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Retirement Income Systems in East Asia1

Hanam S. Phang Korea Labor Institute

(Email: phang@kli.re.kr)

Draft: Please do not cite

2004 1. Introduction

Social security and pension systems in most of the Asian countries have a relatively short history

and thus are less developed both in its formal coverage and substantive protection than in other parts

of the world with comparable levels of economic development. The extended family had long been a

cultural tradition and a major source of old-age income support in most Asian societies. Income

support for the elderly in many Asian countries is still provided overwhelmingly through own

income, private savings and transfers from other family members (World Bank 1994: 49-67). In

most of the Asian countries the old-aged, living in a welfare regime where social security for the old-

aged life was only minimally set up, tend to remain economically active until they become very old

or disabled.

Regarding the apparently late development of the social security system in the region a couple of

key social policy assumptions could be drawn out of their past welfare regime. First, the state of the

East Asian countries in the past had assumed that a continued rapid economic growth and

consequent reduction in poverty rate would suffice to take care of any social concern for old-age

income security. Second, the policy makers have generally regarded social security provision for the

non-public sector labor force as essentially a private concern for the employers, families and local

communities (Phillips 1999). Social security needs of the individuals thus have been considered at

most as secondary to economic growth and to the needs of the corporate sector (Asher 2000b). As a

consequence, the role of the state for social security provisions, if any, had been very limited or in

large part delegated to the private sector (ILO 2000:500-501).

1 Draft paper written to be included in The Oxford Handbook of Pensions and Retirement Income, Oxford University Press, forthcoming.

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This social policy perspective should have constrained the due development of the social

security pensions for private sector workforce while a very generous public pension programs were a

norm for the public-sector employees (e.g., Korea, Taiwan and Singapore). At least it was not long

ago that societal need for old-age income security was publicly recognized because, among others,

the population structure in that region, with a few exceptions, was relatively young thanks to

reasonably high fertility and shorter life-expectancy during the most part of the 20th century.

But with rapid economic development during the past decades that characterizes the region the

trend is that informal systems of family support is being gradually substituted by public and/or

private income security schemes. Industrialization and urbanization has drawn rural self-employed

population that had been engaged in farming into urban labor markets for paid employment. As a

result the number of employees as a percentage of the economically active population has increased

to a great magnitude. This has, in turn, led to a greater need for public system setup for after-

retirement income security.

Countries in the region are now characterized by a limited yet varied development of the systems

used to provide people with old-age income security depending on each country’s past history and

level of economic development. This chapter describes retirement income systems in East and

Southeast Asian countries and discusses important policy issues arising from the regional context

and recent reform efforts to address those issues.

2. The Characteristics of the Retirement Income System

2.1. Retirement Income Systems in Southeast Asian Countries

One striking feature of the region is that many countries have no social security pension scheme

for old-age income provision. The main reason is that they, mostly being former British colonies,

have national provident fund systems instead that covers employees in the private sector (ILO, 2000).

Singapore has Central Provident Fund introduced in the early 1950s by the British to provide social

security for the civilian workforce, while adopting an independent pay-as-you-go (PAYG)-based

pension scheme for civil servants and public-sector employees. Equivalently Malaysia has the

Employee Provident Fund established in 1951 and Indonesia has its Jamestek Provident Fund

mandated for workplaces with at least 10 workers since 1992. Hong Kong has recently introduced

Mandatory Provident Fund in 2000.

These national provident funds have some unique features in common as a retirement income

system (Asher, 2000). First, these national provident funds, as a sort of mandatory savings scheme,

are all based on individual accounts financed by defined contributions from employers and/or

employees. As such they lack any social risk pooling or redistributive mechanism. And whatever

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benefits that individuals may receive from the system is strictly dependent on his/her contribution

records and wage levels.

Second, these provident fund systems are usually designed to fulfill a comprehensive social

security function, operating not only as retirement savings but also as a fund for housing, education,

healthcare, disability, and unemployment during the working life. As such advance withdrawals are

normally allowed and more often then not heavy withdrawals occur. As a consequence they fall

short of retirement pension scheme that should provide a prolonged protection of old-age income

after retirement. In most cases the fund is almost depleted by the time of retirement and if there

remains any balance then benefits will be exhausted within a few years after retirement.

In terms of the distribution of accumulated funds Hong Kong is an exception; the system is titled

as ‘provident fund’ but, in operation, it is a defined contribution-type pension scheme and its benefit

will be paid as annuity. On recognition of the societal need of annuity pension for stable after-

retirement income stream, Singapore has recently decided that a minimum sum of the Central

Provident Fund should be reserved for regular monthly benefit after retirement at age 55 (Asher

2004).

2.2. Retirement Income Systems in East Asian countries

While many South East Asian (except for the Philippines and Vietnam) countries do not have

mandatory retirement pension schemes and, instead, rely on provident funds for old-age income,

Japan, China and Korea, many of the East Asian countries adopted a social insurance principle in

providing people with retirement income security by setting up public as well as private pension

schemes that cover part or all of their workforce and population.

