Key Elements of a Labor Program
PENSIONS AND PPI
The Pension Challenge
Types of Pension Plans
Addressing Prior Pension Obligations
Pensions and Labor Restructuring
Future Pension Design
Pensions: Implementation Steps
Material and Sources
Types of Pension Plans
The first challenge is to meet pension obligations that have been promised and earned by current workers.
The second challenge is to use pensions as an effective tool for labor restructuring through early retirement.
The third challenge is to design pension plans for the post- PPI enterprise.
Pensions are essentially collective arrangements designed to provide income for people no longer able to work because of age. In nontraditional societies or in industrial economies in which the multigenerational household is no longer the norm, pensions provide a means for the elderly population to survive. Pensions can be organized and run by government and public institutions, by private firms, or by a combination of both.
Pensions may be organized as contractual savings in which a worker builds up assets or credits that are returned in a variety of forms as income following retirement or through the redistribution of income from active to retired populations. Pensions are typically afforded tax privileges under which income taxes on the value of payments or contributions are deferred until the time they are received as retirement benefits. This "consumption tax" treatment often has significant fiscal consequences and may be the single largest tax privilege in many countries.
Although there is a wide variation in their specific design, there are two basic types of pensions. The older and more traditional pensions are those that promise workers a level of income for the rest of their lives after they reach a specified retirement age. These generally establish a benefit level based on a formula that takes into account wages earned and years of employment covered under the plan. These are broadly termed defined-benefit plans and include the majority of the public social security systems, civil servants' pension plans, and many older occupational plans. Some defined-benefit plans try to set aside sufficient funds to pay the benefits by estimating their future value at the time they are earned and are therefore called funded plans. Others–commonly public social security and civil servants' plans–pay benefits out of current receipts and are called unfunded arrangements.
Glossary of pension terms
Other pensions essentially provide a savings account for each individual in which contributions from the worker (and often the employer) accumulate. The value of these contributions and the earnings from their investment accumulate in these individual accounts. On reaching a specified age, or sometimes under other conditions such as separation from employment, the worker becomes entitled to the value of the account. In these arrangements there is no promise of a benefit level; all that is promised is the commitment to maintain the account. The benefit received is directly linked to the value of contributions made, so these are generally called defined-contribution plans.
The observation is often made that in defined-benefit arrangements the sponsor incurs all of the risks of unanticipated changes in investment returns or from miscalculations about the amount of time workers will live after retirement, whereas in defined-contribution arrangements these risks fall primarily on the individual worker. This principle is central when considering any restructuring of pensions in the privatization process.
Any type of pension can be organized on a national basis, by a single enterprise, or by a group of related employers. Pensions can be organized and administered by public or private institutions or by a combination of both. Workers in infrastructure enterprises may be covered by any of these types of pensions operated by either type of institution or through a combination of arrangements.
Some of the more prevalent types of pension arrangements are:
Two basic types of pensions:
- Defined-benefit plans, where the risk lies with the sponsor
- Defined-contribution plans, where the risk lies with the employee.
- National pension plans: Some countries have established government-run social security programs that generally cover all workers in the so-called formal sector– those who are receiving money wages. Coverage is typically limited to this group because it is only through wage records that taxes and contributions can be collected and benefit levels can reliably be set, although in many circumstances this relationship is tenuous at best. In developing economies only a small fraction of the total population may be covered–typically including infrastructure workers.
National pension schemes are typically operated primarily on a PAYGO basis and consequently have large unfunded and quite often untenable levels of future benefits. These arrangements can range from modest in scope to very generous (from those that seek to replace half of a worker's income to those designed to replace nearly all of a worker's income, even if that is not feasible over the long term). Infrastructure workers, especially in strategic or dangerous industries, may be afforded special privileges in these plans that provide higher income replacement rates or retirement at a younger age. Compensating workers for the loss of these special privileges can be very complicated and expensive and thus represents one of the more difficult pension problems in privatization. Public plans facing financing shortfalls may also seek payments to cover these future commitments if they are to be maintained–an expense that can be a major issue in privatization.
