Ninety Percent of World Excluded from Pension Plans

Problems Foreseen in Coping with Aging Populations and Diversifying Risk

Released simultaneously in Geneva, London and Washington, D.C.

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(Colin Gillion, ILO Director of the Social Security Department and editor of the book, will be available for telephone interviews on April 26 and 27. Please call 703-820-2244 to schedule time.)

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Some 90 percent of the world’s working-age population is not covered by pension schemes capable of providing adequate retirement income, the International Labour Organization (ILO) says in a new publication: Social Security Pensions: Development and Reform.

Bad management of many of the schemes that do exist makes matters worse and renders much of the world’s population exposed to the risk of poverty in old age.

Even where coverage in nearly universal and schemes are well managed, as in the advanced industrialized countries of the Organization of Economic Cooperation and Development (OECD) — mainly North America, Western Europe, Japan and Australia — major problems in financing pensions will arise in coming years as populations age and as countries seek to diversify the risk to individuals, the book says.

“OECD countries already spend an average of 10 percent of their Gross Domestic Product (GDP) on old-age retirement benefits, which exceeds their total spending on health care,” says Colin Gillion, ILO Director of the Social Security Department and editor of the book. With that number rising, Mr. Gillion says that OECD pension plans are “generally excellent, but expensive. The best way to deal with aging populations is to increase the actual age of retirement and to increase the number of women in employment.”

The ILO study finds that the US pension system — and to a lesser extent, the system in the United Kingdom — carries more risk for its members than those of West European countries, because the US and UK systems rely more heavily on occupational- and privately-funded schemes rather than complete government financing.

The ILO study is also cautious about one of the most fashionable panaceas for helping these pension schemes meet future needs — investing funds in financial markets. According to Colin Gillion, “Investing in financial markets is an uncertain and volatile business: under present pension plans people may save up to30 percent more than they need — which would reduce their spending during their working life; or they may save 30 percent too little — which would severely cut their spending in retirement. Which way round cannot be foreseen at the beginning of a working life.”

The ILO says that an option for the United States might be to increase the Social Security contribution from workers and employers: “Raising the contribution rate by one or two percentage points, or even better, by planning further increases in the actual age of retirement, would solve most of the deficit problems far into the future for Americans,” Mr. Gillion says.

Many OECD countries have legislated increases in the age for early retirement in an attempt to encourage workers to delay leaving their jobs. A number of countries have reduced benefits by increasing the years used in the earnings averaging period, reducing the adjustment for cost-of-living increases for retirees, or requiring more years of work to qualify for certain benefits.

However, this sort of fine-tuning of eligibility and retirement age is a luxury most countries cannot afford. It is one which is politically difficult to achieve, and which can strain the basic social consensus underlying pension schemes.

“The lack of more complete pension coverage throughout the world will become a growing problem as lifetimes are extended and the importance of traditional extended family units, which once provided old age protection, diminishes,” says Mr. Gillion.

Social Security Pensions: Development and Reform was published to coincide with May Day 2000, the global holiday that celebrates the contributions of working people to society.

Among the book’s findings are:

  • Pension schemes in countries of the former Soviet Union have become practically worthless with the collapse of national economies;
  • In general, pension schemes in Africa are very weak and badly managed;
  • Pension schemes in Asia have been weakened by the continent’s financial turmoil of the late 1990s;
  • Retirement schemes in Arab States and the Middle East are relatively young and face major problems in dealing with the high percentage of foreign workers who are not permitted to join the schemes;
  • Many retirement schemes in Latin America and the Caribbean are performing poorly, with at least eight countries converting their schemes to different systems.

The report identifies five main causes for failure of pension schemes in developing and reforming countries to provide wide coverage:

  • In many developing countries, the majority of people work in the informal sector or in rural regions that provide few or no benefits or worker protection of any kind;
  • Employees in small companies with 10 or less employees are often excluded from participation in social security pension schemes.
  • Many pension schemes in existence are badly managed, with the consequence that they have overly high administrative costs and do not deliver benefits when they should;
  • Many schemes are unable to collect contributions from all the people that should pay into them, which leads them into financial deficit;
  • Many schemes are based on weak and unregulated financial systems and may be open to corruption.