Japanese System

Japan has the oldest public pension system in East Asian countries. The earliest plan was one for

military personnel, which was established in 1890 and later extended to civil servants. In 1942 a

mandatory pension program for private sector employees, Employee Pension Insurance, was enacted

as a defied benefit plan on a fully funded basis. In terms of coverage, a major improvement was the

establishment of the National Pension Insurance in 1961. The NPI became a basic pension for both

the employed workers and the self-employed by the major pension reform in 1986. Currently Japan

has five social security pension schemes covering different sectors of the population and a set of

well-established corporate pension plans of defined benefit (DB) or defined contribution (DC). The

majority of private sector employees in Japan are also paid lump-sum retirement allowances upon

termination of employment contract (Conrad 2001; Takayama 2004).

Chinese System

In China, whose economic system was mainly socialist and the enterprises were mostly state-

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owned, the provision of old-age income security was mandated to be a responsibility of each state-

owned enterprise (SOE). It has been a norm that workers in the public sector stayed at the same

enterprise throughout their working lives and retired with a very generous retirement pension benefit.

The social security pension, first established in 1951, covered the employees of the SOEs, public

institutions (schools, universities, and health care affiliations, etc.), plus a portion of urban

collectives. But it should be viewed as largely an urban phenomenon as the SOEs were mostly

urban-based. The vast population living in rural areas was left out of the system.

In addition to being very limited in coverage, China’s pension system was extremely fragmented.

Typically, each SOE established and financed its own benefit rates, while the central government

controlled the rates for its enterprises. Despite variations among enterprises and regions, however,

the overall benefit of the pension system was generous compared even to other developed economies.

The retirement age was 60 for men, 50 for non-managerial women, and 55 for managerial women.

With a minimum contribution period for pension eligibility set at 10 years, the average replacement

rate was on average above 80% of the final salary. The system was financed on a pay-as-you-go

basis: a proportion of the operating funds from SOEs were the only source of funds for current

retirees’ pension benefits (Word Bank 1997).

Following the general economic reform – i.e., move toward a market-based economy - in the

1980s, however, the unfunded enterprise-sponsored pension plans became unsustainable. While

many of the old industries declining, the non-competitive SOEs therein were left with increasing

pensioners but little capacity to pay the defined pension benefits. In contrast, new industries and

private enterprises with young workers and no pensioners were rapidly developed out of open

exports and foreign investments (James 2001). There were pressing societal need for an extended

coverage of old-age pensions towards the private sector workers and the rural population while the

pension benefits promised under the old-regime being properly paid to current state-sector retirees

(ILO 2000:506-509).

The New Labor Law of 1994 stipulated that coverage should eventually be extended to all

salaried workers regardless of the nature of their employment or ownership of the enterprise. The

State Council Decree 26 issued in 1997, on setting up unified basic old-age pension for urban

workers, declares that coverage should be (further) expanded to all enterprises and their workers, as

well as the self-employed. Two main arrangements made for the proposed transition include

(1)social pooling of pension contributions within each municipality along with the new

establishment of Social Insurance Agency as an administrative body of pension funds and

(2)contribution rate raised up to 15% from employers and newly imposed 3% from employees. The

first arrangement, in particular, became an institutional basis for further integration of local pension

programs into a unified system within the boundary of provinces and further at the national level

(Takayama 2002).

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China’s pension system is currently in a transition from an enterprise-based, extremely

fragmented system to a socially integrated ‘safety net’ scheme with extended coverage of workers,

transition from a fully pay-as-you-go system to a partially funded one plus individual accounts

(Whiteford 2001). This will be detailed in the following section.

Korean System

Korean pension system has a very short history and is very young. Its National Pension was first

introduced in 1988 and is still in its early accumulation stage. Full pension benefit is yet to start in

2008 when the minimum contribution requirement of 20 years will be ever reached. The National

Pension scheme is a partially funded defined benefit plan. The system covers all private sector

employees and the self-employed both in the rural (since 1995) and urban areas (since 1999).

For special occupational groups of workers Korea has 3 independently funded and managed

pension schemes: i.e., Special Occupational Pension (SOP) for (1) civil servants (introduced in

1960); (2) private school teachers (1975); and (3) military personnel (1963). The SOPs are all

defined benefit plans with a very generous benefit level guaranteeing 76% of the life-time average

wage for a maximum 33 years of contribution.

Korea has not introduced a corporate pension system yet. For workers in private enterprises,

there exists a retirement allowance scheme (RAS) instead. Under the Labor Standards Act, firms are

required to pay workers leaving the firm one month of wages for every year of service. These

retirement allowances paid in lump-sum on termination, had served a limited role of providing

income support after retirement or in case of job loss prior to retirement (Phang 2001).

