Social Security Reform: Other Countries' Experiences Provide Lessons for the United States
Published: 2005-10-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Many countries, including the United States, are grappling with demographic change and its effect on their national pension systems. With rising longevity and declining birthrates, 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-as-you-go (PAYG) system. Although demographic and economic challenges are less severe in the United States 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 United States, we may draw lessons from their experiences. The current and preceding Chairmen of the Subcommittee on Social Security of the House Committee on Ways and Means asked GAO to study lessons to be learned from other countries' experiences reforming national pension systems. GAO focused on (1) adjustments to existing PAYG national pension programs, (2) the creation or reform of national pension reserve funds to partially prefund PAYG pension programs, and (3) reforms involving the creation of individual accounts. We received technical comments from SSA, Treasury, the OECD, and other external reviewers.
section_title: What GAO Found
paragraphs: All countries in the Organisation for Economic Co-operation and Development (OECD), as well as Chile, have, to some extent, altered their national pension systems, consistent with their different economic and political conditions. While changes in one country may not be easily replicated in another, countries' experiences may nonetheless offer potentially valuable lessons for the United States. 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, and the incentives it creates. Also, how well new provisions are implemented, administered, and explained to the public may affect the outcome of the reform. Most of the countries GAO studied both increased contributions and reduced benefits, often by increasing retirement ages. Generally, countries included provisions to help ensure adequate benefits for lower-income groups, though these can lessen incentives to work and save for retirement. 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. Some 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 nonretirement 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 prefund 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 taken some combination of these approaches. 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 for example capped fees or centralized the processing of transactions. Although countries have attempted to educate individuals about reforms and how their choices may affect them, studies in some countries indicate that many workers have limited knowledge about their retirement prospects.

section_title: Letter
paragraphs: Many countries, including the United States, are grappling with  demographic change and its effect on their national pension systems and  long-term fiscal posture. With increasing longevity and declining  birthrates, the number of workers for each retiree is falling in most  developed countries. These trends can strain the finances of national  pension programs, particularly those 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 United States than in many other developed  countries—the birthrate is not as low, people are more likely to stay in the  labor force for a greater number of years, and immigration continues to  provide young workers. Yet projections show that the Social Security  program faces a significant long-term financing problem. Because some  countries have already undertaken national pension reform efforts to  address demographic changes similar to those occurring in the United  States, their experiences can provide lessons for U.S. policymakers.
To assist the Subcommittee in its deliberations concerning Social  Security’s future, you asked us to review the experiences of other  developed nations and highlight lessons that can be learned from their  various approaches to national pension reform. Historically, developed  countries have had national pension systems that included some form of a  PAYG pension program. Countries have typically undertaken quite  different approaches to reforming their pension systems. These reforms  fall into three broad categories—adjustments to PAYG programs  (decreased benefits or increased contributions), efforts to set aside funds  to help pay future benefits through a national reserve fund, and efforts to  prefund retirement income through contributions to individual accounts.  Accordingly, our objectives were to examine the lessons that can be  drawn from countries that have (1) adjusted their existing PAYG national  pension systems, (2) adopted national pension reserve funds to help  finance their national pension systems, and (3) adopted individual account  reforms to their national pension systems.
To address these objectives, we studied the experiences of the countries  that constitute the Organisation for Economic Co-operation and  Development (OECD), plus Chile, the nation that pioneered the use of  individual accounts. As part of our analysis, we assessed both the extent  to which another country’s circumstances are similar enough to those in  the United States to provide a useful example and the extent to which  particular approaches to pension reform were considered to be  successful. We aligned our lessons with the criteria GAO developed for  evaluating domestic Social Security reform proposals—fiscal  sustainability, adequacy and equity, and implementation and  administration of reform. At the same time, drawing lessons from other  countries’ experiences requires recognition that countries have different  starting points, including unique economic and political environments, and  that availability of other sources of retirement income, such as  occupational pensions, also varies greatly. Therefore, reforms in one  country may not be easily replicated in another or may not lead to the  same outcome.
Our review 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. In addition, we drew from  interviews conducted by GAO with Chilean officials in 2002. We conducted  our review between August 2004 and September 2005 in accordance with  generally accepted government auditing standards. For additional  discussion of our scope and methodology, see appendix I. We also include  a glossary of key terms in the back of this report.
subsections: section_title: Background
paragraphs: The U.S. Social Security program’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. A similar demographic trend is  occurring or will occur in all OECD countries. (See table 3 in app. II for  demographic and other characteristics of OECD countries and Chile.)  Although the number of workers for every elderly person (aged 65 and  over) in the United States has been relatively stable over the past few  decades, this ratio has already fallen substantially in other developed  countries. The number of workers for every elderly person in the United  States is projected to fall from 4.1 in 2005 to 2.9 in 2020 and to 2.2 in 2030.  In nine of the OECD countries, this number has already fallen below the  level projected for the United States in 2020. These decreases in the  projected number of workers available to support each retiree could have  significant effects on countries’ economies, particularly during the period  from 2010 to 2030. These effects may slow growth in the economy and  standards of living, and increase costs for aging-related government  programs. Long run demographic projections are imprecise, however, due  to uncertainty about future changes in longevity, for example.
subsections: section_title: Pension and Other Social Insurance Programs in OECD Countries
paragraphs: Although social security programs in all OECD countries and Chile  provide benefits for qualified elderly people, survivors, and the disabled,  the programs differ in many respects across the countries. In some  countries, “social security” refers to a wide range of social insurance  programs, including health care, long-term care, workers’ compensation,  unemployment insurance, and so forth. 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.
Although nearly all OECD countries use contributions from workers and  employers designated to finance pension benefits, most also use general  revenues as a funding source. Nearly all OECD countries, including the  United States, make pension benefits dependent on an individual’s work  history, while several also provide benefits to all qualified residents  whether or not they have a work history. Countries’ pension systems may  be financed differently, use different criteria for identifying qualified  beneficiaries, and calculate benefits in a different manner. Several OECD  countries finance benefits to the disabled or survivors with worker or  employer contributions designated for this purpose. Others use general  revenue to finance these benefits or have a single fund that provides old- age pension benefits and benefits for the disabled and survivors. Some  OECD countries provide a universal benefit of a specified amount each  week or each month. Some adjust benefits based on time spent raising  children, or pursuing education, as well as years spent working. Some  national pension programs, identified as “defined benefit” programs,  provide retirees a pension of a set amount per week or month or an  amount calculated based on such factors specified by law as their number  of years of work and the level of their earnings or contributions, and their  age at retirement. Other national pension programs, identified as “defined  contribution” programs, provide retirees income based on the  accumulated value of contributions and investment earnings on those  contributions. Many OECD countries have a pension system that includes  a combination of pension programs rather than a single program,  providing many retirees with more than one source of income.   (See table 4 in app. II for additional information concerning countries’  national pension systems.)
