Financial Crises: Lessons from the Past, Preparation for the Future

Chapter 8. Old-Age Income Support in the Twenty-first Century: Conceptual Framework and Select Issues of Implementation

 Old-Age Income Support in the Twenty-first Century Conceptual Framework and Select Issues of Implementation 8 The past decade has brought increased recognition of the importance of pension systems for the economic stability of nations and the security of their aging populations. In developing countries, the traditional systems of support for the elderly are being eroded by migration, urbanization, and other factors that break down extended families. At the same time, pension systems, where they exist, are proving limited and increasingly costly in fiscal terms. For the past ten years, the World Bank has taken a leading role in addressing these challenges through its support for pension reform around the world. The World Bank has been involved in pension reform in more than eighty countries and provided financial support for reform to more than sixty countries. The demand for such support continues to grow. What has emerged from interactions with policymakers, pension experts, and representatives from civil society in client and donor countries is the continued relevance of the main objectives of pension systems—poverty alleviation and consumption smoothing—and of the broader goal of social protection . The World Bank continues to perceive advantages in multipillar robert holzmann This paper draws heavily on the recently published World Bank report on pension reform (Holzmann , Hinz, and Bank Team 2005). It was written to clarify and update the World Bank’s perspective on pension reform, incorporating the lessons learned from recent experience and research that has advanced the understanding of how best to proceed in the future. It does not announce a new approach. designs that contain some funded element when conditions are appropriate but increasingly recognizes that a range of choices can help policymakers to achieve effective old-age protection in a fiscally responsible manner. The suggested pension system is composed of some combination of five elements or pillars: (a) a basic, noncontributory or “zero pillar” (in the form of a demogrant or social pension) that provides a minimal level of protection ; (b) a “first-pillar” contributory system that is linked to varying degrees to earnings and seeks to replace some portion of income; (c) a mandatory “second pillar” that is essentially an individual savings account but can be constructed in a variety of ways; (d) voluntary “third-pillar” arrangements that can take many forms (individual, employer sponsored, defined bene- fit, defined contribution) but are essentially flexible and discretionary in nature; and (e) informal intrafamily or intergenerational sources of both financial and nonfinancial support for the elderly, including access to health care and housing. For a variety of reasons, a system that incorporates as many of these elements as possible, depending on the preferences of individual countries as well as the level and incidence of transaction costs, can, through diversification, deliver support to aging populations relatively more effectively and efficiently. The main changes to the World Bank’s perspective are related to an enhanced focus on basic income provision for all vulnerable elderly as well as an enhanced role for market-based, consumption-smoothing instruments for individuals both within and outside mandated pension schemes. The World Bank increasingly recognizes the importance of initial conditions and the extent to which conditions in a particular country necessitate a tailored or tactically sequenced implementation of the multipillar model. This chapter has two parts. The first part outlines the framework for the World Bank’s thinking on pension reform, including its origins and scope. The second highlights key issues pertaining to design and implementation and focuses on three issues related to financial markets: financial market readiness, regulation, and supervision; costs and fees; and retirement-income products. A Framework for Pension Reform A framework for analyzing pension systems and their reform should be based on some core principles and the capacity to achieve a flexible and context-specific set of social and economic outcomes. It should not nar-   rowly prescribe the structure, implementing institutions, or operations of a system. On a practical level, the application of such a standard requires the articulation of goals and criteria against which a proposed reform can be evaluated. Goals of a Pension System and Reform The primary goals of a pension system should be to provide adequate, affordable, sustainable, and robust retirement income, while seeking to implement welfare-improving schemes in a manner appropriate to the individual country: —An adequate system is one that provides benefits to the full breadth...