Korea is quite unusual among OECD countries in that private firms are required by law to make

these severance payments to workers leaving the firm whether voluntarily or involuntarily. A similar

system exists in Italy and Japan but with some notable differences. Italy probably comes closest to

the Korean system in that severance pay is compulsory for all workers leaving the firm and there is a

standard formula for calculating the minimum amount of the lump-sum payment. The Japanese

system is from Korean RAS in that it is paid on a voluntary basis but with no standard formula for

calculating these allowances (Keese and Lee 2002). Reforms are planned to convert the retirement

allowance scheme into a corporate pension fund.

As of 2005, however, it is expected that Korea will enact a so-called ‘Employee Retirement

Income Security Act’ by which firms will be allowed to set up corporate pension plans – either DB

or DC - that could replace the current RAS. This reform will be able to help strengthen retirement

income security for Korean workers (Phang 2004).

3. Current Pension Arrangements and Pending Issues

3.1. Public and Private Pension Schemes in Japan

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Japanese public pension system is composed of two tiers. The first tier, National Pension

Insurance (NPI) is a so-called ‘basic pension’ which purports to provide a flat benefit to the general

population. In principle, all residents between ages 20-59 are required to participate in and make

monthly flat-rate contributions to the system. The basic pension benefits are solely based on the

length of their participation. The system is run on a PAYG basis but one third of the total benefit

expenditure has been subsidized by the general budget. The second-tier is an earnings-related

defined benefit plan called the Employees’ Pension Insurance (EPI). It covers most employees in the

private and the public sector. Employees in the private sector are insured by Employee Pension

Insurance (EPI) and those in the public sector (i.e., civil servants, teachers, etc.) are insured by

Mutual Aid Associations of their own.

The monthly contribution to the EPI had been 17.35% of the employee’s monthly standard

remuneration excluding bonuses. For bonuses, usually amounting to about 5-month’s salary paid

biannually, contribution rate of 1% had been applied. According to the 1999 pension reform, a new

‘comprehensive contribution rate’ of 13.58% has been applied for the total remuneration including

the biannual bonuses paid since 2003.

In order to qualify for the old-age pension, the insured person must satisfy the eligibility

conditions, a minimum 25 years of contribution under maximum 40 years. The normal retirement

age by the National Pension Act is now 65, although the old-age pension is payable from age 60

under the special provision, called ‘specially provided old-age pension’ for those who had been in

the EPI before the 1986 pension reform. Under the provision, both a fixed amount basic pension and

the earnings-related pension benefit is paid from the EPI until the beneficiary reaches the age 65,

after which basic pension is paid out of the NPI.

For private arrangement of retirement income Japan has employer-based occupational pension

schemes. There are three main types of company retirement plans in Japan: unfunded severance

benefit plans, the Employee Pension Funds (EPF), and the Tax Qualified Pension Plans (TQPP). The

latter two are mostly defined benefit plans and about half of all Japanese full-time employees

participate in an EPF or a TQPP. More than 90 percent of all Japanese employees have severance

pay plans that relate termination benefits to years of service and earnings. These are financed out of

corporate operating revenue (they are book reserved for funding purposes). Severance benefits are

typically paid as lump sums when workers leave their career employers.

What is characteristic of the Japanese pension system is that these company-based private

pension plans are permitted to partially ‘contract out’ the earnings-related part of the public EPI in

return for lower contributions to the public system. The benefits of the EPF plans, thus, consist of

two components: the ‘substitutional component’ contracts out and substitutes the earnings-related

portion of the public EPI while the EPF plans are required, to be approved, to pay a ‘supplementary’

pension benefit, which must not be less than 30% of the EPI (Conrad 2001).

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Using the current benefit formula, a worker with 40 years of coverage would receive an

earnings-related benefit of 30 percent of average real earnings. The flat benefit for a married worker

and spouse provides a total replacement rate of over 50 percent for most retirees (Miyatake 2000).

Reforms implemented in 1994 gradually boosted the eligibility age for the NPI flat benefit from age

60 to age 65; however, eligibility for EPI benefits was maintained at age 60 throughout the 1990s.

Japanese public pension plans, NPI and EPI, both were designed to be a capital-funded system.

But it became quickly transformed into a pay-as-you-go-based unfunded system due to rapid

increases in benefit level in the past, backed by the successful economic growth of the 1960s and

1970s, and increasing number of pension beneficiaries out of ageing population. Although a

considerable amount of fund is accumulated and trusted to the social security trust fund, this fund,

however, is found insufficient to pay for current retirees and for accrued benefits earned by current

workers without raising contribution rates to a great extent in the future. It is projected that, if

current benefit promises have to be maintained in the face of rapid ageing of the population, the EPI

tax rates would have to increase from 17.35 up to 34.5% by 2025 and that contributions to the NPI

would also have to be raised by about 100% (Clark and Mitchel 2002).

