Mandatory earnings-related pensions
Key results
The second-tier of the OECD’s taxonomy of retirement-income provision comprises mandatory earnings-related pensions. Key parameters and rules of these schemes determine the value of entitlements, including the long-term effect of pension reforms that have already been legislated.
Earnings-related schemes can be of four different types: defined benefit (DB), points, notional defined contribution (NDC), or defined contribution (DC). The accrual rate shows the rate at which benefit entitlements build up for each year of coverage. The accrual rate is expressed as a percentage of the earnings that are “covered” by the pension scheme.
For points systems, the effective accrual rate is calculated as the ratio of the cost of a pension point to the pension-point value. In notional-accounts schemes, the effective accrual rate is calculated in a similar way; it depends on the contribution rate, notional interest rate and annuity factors. In Thailand and Viet Nam the accrual rates are not constant, in contrast to all the other economies that have DB systems. In Thailand the first 15 years of contribution give 20% with each subsequent year giving 1.5%. In Viet Nam the accrual rates have been different for men and women but these have being equalised from 2018.
Earnings measures used to calculate benefits also differ. Three economies solely use lifetime earnings to calculate benefits, China, Indonesia and Viet Nam, with the Philippines using the higher of lifetime earnings the final five years. Thailand also uses the final five years for the calculation of benefits whilst Pakistan just uses the last year of salary.
Closely linked with the earnings measure is valorisation, whereby past earnings are adjusted to take account of changes in “living standards” between the time pension rights accrued and the time they are claimed (sometimes called pre-retirement indexation).The uprating of the pension-point value and the notional interest rate in points and notional-accounts systems, respectively, are the exact corollaries of valorisation in DB plans. The most common practice is to revalue earlier years’ pay with price inflation, used in four economies compared to the growth of average earnings, which is used in only two.
One key parameter for defined contribution (DC) plans is the proportion of earnings that must be paid into the individual account, as this is directly linked to size of the pension pot at retirement. Seven Asian economies have defined contribution systems and the average contribution rate is 17% across the economies, ranging from a high of 37% in Singapore to a low of 5.7% in Indonesia.
Some economies set a limit on the earnings used to calculate both contribution liabilities and pension benefits. The average ceiling on public pensions for the three economies is 175% of average economy-wide earnings, though this excludes the other eight economies that do not have a ceiling.
Indexation refers to the uprating of pensions in payment. Price indexation is most common, being applicable for three economies. Viet Nam uses wage indexation with both China and Thailand having a discretionary indexation to a combination of wages and prices.