Mandatory earnings-related pensions
Generic earnings-related schemes are of four different types governed by different rules of benefit calculation. DB schemes typically specify a nominal accrual rate, expressed as a percentage of individual pensionable earnings, at which benefit entitlements build up for each year of coverage. The higher the contribution rate the higher the accrual rate that can be sustained by contributions. In points schemes, the pension benefit is equal to the number of points accumulated during the career multiplied by the point value. FDC schemes apply an annuity divisor to turn accumulated capital in the individual account at retirement age into a monthly pension benefit. NDC schemes also do that to notional accumulated capital. Table 3.4 presents future parameters and rules for benefit calculation that will apply to people who enter the labour market in 2020, according to the latest legislation.
Nominal accrual rates of at least 2% apply in Colombia, Portugal, Spain and Turkey. Japan and Korea credit the lowest rates of about 0.5%. In half of DB schemes the accrual rate is constant. In the Czech Republic, Portugal, for the public scheme in Switzerland and the United States, entitlements vary with earnings levels, granting higher accrual rates to lower earners. Accrual rates increase with a longer contribution history in Greece and Luxembourg while in Hungary, Slovenia and Spain accruals are higher for the first years of coverage. Moreover, in the Swiss occupational plan accrual rates increase with age as contribution rates do. In some countries, total accrual rates are limited by a ceiling or by a maximum number of years that generate accruals.
Earnings measures used to calculate benefits differ by country. The vast majority of OECD countries uses entire career earnings, with Portugal and the United States coming close by using the best 40 and 35 years, respectively. Only the main scheme in France and public pensions in Colombia, Costa Rica, Slovenia and Spain will be based on a comparatively small fraction of career earnings; the best 25, final 10, final 20, best 24 and final 25 years of earnings, respectively.
All schemes apply a valorisation rate to past earnings to take account of changes in “living standards” between the time pension rights accrued and the time they are claimed. The most commonly used rate is the growth of average earnings. Belgium, Colombia, Costa Rica, the main scheme in France, occupational DB schemes in the Netherlands and the system in Spain only revalue earnings with price inflation, thereby leading to a negative impact of real-wage growth on replacement rates and making the finances of the system (more) sensitive to real-wage growth (OECD, 2019[1]). Also Finland, Portugal and the United States revalue earlier years’ earnings with a mix of price and wage inflation, and in Estonia and Turkey it is a mix of prices and, respectively, wage bill and GDP growth.
The interest rate applied to paid contributions in DC plans is the counterpart to valorisation rates in DB and points schemes. It is based on financial market returns in FDC schemes and on notional interest rates in NDC schemes. The latter are equal to the rate of GDP growth in Italy, wage bill growth in Latvia and a mix of the two in Poland. Norway and Sweden apply earnings growth. On top, Sweden redistributes accrued entitlements of deceased contributors to all other contributors in the system. One key parameter for DC plans is the contribution rate paid into individual accounts.
Most countries set a limit on the earnings used to calculate pension benefits. Pension schemes in ten countries do not have a ceiling. The highest ceilings apply in the occupational scheme in Colombia, France, Lithuania, Mexico and the Slovak Republic, at over six times average earnings. The lowest ceilings at about 0.75 times average earnings is in Israel and Switzerland, with no other country having a ceiling below the average wage.
Indexation refers to the growth of pensions in payment. Price indexation is most common. However, eight countries uprate benefits with a mix of price inflation and wage growth, and four countries combine inflation and GDP or wage bill growth. Norway indexes to wage growth minus 0.75% while Sweden indexes pensions based on wage growth minus 1.6%.
The effective accrual rate measures the rate at which benefit entitlements are effectively built for each year of coverage. It is thus closely connected to the replacement rates shown in Chapter 4. For DB schemes, it equals the nominal accrual rate corrected for the effects applying to pensionable earnings (thresholds, valorisation of past earnings, sustainability factors). In FDC and NDC schemes the effective accrual rate depends on contribution rates, rates of returns and annuity factors.
Based on current legislation, the highest future effective annual accrual rates are in Austria (1.72%) and Colombia (1.87%) with Italy, Luxembourg, Portugal, Spain and Turkey also larger than 1.5%. The lowest rates, below 0.2%, are in the points scheme in Lithuania and the FDC schemes of Norway and Sweden, reflecting low contribution rates. The effective accrual rate from mandatory schemes will equal 1.1% on average among OECD countries.