MANAGING SOCIAL SECURITY COSTS THROUGH BENEFIT DESIGN Gary Hendricks Regional Pension Workshop Majuro, Republic of the Marshall Islands April 25-29, 2016

Managing Social Security Costs Population aging is a worldwide phenomenon Increasing the retirement age is the most important adjustment countries should be making now and in the future. All other provisions of Social Security schemes also affect costs and require periodic review.

Managing Social Security Costs: Design Features to Consider FUND INCOME Contribution Rate Assessment Base New Sources FUND OUTGO (BENEFITS) Eligibility requirements Years of service Accrual rate Valorization of earnings (pensionable earnings) Minimum and maximum benefits Post-retirement benefit adjustments

Managing Social Security Costs: Fund Income: Contribution Rate Perform cash flow projections of income and outgo How large is the shortfall How does it develop (quickly, gradually, in spurts) Scrutinize patterns What contribution rates are politically “possible”? Are there contribution rate differentials between occupations and sectors? Should there be? Develop a strategy for adjusting rates Longest lead times are better Phasing using small incremental changes Intermittent changes

Managing Social Security Costs: Fund Income: Assessment Base Assessment Base is the financial base to which contribution rate is applied. Defining the Base Near universal one is earnings Must be measurable and verifiable Broadening the base All occupations covered? Government employees integrated? Adjusting minimum covered wage Adjusting minimum and maximum covered wages

Managing Social Security Costs: Fund Income: New Income Sources Government subsidies (from general revenue or earmarked tax to avert poverty of widows and orphans) Company revenues/profits that are partly the result of labor inputs Must not be highly discriminatory against particular companies or industries Borrow money from government or international development bank (WB, ADB)

Managing Social Security Costs: Calculation of Benefits Eligibility requirements Number of months of contribution or recorded earnings required to receive a benefit Reason for requirement in a public scheme: Worker should have substantial commitment to labor force Avoid de minimus benefits This is usually at least 10 and as many as 20 years

Managing Social Security Costs: Accrual Rate and Years of Service Key determinants of replacement rate (percent of earnings worker receives as pension) Accrual rate Percent of pensionable earning worker receives for each month of service. Length of service (creditable) Number of months to which accrual rate applies Rules vary for determining months of service Use multiple accrual rates lowering the rate at higher earnings levels When change retirement age, good time to review things like number of creditable years of service

Managing Social Security Costs: Valorization of Earnings Many different measures are in use Average of last 3 or 5 years of credited earnings Career or work life earnings Can use an Indexing factor for each year in the calculation (e.g., scale worker’s covered wages to average covered wage for each year) Length of averaging period (beginning and ending age) can affect average pensionable wage Elimination of low/high earnings years

Final Adjustments to Benefit Calculation Apply a minimum Apply a maximum

Managing Social Security Costs: Adjusting Benefits after Retiring Benefit indexation None Change in wages Change in prices Minimum benefits (adjust minimum)