The ILO is working with middle income and developing countries to develop pension schemes or to reform existing schemes. These countries include Turkey, Ukraine, Thailand, Vietnam, Philippines, Indonesia, China, Madagascar, Tunisia, South Africa, Morocco, several Central European countries, Panama, Uruguay and several Caribbean countries.

The Search for a New Balance

The ILO study makes specific recommendations on how countries can increase the percentage of protected workers and improve benefits for everyone.

The ILO says that all countries should adopt the goal of extending coverage to all members of the population. Other desirable goals include instituting schemes that protect not only against poverty in old age, but also against disability and benefits for the family in case the wage earner dies; adjustment of retirement income to take account of inflation and a general rise in living standards; development of additional voluntary provisions for retirement income.

The most crucial challenge is extending even minimal old-age retirement benefits to the hundreds of millions of workers in the informal sector. In Africa, upwards of 90 percent of the workforce are engaged in informal, small-scale and often subsistence-level activities with little or no social protection. In Latin America the informal sector is the only part of the labor market that is growing, accounting for 80 percent of all new jobs created.

Among the ILO recommendations to extend coverage to this vast and growing sector are modification of existing schemes to cover excluded groups; designing special schemes for excluded groups; introducing tax-based, universal or targeted anti-poverty schemes; encouraging the development of special schemes based on self-help among people in the informal sector.

The ILO also emphasizes the need to improve management and governance of existing pension funds by involving workers and employers in the process. The ILO also says that compliance in nearly all schemes needs improvement. Ensuring this remains the responsibility of governments.

The ILO also says that countries should take many ideas into consideration before raising the age of retirement. The ILO warns that by raising the retirement age, older workers will then need better disability and unemployment benefits.

The ILO also recommends that countries avoid trying to develop a single perfect retirement system. “All countries need to develop pluralistic designs and flexible structures for their social security schemes,” the book says.

Pension Schemes by Region

The OECD Countries — OECD countries rely primarily on pay-as-you-go, defined-benefit schemes for providing social security retirement benefits. These schemes are frequently supplemented by voluntary funded schemes, mostly operated by the private sector.

“This means that the schemes will all need more revenue of some kind — whether from higher taxes or higher participation rates or from the active generation,” Mr. Gillion says. “The ILO believes the active generation can increase its participation by pushing up the actual age of retirement or increasing the participation rates of women. That is true whether the plan is public or private, partially or fully funded.”

Asia and the Pacific — Funded pension schemes in the Asian region have been hard hit by financial turmoil, arising in part from excess government regulation of the national financial systems.

“Singapore and South Korea probably have the healthiest and most comprehensive pension schemes in Asia,” Mr. Gillion says.

One striking feature of this region is the large number of countries with no mandatory pension schemes, a legacy of the time when most of these countries were former British colonies where provident funds existed. A provident fund — which normally pays out one lump sum upon retirement rather than a fixed monthly payment over a lifetime — does not fulfill the same function as a pension scheme as it does not provide a replacement income for the length of the retirement. Indonesia, Malaysia and Singapore provide benefits through provident funds.

Countries in the region less exposed to British influence have, for the most part, set up social insurance pension schemes to cover employees and sometimes the self-employed. These include countries as diverse as the Republic of Korea, the Philippines and Viet Nam. A few countries, such as Thailand until 1998, did not provide any statutory retirement benefits.

Pakistan, despite its strong British connections, opted for a social insurance pension scheme in the 1970s. India has recently established a social insurance pension scheme, though this did not happen until half a century after the end of British rule.

Africa — In general, and with few exceptions, the coverage and effectiveness in Africa of existing social protection schemes for retirement, invalidity and death is weak. This derives from a number of factors — some political and economic, and others that reflect failures in governance at all levels, from the design of pension schemes to their operation.

Pension schemes originally designed by colonial governments often took insufficient account of the socio-cultural context and thus proved limited and inappropriate coverage. Since independence, this tendency has been compounded by adverse economic and political circumstances in most African economies, as well as by mismanagement. Many African pension schemes have failed to provide effective social protection, even for the small minority of the population they cover.

Some African countries provide benefits through provident funds, but a trend has emerged of ending those funds and converting them to defined benefit pay-as-you-go funds, as Tanzania recently did.

