pensions in transition: united states and japan robert l. clark professor of economics north...
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PENSIONS IN TRANSITION:United States and Japan
Robert L. Clark
Professor of Economics
North Carolina State University
19 September, 2002
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NATIONAL RETIREMENT PLANS
NATIONAL RETIREMENT PLANS CONSIST OF
employer pensions
social security
national retirement policies
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PARALLELS AND CONTRASTS
Employer pensions in U.S.,
DC plans are dominant
Emergence of cash balance plans
In Japan,
new regulations allow DCs
underfunding plagues DBs
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PARALLELS AND CONTRASTS
Both countries face significant Social Security funding problems due to population aging– In U.S., debate rages over use of
individual accounts– In Japan, five year modifications lower
benefits and raise costs
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U.S. AND JAPAN RETIREMENT SYSTEMS
Similar pressures Similar options Different choices? Can we learn from each other?
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OUTLINE OF PRESENTATION
Employer pensionsTrends in U.S.
New options in Japan Social Security
Need for action now
Options for both countries
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CHOICE OF PENSION PLAN
Pensions are an important component of labor compensation.
The generosity and style of pension depends on worker preferences and employer preferences.
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PENSION COVERAGE Approximately half of the labor force
covered by pension in the US
Total coverage rates have been relatively stable over the past three decades
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Trends in Pension COVERAGE
30%
35%
40%
45%
50%
55%
60%
65%
Sponsorship RateParticipation Rate
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COVERAGE RATES Coverage rates vary considerably by
– level of earnings – firm size – industry
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Pension Participation Rates for Workers
0%
15%
30%
45%
60%
75%
90%
1979 1983 1987 1991 1995 1999
Year
Pe
rce
nt
of
wo
rek
rs
pa
rtic
ipa
tin
g
LT $15,000
$15 - $24 K
$25 -$49 K
$50,000 +
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TYPES OF PENSION PLANS
Overall coverage has remained stable in the United States
However, there have been significant changes in plan type and plan design
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TYPES OF PENSIONS traditional defined benefit defined contribution hybrid
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Features of Alternative Plan Types
Plan feature DB Plan DC Plan Hybrid Tendency
Employer contributes Always Sometimes Always DBEmployee contributes Rarely Generally Rarely DBParticipation Automatic EE choice Automatic DBContribution level Automatic EE choice Automatic DBPBGC insurance Always No need Always DBEarly departure penalty Yes No No DCBenefits easily portable No Yes Yes DCAnnual communication Benefit at Current Current
retirement balance balance DCRetirement incentives Generally Neutral Most neutral DCAccrual of benefits Back loaded Level Varies MixedFinancial market risks Employer Employee Shared Mixed
bears bearsLongevity insurance Generally Generally no Not often taken Mixed
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WORKER PREFERENCES Workers want the pension plan that
gives them the most value of each dollar of reduction in salary
Portability is important
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WORKER PREFERENCES Understanding the value of the
pension
Workers express preferences for individual accounts and lump sums
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EMPLOYER PREFERENCES Employer preferences are to develop
compensation policies that attract and retain quality workers
Plans that provide appropriate retirement incentives
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PENSION PREFERENCES Desired pension policies can change
with economic conditions
Workers and firms want to provide the most value in retirement benefits for the lowest cost
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ADMINISTRATIVE COSTS Administrative costs are affected by
government regulations
Higher administrative cost make some firms less likely to offer a pension
Changes in administrative costs can affect the most desirable plan type
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Small Plan Per Capita Administration Costs
0
100
200
300
400
500
600
700
1981 1983 1985 1987 1989 1991 1993 1995
DB
DC
Dollars per year
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Large Plan Per Capita Administration Cost
0
10
20
30
40
50
60
70
80
1981 1983 1985 1987 1989 1991 1993 1995
DB
DC
Dollars per year
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PLAN CHOICE If establishing a new plan, which plan type
should the firm adopt?
Increasingly firms starting first time pension plans are selecting DC plans.
Cash balance plans have typically come from converting traditional DB plans into the new hybrid plan.