Voluntary occupational pension programs are common in many OECD  member countries though the aggregate accumulated value of these  pension funds exceeds 25 percent of gross domestic product (GDP) in  only seven countries, including the United States, Canada, and Denmark.  These include programs sponsored by employers, trade associations, or  trade unions and regulated by governments; in some cases, the pensions  provided by these programs are to some extent insured by governmental  entities—counterparts to the Pension Benefit Guaranty Corporation in the  United States. Tax laws in many countries encourage participation in these  voluntary programs. Germany, for example, supplements its national  pension system with voluntary individual “Riester” accounts, supported by  subsidies as well as tax incentives. Our review, however, did not include  these programs, except in the United Kingdom, where workers’  contributions to PAYG national pension programs are reduced if they  choose to participate. Where these voluntary programs are prevalent, they  can affect countries’ decisions about public pension reforms.
section_title: Types of National Pension Reform
paragraphs: Historically, developed countries have relied on some form of a PAYG  national pension program. Over time, countries have used a variety of  approaches to respond to demographic challenges and the ensuing  increases in expenditures for these programs. 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 prefund 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 (see table 1 for  the reforms OECD countries and Chile have undertaken):    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 life  expectancy and the growth rate of the economy.
National pension reserve funds. These are set up to partially prefund  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 for large increases in  contributions to pay scheduled benefits. Funds can be invested in a  combination of government securities and domestic as well as foreign  private sector securities. Because of differences in accounting practices,  some countries report reserve funds as part of national budgets while  others do not include them in federal figures.
Individual accounts. These are fully funded accounts that are  administered either by employers, the government, or designated third  parties and are owned by the individual. The level of retirement benefits  depends largely on the amount of contributions made by, or on behalf of,  an individual into the account during his or her working life, investment  earnings, and the amount of fees individuals are required to pay.
section_title: Adjustments to Existing PAYG Programs Show Importance of Sustainability, Safety Nets, and Incentives to Work and Save
paragraphs: The countries that have adjusted their existing PAYG national pension  programs demonstrate a broad range of approaches for both reducing  benefits and increasing contributions in order to improve the programs’  financial sustainability. Their experiences also provide lessons about the  potential effects of some adjustments on the distribution of benefits,  including the maintenance of a safety net and incentives to work and save.  They also emphasize the care required in implementing and administering  reforms and ensuring that the public understands the new provisions.
subsections: section_title: PAYG Adjustments Prove Key to Financial Sustainability
paragraphs: 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, based on estimated changes in spending on old-age  pensions, have undertaken a package of several far-reaching adjustments.  Most of the countries we studied increased program revenue 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  United Kingdom, increased contributions by expanding the range of  earnings subject to contribution requirements.
Nearly all of the countries we studied decreased the promised level of  benefits provided to future retirees, 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. Austria  is gradually increasing the number of years from 15 to 40 years.
Increased minimum years of contributions. Another approach is to  increase the minimum number of years of creditable service required to  receive a 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.
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 studied use some kind of average wage index, others,  including Belgium and France, have adopted the use of price indexes. The  choice of a wage or price index can have quite different effects, depending  on the rate at which wages increase in comparison with prices. The extent  to which wages outpace prices varies over time and among countries.
Changed basis for determining year-to-year increases in benefits once  retirement begins. In many of the countries we studied, 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 indexes. 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 adjust benefits in response to economic  and demographic changes. Adjustments, which link benefits to factors  such as economic growth, longevity, or the ratio of workers to retirees,  may contribute to the financial sustainability of national pension systems.  Finland and Germany, for example, have adopted adjustment mechanisms  of this kind. In some countries, such as Italy and Sweden, this approach  takes the form of a notional defined contribution program. Italian and  Swedish workers have “notional” accounts in that both the incoming  contributions and the investment earnings exist only on the books of the  managing institution. At retirement, the accumulated notional capital in  each account is converted to a stream of pension payments using a  formula based on factors such as life expectancy at the time of retirement.
Most of the countries we studied undertook more than one of these types  of reforms as indicated in table 2. See table 5 in appendix II for additional  information concerning adjustments to PAYG programs.
Several countries, such as Sweden and the United Kingdom, have  undertaken one or more of these adjustments to their PAYG programs and  have achieved, or are on track to achieve, relative financial sustainability.  Other countries, including France, and Germany, may need to take  additional action to finance future benefit commitments. Generally, the  countries that have come closest to achieving sustainability are those that  have undergone more than one type of national pension reform.
subsections: section_title: Essential Reform Elements Include Maintenance of a Safety Net and Work and Saving Incentives
paragraphs: All of the countries we studied that reformed their PAYG pension  programs by reducing projected benefits included provisions to help  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 did so by providing a 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  providing 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 (but not the level of earnings during those years). In Ireland, for  example, workers who contribute to the program for a specified period  receive a flat-rate pension equal to about 167 euros a week in 2004— approximately one-third of average earnings. According to the Social  Security Administration (SSA), Chile set a minimum pension for those  younger than age 70 at 62.7 percent of the minimum wage in 2004. The  United Kingdom and Belgium give low-income workers credit equivalent  to the minimum level contribution even though their earnings were too  low to require a contribution. Several countries give workers credit for  years in which they were unemployed, pursued postsecondary education,  or cared for dependents. Establishing a safety net requires a careful  consideration of costs and incentives for working and saving. 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 United Kingdom provides both  a basic state pension and a means-tested pension benefit. Concern about  the decline in the proportion of preretirement earnings provided by the  basic state pension has led some to advocate 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.
Prior to 2003, retirees in the United Kingdom received a means-tested  benefit that brought their income up to a guaranteed minimum retirement  income level. This benefit left those retirees with low to moderate incomes  no financial incentive to work or save, because additional income was  offset by equal reductions in the means-tested benefit. To help remedy  this, the United Kingdom introduced the savings credit, which provides a  supplementary benefit equal to a portion of an individual’s additional  income within a range near the guaranteed retirement income level. This  new benefit increases, but does not fully restore, the incentive to work and  save because a portion of the additional income is lost through reductions  in pension income. If, for example, a retiree with pre-benefit income of   $700 a month increases this income to $800 a month, his or her total  retirement income including these means-tested benefits would increase  by $60, from $892 to $952. The proportion of United Kingdom pensioners  eligible for these means-tested benefits is expected to rise. The United  Kingdom Pensions Commission projects that unless current pension rules  are changed, almost 65 percent of retiree households will be eligible for  these means-tested benefits by 2050, because the increases in the Basic  State Pension are linked to prices, but increases in other components of  the United Kingdom’s pension system are linked to earnings.
section_title: Successful Reform Requires Careful Implementation, Administration, and Public Education
paragraphs: The extent to which new provisions are implemented, administered, and  explained to the public may affect the outcome of the reform. Although  many adjustments to PAYG programs are not difficult to implement and  administer, some more complex reforms, such as the development of a  notional defined contribution program, can be challenging. 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 documenting contributions workers made  during 2002, but there was no indication of what workers had 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. Additionally, countries  typically phase in certain changes, such as increasing the retirement age.  This could help to provide workers with enough time to understand how  the changes to the pension program will affect their retirement income.