A comprehensive review of the public pension system’s benefit formulas, eligibility conditions,

retirement ages, and financing options were conducted in the pension reform in 2000. A Key aspect

of the parametric reform was cutting future social security benefits in various ways: the benefit

accrual rate for the EPI was further curtailed from 0.75 to 0.715 per year of contribution; the

indexation of the EPI and NPI benefits was switched from wage to price indexation for the

pensioners aged 65 and over; the normal retirement age for the EPI pension was scheduled to be

raised from 60 to 65 for both men and women. These changes will be gradually phased in over time

for new generations of retirees. Along with those parametric adjustments, government subsidy to the

NPI pension was decided to be raised from 1/3 to 1/2 of the total annual cost (Takayama 2004).

On the other hand those parametric adjustments – repetitive benefit cuts and contribution raises -

applied to the system to improve its long-term financial prospect should be begetting an excessive

intergenerational inequity within the system by transferring most of the increasing pension costs to

younger generations (Clark and Ogawa 1996). It is estimated that the cohorts born after the 1980s

will receive less from the public pension scheme (NPI and EPI) than what they will have to pay into

the current system. The situation would be worse if the government subsidy to the NPI (worth 1/2 of

the current cost) were taken out of the equation. It is estimated that those born after the 1960s, the

baby-boomers who will retire in around 2020, would be worse off for having stayed in the public

pension plan (Tajika 2002).

In sum, today’s public pension system of Japan is suffering from both intra- and inter-

generational excess inequity: the former arising from between-sector (the self-employed vs. the

employed workers) imbalance in participation and active contribution; the latter arising from over-

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generous benefit structure of the system in the earlier stage and subsequent readjustment of the

system parameters in the direction that penalizes the younger generations.

Long-term economic recess in Japan during the 1990s had also brought in a deteriorating

condition for company-based private occupational pension schemes. Limited evidence indicates that

Japanese pensions are currently quite under-funded at least according to Western standards and that

the old occupational pension plans are faced with a long-term sustainability problem (Takayama

2004). According to the 2001 Pension Reform Bill a new defined benefit-type and defined

contribution-type pension plans – modeled after American 401(k) plan - are newly introduced and

expected to take the place of the old ones. However, the 2001 pension reform bill is known to have

left many transitional issues unsolved (Clark and Mitchell 2002).

3.2 China’s Public Pension System in Transition

According to the 1997 reform provisions the social security pension of China has a two-tier

structure. The 1st-tier is a pay-as-you-go defined benefit plan with flat-rate basic benefits

guaranteeing a replacement rate of 20% of the regional wages at retirement with a minimum 15-

year’s coverage and contribution.1 The 2nd-tier pension is designed to be a funded defined

contribution plan with individual accounts. The final benefit from the 2nd-tier pension would depend

on an individual’s contribution history and earnings level plus returns from investment. Officials

estimate that, on average, the 2nd-tier pension would provide a replacement of at least 38.5% of final

wages for 35 years’ contribution. The combined replacement rate by the 1st- and 2nd-tier pension

benefits is, then, to be 58.5% for average wage-earners with 35 years of coverage and contribution, a

drop of about 20% from the old system.

The 1st-tier social security pension would be financed on a pay-as-you-go basis by a payroll tax

of 13% on employers. The 2nd-tier pension with individual accounts would be financed by a payroll

tax of 11% (7% by employers, 4% by employees). The two-tier pension system requires a total 24%

contribution rate. The employer-employee share of the 2nd-tier pension contribution has changed

recently by the State Council, 2000. Employee’s contribution is to rise by 1% every two year until it

reaches 8%. By offset employer’s contribution rate would be reduced by 1% every 2 year until it

reaches 3%, while total contribution rate to individual pension account will remain unchanged.

Under these provisions, the success of China’s pension reform would critically depend on how

and to what extent the 2nd-tier individual account will be funded while the old pension benefits

obliged to current retirees are paid without interruption (Rosegrant 1999). Since the reform

ordinance in 1997 was issued, many municipalities had set up both pooled accounts and individual

accounts for enterprise workers. In almost all cases, however, the individual accounts were empty

and notional. That is, while these accounts existed on paper and were being credited with a certain

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rate of interest, no actual money was being saved or invested. Because of inadequate reserves,

money that would have gone into the individual accounts was going instead to pay pension

obligations due to current retirees. Pension benefits for current retires have been paid out of the

contributions collected for the intended 2nd-tier pension. Actual funding into the 2nd-tier accounts

would have to wait until the new system get out of the liabilities of the old unfunded system.

Because most individual accounts were empty, China’s new pension system is essentially an

unfunded pay-as-you-go system. This is a typical case of transition cost falling on the current

generation and thus the most serious challenge threatening a successful transition from an unfunded

to a funded pension system (James 2001; McCarthy and Zheng 1996).

