Testimony Before the Subcommittee on 

Social Security, Committee on Ways and 

Means, House of Representatives

United States Government Accountability Office

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Thursday, June 16, 2005 SOCIAL SECURITY 

REFORM 

Preliminary Lessons from 

Other Countries' 

Experiences 

Statement of Barbara D. Bovbjerg, Director, 

Education, Workforce, and Income Security 

GAO-05-810T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-810T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Barbara D. 

Bovbjerg at (202) 512-7215 or 

bovbjergb@gao.gov. 

Highlights of GAO-05-810T, a report to 

Subcommittee on Social Security, 

Committee on Ways and Means, House of 

Representatives 

June 16, 2005

SOCIAL SECURITY REFORM 

Preliminary Lessons from Other 

Countries' Experiences 

Based on preliminary work, all countries in the Organisation for Economic 

Co-operation and Development (OECD), as well as Chile, have, to some 

extent, reformed their national pension systems, consistent with their 

different economic and political conditions. While reforms in one country 

may not be easily replicated in another, their experiences may nonetheless 

offer lessons for the U.S. Countries’ experiences adjusting PAYG national 

pension programs highlight the importance of considering how 

modifications will affect the program’s financial sustainability, its 

distribution of benefits, the incentives it creates, and public understanding of

the new provisions. Nearly all of the countries we are studying reduced 

benefits, and most have also increased contributions, often by increasing 

statutory retirement ages. Countries included provisions to ensure adequate 

benefits for lower-income groups, though these can lessen incentives to 

work and save for retirement. Also, how well new provisions are 

implemented, administered, and explained to the public may affect the 

outcome of the reform. 

Countries with national pension reserve funds designed to partially pre-fund 

PAYG pension programs provide lessons about the importance of early 

action and sound governance. Funds that have been in place for a long time 

provide significant reserves to strengthen the finances of national pension 

programs. Countries that insulate national reserve funds from being directed 

to meet other social and political objectives are better equipped to fulfill 

future pension commitments. In addition, regular disclosure of fund 

performance supports sound management and administration, and 

contributes to public education and oversight. 

Countries that have adopted individual account programs—which may also 

help pre-fund future retirement income—offer lessons about financing the 

existing PAYG pension program as the accounts are established. Countries 

that have funded individual accounts by directing revenue away from the 

PAYG program while continuing to pay benefits to PAYG program retirees 

have expanded public debt, built up budget surpluses in advance, cut back 

or eliminated the PAYG programs, or some combination of these. Because 

no individual account program can entirely protect against investment risk, 

some countries have adopted individual accounts as a relatively small 

portion of their national pension system. Others set minimum rates of return 

or provide a minimum benefit, which may, however, limit investment 

diversification and individuals’ returns. To mitigate high fees, which can 

erode small account balances, countries have capped fees, centralized the 

processing of transactions, or encouraged price competition. Although 

countries have attempted to educate individuals about reforms and how 

their choices may affect them, some studies indicate that many workers 

have limited knowledge about their retirement prospects. 

Many countries, including the 

United States, are grappling with 

demographic change and its effect 

on their national pension systems. 

The number of workers for each 

retiree is falling in most developed 

countries, straining the finances of 

national pension programs, 

particularly where contributions 

from current workers fund 

payments to current 

beneficiaries—known as a “pay-asyou-go” (PAYG) system. Although 

demographic and economic 

challenges are less severe in the 

U.S. than in many other developed 

countries, projections show that 

the Social Security program faces a 

long-term financing problem. 

Because some countries have 

already undertaken national 

pension reform efforts to address 

demographic changes similar to 

those occurring in the U.S., we may 

draw lessons from their 

experiences. 

The Chairman of the Subcommittee 

on Social Security of the House 

Committee on Ways and Means 

asked GAO to testify on 

preliminary results of ongoing 

work on lessons learned from other 

countries’ experiences reforming 

national pension systems. GAO 

focuses on (1) adjustments to 

existing PAYG national pension 

programs, (2) the creation or 

reform of national pension reserve 

funds to partially pre-fund PAYG 

pension programs, and (3) reforms 

involving the creation of individual 

accounts.
Page 1 GAO-05-810T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss our preliminary findings 

concerning other countries’ experiences with national pension reform. 

Many countries, including the United States, are grappling with 

demographic change and its effect on their national pension systems. With 

rising longevity and declining birth rates, the number of workers for each 

retiree is falling in most developed countries. A rising dependency ratio is 

straining the finances of national pension programs, particularly programs 

in which contributions from current workers fund payments to current 

beneficiaries—a form of financing known as “pay-as-you-go” (PAYG). 