To educate workers about how PAYG programs and PAYG reforms affect  them, countries including Canada, Sweden, the United Kingdom, and the  United States, send workers periodic statements concerning the program,  the record of their contributions to it, and the benefits they are projected  to receive. To increase the likelihood that recipients will read and  understand them, the United Kingdom provides different messages  tailored to workers of different ages. Nonetheless, the United Kingdom has  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 United Kingdom 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. A large proportion (70 percent) of younger  women indicated that they expect to retire before their state pension  eligibility age—65 years.
section_title: Early Action and Effective Management Help Strengthen National Pension Reserve Funds
paragraphs: Another measure often found in reform packages is the accumulation of  reserves in national pension funds with the aim of partially prefunding  PAYG pension programs. With public centralized prefunding, governments  set aside resources in the current period to safeguard the financing of their  PAYG pension programs in the future. Typically invested in various  combinations of bonds and equities, these reserve funds are in some cases  meant to remain untouched for several years before being channeled into  the public pension system, in particular to maintain adequate pension  levels for the baby boom cohort. Pension reserve funds can contribute to  the system’s financial sustainability, depending on when they are created  or reformed, as well as how they are invested and managed. Countries that  took action early have had time to amass substantial reserves, reducing  the risk that they will not meet their pension obligations. Effective  management of reserve funds has also proved important, as a record of  poor fund performance has led some countries to put reserve funds under  the administration of a relatively independent manager with the mandate  to maximize returns and minimize avoidable risk.
subsections: section_title: Early Action Matters
paragraphs: 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 help meet future  pension obligations. In countries such as Sweden and Denmark, which  have had long experience with partial prefunding of PAYG programs,  important reserves have already built up. Combined with long-term  policies aimed at ensuring sound public finances, raising employment  rates, and adjusting pension program provisions, these resources are  expected to make significant contributions to the long-term finances of  public pension programs. For example, Denmark’s reserve fund, set up in  1964, had assets equivalent to about 25 percent of GDP in 2000. Sweden’s  reserve fund, created in 1960, was around 24 percent at the end of 2003.
Other countries that have recently created pension reserve funds for their  pension programs have a shorter period in which to accumulate 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. Given its  demographic trends, however, it may be unable to do this beyond the next  few years. Similarly, Belgium and the Netherlands plan on maintaining  budget surpluses, 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.  Some countries have set specific starting  dates for drawing down national funds to resist demands for their  immediate use.
Though the Irish National Pensions Reserve Fund was established in 2001,  as of 2004 it had already amassed substantial assets, nearly 10 percent of  GDP. Its resources are projected to support the financial sustainability of  the pension program for two main reasons. First, Ireland enjoys relatively  favorable demographics. Its aging problem is expected to increase in  severity at a later date than those of other Western European countries;  thus, it has in effect created its pension fund relatively early, with more  time for returns to accumulate. Second, Ireland provides somewhat less  generous public pensions to their beneficiaries than other OECD  countries; its pension spending is, therefore, relatively low.
subsections: section_title: Effective Management Can Contribute to Financial Sustainability
paragraphs: Examples from several countries reveal that prefunding with national  pension reserve funds is less likely to be effective in helping assure that  national pension programs are financially sustainable if these funds are  also used for purposes other than supporting the PAYG 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 public prefunding, which is to save in  advance and accumulate assets so as to continue providing adequate  benefits to retirees while keeping contribution rates of workers stable.  Japan has since implemented a series of reforms. The latest wave, which  became effective in 2001, refocused the fund’s objective in the interests of  participants, rather than those of the general public. Measures introduced  include management improvements and more aggressive investment  strategies with the aim of maximizing returns.
Past experiences have also highlighted the need to mitigate certain risks  that pension reserve funds face, in addition to the risks that are inherent in  investment of any pension funds. One kind of risk has to do with the fact  that asset buildup in a fund may lead to competing pressures for tax cuts  and spending increases, especially when a fund is integrated into the  national budget. For instance, 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. For example, according to many observers, the United States’  Social Security trust fund, which is included in the unified budget and  invested solely in U.S. Treasury securities that cannot be bought or sold in  the open market, may have facilitated larger federal budget deficits.  Ireland sought to alleviate the risk that its reserve fund could raise  government consumption by prohibiting investment of fund assets in Irish  government bonds. Some economists argue in favor of similar limits on the  share of domestic government bonds the fund portfolio can hold.
Additionally, pension reserve fund investments in private securities can  have negative effects on corporate governance. There is the danger that if  the government owns a significant percentage of the stocks of individual  companies and as a result controls their corporate affairs, the best interest  of shareholders may not be upheld because of potential conflicts of  interest. Limiting the government’s stock voting rights by investing  national pension resources in broad index funds may provide a safeguard  against this type of risk.
Another risk is that groups may exert pressure to constrain fund  managers’ investment choices, potentially lowering returns. For example,  Canada and Japan have requirements to invest a minimum share of their  fund portfolios in domestic assets, restricting holdings of foreign assets to  stimulate economic development at home. In contrast, Norway chose to  invest its fund reserves almost exclusively in foreign assets. The funds of  Ireland and New Zealand also have large shares of foreign investments.  Investing a significant share of reserves in foreign assets may not be a  realistic or viable option for large economies with mature financial  markets, such as the United States. Funds in several countries have also  faced pressure to adopt ethical rather than purely commercial investment  criteria, with a possibly negative impact on returns. In recent years, some  countries have taken steps to help ensure that funds are managed to  maximize returns and minimize avoidable risk. Canada, for example, has  put its fund under the control of an Investment Board operating  independently from the government since the late 1990s. Several  countries, including New Zealand, have taken steps to provide regular  reports and more complete disclosures concerning pension reserve funds  which may help achieve transparency in management and administration  and contribute to public education and oversight. (For additional  information concerning national pension reserve programs, see fig. 1 and  table 6 in app. II.)
