Key Social Security Policy
Choices in Thailand
by
Estelle James
Key policy choices that affect
sustainability, equity, growth
• Structure:
– Pay-as-you-go (PAYG) or funded (FF)?
– Defined benefit (DB) or defined contribution
(DC)?
– Public or private management?
• Substance
–
–
–
–
What is the target replacement rate?
What is the normal retirement age?
How much and what kind of redistribution?
How much coverage?
1. Pay-as-you-go (PAYG) v.
Funding (FF)
• Most industrialized countries have PAYG systems:
Worker’s (W) contribution today is used to pay
pensioners (P) today.
• Required CR = (RR)/(W/P) where CR =
contribution rate, RR = replacement rate, W/P =
support ratio
Example of PAYG
• Assume:
– promised benefit (RR) = 40% wage
– System is new & populations young, W/P = 8.
– So each point of CR yields 8 points RR.
• Then: 40% RR requires 5% CR (Thailand today
has even higher W/P, lower CR--new system)
• But:
– As populations and system age, W/P = 2.
– So each point of CR yields 2 points RR.
• Then: 40% RR requires 20% (Thailand 2030?)
• In long run W/P < 2, each point CR yields < 2
Advantage of PAYG system
• Low contribution rate needed in early years.
Easy to pay current generation of retirees,
and they get benefits that far exceed their
contributions
Problems with PAYG systems
• Non-sustainable: Initial low CR is deceptive
because few retirees, but high contribution
rate needed as system matures and populations
age.
• Equity: first cohorts get large redistribution
(B>C), later cohorts lose
• Security: Overly generous benefits promised
at first, but high political risk: promises may
not be kept in future because of high costs
PAYG Problems (Cont’d): Impact
on economic growth
• High payroll tax later may decrease formal sector
employment and income
• Initial transfer decreases national saving
• Hidden implicit pension debt (IPD) accumulates-present value of obligations to workers (figure)
• Future burden may be shifted to government’s
budget, less resources for other services
Implicit Public Pension Debt, 1990
Explicit debt
Canada
Implicit public pension debt
France
Germany
Italy
Japan
United States
0
50
100
150
200
250
300
Fully funded systems
• Assets are accumulated to match liabilities, and
earn interest, so no IPD, unaffordable promises or
inter-generational transfers
• Can be used to increase sustainability, national
savings and growth
• Requires higher CR initially, much lower CR later;
that is why many countries are moving toward
pre-funding
• But: financial market risk--so fund management
and investment choice is crucial
Example : FF system
• If funds earn 5% interest, each point of CR yields 6
points of RR, so 40% RR requires only 7% CR; while
PAYG in long run would require > 20% CR
• Rate of return is crucial: Suppose worker works 40
years, retires 20 years, wage growth=2%, CR=10%.
• Then: If r = 2%, RR = 25%,
–
4%
44 %
–
5%
60%
• Each interest point raises RR 10-15 percentage points
• If r > 2%, FF costs less or gives higher benefits
than PAYG in long run
Contribution rate required to pay replacement rate =
40% under PAYG funding
Contribution rate
20
17
15
10
7
5
PAYG
0
0
2
4
Assumptions
rate of wage growth = 2%
r = net rate of return for funded plan
Pension is indexed
worker works 40 years, retires for 20 years
6
8
10
12
Workers/pensioners
2. Defined benefit (DB) v.
Defined contribution (DC)
• In DB benefit depends on number of years worked
and wages per year, according to formula
• In theory--benefits are guaranteed
– but in practice promises too generous, not kept
• In theory--could penalize early retirement
– but in practice usually doesn’t
• In theory--provides safety net to low earners
– but in practice high earners often benefit the most
– DB pillars in L. America, Ireland, Switzerland,
HK redistribute to low earners in different ways
Defined contribution plans (DC)
• Contribution is specified; retirement income depends
on accumulated savings + interest
– Close link between benefits and contributions
• No hidden redistributions to high earners
– but other safety net is needed for low earners
• Rate of return determines accumulation, pension
– so high rate of return important, benefit uncertain
• For company plans--DC more portable than DB
• Provident funds in Thailand are DC: What is rate of
return? expected benefit? Are funds portable? are
annuities available? Where is social safety net?
Questions for new Thai plan
• Sustainability:Thailand recognizes need for prefunding. New DB system is partially funded at first-but becomes PAYG as soon as workers start to
retire. By 2020’s system will run deficit.
• How much will contribution rate rise in future, how
much will benefit rate fall?
• Equity: How much will present generations gain,
future generations lose?Where is social safety net?
• Growth: What is impact on employment, formalinformal sectors, retirement age, long term saving?
Will large IPD build up, become govt burden?
3. Public v. private management?
• Crucial question: if funds are accumulated,
how will they be managed and invested?