As a result, even with the reformed pension system, it is argued that, the future viability of the

pension system is still under question, especially when the population is rapidly aging and when the

number of SOE sector workers – the main source of contributor - is decreasing and that of SOE

retirees is increasing.

The new system is also suffering from wide spread non-compliance and moral hazard problems

while the local and central government agencies lacking proper regulatory enforcement means.

Underreporting of wages, misuse of early retirement privileges and over-report of service years for

their retiring workers are reportedly widespread. However, there is virtually no penalty against

under-reporting and delaying of pension contributions and benefit payments (James 2001).

The low rate of compliance and high incidence of moral hazard problems are mainly an outcome

of the strong disincentives placed in the current provisions. While transition to a centralized funded

system is still incomplete local enterprises continue to be practical administer and thus are still

burdened with ultimate financial obligations of paying pension benefits to their retired employees.

And for the non-SOE private enterprises, the newly applied system means a heavy payroll tax for

employers, part of their contributions being used to subsidize the old SOEs’ retired workers’ pension

benefit. For their employees, they are forced to receive a lower rate of return from the 2nd-tier fund

investment where the return rate is centrally administered (Takayama 2002).

China’s venture of transforming an enterprise-based unfunded PAYG pension system (inflicted

with excessive overhung liabilities) into a pre-funded, centrally managed system should not be

viewed as an easy mission by any standards. It may be simply infeasible if not impossible, especially

for country with a planned economy in transition to market economy, to mandate payroll

contributions to be paid to finance both the massive pension liabilities and the new earnings-related

funded scheme. The contribution rate for the mission would be too high to be successfully enforced.

The current pension payment alone in the state sector came to around 23% as of 1999, while the new

funded scheme requires another 11% contribution of total earnings for funding. Then the total

mandatory contribution rate should be around 34% of the total earnings, which is too high even in

European experiences and is 14% points above the guidance ceiling of 20% laid down by the State

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Council 2000. It is pointed out that more feasible and low-cost reform options should have been

considered (Takayama 2002).

3.3 Korean Public Pension System at a Crossroads

The National Pension Scheme (NPS) and Special Occupational Pensions (SOP) constitute

Korea’s public old-age pensions. Since its introduction in 1988, the coverage of the NPS has been

extended progressively to cover, in theory, all private-sector employees and the self-employed.

While coverage is now compulsory for all regular employees in workplaces it is only voluntary for

other types of workers such as part-time employees and family workers. Currently, only around 50%

of the labor force is effectively covered. This large discrepancy between formal and effective

coverage of the NPS is in large part due to high rates of system evasion and non-contribution

predominantly among the self-employed (Phang 2004).

The current contribution rate for the NPS is set at 9% of the standard monthly wage which

employer and employee share half-and-half. Contribution rates for the self-employed started from

3.0% in 1995, when the system was applicable only to the rural self-employed (farmers) and then

were increased by 1% per year, which will reach at 9% by 2005.

Workers become eligible for old-age pension once they reach 60 years of age and have a

contributions record of at least 20 years. For workers with average earnings, the accrual rate is 1.5%

of earnings per year of contribution and workers with 40 years of contributions would receive 60%

of their former wages. According to the NPS’s benefit formula, the level of an individual’s pension

benefit depends both on the average wage of all insured persons in the year prior to retirement and

on the individual’s own wages averaged over the entire period for which contributions were made.

Thus built in the benefit formula is a redistributive element: workers with lower than average

earnings receive a benefit that is higher relative to their former earnings than workers with higher

than average earnings.

These SOP schemes are all defined benefit schemes that guarantee a maximum 76% of the final

3-year average salary (for minimum, 20-year, maximum 33-year contribution). For the government

employees, a special retirement allowance that amounts to variable percentage (10%-60%) of the

monthly salary, depending on the length of service, is accrued for each year of service, payable in

lump-sum at the time of retirement. The contribution rates for the SOP schemes for Government

employees are currently set at 17%: 8.5% by the employee, 8.5% by the Government. The

contribution rate for the SOP for private school teachers is also 17%: 8.5% by the employee, 5% by

the corporate, 3.5% by the Government.

Many countries made public pension promises without a sober assessment of the long-run

financial sustainability of the system. A pattern of financial deterioration of many public defined

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benefit schemes has been widely observed around the world. Korea was not an exception (World

Bank 2000). Its National Pension system was started with a ‘too generous’ benefit promises, that is,

70% replacement rate of the life-time earnings for 40 years’ contribution at 9.0% rate. Recognizing

that the system will not be financially sustainable, even without the changing demographic factors

taken into account, Korean government reduced the promised pension benefit by about 15

percentage points (from 70% replacement rate to 60%) in 1998 reform. In 2003 reform, another 8

benefit cut is proposed by the government, further reducing the promised replacement rate from 60%

to 55%. At the same time, the reform proposal suggests that the normal retirement age shall be raised

from 60 to ultimately 65 and that contribution rate shall be raised to above 16% by 2025.