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TRANSITIONS When converting a traditional defined
benefit plan, companies must consider the impact on current and future workers.
Impact of plan change varies by type of worker.
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IMPACT OF PLAN CONVERSIONS
Workers who leave before reaching the age of early retirement will tend to be better off under a cash balance or DC plans compared to DB plans
Workers leaving between the early and normal retirement ages will tend to have higher benefits in a DB plan
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EARLY RETIREMENT SUBSIDIES
Virtually all traditional defined benefit plans have subsidized early retirement plans.
These plan provisions create substantial jumps in the value of lifetime pension benefits.
Neither defined contribution or cash balance plans have these provisions.
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Decline of Defined Benefit Plans in U. S.
Coverage by traditional defined benefit plans has been declining for the past quarter century
Since the mid-1970s, coverage by defined contribution plans has increased sharply.
This trend has been primarily among smaller firms.
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PRIMARY PENSION COVERAGE
0102030405060708090
1979 1996
DBDC401(k)
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DECLINE OF DEFINED BENEFIT PLANS
This trend has been driven by:– increased administrative cost of DB plans
relative to DC plans.– change in composition of labor force and
preference for portable pensions.– change in industrial mix with employment
decreasing in companies with traditional DB plans.
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DECLINE OF DEFINED BENEFIT PLANS
Many large firms have converted their traditional DB plans to cash balance plans.
First cash balance plan in 1985.
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REASONS FOR PLAN CONVERSIONS
– Restructure compensation to appeal to a changing labor force.
– Value of plans is easier to explain to workers.
– Reducing the level and uncertainty of pension costs.
– Ending early retirement subsidies.
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COMPANY POLICIES Companies must consider impact on
current and future workers New policies must be explained Rationale for pension changes should
be explained
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TRANSITION BENEFITS Many workers who are near retirement
will accumulate lower retirement benefits.
To moderate the loss of expected pension benefits for senior workers, many companies have provided transitional benefits.
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COMMUNICATION Full disclosure and effective
communications with workers is a key to plan transitions
Workers should know the reasons for the change
Computer software should be developed to all workers to estimate the impact of the plan change on them
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PENSIONS IN THE 21ST CENTURY: U.S.
Pensions in the 21st century will be increasingly based on individual accounts
Workers will have greater responsibility for their own retirement income
Government regulation of pensions will affect the outcome
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PENSIONS IN THE 21ST CENTURY: Japan
New regulations – permit DC plans– eliminate TQPPs– allow conversion of EPFs
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PENSIONS IN THE 21ST CENTURY: Japan
Conversion made more difficult by– underfunding of existing DB plans– relatively low limits on DC contributions– not allowing both employer and employee
contributions– available rates of return on future
individual accounts
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FINANCIAL EDUCATION Defined contribution plans place
greater responsibility on workers Employees must decide when to start
contributing and how much to contribute
Employees must decide how to invest account balances
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FINANCIAL EDUCATION Do workers have sufficient financial literacy
and know to make appropriate choices? Do firms with DC plans have an obligation to
provide financial education? Does the government have an obligation to
provide increased financial education to workers?
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SOCIAL SECURITY IN TRANSITION
Population aging placing increasing stress on social security systems in U.S. and Japan
In U.S., great debate but no action as yet
In Japan, periodic changes do not solve funding problem
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SOCIAL SECURITY IN TRANSITION
Will there be individual accounts?
How will existing program be restructured?
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COMMISSION REPORTS IN U.S.
Options presented by 1994-1996 Advisory Council (www.ssa.gov/history/reports/adcouncil/report/findings.htm#overview)
Option proposed by President Clinton Options proposed by Bush
Commission on Social security (www.csss.gov)
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FIVE YEAR REVIEWS IN JAPAN
Since 1985, regular 5 year reviews have Lowered benefits
Increased retirement ages
Increased tax rates
Increased government contributions
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CONTINUED POPULATION AGING
Continued population aging raises projections of future costs – especially true in Japan
Need for action is immediate
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RETIREMENT POLICIES Important to recognize the linkage
between – Employer pensions– Social security– National retirement policies