Demographic and economic challenges are less severe in the U.S. than in 

many other developed countries—the birth rate is not as low, a greater 

number of older people stay in the labor force, and immigration continues 

to provide young workers. Yet projections show that the Social Security 

program faces a long-term financing problem. Because some countries 

have already undertaken national pension reform efforts to address 

demographic changes similar to those occurring in the U.S., we may draw 

lessons from their experiences. It is important to remember, however, that 

reforms in one country may not be easily replicated in another or may not 

lead to the same outcome. 

We are in the process of preparing a report covering the experiences of 

countries that may be applicable to our own debate over reforms to the 

U.S. Social Security program—the 30 members of the Organisation for 

Economic Co-operation and Development (OECD) plus Chile, the nation 

that pioneered the use of individual accounts.1

 My remarks today are 

based on an ongoing study and our observations are preliminary. We are 

focusing on (1) adjustments to existing PAYG national pension programs, 

(2) the creation of national pension reserve funds to help finance PAYG 

pension programs, and (3) reforms involving the creation of individual 

accounts. 

To date our study has included interviews with, and analysis of materials 

provided by, officials and interest group representatives in Washington, 

D.C., Paris, and London. We met with pension experts and country 

specialists at the OECD as well as French and British experts, officials, 

 1

 The OECD is a forum for the governments of 30 market democracies to work together on 

economic, social, environmental, and governance issues. The OECD works to promote 

economic growth, financial stability, trade and investment, technology, innovation, and 

development co-operation. 
Page 2 GAO-05-810T 

and interest group representatives. We conducted our review in 

accordance with generally accepted government auditing standards. 

In summary, all OECD countries have, to some extent, reformed their 

national pension systems, and may offer lessons for the U.S. Countries’ 

experiences adjusting PAYG national pension programs highlight the 

importance of considering how modifications will affect the program’s 

financial sustainability, its distribution of benefits, the incentives it 

creates, and public understanding of the new provisions. Nearly all of the 

countries we are studying reduced benefits, and most have also increased 

contributions, often by increasing statutory retirement ages. Countries 

with national pension reserve funds designed to partially pre-fund PAYG 

pension programs provide lessons about the importance of early action 

and effective management. Some funds that have been in place for a long 

time have accumulated significant reserves to strengthen the finances of 

national pension programs. Countries that insulate pension reserve funds 

from being directed to meet social and political objectives may be better 

equipped to fulfill future pension commitments. In addition, regular 

disclosure of fund performance supports sound management and 

administration, and contributes to public education and oversight. 

Countries that have adopted individual account programs—which may 

also help pre-fund future retirement income—offer lessons about 

financing the existing PAYG pension program as the accounts are 

established. Countries that have funded individual accounts by directing 

revenue away from the PAYG program while continuing to pay benefits to 

PAYG program retirees have expanded public debt, built up budget 

surpluses in advance of the reform, cut back or eliminated the PAYG 

programs, or some combination of these. Important lessons regarding the 

administration of individual accounts include the need for effective 

regulation and supervision of the financial industry to protect individuals 

from avoidable investment risks. In addition, public education is 

increasingly important as the national pension system becomes more 

complex. 

Social Security’s projected long-term financing shortfall stems primarily 

from the fact that people are living longer and having fewer children. As a 

result, the number of workers paying into the system for each beneficiary 

is projected to decline. This demographic trend is occurring or will occur 

in all OECD countries. Although the number of workers for every elderly 

person in the U.S. has been relatively stable over the past few decades, it 

has already fallen substantially in other developed countries. The number 

of workers for every elderly person in the U.S. is projected to fall from 4.1 

in 2005 to 2.9 in 2020. In nine of the OECD countries, this number has 

Background 
Page 3 GAO-05-810T 

already fallen below the level projected for the U.S. in 2020. This rise in the 

share of the elderly in the population could have significant effects on 

countries’ economies, particularly during the period from 2010 to 2030. 

These effects may include slower economic growth and increased costs 

for aging-related government programs. 