These parametric reform measures, without which the system was projected to run deficit by

2047, seem to be unavoidable to improve the long-term sustainability of the National Pension system.

Nevertheless, major negative changes to a public scheme that has not started paying full pension yet

should have undermined the credibility of the public pension scheme, which may lead to a high rate

of system evasion and illegal non-contribution (Phang 2004; World Bank 2000). The scheduled

increase in contribution rates would also make the incentives to stay out of the system stronger

especially among the low-income class of workers.

Being a partially funded system and in its early accumulation stage the NPS will continue to run

surpluses and keep accumulating reserves for the next 30 years or so. Even under the current

contribution rates, the NPS reserves, according to the World Bank projection, will accumulate up to

50% (100% under future increased rate) of the GDP by around 2040. While the NPS fund is

managed and invested by a government agency, National Pension Corporation, the important

question from the perspective of aggregate mandated savings and growth as well as for

intergenerational equity, is to what extent these surpluses will actually be invested productively in

the Korean economy. Apart from the issue of long term sustainability, the sheer size of the pension

fund accumulating would probably raise important questions about the role of the NPS in the capital

markets, corporate governance and potential conflicts of interests for the Government in its role as

institutional investor and the regulator of financial markets (World Bank 2000).

The SOP schemes are also suffering from serious under-funding. The Government

employee’s scheme has already turned deficit as of 1998 and is financially depleted in 2001.

The size of the under-funding is projected to be rapidly increasing over time. The SOP for

the military personnel is worse: the fund was depleted way ago in 1977 and has been

subsidized by the Government budget. The state of the SOP for the private school teachers

is a little better than the other two, but it is also projected to run deficit in 2012 and be

depleted in 2018 if the current scheme continues.

This severe financing problem inflicting the SOP schemes is mainly due to, among

others, initially an actuarially poor benefit-contribution design and failure to reform the

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system at the right time thereafter (Moon 2002). It is projected that, to meet the current

pension promises, the contribution rate should be raised eventually up to 30-35%, which

would entail an excessive financial burden to be imposed on the future generation and an

increasing government subsidy.

4. Provident Fund System in East Asian Countries

4.1. Malaysia: EPF

Malaysia’s Employee Provident Fund is a funded defined contribution scheme for private sector

employees. For civil servants unfunded defined benefit plan is arranged. The contribution rate for the

EPF is currently 23% (12% by employer and 11% by employee). Within the EPF there exists a

separate account for retirement savings (Account One) along with other accounts for housing

(Account Two) and for education and health (Account Three). These accounts, however, are only

nominal identification and withdrawals are allowed up to 40% of the accumulated fund.

The EPF accumulated a huge asset worth almost 50% of the GDP as of 2003. Investment

portfolio is centrally regulated by the government with a guaranteed minimum return rate set at 2.5%

p.a. While the domestic financial market in Malaysia is still under-developed, investment of the fund

for the best interest of the contributors should be necessarily restricted. The majority (70%) of the

fund is invested by government regulation and guidance in the MGS (Malaysian Government

Securities) for social and economic development, while investment in equities is limited to a

maximum 25% (Thillainathan 2004).

4.2 Singapore: CPF

Singapore, belonging to the high-income and rapidly ageing society, is unique in relying on

single mandatory savings scheme, Central Provident Fund (CPF), to finance retirement income

security for private-sector employees. The CPF is a multi-purpose fund with numerous schemes:

schemes for homeownership, health care, investment in properties, shares and commodities and

loans for education, etc. For government employees and civil servants Government Pension Fund is

arranged.

Contribution rate varies with age. For the main age-group (33-55) the total contribution rate is

fairly high at 33% (13% by employer; 20% by employee), whereas it is much lower for older aged

groups (18.5% for 55-60; 8.5% for 65 and older). About 58% of the total labor force is actively

contributing to the fund. The CPF has also accumulated a huge asset worth 62% of the GDP in

Singapore. The CPF is invested in non-marketable government securities with a guarantee of a

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nominal interest rate of 2.5% p.a.

Like in Malaysia’s EPF, CPF has also three separate accounts set up for different purposes:

Ordinary Account, Medisave Account, and Special Account. Individuals’ contributions are

distributed to different accounts by predetermined proportion, with the Ordinary Account taking the

most. Withdrawals are permitted within a limit. The ratio of withdrawals to contributions over the

period, 1987-2002, was about 79%, which indicates that less than a quarter of the total contributions

are available for retirement income purposes (Asher 2004).