section_title: Individual Account Reforms Show the Importance of Funding Decisions and Benefit Adequacy
paragraphs: Countries that have adopted individual account reforms—which may also  help prefund future retirement income—offer lessons about financing the  existing PAYG pension program as the accounts are established. To  manage this transition period these countries have expanded public debt,  built up budget surpluses in advance of implementation, reduced or  eliminated the PAYG program, or used some combination of these  approaches. Another important consideration for countries that have  individual account programs is how to balance achieving high rates of  return while ensuring individuals receive an adequate level of benefits.  Measures such as limits on how the funds are invested and the level of fees  and charges may help to ensure that benefits will be adequate, but should  not be so restrictive that they unduly harm individuals or pension fund  managers. 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.
subsections: section_title: Approach to Funding Individual Accounts Affects Sustainability of National Pension System
paragraphs: The experiences of other countries demonstrate the importance of  considering how individual accounts may affect the long-term and short- term financing of the national pension system and the economy as a  whole. In the long-term, individual accounts can contribute to  sustainability by providing a mechanism to prefund retirement benefits  that could be less subject to demographic booms and busts than a PAYG  approach. Individual accounts prefund benefits in private accounts rather  than government accounts.  If governments are unable to save through  national pension reserves, private accounts may facilitate pre-funding that  would not occur otherwise.If, however, such accounts are funded  through borrowing, no such prefunding is achieved. In the short-term  countries adopting individual accounts face the common challenge of how  to pay for both a new funded pension and an existing PAYG pension  simultaneously. The cost of the transition from a PAYG program to  individual accounts depends 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 studied vary in the amount of revenue diverted from  their PAYG programs to fund their individual accounts, resulting in a range  of related transition costs. Australia and Switzerland used new sources of  funding to add individual accounts to their existing, relatively modest,  national pension systems. Transition costs were not an issue, because no  resources were diverted from paying current benefits. Nonetheless, new  financing was needed to both fund the new program and to support the  existing program. (For additional information concerning these “add-on”  programs and other countries’ individual account programs, see table 7 in  app. II.) Some countries diverted revenue from the existing PAYG program  to the individual accounts, a “carve out,” resulting in shortfalls that reflect,  in part, the portion of the PAYG program being replaced with individual  accounts. For example, transition costs may be less in countries such as  Sweden where the contribution to individual accounts is 2.5 percent of  covered earnings, than for Poland or Hungary, which have contribution  rates of 7.3 percent and 8 percent, respectively.
In addition to the level of transition costs resulting from redirecting PAYG  revenue, how a country manages these costs also affects the success of  the reform. All of the countries we reviewed also made changes that were  meant to help finance the transition to individual accounts, such as  increasing contributions to or decreasing benefits from their PAYG  programs. In addition, Chile built a budget surplus in anticipation of major  pension reform, and Sweden had large budget surpluses in place prior to  establishing individual accounts. Some countries transferred funds from  general budget revenues to help pay benefits to current and near retirees,  expanding public borrowing. Where they financed individual accounts  through borrowing, these countries will not positively affect national  saving until the debt is repaid, as contributions to individual accounts are  offset by increased public debt. 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.
Countries sometimes had difficulty predicting their transition costs. In  particular, countries that allowed workers to opt in or out of individual  account programs had difficulty estimating costs. For example, more  workers in the United Kingdom, Hungary, and Poland responded to  incentives to contribute to individual accounts than originally anticipated,  leaving the existing PAYG programs with less funding than planned.
Hungary’s short-run fiscal concerns resulted in a slower increase in  contribution rates to individual accounts than originally planned.
Regardless of whether workers have a choice of participating in the  program, individual accounts may also affect the long-term costs to the  government. For example, if income from substitute accounts leaves  particular individuals with less retirement income than if they had not  participated, some may qualify for benefits from other means-tested  programs. On the other hand, to the extent that the accounts increase  retirement incomes, costs for such programs may fall. Under a voluntary  approach, such effects could depend partly on the rate of participation.   The actual effect of countries’ individual account programs on other  programs as they relate to government spending will not be clear for years  to come, when cohorts of affected workers retire.
subsections: section_title: Countries Balanced Opportunities to Realize High Expected Returns with Provisions to Help Ensure Benefit Adequacy
paragraphs: Countries adopting individual accounts as part of their national pension  systems have had to make trade-offs between giving workers the  opportunity to maximize expected returns in their accounts and helping  assure 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. Guaranteed rates of return may be relative,  that is, related to other funds’ returns, as in Chile, or fixed—a guaranteed  percentage rate return, as in Switzerland. In Chile workers with individual  accounts are guaranteed a minimum rate of return set at 2 percentage  points below the average return for funds of the same type during a 3-year  period. In Switzerland, account holders were assured a minimum rate of  return of 2.25 percent in 2004. This type of guarantee may, however,  result in limited investment diversification or conservative investment  decisions, resulting in lower rates of return overall. In Chile, for example,  the guaranteed return may have resulted in a “herding” effect, creating an  incentive for fund managers to hold similar portfolios and reducing  variation in returns. To help ensure that individuals receive at least a  benefit based on the guaranteed rate of return, several countries require  fund managers to have reserve funds to pay benefits at the guaranteed  return level. A number of these countries have further provisions that the  government will provide benefits if all of the fund reserves are used.
Another measure to ensure retirees will have at least a minimally adequate  level of income is to provide some form of minimum guaranteed benefit.  All countries with individual accounts that we reviewed provide such a  benefit. This can be increasingly important as individuals assume risks  with the investment of funds in their individual accounts. Some experts  believe that a minimum pension guarantee could encourage investors to  select riskier investments or spend their assets more quickly. For example,  in countries with a large flat-rate pension, individuals may make risky  investment decisions because they can rely on the guarantee if their risk  taking brings poor results. In countries where additional benefits are  added on to the individual account payment to meet a minimum standard  (“top-up” benefits) individuals may minimize their voluntary contributions  in order to receive a higher benefit from the government. There is some  belief that this may occur in Chile, where low-income workers might try to  stop making contributions after meeting the contribution year  requirement. Individuals in countries with a means-tested benefit may  spend down their retirement assets quickly to qualify for the benefit. This  has occurred in Australia, and as result, that country plans to increase the  age when individuals can access their individual account funds from 55 to  60 between 2015 and 2025. In any of these cases, the government could  incur increased costs because it ensures that individuals have at least a  certain level of income. The financial risk to the government will be  greater in countries that have a larger guarantee. However, the protection  of individuals against poverty could also be greater in these countries.
Outside of providing a minimum pension guarantee, countries have taken  additional measures to help ensure an adequate retirement income. To  prevent fees from eroding small account balances, some of these countries  also exclude low-income workers from participation requirements in the  individual account program. Another approach to help protect low-income  workers occurs in Mexico, where the federal government provides a flat- rate contribution on behalf of workers.