Historically, developed countries have relied on some form of a PAYG 

program and have used a variety of approaches to reform their national 

pension systems.2

 In many cases, these approaches provide a basic or 

minimum benefit as well as a benefit based on the level of a worker’s 

earnings. Several countries are preparing to pay future benefits by either 

supplementing or replacing their PAYG programs. For example, some have 

set aside and invested current resources in a national pension reserve fund 

to partially pre-fund their PAYG program. Some have established fully 

funded individual accounts. These are not mutually exclusive types of 

reform. In fact, many countries have undertaken more than one of the 

following types of reform: 

• Adjustments to existing pay-as-you-go systems. Typically, these are 

designed to create a more sustainable program by increasing contributions 

or decreasing benefits, or both, while preserving the basic structure of the 

system. Measures include phasing in higher retirement ages, equalizing 

retirement ages across genders, and increasing the earnings period over 

which initial benefits are calculated. Some countries have created notional 

defined contribution (NDC) accounts for each worker, which tie benefits 

more closely to each worker’s contributions and to factors such as the 

growth rate of the economy. 

• National pension reserve funds. These are set up to partially pre-fund 

PAYG national pension programs. Governments commit to make regular 

transfers to these investment funds from, for example, budgetary 

surpluses. To the extent that these contribute to national saving, they 

reduce the need for future borrowing or large increases in contribution 

 2

 In other countries, “social security” often refers to a wide range of social insurance 

programs, including health care, long-term care, workers’ compensation, unemployment 

insurance, etc. To generalize across countries, we use “national pensions” to refer to 

mandatory countrywide pension programs providing old-age pensions. We use “Social 

Security” to refer to the U.S. Old-Age, Survivors, and Disability Insurance Program since 

that is how the program is commonly known. 
Page 4 GAO-05-810T 

rates to pay scheduled benefits. Funds can be invested in a combination of 

government securities and domestic as well as foreign equities.3

• Individual accounts. These fully funded accounts are administered either 

by employers or the government or designated third parties. The level of 

retirement benefits depends largely on the amount of each person’s 

contributions into the account during their working life, investment 

earnings, and the amount of fees they are required to pay. 

We are applying GAO’s Social Security reform criteria to the experiences 

of countries that are members of the OECD as well as Chile, which 

pioneered individual accounts in 1981. We are assessing both the extent to 

which another country’s circumstances are similar enough to those in the 

U.S. to provide a useful example and the extent to which particular 

approaches to pension reform were considered to be successful. Countries 

have different starting points, including unique economic and political 

environments. Moreover availability of other sources of retirement 

income, such as occupation-based pensions, varies greatly. Recognizing 

this, GAO uses three criteria for evaluating pension reforms: 

• Financing Sustainable Solvency. We are looking at the extent to which 

particular reforms influence the funds available to pay benefits and how 

the reforms affect the ability of the economy, the government’s budget, 

and national savings to support the program on a continuing basis. 

• Balancing Equity and Adequacy. We are examining the relative balance 

struck between the goals of allowing individuals to receive a fair return on 

their contributions and ensuring an adequate level of benefits to prevent 

dependency and poverty. 

• Implementing and Administering Reforms. We are considering how 

easily a reform is implemented and administered and how the public is 

educated concerning the reform. 

Because each country is introducing reforms in a unique demographic, 

economic, and political context these factors will likely affect reform 

choices and outcomes. For instance, several European countries we are 

reviewing have strong occupation-based pension programs that contribute 

 3

 Reserve funds act as budgetary devices, or “disciplinary” devices, especially where they 

have been recently created. They help contain expenditures. Such containment is needed 

to achieve sustainable fiscal surplus. 
Page 5 GAO-05-810T 

to retirement income security. In addition, some countries had more 

generous national pensions and other programs supporting the elderly 

than others. All countries also provide benefits for survivors and the 

disabled; often these are funded separately from old age benefit programs. 

Some countries are carrying out reforms against a backdrop of broader 

national change. For example, Hungary and Poland were undergoing large 

political and economic transformations as they reformed their national 

pension systems. All of these issues should be considered when drawing 

lessons. 

In addition to the adjustments that countries have made to their existing 

PAYG systems, many countries have undergone other changes as well, 

indicating that change may not be a one-time experience. (See table 1.) 

Understanding the outcomes of a country’s reform requires us to look at 

all of the changes a country has made. 
Page 6 GAO-05-810T 

Table 1: Countries’ National Pension Reforms 

Groups of countries undertaking different types of reforma

Only adjustments to PAYG 

Adjustments to PAYG and 

National Pension Fund 

Adjustments to PAYG and 

Individual Accounts All Three Types 

Austria Belgium Australia Denmark 

Czech Republicb Canada Chiled Sweden 

Italy Finland Hungary Switzerlandg

Germanyc France Icelande 

Turkey Greece Mexico 

 Ireland Poland 

 Japan Slovak Republic 

 Korea UKf 

 Luxembourg 

 Netherlands 

 New Zealand 

 Portugal 

 Norway 

 Spain 

 U.S. 