4.3 Indonesia: JPF

Indonesia, like Malaysia and Singapore, has a provident fund system for private-sector

employees (Jamsostek Provident Fund: JPF). It is mandatory for workplaces with minimum 10

workers employed. JPF provide lump-sum payment upon normal retirement at age 55. Retirees may

choose annuity if their accumulated fund is more than Rp 3million. It is funded by employer (3.7%)

and employee (2%) contributions.

The rate of return for the fund is determined by the government (Ministry of Labor and

Transmigration). Currently the fund has accumulated an asset worth 1.3% of GDP, which is very

low when compared to the Provident Funds of Malaysia and Singapore. Independent pension

program for government employees is administered by PT Taspen (for civil servants) and PT Asabri

(for armed forces). Civil servants make a monthly contribution of 8% of the salary. Any shortfall in

benefit expenditure is met from government budget.

The Indonesian government has proposed a National Security System in 2004 to integrate the

fragmented multiple social security programs (provident fund, health maintenance, life insurance,

work-accident protection) under one unified system. But it is pointed out that the proposal needs to

be further developed and that clear transitional rules need to be specified for each scheme to be

included under the unified system (Rachmatarwata 2004).

4.4 Hong Kong: MPF

Hong Kong has the second highest percentage of old people in Asia after Japan. With

exceptionally low fertility rate (1.2) and long life-expectancy (80), the dependency ratio is expected

to roughly triple between year 2000 and 2050. But there was no mandatory scheme of old age

income protection in Hong Kong before the Mandatory Provident Fund (MPF) schemes ordinance

was enacted in 1995. Hong Kong instead relied on the Social Security Allowance Scheme (SSAS)

and the Comprehensive Social Security Assistance (CSSA) scheme for the zero-pillar public

assistance. The SSAS provides a non-means-tested flat-rate allowances for all elderly individuals

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(aged 65 and over) and the CSSA is a means-tested scheme designed to assist the income of elderly

individuals and others in need. The two social safety-net schemes are mutually exclusive (Chi 2004).

The MPF scheme, in its operation, is quite different from the government-run central provident

funds. It is by design a defined contribution plan that is privately managed for an exclusive purpose

of retirement income security. Both the employer and employee contribute 5% of payroll. The MPF

covers all employees and the self-employed between the age of 18 and 65. As of year 2003, about

63% of the working population has joined the MPF scheme. Compliance rates among the employer

and the self-employed were reported to be reasonably high (above 85%).

4.5 Other Countries

The Philippines, thanks to its colonial past, is one of a few South East Asian countries which

incorporate social insurance principle to provide social security benefits for the general population.

The Social Security System (SSS) set up in 1954 and the Government Service Insurance System

(GSIS) set up in 1936 are partially funded PAYG systems that administer retirement, death, and

disability programs for private sector employees and for public sector employees respectively.

Thailand’s Social Security Act introduced in 1990 purports to provide social security protections

against social risks (sickness, maternity, invalidity, and death) for the general public. But its impact,

so far, is very limited as the proportion of active contributors to the system had been very low

(around 10% of the total labor force as of 1993). Only about 20% of the labor force is reportedly

covered by the retirement pension program introduced in 1999. The social security programs are

financed on a tripartite basis, with the employer, employee, and government, each sharing an equal

share of 1.5% of wages for a total 4.5% up to a ceiling. The self-employed were included into the

system lately in 1995 and pay their own premium with a matching contribution from the government.

5. Evaluations and Future Challenges

5.1 The Provident Fund System of the Southeast Asian countries

The provident pension systems in South East Asian countries can provide only a limited security

for retirement income. There is a strong and persistent tendency observed with the provident fund

systems in Malaysia, Singapore and Indonesia that people withdraw a substantial portion of their

accumulated fund for consumption during their working life and thus under-save for retirement

income.

For example, during 1994-1997, about 80% of the withdrawals from the CPF in Singapore were

pre-retirement withdrawals and the median balance was estimated to be only around two years of

15

mean wage (Asher 2004). It is now well recognized that the CPF system even with it high

contribution rate (30%) is unlikely to meet the retirement income needs of a significant portion of

the population. The situation with other provident funds in Malaysia and Indonesia is not any better

than the CPF in Singapore (James and Vittas 1996).

There could be also longevity risks embedded in the way these provident funds disburse benefits

at the end of the working life. The general practice in the provident fund systems is lump-sum

payments of retirement benefits as annuity markets are not sufficiently developed nor well taken by

the general public. Then the funds could not provide due protection against the risk of outliving one’

income (ILO 2000). This risk is particularly challenging for many of the Asian countries where

people’s life-expectancies and thus post-retirement period will be significantly extended over a short

period of time.