- Civil servants' pension plans: Many countries without national schemes or those with modest benefit levels have established special pension programs for civil servants. These are often designed to provide nearly full income replacement, often at young retirement ages, to compensate for the presumed lower pay levels of civil servants or to retain members within the career civil service. Regardless of whether either of these motivations is necessary, the tradition of high pension levels for civil servants is maintained in many developing countries. They are nearly always defined-benefit plans, although this is slowly changing. They may be operated in conjunction with a national plan or they may move covered workers into a separate arrangement.
Infrastructure workers are often included in these arrangements and may perceive themselves as having forgone a significant portion of their potential wages or other employment opportunities in the expectation of future high pension levels. This may or may not comport with reality, however, because with civil servants more broadly the expectations and perceptions will be key issues in any labor restructuring. Civil servants' plans commonly are operated on an unfunded or partially funded basis.
As with national plans, these plans may not have aligned required contributions with the needs of long-term solvency and thus may represent an indirect source of subsidy for infrastructure entities. This not only distorts the measurement of actual compensation costs on an ongoing basis but may lead to demands for a very high payment to settle previously accrued but unfunded obligations when an employer tries to withdraw from the plan upon privatization.
National pension plans usually are PAYGO.
Provident funds are defined-contribution plans.
- Provident funds: Former colonial powers, particularly the British, established a particular type of savings institution known as provident funds, and these remain common in many developing nations in South Asia and Africa. These are defined-contribution arrangements in which an account is established for each participant and the contribution of a specified portion of wages is mandatory. Contributions often must be made by employers as well.
Typically the funds are invested in safe but low-yielding assets, usually debt instruments of the government. Participants are often permitted to borrow the funds for specified purposes–the purchase of housing is a common example–and are entitled to receive the total amount that has built up in their accounts when they reach a specified age. In some instances provision is made to convert the account balance into a lifetime annuity.
Although provident funds are primarily established as retirement savings vehicles, they are often used for a far broader range of purposes. Workers often deplete the full value of these savings to pay for relatives' funerals, weddings, or education expenses or they are permitted to withdraw funds when leaving a job before retirement age. Because they are purely defined-contribution in nature and therefore, by definition, fully funded, these types of pension arrangements pose fewer problems of past liabilities or future commitment during PPI. They can, in fact, be a type of vehicle that essentially provides a source of severance pay to mitigate the short-term consequences of labor restructuring.
- Occupational or employer-sponsored private pensions: The least common but in some respects most problematic type of pensions likely to be encountered in a privatization initiative is occupational plans. These are special pension arrangements that have been established to cover workers in specific enterprises, sometimes called single-employer plans, or a group of related employers or members of a trade union, sometimes called multiemployer plans. Occupational pensions can be the only source of pension coverage in circumstances where there is no national pension program or where employees in certain industries are excluded from other arrangements. They also can be integrated into other plans, usually designed to provide supplementary benefits where income replacement rates are low or to provide for earlier retirement ages. Traditionally these types of pensions have been of the definedbenefit type; however, there is a recent trend toward defined-contribution plans.
Occupational pensions are extremely diverse in form. They impose particular problems for implementing agencies because most developing countries have not established any sort of comprehensive rules or requirements for their establishment or operation. This can result in circumstances in which the benefits promised are not clearly specified, and that leads to considerable controversy about their settlement. Workers may be led to expectations about their pensions that are considerably at odds with the terms of the arrangement or the resources available.
Most significantly, occupational plans often result in substantial future financial commitments that have not been measured or accounted for in a reliable fashion and that have no funding set aside to ensure they can be met. These problems are especially pronounced for defined-benefit arrangements, but may also occur when defined-contribution plans must be funded or when the funding is not segregated from the sponsor's other financial arrangements. They do, however, afford opportunities for using pensions to manage labor restructuring or to provide incentives to manage a work force, as discussed in subsequent sections.