It is important to consider the payout options available from individual  accounts, as these can also affect income adequacy throughout retirement.  For example, an annuity payout option can help to ensure that individuals  will not outlive their assets in retirement. However, purchasing an  annuity can leave some people worse off if, for example, premiums are  high or inflation erodes the purchasing power of benefits. Several  countries also allow for phased withdrawals, sometimes with restrictions,  helping to mitigate the risk of individuals outliving their assets and  becoming dependent on the government’s basic or safety net pension.  Some countries offer a lump-sum payment under certain circumstances.  For example, Chile and Mexico allow lump sums for persons who have  account balances above a certain amount. Australia allows a full lump- sum payout for all retirees age 55 and above (age 60 and above by 2025).
section_title: Effective Regulation, Implementation, and Education Can Protect Individuals
paragraphs: Countries also protect individuals by regulating how the funds in their  accounts can be invested. Initially, several countries offered individuals  choices among a limited number of investment funds and often restricted  the portion of assets that could be invested in certain products, such as  publicly traded equities, private equities, and foreign securities. Later,  however, the options were expanded in most countries to allow more  investment diversification, but they still include some restrictions.  Additionally, as investment options have expanded, some countries have  incorporated other protections. For example, Chile and Mexico have  incorporated investment options that take into account individuals’ ages  and risk tolerance. Chile requires each pension administrator to offer four  types of funds with varying degrees of risk, including a higher risk fund  and a fund invested in fixed-rate instruments.  Pension administrators may  offer a fifth higher risk fund, available to workers more than 10 years from  the age of retirement. Mexico recently allowed pension fund managers to  offer more than one investment fund and included options to help provide  workers with an adequate rate of return at acceptable risk. Sweden limits  individuals to selecting at most five funds from among all the qualified  investment funds that choose to participate—over 650 funds as of 2004.  Some experts have suggested that having such a large number of funds  available may discourage active choice. About two-thirds of participants  made an active investment choice in 2000. Since 2001, however, about   85 percent of new entrants have left their money in the default fund—a  separate fund for those who do not wish to make a fund choice. This  default option can be an important safeguard. However, depending on who  makes the default decisions, it may be open to some of the same issues as  pension fund reserves, such as political pressures for certain investment  criteria in order to meet other social objectives.
To further protect individuals, most of the countries with individual  accounts have some sort of limit on the fees that fund managers can  charge. Nonetheless, it is unclear how these restrictions may affect an  individual’s account balance and returns. Chile allows funds to charge fees  on new accounts, and individual account contributions, and for phased  withdrawals of funds during retirement. In addition to imposing this type  of limit, Poland has a ceiling on the amount of some types of charges.  Sweden has variable ceilings on charges, and the United Kingdom has a  fixed ceiling charge on its stakeholder pension. Sweden uses a formula to  calculate the size of fees that are permitted to help ensure that fees are not  too high. Additionally, it plans to spread certain fixed costs over the first   15 years of the program, helping avoid high fees in the early years. Limits  on the level of fees can also affect fund managers. In the United Kingdom,  for example, regulations capping fees may have discouraged some  providers from offering pension funds.
Countries have also taken steps to lower administrative costs that  contribute to the fees participants are charged. For example, regulations  regarding how often individuals are permitted to move assets from one  investment fund to another can also protect program participants by  helping contain program costs that arise when people switch funds  frequently. Many countries restrict the number of times an individual can  switch. Mexico reportedly has lower administrative costs than some other  Latin American countries, in part because it limits individuals to annual  switching. Chile permitted people to switch fund managers three times a  year, but later restricted switching to two times a year to help lower costs.  Poland provides an incentive for individuals to stay with a pension fund  manager for at least 2 years by requiring fund managers to charge lower  fees for these contributors. Sweden does not restrict the number of times  individuals can change their investments. To help keep costs low,  however, Sweden aggregates individuals’ transactions to realize  economies of scale.
Some countries’ experiences highlighted weaknesses in regulations on  how pension funds can market to individuals. Poland’s and the United  Kingdom’s 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 United  Kingdom had a widely-publicized “mis-selling” scandal that resulted in  over a million investors opening individual accounts when they would  more likely have been better off retaining their occupation-based  pensions. Insurance companies were ordered to pay roughly $20 billion in  compensation. In contrast, Sweden protects individuals from excessive  marketing by not allowing pension funds access to information about  individuals’ investments. Instead, funds rely on mass advertising and  provide reports and disclosures to investors through a clearinghouse.
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. Sweden purchased a new computer system after the  program it intended to use proved insufficient for managing individual  accounts, resulting in an unexpected cost of $25 million. Once a record- keeping system is in place, however, problems may persist. For example,  Poland had some difficulty matching contributions with contributors  because it allowed two different identification numbers to be used for  reporting purposes. In such cases, workers’ contributions were not being  credited to their accounts. Additionally, Poland experienced problems  with its computer system that resulted in a backlog. The government was  required to make interest payments to funds for delays in contribution  transfers. According to a report from the International Labour  Organization (ILO), the government initially failed to make 95 percent of  the transfers to private funds and as of 2002 was still unable to make   20 percent to 30 percent of required monthly transfers.
In countries where workers have a choice of whether to participate in the  individual account program, it is important that policymakers make timely  decisions about other details concerning the administration and  implementation of the program, so that workers can make informed  choices. Hungary and Poland reportedly implemented their individual  account systems without having made such decisions, including those  concerning annuities. Both countries required annuity payouts, but the  markets did not have the appropriate type of annuity available. For  example, inflation-adjusted and gender-neutral annuities were not  available in Hungary. Experts suggest that while these decisions may not  have seemed important initially, the lack of information could make it  difficult for workers to decide whether to participate in the individual  account program and to assess their potential retirement security.
Not only is information important to help workers make initial decisions  about participation in an individual account program, but it should be  provided on an ongoing basis. It is also of increasing importance as  national pension systems become more complex. Several countries require  disclosure statements about the status of a pension fund. The inclusion of  fees charged on these disclosure statements could help individuals to  make more informed decisions when choosing a fund manager. Some  countries have done a better job than others of providing fund  performance information. 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 reportedly did not have clear rules for  disclosing operating costs and returns, making it hard to compare funds’  performances. Other more general information about individual account  savings is also important. In the United Kingdom, individuals must decide  whether they should participate in the state earnings-related pension  program, their employer-sponsored pension plan, or an individual account.  To help individuals make this decision, the Financial Services Agency  publishes decision trees on its Web site. Decision trees in the United  Kingdom ask basic questions about pension arrangements to help  individuals make their own choices. Individuals may find that these are  somewhat complicated, however, in part because the United Kingdom’s  system is complex. In Mexico, a government entity provides information to  workers on the mandatory pension system and includes information about  the importance of reviewing commissions and returns when making a  pension fund choice.
