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Retirement Savings in Asean
November 15-16, 1996
A main focus will be Indonesia, the largest country in the region and the fourth largest in the world by population, that is after China, India, and the United States. In 1992, Indonesia enacted the Pension Law, which signaled its reliance on privately funded pension plans to mobilize savings and provide financial security in retirement. In its 1994 Policy Research Report entitled Averting the Old Age Crisis, the World Bank commented as follows on the Indonesian Pension Law : "The new Law brings Indonesia up to oecd norms and will probably set the standards for developing countries," which certainly justifies our interest.
I will also comment on other trends in the region. I do not intend to focus on specific, although important, aspects such as the tax treatment of contributions, returns on assets and benefits, or on the protection of purchasing power through indexation or other means. These are generic issues that are of importance in all regions of the world.
Overview
The map that follows may help you to locate more precisely all of these countries, which should become better known as the year of the Pacific unfolds in 1997. I add some key statistics as a starter.
Demographics
From a demographic point of view, Brunei and Singapore are special cases. The five other countries range in population from about 20 to 200 million, a ratio of one to ten. It is interesting to note that the two extremes share the same language, Bahasa Melayu and Bahasa Indonesia, in as much as we can say that English and American are the same language, that is, until we see American films with English subtitles. The remaining three are closely grouped in the 60 to 75 million range. On the accompanying chart, the rates of growth are compared with Canada, the United States, and the oecd countries.
The rates of growth are very much related over time to the graying of the population, the contributing factors being the decrease in mortality rates and fertility rates. I have shown life expectancy at birth, a frequently used indicator; however, as we focus on retirement, I should have shown the life expectancy at age 60 or 65. Another useful statistic would be infant mortality rates.
Economics
The next chart gives some indication of the level of public pension spending, as opposed to contributions, flowing through privately managed systems. It also compares various economic indicators. The complement of the labor force as a percentage of the population is a proxy for the complement of the dependency ratio.
Systems
The next three charts summarize information gathered from various sources that were not always consistent, so the comparison is only illustrative. Most of the information is updated to 1995-96 but has not been validated.
The countries reviewed offer either: a social security system, that is, defined-benefits in accordance with a formula that reflects earnings and years of contributions, which entails redistribution effects; or a provident fund, that is, benefits of the defined-contributions type, generally payable as a lump sum, which entail lifetime income smoothing but little redistribution, except possibly through sharing of administrative costs and returns on assets. Both include some insurance components.
Another distinction is that the social security systems are output driven, since they promise defined-benefits, while the provident funds are input driven, the promise being represented by the accumulation of the contributions. However, a more significant strategic distinction is that these social security systems, like most others around the world, are financed on a pay-as-you-go basis whereas the provident funds, by design, are fully funded.
The percentage of the labor force that contributes to the system confirms the indication given on the previous chart by the percentage of gdp going to public pension spending as to the degree of reliance on public pensions. It can be seen, as noted above, that Indonesia is relying on the growth of its private sector pensions. At the other end of the spectrum, Singapore has high publicly managed mandatory coverage, combining a 40 percent rate of contribution with coverage of over 75 percent. It should be noted that only part of the 40 percent is actually used for retirement benefits: part of the accumulation can be used for such expenses as housing, education, medical expenses. The Singapore system is more a savings scheme than a retirement plan, which may explain why only 2.2 percent of gdp is reported as public pension spending.
Vietnam is next in line with over 30 percent of earnings going to the public system and no private sector worth mentioning, as would be expected under a communist economic system. However, the system is still in a pilot stage, being only in five provinces.
Malaysia follows with contributions totaling 24 percent of payroll and almost half the labor force covered by the provident fund. At 1.6 percent of gdp, public pension spending is the second highest in ASEAN, but still low by Western standards. Part of the accumulation can be diverted to medical health services or other specified purposes. This explains why Malaysia is now promoting the development of private pensions.
The Philippines channels 0.6 percent of gdp to public pensions, about one-third that of Malaysia; less than 20 percent of the labor force is covered with contributions to a social security system aggregating 8 percent. There are private pension funds in the Philippines, but their coverage is still limited. In July 1996, Philippines President Fidel Ramos ordered Congress to look into the possibility of merging the social security system and the Government Service and Insurance System. The ultimate objective is to create a national provident fund that would consolidate state-owned and private sector pension funds, eventually privatizing the whole system. President Ramos has said that "privatization will allow an enlarged provident fund system to widen its coverage, increase management flexibility in investing its portfolio, decentralize its operations, and raise minimum contributions."
Other sources indicate the intervention of President Ramos can be traced back to a recent visit of the Chilean president, which led the Department of Finance to support privatization as a way of stimulating the growth of savings. Eduardo Chaves, senior vice president for trust and investments of AB Capital and Investment Corporation, pointed out that Chile, with a population four times smaller and a gnp 15 percent lower, has accumulated over three times as much retirement savings as the Philippines. He estimated Chilean retirement assets at 55 percent of gnp versus 15 percent of gnp for the Philippines; there are additional private funds outside the system, but these do not come close to filling the gap. These figures compare with 41 to 42 percent of gnp for Japan and Canada, 75 percent for the United States, 100 percent for Switzerland, and 121 percent for Holland.