• Empirical evidence shows private
competitive management earns higher
return than public management--portfolios
are diversified, economic rather than
political criteria determine investments
• New plans in Latin America, Hong Kong
use private management; Ireland is trying to
insulate public funds from political control
Difference between annual compounded real publicly-managed pension fund
returns and bank deposit rates in 20 countries (from worst to best)
Ave rage
-1.8%
Uganda
Zam bia
V e ne zue la
Egypt
Ecuador
Sri Lank a
Guate m a la
Ke nya
Cos ta Rica
Jam aica
Canada
Singapore
Morocco
India
M ala ys ia
US
Sw e de n
Philippine s
Kore a
Japan
-12%
-10%
-8%
-6%
-4%
-2%
0%
gros s re t urns m inus bank de pos it r ate
2%
4%
Difference between real annual compounded publicly-managed
pension fund returns and real income per capita growth in selected countries
-8 .4 %
A ve r a g e
Peru
Ug a n d a
Z a m b ia
V e n e z u e la
Eg y p t
T a n z a n ia
Ecu a d o r
C o s t a R ic a
G u a t e m a la
Ke n y a
Sin g a p o r e
Sri Lan k a
J am a ic a
Kor e a
Jap an
I n d ia
Can ada
M a la y s ia
Sw e de n
US
M oro cco
P h i li p p i n e s
-5 0 %
-4 0 %
-3 0 %
-2 0 %
-1 0 %
0%
g r o s s r e tu r n s m in u s in co m e p e r cap ita
Source: IMF International Finance Statistics; Authors’ calculations.
10 %
Average private schemes
Average public schemes
Switzerland (70-90)
Japan (70-87)
United States (70-90)
Canada (75-89)
Denmark (70-88)
Hong Kong (83-96)
Netherlands (70-90)
Japan (84-93)
Switzerland (84-96)
Denmark (84-96)
Australia (87-94)
United Kingdom (70-90)
Spain (84-93)
Netherlands (84-96)
Ireland (84-96)
Chile (81-96)
Belgium (84-96)
United States (84-96)
Sweden (84-93)
United Kingdom (84-96)
-10% -8% -6% -4% -2%
0%
2%
4%
6%
Gross returns minus income per capita growth
8%
10%
Funded plans in Thailand
• Crucial question for Thailand--how will provident
funds, public employees’ pension fund and
partially funded DB plan be invested?
• Will they maximize return and productivity?
• How will private funds be regulated?
• How will public funds be insulated from political
manipulation?
• Dilemma: build-up of funds in new DB plan and
GPF can reduce required CR in future, but
increase political manipulation. Can private
competitive management prevent this?
International experience
• In next few days we will discuss how many
countries --Hong Kong, Singapore,
Malaysia, Latin America, Switzerland--have
handled questions of funding v. PAYG and
how to manage funds--advantages and
problems of each system--to help analyze
what is best system for Thailand
4. What is the target replacement
rate?
• Replacement rate (RR) tells how large
pension is compared with wage level
• Higher RR requires higher CR--so trade-off
between consumption when young and old
• Young have children, work expenses
• Rule of thumb: mandate 40-50% RR, those
who want more can save more, redistribute
to poor. Many countries pay pensioners
more, but this costs more when young
Replacement rate in Thailand
• New DB system provides RR = 35% for worker
with 35 years contributions
• This is modest benefit but in medium term will
require >20% CR if PAYG
• Below poverty for low earners
• Should RR be raised, espec for low earners?
• Or should PAYG part be reduced and part of
burden shifted to funded plan? If PAYG RR
were 20% and funded plan provided 20%, this
would cut long run CR to 14% instead of 20%.
• Funded part: second pillar of multi-pillar
system--we will discuss further.
5. Normal retirement age
• Retirement age has big effect on pension
fund and economy
• Impact on required CR:Suppose PAYG,
stable population, people start work at age
20, die at 80, RR = 40%:
– if retirement age = 60, W/P = 2/1, CR = 20%
– if retirement age = 65, W/P = 3/1, CR = 15%
• Later retirement age decreases CR, increases
experienced labor force, GDP, growth
Retirement age in Thailand
• Currently retirement age in Thai system is
55, no actuarial penalty for early retirement
or reward for postponed retirement. This
raises dependency rate, CR, lowers RR
• Workers in formal sector, covered by social
security, live longer than average
• Does Thailand want to keep low retirement
age, or to raise benefits, or to cut long run
contribution rate instead? Early retirement is
very costly, to the system and economy
6. What kind of redistribution?
• Should social security be redistributive or tie benefits
to contributions? If redistributive, toward whom?
• Most analysts say close benefit-contribution link (DC)
reduces work disincentives but safety net for low
earners should also be provided (well structured DB)
• In new Thai DB plan chief gainers are: high earners,
early retirees, first cohorts to retire; no safety net
• Noncontributory means-tested scheme targeted toward
rural poor
• Is this the redistribution you want?
7. Coverage by contributory
system--how fast to increase?
• Currently only 25% of labor force covered
• Important to expand. How fast? Expand when:
• Inclusion will make workers better off, not
worse off: low earners may be better off with
more take-home pay, family system for old age
• System is sustainable, equitable, good return
• Government has capacity to monitor
compliance--avoid culture of evasion
• Public program won’t crowd out family system
Policy choices for Thailand
• Aging rapidly, needs economic growth
• How high total replacement rate and how much
from PAYG v. funded, DB v. DC, public v. private
management?
• How should pension funds be invested?
• How can public funds be insulated from political
manipulation?
• How should private funds be regulated?
• What should normal retirement age be, how to
discourage early retirement?
• How to target redistributions and how fast to
increase coverage?
• Answers determine sustainability, equity, growth