While countries have made efforts to inform the public about the  individual account program and the different options they will have  available, little research on the effectiveness of these campaigns has been  conducted. There has been research, however, looking at the overall  financial literacy of individuals across many OECD countries. The OECD  recently conducted a study on financial literacy and found that most  respondents to financial literacy surveys in member countries have a very  low level of knowledge concerning finances, often seeming to think that  they know more about financial issues than they really do. For example,  about two-thirds of Australian respondents to a survey indicated that they  understand the concept of compound interest. However, only 28 percent  correctly answered a question using the concept. Countries have realized  the growing need for more financial literacy, and several countries provide  or are planning to provide general information about pensions and savings  for retirement.
section_title: Concluding Observations
paragraphs: Demographic challenges and fiscal pressure have necessitated national  pension reform in many countries. Though the reform efforts we examined  all had the common goal of improving financial sustainability, countries  adopted different approaches depending on their existing national pension  systems and the prevailing economic and political conditions. That 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 equity; as a result, what is perceived to be  successful in one place may not be viewed as a viable option somewhere  else. Although some pension reforms were undertaken too recently to  provide clear evidence of results, the experiences of other developed  countries do suggest some lessons for U.S. deliberations on Social  Security’s future.
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 reducing projected benefits,  raising projected revenues, or both. Additionally, with early reform,  policymakers are more likely to 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, in large part, on the long-term health of the  national economy. As the number of working people for each retiree  declines, average output per worker would have to 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. Good public understanding of pension issues is  needed to provide reasonable assurance that people plan ahead to have  adequate income in retirement and to help ensure that pension reforms  have enough public support to be sustainable. 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  high levels of financial literacy and personal responsibility.
In nearly every country we studied, debate continues about alternatives  for additional reform measures. It is clearly not a process that ends with  one reform and often requires more than one type of reform. This may in  part be true 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.
section_title: Agency Comments
paragraphs: We provided a draft of this report to the Social Security Administration,  the State Department, and the Department of the Treasury. SSA and  Treasury provided technical comments on the draft; the State Department  did not provide comments.  We also provided copies of the draft to OECD  staff and other external reviewers, who provided technical comments.  In  response to these technical comments, we modified the draft where  appropriate.
We are sending copies of this report to the Commissioner of Social  Security, the Secretary of State, and the Secretary of the Treasury. We will  also make copies available to others on request. In addition, the report will  be available at no charge on GAO’s Web site at http://www.gao.gov/.
If you or your staff have any questions about this report, please contact me  at (202) 512-7215 or bovbjergb@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who made major contributions to this report are  listed in appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: We reviewed national pension reforms that occurred since 1970 in all   30 Organisation for Economic Co-operation and Development (OECD)  countries and Chile. We included Chile in our study because it was the  first country to undertake national pension reform that resulted in  individual accounts. On the basis of our preliminary research, we  identified three types of reform—adjustments to the existing pay-as-you-go  (PAYG) program, national pension reserve funds, and individual account  programs—that illustrate a variety of circumstances and experiences with  national pension reform across these countries. While we reviewed each  type of reform separately for this report, we do indicate when countries  have undergone more than one of these types of reform.
We did not conduct an evaluation or audit of any country’s national  pension program or its reform efforts; rather, we relied on the work of  officials in individual countries and international organizations with  expertise in this area. We did, however, draw some lessons based on our  review, as well as including the lessons that others have drawn. We  attempted to report the most current status of a country’s reform by using  the most recently available data. Some countries may have undergone  changes to their systems subsequent to the publication of the literature we  reviewed, however. In many countries reforms are implemented over an  extended period of time, so the results are yet to be apparent. We also  contacted supreme audit institutions or reviewed their Web sites to see if  they have done similar work. However, much of their work was of the  audit nature and not relevant for our study.
subsections: section_title: Methodology
paragraphs: To obtain information on other countries’ national pension reforms, we  reviewed the types of reforms undertaken in OECD countries and Chile.  We selected the OECD countries in part because they are most  comparable to the United States. Additionally, the OECD has relatively  comparable data for its member countries. We conducted background  research and interviews to identify the types of reforms, if any, the  selected countries had undertaken. We primarily used information from  the following sources to identify countries’ reforms and characteristics of  national pension systems: the Social Security Programs Throughout the  World publications, provided through a cooperative effort by the Social  Security Administration and the International Social Security Association;  publications from the International Social Security Association and  updates from its Social Security Worldwide database; and publications  from OECD, World Bank, International Monetary Fund, and the European  Union’s Economic Policy Committee.
After identifying the countries to be reviewed and the types of reform they  had undertaken, we conducted a review of relevant literature on these  countries’ national pension reforms, including the following sources:    OECD publications on national pension reform and other related issues;    World Bank’s Pension Reform Primer;    Relevant government agency publications and Web sites from selected    Reports from U.S. and international policy groups; and    Reports from U.S., international, and country-specific experts.
We also interviewed officials and interest group representatives in  Washington, D.C.; Paris; and London. We met with pension experts and  country specialists at the OECD, the World Bank, and French and British  experts, officials, and interest group representatives, as well as  international pension experts in the United States. We formulated the  lessons learned in our report from those identified by experts and officials  and based on our own analysis of countries’ reforms. Generally, we  aligned our lessons with GAO’s criteria for evaluating national pension  reform, identifying key lessons related to fiscal sustainability, adequacy  and equity, and implementation and administration of reform.
We relied mainly on OECD data for information on country demographics,  economics, and information related to the national pension programs.  OECD collects much of its data from its member countries and validates  its reports with these countries. For example, OECD recently published a  description of each OECD member country’s mandatory pension system,  including the results of modeling that projects the net replacement rates  expected from old-age pension benefits once all reforms enacted through  2002 have been fully implemented. OECD has also undertaken studies of  the projected level of public spending on national old-age pension  programs through 2050 based on national estimates and common OECD  economic assumptions. In cases where national governments have  completed more recent estimates, we cited those rather than the earlier  OECD estimates. Also, we do not make a link between specific national  pension reforms and changes in the economy or of any specific reform  measure and the sustainability of the program. This is because most  countries have undergone more than one type of reform at different points  in time, making causes and effects difficult to determine.
