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Super History: The international pattern

In the first part of a regular series on retirement income in New Zealand the Office of the Retirement Commissioner describes the different types of pension systems available to Governments.

Monday, March 19th 2001, 11:08PM
Cash incomes for retired people in developed countries can be grouped into three major categories:

1. Public pensions
2. Private and occupational pensions or superannuation
Private investment and savings


Public pensions
"Public pensions" are largely a development of the late 19th and the 20th centuries. However, England has had some degree of public financial provision for supporting the elderly since at least the 16th century.

For example, the English Poor Laws provided for the destitute elderly to be financially supported by local or parish property rates.

However, this largely rural-based system came under increasing strain as the population shifted to urban areas, and was not transplanted to New Zealand during 19th century colonisation. New Zealand began its modern era without any form of public pensions for the elderly.

With the spread of industrial society and the growing proportion of wage and salary earners in the population, all developed countries adopted a more systematic way of providing publicly mandated cash retirement income. Three separate types of public pension emerged:

social insurance
social assistance
universal pensions

Social insurance
Social insurance is the main type of public pension adopted by developed countries, requiring people to make a compulsory contribution from their earnings to social insurance funds. These contributions are invested in income-earning assets, which are built up to finance the pension payments that become due when the contributor retires.

Most social insurance schemes require contributions from both employers and employees. Some also receive government subsidies.

Retirement pensions paid out from social insurance funds are mainly based on members' earnings and contributions, which means pension levels vary. Those with high earnings and a long working life receive high pensions, while those with low earnings or limited employment periods receive low pensions.

Social insurance pensions are paid as of right, and are not subject to any assessment of need.

The retirement income pattern produced by most social insurance systems is somewhat similar to the pattern that would be produced by voluntary private superannuation, as the level of retirement pension depends on contributions made during a person's working life.

The fact that fund membership is compulsory means that people with adequate lifetime earnings cannot end up destitute through failing to provide for their retirement. However, because they are contribution-based, social insurance pensions do not provide an adequate retirement income for those with low lifetime earnings.

In practice, a number of developed countries with social insurance schemes do not calculate pensions entirely on the basis of contributions - some groups may receive cross-subsidies from other contributors. For example, some schemes pay guaranteed minimum pensions for those with a specific number of years of contributions, no matter what their actual contribution.

Many funds have chosen not to fully fund their future pension obligations with investment assets, taking a "pay-as-you-go" approach. This means some are experiencing a financial crisis as the population ages and the ratio of pensioners to contributors rises.

Resolving this will require some combination of higher contributions, lower pensions, later retirement ages, higher fund investment earnings, and finnancial assistance from the government budget - a major policy issue in Europe, Japan and the United States.

Many developing countries such as India or Indonesia use a variation on the compulsory contribution approach: provident funds. However, these compulsory savings schemes usually apply only to employees in medium and large businesses.

When an employee retires, the provident fund pays out a lump sum based on accumulated contributions plus interest. The retired employee is then responsible for deciding how to spend or invest the lump sum. Some Provident Funds now also provide a pension option.

Social assistance
Not everyone can be adequately covered by social insurance systems. Low earners, the sick, invalids or unemployed, and many parents who drop out of the paid workforce to care for children or elderly parents end up with inadequate pensions under a system that depends mainly on contribution records.

As a result, countries with social insurance systems usually develop a second level of "social assistance", to ensure that elderly people are not left destitute because they have not earned or saved enough during their working life.

Assistance is income or asset tested, and often has other conditions attached to it. It is funded from taxation or other general government revenue and is the lowest cost way of providing public pensions of any given level from taxpayer funds.

Australia is one of the few developed countries with a core public pension system based on social assistance principles, although it now also has compulsory contributory superannuation.

Social assistance principles that target help according to need have played a large part in New Zealand's public pensions history.

Currently they apply only to the Transitional Retirement Benefit and to various forms of supplementary assistance, but not to New Zealand Superannuation. However, this targeting has always been unpopular with parts of the population - the Else and St John publication, A Super Future, contains more detail on this issue. (This book is available through the Good Returns' bookstore - CLICK HERE to order your copy)

Some types of social assistance may be tied to particular types of spending or costs, including free or subsidised help for health care, housing, transport or other services. New Zealand examples include the Community Services Card for health costs and the Accommodation Supplement for housing costs. However, this approach is more heavily used in Australia than in New Zealand.

Universal pensions
Universal pensions - flat rate pensions paid out to all residentially qualified people once they reach a designated age - are the least common form of public pension internationally. They have no income or asset tests, no requirement to make individual contributions to a pension fund, and often no requirement to actually be retired from work. They are usually funded out of taxation or general levies on earnings, or general government revenues.

Universal pensions are the most fiscally expensive way of providing a minimum income for retired people. Their lower administration costs only partly offset the higher pension payment costs. However, preventing poverty is usually only one objective of a universal pension scheme; other objectives may include ensuring separate pension entitlements for women as well as men.

New Zealand is unique among developed countries in having a universal pension (New Zealand Superannuation) as its only form of public pension for those who have reached full retirement age. However, Norway, Sweden, Denmark and Iceland operate a "part universal" pension system, where older citizens receive a modest universal pension from the state in conjunction with an earnings-related contributory pension based on a social insurance model.

Private and occupational pensions
Occupational pensions
Occupational (or job-based) pensions are very common in many countries and form part of the employment remuneration system. Some schemes provide for pensions only, while others may have lump sum and pension options.

The boundary between occupational pensions and social insurance is often blurred. For the purpose of this publication, the term "occupational pensions" means voluntary pension scheme arrangements between employers and employees. This may include pension schemes set up because of an industrial agreement, but does not include schemes required under the general law of a country.

Occupational pension schemes normally provide for contributions from both employees and employers. Many are administered for employers by separate insurance or investment funds.

Occupational pensions appear to be shifting to a "defined contribution" rather than "defined benefit" basis.

"Defined contribution" systems work like investment funds, with the value of entitlement at retirement depending on the level and timing of contributions and the fund's earnings rate. Pension or lump sum entitlements therefore depend on the amount accumulated in the person's account.

"Defined benefit" schemes usually link pensions or lump sums to the employee's length of employment and their earnings in the later stages of their career, and require variable employer subsidies. The largest defined benefit scheme in New Zealand, the former Government Superannuation Fund for public servants, has been closed to new members for some years.

Private pensions
Private pensions or annuities are of varying importance in developed countries. They provide retirement income options for people who are not covered by other contributory pension plans, such as the self-employed. They also offer a way for people to supplement their retirement pensions from other sources.

Annuities from private pensions provide a reasonably certain income in retirement. However, inflation may affect real payment levels - and because it is difficult to forecast inflation, it is difficult to obtain a private pension whose payments are fully indexed to price changes. In addition, once someone entitled to the pension or annuity dies, the payment stops and there is no capital asset left to hand on to any heirs. This means private pensions will suit the retirement income needs of some people but not of others.

Private investment and savings
Providing for retirement income through investing in other income-earning assets is more common than private pensions. The wide range of investment approaches includes shares, rental property, government bonds, debentures, mortgage lending, bank deposits, mutual funds, unit trusts or investing in a business or farm.

This type of saving normally means the assets can be passed on to heirs once the retired person dies. However, the retirement income actually achieved depends on business profit levels, dividends and interest rates earned on the assets in retirement. Risks also vary depending on the type of asset.

This is an extract from Retirement Income in New Zealand: The historical context, written by David Preston for the Office of the Retirement Commissioner.

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