstacles under the old regulations, which restricted movement of the country's increasing migrant population. Citizens should be allowed to pay pension premiums in one place and withdraw money from another.

More Transparency and Confidentiality

• In order to prevent the misappropriation of social insurance funds, the law says that the funds' income and expenses, management processes and investment should be made public.

• On social security information confidentiality issues, the law says that social security authorities cannot disclose insurance information, with violations of such confidentiality subject to punishment.

Tougher Compliance

• The new law empowers the social security agency with more authority to collect social security contributions when an employer who fails to make payments. The Agency can apply to the People's Court to seize assets of the employee, and apply penalties.

• The new law prevents the improper use of social security funds, in response to Shanghai pensions scandal. Social security funds cannot be used to cover government budget deficits, or pay government agency expenditures.

International Workers To Be Part of System

• Foreign nationals employed in China to participate in the Chinese social security system -- but what this means is yet to be determined, i.e., whether foreign nationals’ participation is mandatory and how the term foreign nationals employed in China is defined.

• This likely will lead over time to international “totalization agreements” between China and other countries –similar to current agreements between the USA and Japan.

• These agreements allow for integration and harmonization of social security taxes paid by workers and benefit payments for retirees.

China’s goal: a portable and unified system

• Individuals will be able to transfer their pension, basic medical and unemployment insurance relationships when they move to a different city for new employment.

• Individuals can also calculate their social security contribution years cumulatively, regardless of their work location changes.

• A system will be established to track pensions across regions and to create a unified national social insurance number system.

• The pension insurance fund will initially be set up on the provincial scale and then gradually be converted to the nationwide scale.

Two Pension Challenges That All Nations Face:

1. Sound delivery systems: efficiency, stability, transparency and broad–based public legitimacy

2. Sound program model: benefit adequacy for individuals and sustainability for society

SUMMARY• EFFECTIVE MANAGEMENT AND FINANCE PRACTICES (INCLUDING

TRANSPARENCY MEASURES) ARE ESSENTIAL IF WORKERS AND EMPLOYERS ARE TO HAVE TRUST IN THE PENSION SYSTEM.

• WORKERS IN USA AND IN CHINA NEED THE PROMISE OF UNIVERSAL AND PORTABLE BASIC RETIREMENT BENEFITS: -- THIS WILL BE HARD FOR THE USA TO CONTINUE -- THIS WILL BE HARD FOR CHINA TO ESTABLISH.

• BOTH COUNTRIES ARE GENERALLY ON THE RIGHT PATH. BUT BOTH COUNTRIES STILL HAVE MUCH MORE TO DO!

• TO ACHIEVE FISCAL SUSTAINABILITY AS WELL AS BETTER ECONOMIC SECURITY LATER IN LIFE, BOTH GOVERNMENTS MUST ENCOURAGE MORE WORK, LATER IN LIFE

• BOTH NATIONS MUST DEVOTE MORE RESOURCES TO ENSURE THE ECONOMIC SECURITY OF OLDER PEOPLE – CHINA WILL HAVE TO DRAMATICALLY INCREASE RESOURCES DEVOTED TO PENSIONS IN THE YEARS AHEAD.