Source: OECD, International Social Security Association, and the Social Security Administration. 

a

Member nations of the OECD and Chile. 

b

The Czech Republic’s defined contribution account program is not included as an “individual account 

reform” as it is a voluntary supplementary program. For a discussion of these accounts, see U.S. 

General Accounting Office, Social Security Reform: Information on Using a Voluntary Approach to 

Individual Accounts, GAO-03-309 (Washington, D.C.: Mar. 10, 2003), p. 46-54. 

c

Germany’s Riester pension program is not included as an individual account reform because it is a 

supplement to the mandatory national pension program, rather than an alternative. For a discussion 

of these accounts, see U.S. General Accounting Office, Social Security Reform: Information on Using 

a Voluntary Approach to Individual Accounts, GAO-03-309 (Washington, D.C.: Mar. 10, 2003), p. 55-

63. 

d

Chile is not an OECD country, but was included in our study because it pioneered individual account 

reforms. 

e

Iceland’s mandatory occupation-based pension program allows for the creation of defined 

contribution individual accounts as a complement to defined benefit pensions. However, in practice, 

employers have not yet established these. Voluntary supplementary individual accounts are also 

available. 

f

The UK requires either participation in a state earnings-related pension program or an approved 

alternative including individual accounts. 

g

Switzerland’s mandatory occupation-based pensions provide individual accounts that accrue credits 

at at least a minimum prescribed interest rate. 
Page 7 GAO-05-810T 

The experiences of the countries that have adjusted their existing PAYG 

national pension programs highlight the importance of considering how 

modifications will affect the program’s financial sustainability, its 

distribution of benefits, the incentives it creates, and the extent to which 

the public understands the new provisions. 

To reconcile PAYG program revenue and expenses, nearly all the 

countries we studied have decreased benefits and most have also 

increased contributions, often in part by increasing retirement ages. 

Generally countries with national pension programs that are relatively 

financially sustainable have undertaken a package of several far-reaching 

adjustments. The countries we are studying increased contributions to 

PAYG programs by raising contribution rates, increasing the range of 

earnings or kinds of earnings subject to contribution requirements, or 

increasing the retirement age. Most of these countries increased 

contribution rates for some or all workers. Canada, for example, increased 

contributions to its Canadian Pension Plan from a total of 5.85 percent to 

9.9 percent of wages, half paid by employers and half by employees. 

Several countries, including the UK, increased contributions by expanding 

the range of earnings subject to contributions requirements. 

Nearly all of the countries we are studying decreased scheduled benefits, 

using a wide range of techniques. Some techniques reduce the level of 

initial benefits; others reduce the rate at which benefits increase during 

retirement or adjust benefits based on retirees’ financial means. 

• Increased years of earnings. To reduce initial benefits several countries 

increased the number of years of earnings they consider in calculating an 

average lifetime earnings level. France previously based its calculation on 

10 years, but increased this to 25 years for its basic public program. 

• Increased minimum years of contributions. Another approach is to 

increase the minimum number of years of contributions required to 

receive a full benefit. France increased the required number of years from 

37.5 to 40 years. Belgium is increasing its minimum requirement for early 

retirement from 20 to 35 years. 

Adjustments to 

Existing PAYG 

Programs Show 

Importance of 

Sustainability, Safety 

Nets, and Incentives 

to Work and Save 

PAYG Adjustments Prove 

Important to Financial 

Sustainability 
Page 8 GAO-05-810T 

• Changed formula for calculating benefits. Another approach to decreasing 

the initial benefit is to change the formula for adjusting prior years’ 

earnings. Countries with traditional PAYG programs all make some 

adjustment to the nominal amount of wages earned previously to reflect 

changes in prices or wages over the intervening years. Although most of 

the countries we are studying use some kind of average wage index, 

others, including Belgium and France, have adopted the use of price 

indices. The choice of a wage or price index can have quite different 

effects depending on the rate at which wages increase in comparison to 

prices. We see variation in the extent to which wages outpace prices over 

time and among countries. 

• Changed basis for determining year-to-year increases in benefits. In many 

of the countries we are studying, the rate at which monthly retirement 

benefits increase from year-to-year during retirement is based on increases 

in prices, which generally rise more slowly than earnings. Others, 

including Denmark, Ireland, Luxembourg, and the Netherlands, use 

increases in earnings or a combination of wage and price indices. Hungary, 

for example, changed from the use of a wage index to the Swiss method—

an index weighted 50 percent on price changes and 50 percent on changes 

in earnings. 