For any pre-funded retirement system, the investment policies and performance are of crucial

importance. For the best interest of the contributors, the funds for retirement income should be

invested in a prudent yet remunerative manner. In the provident fund systems currently operating in

Asian countries, the government determines the use of the funds and sets the rate of return. Under

that centralized management of the funds it is highly probable that political considerations should be

involved in setting up investment portfolios and performances. Nevertheless, investment risks are

still borne by individual participants. The result would be low returns and a low public confidence in

the system. In addition under-developed domestic financial markets have constrained optimal

management of pension funds and resulted in a lower return to the fund than would have been

possible otherwise. The national provident fund system need to be reformed in the direction that

could provide more options for members to choose in allocating and investing their balances (Asher,

2000b).

5.2 The Public and Private Pension Systems of the East Asian Countries

The most obvious and apparent problem with social security or public pension systems in East

Asian countries is the system’s very limited and incomplete coverage of the population and

workforce. In many Asian countries a large proportion of employment in small enterprises or in

informal sector is not covered by mandatory retirement pension plans (ILO 2000:499-514). China’s

public pension is among the most limited in its effective coverage. Leaving aside the rural

population and the self-employed that comprise more than 70% of the population, only 46% of the

urban labor force is covered by the system (Chen 2004). It is practically limited to the employees of

the state-owned enterprises (SOEs).

The problem of very limited coverage is, however, more serious in many of the Southeast Asian

countries. For instance, in Indonesia only about 10% of the population or around 20% of the labor

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force is covered by any public provident fund or pension plan (Rachmatarwata 2004). In Thailand

active contributors to the Social Security schemes (sickness, maternity, invalidity, and death

benefits) are only 10% of the total labor force, while about 20% of the labor force is covered by the

Old-Age Pension Fund newly introduced in 1999 (Kanjanaphoomin 2004). The majority of the

workers in the large informal sector in those countries are not covered by or not actively

participating in the formal retirement income system.

The problem of non- or limited coverage of the private sector employees and the self-employed

people are particularly acute considering that the majority of them are employed in small enterprises

or engaged in subsistence-level small businesses and that they are the most vulnerable to the risk of

old-age poverty. The expansion of the pension coverage in the Asian countries will be dependent, in

large part, on the growth of wage employment in the formal sector.

What matters is not only a formal coverage. Effective coverage and active contribution of the

covered members also matter a lot for a national pension system to be financially healthy and

system-effective. But in many East Asian countries pension systems are suffering from high rates of

system evasion and low rates of active participation. For instance, the formal coverage of the Korean

National Pension is universal but its active participation is considerably low because of high rates of

non-contribution among those working in small businesses. More than 40% of the self-employed,

even though they are formally covered, are reportedly not contributing to the system for various

reasons (e.g., no income, unemployed, out-of-business, etc.). Large scale under-report of income by

the self-employed, while employed workers’ wages are payroll-taxed, is another serious problem

undermining the National Pension’s prescribed policy of social equity (Phang 2004).

In Japan, the National Pension Insurance for the self-employed is heavily cross-subsidized by

the Employee Pension Fund for the employed workers. The cross-subsidization between the public

pension programs occur because the cost for the basic pension is shared by the NPI and EPI and the

share is based on the number of contributors instead of beneficiaries. As the active contribution rate

among the self-employed is much lower than that among the employed workers, it is argued that

salaried workers will keep supporting the self-employed for their old-age income security (Tajika

2002).

Another important issue that could be raised with the current retirement income systems in the

region is that the target replacement rate of the public pension system was set too high and, after a

few decades of running, the system is now faced with a serious future funding problem. It is exactly

the case with Japan, Korea and China. Their public pension system started with an overly generous

pension promises and those promises, in the face of rapid ageing and macro-economic reform, are

not to be kept or considerably cut down in the future. Intergenerational inequity will remain as a

serious pending issue for a long time.

Retirement income systems in East Asian countries need to be developed in the direction that

17

public and private pension schemes become more integrated and balanced. In one part of the region

(East Asian countries), the social security pension based on social risk pooling is designed to be too

generous and, in many times, too costly to maintain, leaving not much room for the private pension

to step in and share the role (e.g., Korea, China). In other part of the region (Southeast Asian

countries), mandatory savings scheme based on individual accounts replaces the social security

scheme with social risk pooling being totally ignored (i.e., national provident fund systems). In an

ideal multi-pillar system old-age income security would be achieved in a balanced role-sharing

between the public (equity) and private (efficacy) pensions.

Lastly population ageing will be affecting East Asian countries in a rapid way during the first

part of 21st century. Japan has already entered a hyper-aged society with her old-age population over

23% in 2000. In 20-30 years ahead, China and South Korea are projected to enter an aged society

with 20-25% of their population being over age 60. Hong Kong and Singapore are in a similar

situation with their old-age dependency ratios being expected to go over 30% by 2025 and 50% by

2050. Such a rapid ageing of population will pose a serious challenge to the pension systems in those

countries in terms of long-term financial sustainability. Without a properly designed and well-

managed old-age income security system, it would be very difficult for East Asian countries to cope

with the coming old-age challenges (McCarthy and Zheng 1996).

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