To assess the reliability of the data on countries’ national pension systems,  we (1) interviewed officials at the OECD including those in the Statistics  Directorate and the Economics Department responsible for compiling  these data based on information provided by government officials in  OECD member countries, and (2) performed some basic reasonableness  checks of the data against other sources of information. We determined  that the data are sufficiently reliable for the purpose of making broad  comparisons of the United States’ and other countries’ pension systems.  To ensure the reliability of its data, OECD also compares and investigates  alternative sources of data, uses an internal peer and supervisory review  process, and a process through which draft reports are reviewed and  validated by member governments prior to publication. Nonetheless,  OECD officials note several limitations in the data, including the fact that  the data are largely self-reported by each country and are affected by  differences in exchange rates, methods for analyzing national account data  and tracking price inflation, as well as different methods used to predict  longevity and economic growth. OECD works to develop comparable data  by, for example, developing purchasing power parity factors, harmonized  price indexes, and projections of old-age pension spending based on  common economic assumptions. Because of, these limitations, we were  unable to determine the reliability and precision of estimates for each  country. We conducted our review from August 2004 through September  2005 in accordance with generally accepted government auditing  standards.
section_title: Appendix II: Information on OECD Countries and Chile, Their Pension Systems, and Reforms
paragraphs: Below are tabular data concerning OECD countries and Chile. Table 3  provides background information concerning each country’s  demographics, economy, and political structure. Table 4 provides basic  information about each country’s national pension system, including  information about spending on mandatory old-age pension programs,  contribution rates, the extent to which mandatory pensions replace  workers’ earnings, and the size of voluntary supplementary private and  occupational pensions. Table 5 provides examples of various adjustments  to PAYG pension programs. Table 6 provides information on national  pension reserve funds for countries that have established such funds.  Table 7 provides information on individual account programs that  countries have adopted as part of their mandatory national pension  systems.
Table 5 provides examples of adjustments to national PAYG pension  programs undertaken by OECD countries and Chile. The table primarily  includes examples of reforms that increased contributions to the programs  or decreased benefits. It does not provide a comprehensive list of such  reforms.
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Alicia Puente Cackley, Assistant  Director; Benjamin P. Pfeiffer; Joseph Applebaum; Thomas A. Moscovitch;  Nhi Nguyen; Nyree M. Ryder; Roger Thomas; Seyda G. Wentworth;  Corinna A. Nicolaou; Lise Levie; and Pat Elston made key contributions to  this report.
section_title: Glossary
paragraphs: Individual accounts supplement Social Security benefits and would draw  contributions from new revenue streams.
subsections: section_title: Adequacy
paragraphs: (See Income adequacy.)
section_title: Annuity
paragraphs: An insurance product that provides a stream of payments for a pre- established amount of time in return for a premium payment—the amount  being converted into any annuity. For example, a life annuity provides  payments for as long as the annuitant lives. Only insurance companies can  underwrite life annuities in the United States. Other financial  intermediaries, such as banks and stock brokerage firms, may sell  annuities issued by insurance companies.
section_title: Baby boomers
paragraphs: Cohort of people born after World War II. This includes Americans born  from 1946 through 1964; 76 million strong, they represent the longest  sustained population growth in U.S. history. Other countries generally use  the term “baby boomers” to describe this generation.
Individual accounts that would result in some reduction of or offset to  Social Security benefits because contributions to those accounts would  draw on existing Social Security revenues.
section_title: Consumer price index (CPI)
paragraphs: A measure of the change over time in the prices, inclusive of sales and  excise taxes, paid by urban households for a representative market basket  of consumer goods and services. The CPI is prepared by the U. S.  Department of Labor and used to compute Social Security cost of living  adjustment (COLA) increases.
section_title: Covered worker
paragraphs: A worker in covered employment, that is, a job through which the worker  has made contributions to Social Security.
section_title: Deficit
paragraphs: The amount by which the government’s spending exceeds its revenues in a  given period, usually a fiscal year. The federal deficit is the shortfall  created when the federal government spends more in a fiscal year than it  receives in revenues. To cover the shortfall, the government sells bonds to  the public.
section_title: Defined benefit (DB)
paragraphs: A type of retirement plan that guarantees a specified retirement payment  and in which the plan’s sponsor assumes the risk of providing these  benefits. Defined benefit plans promise their participants a steady lifetime  retirement income, generally based on years of service, age at retirement,  and salary averaged over some number of years. Defined benefit plans  express benefits as an annuity but may offer departing participants the  opportunity to receive lump-sum distributions. Defined benefit plans are  one of two basic types of employer-sponsored pension plans.
section_title: Defined contribution (DC)
paragraphs: A type of retirement plan that establishes individual accounts for  employees to which the employer, participants, or both make periodic  contributions. Defined contribution plan benefits are based on employer  and participant contributions to and investment returns (gains and losses)  on the individual accounts. Employees bear the investment risk and often  control, at least in part, how their individual account assets are invested.
section_title: Dependency ratio
paragraphs: An estimate of the number of dependents per worker, generally defined as  the ratio of the elderly (ages 65 and older) and/or the young (under age 15)  to the population in the working ages (ages 15-64) or to the projected size  of the labor force.
section_title: Dependent
paragraphs: A person who is eligible for benefits or care because of his or her  relationship to an individual. Under the Social Security Act, “dependent”  means the same as it does for federal income tax purposes; i.e., someone  for whom the individual is entitled to take a deduction on his personal  income tax return, generally an individual supported by a tax filer for over  half of a calendar year.
section_title: Early retirement age
paragraphs: The age at which individuals qualify for reduced retirement benefits if they  choose to collect benefits before the normal retirement age; the current  early retirement age for Social Security is 62. Individuals who choose to  take retirement benefits early will have their monthly benefits  permanently reduced, based on the number of months they receive checks  before they reach full retirement age.
section_title: Full retirement age (FRA)
paragraphs: (Also called normal or statutory retirement age.) The age at which  individuals qualify for full, or unreduced, retirement benefits from Social  Security and employer-sponsored pension plans. The normal retirement  age for Social Security was 65 for many years. For workers and spouses  born in 1938 or later and widows/widowers born in 1940 or later, the  normal retirement age increases gradually from age 65 until it reaches age  67 in the year 2022. Among OECD countries, based on full implementation  of laws enacted as of 2002, the retirement age ranges from 60 (in France  and Korea) to 67 (in Iceland, Norway, and the United States).
section_title: Full funding
paragraphs: A pension system that is fully funded is one in which sufficient  contributions have been put aside so that assets accumulated to date are  equal to the value of benefits accrued to date. Defined contribution  pensions and individual retirement accounts are fully funded by definition.
section_title: General revenue transfers
paragraphs: Funds moved from the General Fund of the Treasury to other programs  that are usually funded with earmarked revenue, sometimes to maintain  the solvency of those programs. General funds, constituting about two- thirds of the budget, have no direct link between how they are raised and  how they are spent. General fund receipts include income and excise  taxes.