• Implemented provisions that provide a closer link between pension 

contributions and benefits. Countries that have adopted this approach 

stop promising a defined level of benefits and instead keep track of 

notional contributions into workers’ NDC accounts. Unlike individual 

accounts, these notional defined accounts are not funded. Current 

contributions to the program continue to be used largely to pay benefits to 

current workers, while at the same time they are credited to individuals’ 

notional accounts. When these programs include adjustments that link 

benefits to factors such as economic growth, longevity, and/or the ratio of 

workers to retirees, they may contribute to the financial sustainability of 

national pension systems. 

Several countries, such as Sweden and the UK, have undertaken one or 

more of these adjustments to their PAYG programs and have achieved, or 

are on track to achieve relative financial sustainability. Others, including 

Japan, France, and Germany, may need additional reforms to fund future 

benefit commitments. 
Page 9 GAO-05-810T 

All of the countries have included in their reforms provisions to ensure 

adequate benefits for lower-income groups and put into place programs 

designed to ensure that all qualified retirees have a minimum level of 

income. Most do so by providing a targeted means-tested program that 

provides more benefits to retirees with limited financial means. Two 

countries—Germany and Italy—provide retirees access to general social 

welfare programs that are available to people of all ages rather than 

programs with different provisions for elderly people. 

Twelve countries use another approach to providing a safety net: a basic 

retirement benefit. The level of the benefit is either a given amount per 

month for all retirees or an amount based on years of contributions to the 

program. In Ireland, for example, workers who contribute to the program 

for a specified period receive a minimum pension. Chile set a minimum 

pension equal to the minimum wage—about one-quarter of average 

earnings as of 2005. In addition, several of the countries we are studying 

give very low-income workers credit for a minimum level contribution. 

Other countries give workers credit for years in which they were 

unemployed, pursued postsecondary education, or cared for dependents. 

In selecting between the many reform options, policy makers need to 

strike a careful balance among the following objectives: provide a safety 

net, contain costs, and maintain incentives to work and save. Costs can be 

high if a generous basic pension is provided to all eligible retirees 

regardless of their income. On the other hand, means-tested benefits can 

diminish incentives to work and save. The UK provides both a basic state 

pension and a means-tested pension credit. Concerned about the decline 

in the proportion of preretirement earnings provided by the basic state 

pension, some have advocated making it more generous. Others argue that 

focusing safety-net spending on those in need enables the government to 

alleviate pensioner poverty in a cost effective manner. However, a 

guaranteed minimum income could reduce some peoples’ incentive to 

save. In view of this disincentive, the UK adopted an additional meanstested benefit that provides higher benefits for retirees near the minimum 

income level. This benefit, called the savings credit, allows low-income 

retirees near the minimum pension level to retain a portion of their 

additional income. However, any loss of income due to means-testing still 

diminishes incentives to save. Without changes to pension rules, the 

proportion of pensioners eligible for means-tested income is expected to 

increase to include almost 65 percent of retiree households by 2050. 

Maintenance of a Safety 

Net and Work and Saving 

Incentives Proved 

Important 
Page 10 GAO-05-810T 

The extent to which new provisions are implemented, administered, and 

explained to the public may affect the outcome of the reform. Poland, for 

example, adopted NDC reform in 1999, but the development of a data 

system to track contributions has been problematic. As of early 2004, the 

system generated statements indicating contributions workers made 

during 2002, but there was no indication of what workers contributed in 

earlier years or to previous pension programs. Without knowing how 

much they have in their notional defined accounts, workers may have a 

difficult time planning for their retirement. Some governments have had 

limited success in efforts to educate workers about changes in provisions 

that will affect their retirement income. For example, a survey of women 

in the UK showed that only about 43 percent of women who will be 

affected by an increase in the retirement age knew the age that applied to 

them. 

Another type of pension reform is the accumulation of reserves in national 

pension funds, which can contribute to the system’s financial 

sustainability depending on when the funds are created or reformed and 

how they are managed. Countries that chose to partially pre-fund their 

PAYG programs decades ago have had more time to amass substantial 

reserves, reducing the risk that they will not meet their pension 

obligations. A record of poor fund performance has led some countries to 

put reserve funds under the administration of relatively independent 

managers with the mandate to maximize returns without undue risk. 