Latin America and the Caribbean — Most countries in the region provide benefits through defined pay-as-you-go schemes. However, because of the poor functioning of their defined benefit social security schemes, an increasing number of countries — eight as of 1998 — have converted at least partially to funded pension schemes. These schemes involved fully funded individual accounts that are managed by private sector pension fund managers. Sometimes the government also operates a pension fund management company that competes with private companies to attract workers as clients.

While it was thought that converting to a defined contribution scheme would reduce contribution evasion (because benefits would be tied more closely to contributions) evasion remains a problem in many Latin American, Caribbean countries. Some Caribbean countries have begun converting their provident funds into defined benefit pay-as-you-go schemes.

The Arab States of the Middle East — In much of this region, which contains both some of the world’s wealthiest and poorest countries, most pension schemes are relatively young, with none more than 50 years old. All of the programs are traditional, defined-benefit social insurance programs, in most cases financed by contributions from both employers and employees, with the state covering any deficit.

Birth rates tend to be high in this region and population aging is not viewed as a problem. Some of the countries have work forces with a high percentage of foreign workers. The treatment of foreign workers is a social security issue in the region because some of the countries (which ones) exclude them from pension coverage.

Central and Eastern Europe and Central Asia — Countries in the region are still in the process of transforming their economies from command-based to market economies or of coming to terms with the costs of the transition. The social-protection schemes in most of these countries have features inherited from the systems of the former planned economies, which consisted of a viable or explicit component, and an invisible or implicit component. The visible meant provided pensions, short-term cash benefits and health care. The implicit component added security through specific socialist income redistribution mechanisms, such as guaranteed employment, the provision of low-cost housing and heavily subsidized basic goods and services, educational supplies, books and cultural goods and services.

Many of these countries are rethinking their social security schemes, with some adopting defined contribution schemes. It is too early to evaluate their performance, but schemes in countries such as Poland, the Czech Republic, Hungary and Slovakia are in decent shape. The countries that arose out of the Soviet Union, from Russia itself to the Central Asian nations, are in much worse shape, because their economies are so weak.

Rise of Pension Schemes

At the beginning of the 20th century, few workers possessed the security of an old age pension. In developed countries, most people either died early or worked until they were in their late 60s, spent a brief retirement living with their children, then died in their early 70s. To be old generally meant to be poor. Becoming disabled signified that poverty began earlier.

For developing and middle-income countries, older people faced much worse prospects. Incomes were substantially closer to subsistence levels and the capacity of children to support their parents was less. Death came earlier, and the famous expression applied more: “life was nasty, brutish and short.”

By the beginning of the 21st century, the situation has dramatically changed. In developed countries, the incidence of poverty in old age is now comparable to levels in the remainder of the population. Life expectancy is longer and most workers can expect a significant period of retirement with a reasonable income.

Disability pensions and the possibility of early retirement have reduced the financial risks of incapacity to work. Almost all women are entitled to a survivor’s pension, and a growing majority are entitled to a pension as workers in their own right.

Alongside these changes, an increasing number of developing countries are beginning to emulate the experience of the developed countries, in terms of the extension of coverage and in the improvement of benefits.

A large part of this profound improvement in social conditions can be attributed to the creation of social security pensions that must be counted as one of the great social developments of the last 100 years. Pensions accelerated in the second half of the 20th century, after growing hesitantly in the first half of the century. Pension outlays in the developed countries grew at twice the rate of gross domestic production (GDP) and more and more developing countries and middle-income countries attempted to provide benefits for retirees.

The task is only half-complete, the book shows. Pension schemes throughout the world are in a state of upheaval. On the one hand, the developed countries are contemplating new architectures for the financing of pension outlays. This will require careful thought and the development of a new consensus. But on the other hand, the overwhelming majority of the world’s population is still without some form of income security in old age or disability.

To extend the security available to workers in the developed countries of the world to workers in all other countries remains a paramount task for the early years of the century.

“It will require great effort, great imagination and an enlightened adaptation to the different circumstances of developing countries,” the book says. “It means extending the coverage of pension schemes (and all other forms of social security) improving their governance, and ensuring that the design of the schemes is both economically efficient and compatible with internationally accepted human and social values.”

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