section_title: Gross domestic product (GDP)
paragraphs: A commonly used measure of domestic national income. GDP measures  the market value of output of final goods and services produced within a  country’s territory, regardless of the ownership of the factors of  production involved, i.e., local or foreign, during a given time period,  usually a year. Earnings from capital invested abroad (mostly interest and  dividend receipts) are not counted, while earnings on capital owned by  foreigners but located in the country in question are included. GDP may be  expressed in terms of product—consumption, investment, government  purchases of goods and services, and net exports—or it may be expressed  in terms of income earned-wages, interest, and profits. It is a rough  indicator of the economic earnings base from which government draws its  revenues.
section_title: Income adequacy
paragraphs: Helping workers maintain living standards during retirement by replacing  income from work at an adequate level and to prevent destitution in old  age. The U.S. Congress expected that Social Security benefits would  eventually provide more than a “minimal subsistence” in retirement for  full-time, full-career workers. Various measures help examine different  aspects of this concept, but no single measure can provide a complete  picture. Such measures include poverty rates, replacement rates, and the  proportion of the population that depends on others for income support.
section_title: Indexation
paragraphs: (See Price indexation, Wage indexation.)
section_title: Individual account
paragraphs: These are fully funded accounts that are administered by either employers,  the government, or designated third parties and are owned by the  individual. The level of retirement benefits depends largely on the amount  of contributions made by, or on behalf of, an individual into the account  during his or her working life, investment earnings, and the amount of fees  the individual is required to pay.
section_title: Individual equity
paragraphs: The relationship of benefits to contributions—for example, implicit rates  of return on Social Security contributions or money’s worth ratios.
section_title: National pension reserve funds
section_title: National saving
paragraphs: Total saving by all sectors of the economy: personal saving, business  saving (corporate after-tax profits not paid as dividends), and government  saving (the budget surplus or deficit—indicating dissaving—of all  government entities). National saving represents all income not consumed,  publicly or privately, during a given period. Net national saving is gross  national saving less consumption of fixed capital (depreciation).
section_title: Notional defined contribution (NDC) program
paragraphs: PAYG pension programs in which "notional" accounts track both incoming  contributions and investment earnings, but these exist only on the books  of the managing institution.  At retirement, the accumulated notional  capital in each account is converted to a stream of pension payments using  a formula based on factors such as life expectancy at the time of  retirement.
section_title: Old-Age, Survivors, and Disability Insurance (OASDI)
paragraphs: The two U.S. Social Security programs—Old-Age and Survivors Insurance  (OASI) and Disability Insurance (DI)—that provide monthly cash benefits  to beneficiaries and their dependents when the beneficiaries retire, to  beneficiaries’ surviving dependents, and to disabled worker beneficiaries  and their dependents.
Pay-as-you-go (PAYG:)
System of financing in which contributions that workers and/or employers  make in a given year are used to fund the payments to beneficiaries in that  same year, and the system’s trust funds are kept to a relatively small  contingency reserve.
section_title: Payroll tax
paragraphs: Tax imposed on some or all of workers’ earnings that can be imposed on  employers, employees, or both. In the United States, payroll taxes are used  to finance the Social Security and Medicare programs. Employers and  employees each pay Social Security taxes equal to 6.2 percent of all  employee earnings up to a cap and pay Medicare taxes of 1.45 percent,  with no cap. Payroll taxes are also known as FICA (Federal Insurance  Contributions Act) taxes or SECA (Self-Employment Contributions Act), if  the taxpayer is self-employed. All OECD countries except New Zealand  levy payroll taxes to support their pension programs, though the rates and  the shares borne by employers and employees vary, as do the minimum  and maximum level of earnings subject to the tax and the kinds of  programs funded.
section_title: Price indexation (Compare with Wage indexation.)
paragraphs: A method by which benefits are adjusted at periodic intervals by a factor  derived from an index of prices; some Social Security reform proposals in  the United States would price-index earnings to compute benefits, instead  of using wage indexing. Over time, increases in wages have been greater  and are expected to continue to be greater than increases in prices.  Indexing earnings to prices instead of wages would, therefore, reduce the  average lifetime earnings used in the formula, which, in turn, would  reduce benefits.
section_title: Rate of return
paragraphs: Usually expressed annually, the rate of return is the gain or loss generated  from an investment, expressed as a percentage of the value at the time of  the initial investment.
section_title: Replacement rate
paragraphs: The ratio of retirement benefits (from Social Security or employer- sponsored plans) to preretirement earnings. Analysts often compare  current benefits with a recipient’s previous wages to judge the adequacy of  Social Security payments.
section_title: Social insurance
paragraphs: Under a social insurance program, the society as a whole insures its  members against various risks they all face, and members pay for that  insurance at least in part through contributions to the system. Social  insurance programs, including Social Security, are designed to achieve  certain social goals.
section_title: Social Security Administration (SSA)
paragraphs: The federal agency that administers all Social Security related programs,  including the Supplemental Security Income (SSI) and the Disability  Insurance (DI) programs.
section_title: Solvency
paragraphs: For Social Security, a condition of financial viability in which the program  can meet its full financial obligations as they come due. Specifically, the  ability to pay full benefits using existing revenue sources and trust fund  balances. When a program does not meet these conditions, it is said to be  insolvent.
section_title: Sustainable solvency
paragraphs: For Social Security, sustainable solvency means the ability to pay benefits,  based on current law projections of revenue and outlays, beyond Social  Security’s Board of Trustees’ 75-year forecast and make Social Security  permanently solvent. Also defined as having a stable and growing trust  fund ratio with program revenues increasing faster than outlays at the end  of the 75-year period. The European Union and OECD have examined the  fiscal sustainability of national pension systems based in part on  projections of the change in the percentage of countries’ GDP to be spent  on old-age pensions from 2000 to 2050 under current law.
section_title: Transition costs
paragraphs: Refers to the additional revenue required to implement substitute  individual account plans. Under some individual account plans, portions of  Social Security contributions would be diverted to the accounts. However,  under Social Security’s pay-as-you-go financing, some of those  contributions would also be needed to pay for current benefits. Making  account deposits while also meeting current benefit costs requires  additional revenue, which we refer to as transition costs.
section_title: Wage indexation
paragraphs: (Compare Price indexation.) A method by which benefits are adjusted at  periodic intervals. Under its current formula, SSA uses the national  average wage indexing series to index a person under age 60’s lifetime  earnings when computing that person’s Social Security benefits. Earnings  from age 62 to age 67 are adjusted using a price index.