Establishing reserve funds ahead of demographic changes—well before 

the share of elderly in the population increases substantially—makes it 

more likely that enough assets will accumulate to meet future pension 

obligations. In countries such as Sweden, Denmark, and Finland, which 

have had long experiences with partial pre-funding of PAYG programs, 

important reserves have already built up. These resources are expected to 

make significant contributions to the long-term finances of national 

pension programs. Other countries that have recently created pension 

reserve funds for their pension program have a tighter time frame to 

accumulate enough reserves before population aging starts straining 

public finances. In particular, the imminent retirement of the baby-boom 

generation is likely to make it challenging to continue channeling a 

substantial amount of resources to these funds. France, for example, relies 

primarily on social security surpluses to finance its pension reserve fund 

set up in 1999, but given its demographic trends, may be able to do so only 

in the next few years. Similarly, Belgium and the Netherlands plan on 

Implementation, 

Administration, and Public 

Education Are Important 

Early Action and 

Effective Management 

Help Make National 

Pension Reserve 

Funds Successful 

Early Action Matters 
Page 11 GAO-05-810T 

maintaining a budget surplus, reducing public debt and the interest 

payments associated with the debt, and transferring these earmarked 

resources to their reserve funds. However, maintaining a surplus will 

require sustained budgetary discipline as a growing number of retirees 

begins putting pressure on public finances. 

Examples from several countries reveal that pre-funding with national 

pension reserve funds is less likely to be effective in helping ensure that 

national pension programs are financially sustainable if these funds are 

used for purposes other than supporting the PAYGO program. Some 

countries have used funds to pursue industrial, economic, or social 

objectives. For example, Japan used its reserve fund to support 

infrastructure projects, provide housing and education loans, and 

subsidize small and medium enterprises. As a result, Japan compromised 

to some extent the principal goal of pre-funding. 

Past experiences have also highlighted the need to mitigate certain risks 

that pension reserve funds face. One kind of risk has to do with the fact 

that asset build-up in a fund may lead to competing pressures for tax cuts 

and spending increases, especially when a fund is integrated in the 

national budget. For example, governments may view fund resources as a 

ready source of credit. As a result, they may be inclined to spend more 

than they would otherwise, potentially undermining the purpose of prefunding. Ireland alleviated the risk that its reserve fund could raise 

government consumption by prohibiting investment of fund assets in 

domestic government bonds. 

Another risk is the pressure that groups may exert on the investment 

choices of a pension reserve fund, potentially lowering returns. For 

example, Canada and Japan have requirements to invest a minimum share 

of their fund portfolio in domestic assets, restricting holdings of foreign 

assets to stimulate economic development at home. Funds in several 

countries have also faced pressure to adopt ethical investment criteria, 

with possible negative impacts on returns. In recent years, some countries 

have taken steps to ensure that funds are managed to maximize returns, 

without undue risk. Canada, for example, has put its fund under the 

control of an independent Investment Board operating at arm’s length 

from the government since the late 1990’s. Several countries, including 

New Zealand, have taken steps to provide regular reports and more 

complete disclosures concerning pension reserve funds. 

Effective Management Can 

Contribute to Financial 

Sustainability 
Page 12 GAO-05-810T 

Countries that have adopted individual account programs—which may 

also help pre-fund future retirement income—offer lessons about 

financing the existing PAYG pension program as the accounts are 

established. Some countries manage this transition period by expanding 

public debt, building up budget surpluses in advance of implementation, 

reducing or eliminating the PAYG program, or some combination of these. 

In addition, administering individual accounts requires effective regulation 

and supervision of the financial industry to protect individuals from 

avoidable investment risks. Educating the public is also important as 

national pension systems become more complex. 

It is important to consider how different approaches to including 

individual accounts may affect the short-term and long-term financing of 

the national pension system and the economy as a whole. A common 

challenge faced by countries that adopt individual accounts is how to pay 

for both a new funded pension and an existing PAYG pension 

simultaneously, known as transition costs. Countries will encounter 

transition costs depending on whether the individual accounts redirect 

revenue from the existing PAYG program, the amount of revenue 

redirected, and how liabilities under the existing PAYG program are 

treated. 

The countries we are examining offer a range of approaches for including 

individual accounts and dealing with the prospective transition costs. 

Australia and Switzerland avoided transition costs altogether by adding 

individual accounts to their existing national pension systems, which are 

modest relative to those in the other countries we are studying.4

 Some 

countries diverted revenue from the existing PAYG program to the 

individual accounts. The resulting shortfall reflects, in part, the portion of 

the PAYG program being replaced with individual accounts and the 

amount of PAYG revenue being redirected to fund the accounts. For 

example, transition costs may be less in countries such as Sweden or 

Denmark where the contribution to individual accounts is 2.5 percent of 

covered earnings and 1 percent, respectively, than for Poland or Hungary, 

which replaced a larger portion of the PAYG program. 