The Chilean approach means the Philippines would hire a number of plan administrators that would collect contributions, manage the assets, and pay the benefits, in competition with each other. The Chilean model in place since 1981 has already inspired other countries: Argentina, Peru, Colombia, and, more recently Bolivia. It can be improved, especially from the point of view of operating costs, which may become unduly high because of excessive competition between plan administrators, resulting in high promotional and marketing expense. This has led Bolivia, in the Pension Law approved by the Senate on November 10, 1996, to limit the number of plan administrators to two while imposing restrictions on transfers of participants between funds. Neighboring Malaysia and Singapore have operating costs that are on the order of ten times lower than Chile's. No doubt the Philippines can benefit from the experience of others and combine the lower costs of its neighbors with the higher return on assets obtained by the Chilean fund administrators.
Will the Philippines replace its current social security system by a mandatory privatized provident fund, or will it accelerate the development of funded private plans, or will it develop a combination of both? We should know soon.
Thailand has a very basic social security system, which now offers only sickness and maternity benefits supported by 4.5 percent contributions split equally between employees, employers, and the government. It appears headed in the direction of strengthening the private pillar of the system. It intends, however, to add retirement coverage for employees after 1996 and for self-employed in 1998 to its social security system. The government has been issuing licenses to provident fund managers and grants preferential tax treatment to pension contributions. A clipping from the Bangkok Post summarizes the issues very neatly. The author first states that "considering the problems many Western countries have faced in funding government-backed pension systems, it's doubtful that Thailand will look to adopt a fully funded public system." The author then refers to the World Bank suggestion of a three-pillar system: "First, a limited mandatory public system financed through taxes and offering defined-benefits; second, a privately managed system that links benefits to costs; third, a voluntary personal savings or occupational programme for those wanting additional income security in old age." The author continues in noting that 'for developing Asian countries, critical to reform is building strong regulatory and banking systems, and stock and bond markets, so that management institutions can have a variety of choices to maximize investment returns."
Common Needs
These words of wisdom can apply to many countries. Among others, they are echoed by the proponents of the reform of the Philippines system who stress the need for a proper regulatory body, capitalization, governance, and reporting requirements for private administrators, an accreditation process, investment guidelines, proper use of information technology, a legal and operational framework, favorable tax treatment, etc. Quite a challenge!
Better discipline would rule out, for example, concessional loans at below market rates that benefit some borrowers at the expense of contributors and future retirees, even though such practices are rationalized as consistent with social objectives such as housing or education.
A common requirement for Indonesia, Malaysia, the Philippines, and Thailand is thus to reinforce the systems' infrastructures, especially those supporting the capital markets and the control and supervision of the private managers, whether they operate a mandatory provident fund, occupational funded pension plans, or retirement savings in individual accounts.
Although the importance of each of the three pillars recommended by the World Bank can vary from one country to the next, none appears to be moving in the direction of creating larger unfunded entitlements in defined-benefits pay-as-you-go systems. Vietnam may be the exception, for ideological reasons, but it is still in the pilot stage. More important, the warning of an impeding pension crisis reaches them while their population is still young: 4 or 5 percent are over 65, versus 12 or 13 percent in Canada and the United States.
Recent Indonesian Legislation
It has been noted that Indonesia has recently enacted legislation that could be a model for developing countries that wish to mobilize savings and build up financial security in retirement through the accumulation of income-generating assets under private sector management. In addition to the Pension Law, Indonesia over the last decade has proceeded to major reforms of the legal framework governing financial institutions.
For example, in December 1990 Presidential Decree 53 created a new Capital Market Supervisory Agency (bapepam) and Ministry of Finance Decree 1548 detailed comprehensive prudential regulations. kdei, the Clearing, Settlement, and Depository Institution, was established in 1993. The Jakarta Stock Exchange was detached from bapepam and granted a license to operate as a privatized institution on April 16, 1992.
The new Insurance Law was adopted February 11, 1992, and made complete by a number of decrees. In parallel, and to the surprise of the Minister of Finance, a new Workers Social Security Law was prepared and adopted more or less at the same time providing health insurance, life insurance, workers' compensation, and limited lump-sum retirement benefits. This revised social security system is managed by astek, a government agency specifically exempted from the requirements of the Insurance Law, even though it operates the largest insurance scheme in Indonesia!
The Indonesian Pension Legislation
The Pension Law was promulgated on April 20, 1992, and a number of Decrees followed; the Funding and Solvency Decree is dated February 3, 1995, and the 1993 Investment Decree was replaced at the same time by a new Decree. The main features of the recently enacted Pension Legislation in Indonesia are:
Summary and Conclusions
Probably more by chance than by choice, the countries of asean have avoided the building up of large unsustainable systems of unfunded entitlements. Given current demographic trends, it is comforting that most of Southeast Asia is moving in the direction of capitalized retirement schemes; whether it be through mandatory defined-contribution plans, voluntary defined-benefit employer pension plans, or individual retirement savings is of less importance than the fact that assets management will be in the hands of the private sector, and thus market forces will be allowed to direct capital flows towards the most efficient producers. The presence or the absence of foreign investment limits will allow the optimization to be national only or truly global.
Retirement systems may result in four different type of redistribution:
How much redistribution should there be, and what is fair, acceptable, or sustainable, are much-debated questions. Obviously, everybody is trying to get on the favorable end of a redistribution scheme.
If you intend to enjoy long retirement years, consider moving to countries where either the worker-to-retiree ratio will remain high, or to countries with a high proportion of fully funded pensions! Or, if you are an optimist, just check the on-going fertility rate!
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