 4

 Australia’s national PAYG program consistently replaces approximately 25 percent of 

average wages (23 percent in 2005); Switzerland’s national PAYG program replaced 

approximately 26 percent of average wages in 2005. 

Individual Account 

Reforms Show the 

Importance of 

Funding Decisions 

and Ensuring Benefit 

Adequacy 

Approach to Funding 

Individual Accounts 

Affects Sustainability of 

National Pension System 
Page 13 GAO-05-810T 

All of the countries we are reviewing also made changes to their PAYG 

program that were meant to help reduce transition costs, such as 

increasing taxes or decreasing benefits. In addition, Chile built a surplus in 

anticipation of major pension reform, and Sweden had large budget 

surpluses in place prior to establishing individual accounts. Countries also 

transfer funds from general budget revenues to help pay benefits to 

current and near retirees, expanding public borrowing. If individual 

accounts are financed through borrowing they will not positively affect 

national saving until the debt is repaid, as contributions to individual 

accounts are offset by increased public debt.5

 For example, Poland’s debt 

is expected to exceed 60 percent of GDP in the next few years in part 

because of its public borrowing to pay for the movement to individual 

accounts. 

It is sometimes difficult for countries to predict their transition costs. In 

particular, countries that allow workers to opt in or out of individual 

account programs have had difficulty estimating costs. For example, 

Hungary and Poland experienced higher than anticipated enrollment from 

current workers in their individual account programs, leaving the existing 

PAYG program with less funding than planned. As a result, both countries 

had to make subsequent changes to their individual account and PAYG 

programs. 

Countries adopting individual accounts as part of their national pension 

system have had to make trade-offs between giving workers the 

opportunity to maximize returns in their accounts and ensuring that 

benefits will be adequate for all participants. Some countries set a 

guaranteed rate of return to reduce certain investment risks and help 

ensure adequacy of benefits. These guarantees may, however, result in 

limited investment diversification with a potentially negative impact on 

returns. In Chile, for example, fund managers’ performance is measured 

against the returns of other funds. This has resulted in a “herding” effect 

because funds hold similar portfolios, reducing meaningful choice for 

workers. All the countries with individual accounts provide some form of 

a minimum guaranteed benefit so retirees will have at least some level of 

income. Some experts believe that a minimum pension guarantee could 

raise a moral hazard whereby individuals may make risky investment 

 5

 Additionally, increased government debt may crowd out private sector access to lending 

markets and dampen the economic growth individual accounts are meant to access. 

Balancing Opportunities to 

Realize High Returns and 

Benefit Adequacy Is 

Important 
Page 14 GAO-05-810T 

decisions, minimize voluntary contributions, or, as in the case of Australia 

where the minimum guarantee is means-tested, may spend down their 

retirement assets quickly. 

It is important to consider the payout options available from individual 

accounts, as these can also have substantial effects on adequacy of income 

throughout retirement. For example, an annuity payout option can help to 

ensure that individuals will not outlive their assets in retirement.6

However, purchasing an annuity can leave some people worse off if, for 

example, the annuities market is not fully developed, premiums are high, 

or inflation erodes the purchasing power of benefits. Several countries 

also allow for phased withdrawals, in some cases with restrictions, helping 

to mitigate the risk of individuals outliving their assets and becoming 

reliant on the government’s basic or safety-net pension. Some countries 

offer a lump-sum payment under certain circumstances, such as small 

account balances, and Australia allows a full lump-sum payout for all 

retirees. 

Important lessons can be learned regarding the administration of 

individual accounts, including the need for effective regulation and 

supervision of the financial industry to protect individuals from avoidable 

investment risks. Some countries have expanded their permitted 

investment options to include foreign investments and increased the 

percentage of assets that can be invested in private equities. The 

experiences of countries we are studying also indicate the importance of 

keeping administrative fees and charges under control. The fees that 

countries permit pension funds to charge can have a big influence on the 

amount of income retirees receive from their individual accounts. Several 

countries have limits on the level and types of fees providers can charge. 

Additionally, the level of fees should take into consideration the potential 

impact not only on individuals’ accounts, but also on fund managers. In 

the UK, for example, regulations capping fees may have discouraged some 

providers from offering pension funds. To keep costs low, Sweden 

aggregates individuals’ transactions to realize economies of scale. 

Some countries’ experiences highlighted weaknesses in regulations on 

how pension funds can market to individuals. The UK’s and Poland’s 

 6

 The countries we reviewed require a range of annuity options, including, for example, 

inflation indexed, joint and survivor, or gender-neutral. 

Effective Regulation, 

Implementation, and 

Education Can Protect 

Individuals 
Page 15 GAO-05-810T 

regulations did not prevent problems in marketing and sales. Poland 

experienced sales problems, in part because it had inadequate training and 

standards for its sales agents, which may have contributed to agents’ use 

of questionable practices to sign up individuals. The UK had a widelypublicized “mis-selling” scandal involving millions of investors. Many 

opened individual accounts when they would more likely have been better 

off retaining their occupation-based pension. Insurance companies were 

ordered to pay roughly $20 billion in compensation. 

Countries’ individual account experiences reveal pitfalls to be avoided 

during implementation. For example, Hungary, Poland, and Sweden had 

difficulty getting their data management systems to run properly and 

continue to experience a substantial lag time in recording contributions to 

individuals’ accounts. In addition, Hungary and Poland did not have an 

annuities market that offered the type of annuity required by legislation. 

Education becomes increasingly important as the national pension 

systems become more complex. It is particularly important for workers 

who may have to make a one-time decision about joining the individual 

account program. Several countries require disclosure statements about 

the status of a pension fund, and some provide annual statements. To help 

individuals choose a fund manager, one important component of these 

statements should be the disclosure of fees charged. Some countries have 

done a better job of providing fund performance information than others. 

For example, Australia requires its fund providers to inform members 

through annual reports clearly detailing benefits, fees and charges, 

investment strategy, and the fund’s financial position. In contrast, Hungary 

did not have clear rules for disclosing operating costs and returns, making 

it hard to compare fund performance. 

Demographic challenges and fiscal pressure have necessitated national 

pension reform in many countries. Though one common goal behind 

reform efforts everywhere is to improve financial sustainability, countries 

have adopted different approaches depending on their existing national 

pension system and the prevailing economic and political conditions. This 

is why reforms in one country are not easily replicated in another, or if 

they are, may not lead to the same outcome. Countries have different 

emphases, such as benefit adequacy or individual equity; as a result, what 

is perceived to be successful in one place may not be viewed as a viable 

option somewhere else. 

Concluding 

Observations 
Page 16 GAO-05-810T 

Although some pension reforms were undertaken too recently to provide 

clear evidence of results, the experiences of other countries may suggest 

some lessons for U.S. deliberations on Social Security reform. Some of 

these lessons are common to all types of national pension reform and are 

consistent with findings in previous GAO studies. Restoring long-term 

financial balance invariably involves cutting benefits, raising revenues, or 

both. Additionally, with early reform, policy makers can avoid the need for 

more costly and difficult changes later. Countries that undertook 

important national pension reform well before undergoing major 

demographic changes have achieved, or are close to achieving, financially 

sustainable national pension systems. Others are likely to need more 

significant steps because their populations are already aging. 

No matter what type of reform is undertaken, the sustainability of a 

pension system will depend on the health of the national economy. As the 

number of working people for each retiree declines, average output per 

worker must increase in order to sustain average standards of living. 

Reforms that encourage employment and saving, offer incentives to 

postpone retirement, and promote growth are more likely to produce a 

pension system that delivers adequate retirement income and is financially 

sound for the long term. 

Regardless of a country’s approach, its institutions need to effectively 

operate and supervise the different aspects of reform. A government’s 

capacity to implement and administer the publicly managed elements of 

reform and its ability to regulate and oversee the privately managed 

components are crucial. In addition, education of the public becomes 

increasingly important as workers and retirees face more choices and the 

national pension system becomes more complex. This is particularly true 

in the case of individual account reforms, which require higher levels of 

financial literacy and personal responsibility. 

In nearly every country we are studying, debate continues about 

alternatives for additional reform measures. It is clearly not a process that 

ends with one reform. This may be true in part because success can only 

be measured over the long term, but problems may arise and need to be 

dealt with in the short term. The positive lessons from other countries’ 

reforms may only truly be clear in years to come. 

Mr. Chairman and Members of the Subcommittee, this concludes my 

prepared statement. I’d be happy to answer any questions you may have. 
Page 17 GAO-05-810T 

For further information regarding this testimony, please contact Barbara 

D. Bovbjerg, Director, Education, Workforce, and Income Security Issues 

at (202) 512-7215. Alicia Puente Cackley, Assistant Director, 

Benjamin P. Pfeiffer, Thomas A. Moscovitch, Nyree M. Ryder, 

Seyda G. Wentworth and Corinna A. Nicolaou, also contributed to this 

report. 

GAO Contacts and 

Staff 

Acknowledgements 

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