The decline of the traditional pension : a comparative study of threats to retirement security

The Reality of the Retirement Crisis

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The pension contract tends to be particular to a nation and is culture-laden, 2 and the social institutional contexts influence accounting for pensions. For each jurisdiction, the genesis, social context and institutional pension rules are linked to the accounting regulations in the context of the incidence of investment, bankruptcy and longevity risk. Accounting records the pension transaction and reflects the investment, bankruptcy and longevity risks, as the incidence of these differs between defined benefit and defined contribution arrangements.

Until recently, both South Korea and Australia arguably had limited need for IFRS pension accounting owing to the less significant role of traditional defined benefit plans, compared to other jurisdictions. This article reports a study in which pension disclosures for the top listed companies in Australia for the year immediately preceding the introduction of IFRS in Australia and for 3 years subsequent — , and for the top listed South Korean companies in were collected.

The financial reports of the top listed companies in South Korea were accessed using the TS — database. The genesis of retirement benefits in South Korea is in redundancy payments, rather than post-employment income.

Factors Affecting Retirement Security

Since , private sector employees have been offered mandatory retirement allowance plans RAP by employers under the Labor Standards Act. Tax laws in South Korea provide a significant incentive for employees to take a lump sum.

RAP may be internally funded, externally funded or both, with tax exemption up to certain limits for internal funding although these tax incentives are declining. Although there is no insurance protection plan, retirement insurance assets are protected as part of a general deposit plan.

Pensions crisis

Most retirement allowance benefits approximately 80 per cent are paid upon termination before retirement and are used for purposes other than directly providing retirement income. To this extent, RAP payouts resemble redundancy payments. During the s, economic growth created employment, and the resulting increase in household income made the introduction of the NPS possible. These benefits include a public pension, social health insurance, unemployment compensation and industrial accident insurance.

The NPS provides for a target pension of 60 per cent of final salary for the average worker with 40 years in the system with a normal retirement age of 60, and a funded system with a 9 per cent contribution rate split equally between employers and employees. The public sector pension schemes are strongly supported by policy makers because they are a source of investment capital for government economic projects.

The NPS is an essential component of the social safety net, but it currently faces questions as to its long-term sustainability. This imbalance between high benefits and low contributions weakens the NPS, despite the fact that its coverage has broadened over the years.

Although South Korea is the tenth largest economy in the world, it has only recently introduced an occupational pension system focused on providing an income stream after retirement as distinct from a redundancy payout. Traditional defined benefit and defined contribution plans were encouraged from 1 December as replacements for the RAP. Although ERSA may be regarded as limited legislation, its objective is to reform private sector occupational pensions by encouraging the substitution of RAP with defined contribution plans and defined benefit plans.

A related objective is to move away from lump sum payments and encourage the use of annuities as retirement income streams. However, the plans under ERSA require at least 50 per cent employee consent. In a highly unionised industry, this translates to majority approval by the union members for the defined benefit plans or defined contribution plans. Unions are opposed to these ERSA plans, especially defined contribution plans. The popularity of defined contribution plans is limited, as this type of plan is new to South Korea, 14 even though defined contribution plans offer the younger workforce portability.

It is likely that the balancing of investment and longevity risks, and the jostling of political interests between the unions and employers, will determine whether defined benefit plans or defined contribution plans dominate in South Korea. However, it is expected that the transition to ERSA will not occur until For more than years, superannuation schemes in Australia were generally defined benefit funds.

At the same time, some public sector superannuation funds were established, for example the Police Superannuation and Reward Fund in Therefore, coverage of pension benefits for the general Australian workforce was limited until the advent of award superannuation in the mids. As the union movement became involved in negotiating superannuation benefits for its members, the popularity of the defined contribution plans structure increased.

The National Wage case delivered a 3 per cent wage productivity increase through superannuation rather than direct wage increases. After compulsory superannuation was introduced in Australia, superannuation was regarded as a form of deferred pay. On the other hand, for the defined contribution plans, there is immediate vesting of benefits while the employer's risk ceases on termination of the labour services. Superannuation coverage of the general workforce in was To protect superannuation arrangements, the Government enacted superannuation-related legislation in Australia, setting out the duties of trustees, auditors and plan administrators, including the reporting requirements of superannuation plans.

Australia's institutional pension arrangements have shortcomings, namely, the lack of security for defined benefit arrangements if the employer becomes insolvent. In addition, the restricted membership of the early defined benefit plans in Australia spurred the introduction of many corporate defined contribution plans that increased workforce coverage, but also shifted the incidence of the investment risk from the employer to the member. This meant that in the presence of a pension deficit, it was possible to keep the pension liability off the sponsor's balance sheet. Conversely, in the event of a pension surplus, it was possible for the sponsor to take a contribution holiday and not necessarily disclose this fact.

In Australia, the sponsors of defined benefit plans are mostly top listed companies, and most firms in the sample have at least one defined contribution plan and one hybrid fund. In Australia, the total assets invested by superannuation funds have grown substantially since compulsory superannuation legislation in In Australia today, the business of superannuation is conducted primarily through defined contribution plans, although in economic terms the defined benefit plan and hybrid fund which is technically a defined benefit plan is still relevant.

But the varying social and institutional contexts of pensions across jurisdictions, for example South Korea and Australia, must be a factor in any comparison. One of the overarching objectives of accounting for pensions is to ensure that the incidence of investment, longevity and bankruptcy risks is accurately portrayed by the employer so that the actuarial position of the pension plan may be understood by users of the employer's financial accounts. Unlike the defined contribution plan, the employer accepts the investment risk in a defined benefit plan and is required to recognise the net pension position on its balance sheet.

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Year-to-year differences in the net pension position from one period to the next are taken to the profit and loss, potentially introducing market volatility. As a result, sponsors of defined benefit plans are concerned about the volatility of the profit and loss induced by the new pension accounting rules and the recognition of a net pension liability if the market is declining and the pension plan is in deficit.

On the other hand, the accounting for defined contribution plans by the employer is straightforward because the employer's obligation to the defined contribution plans is discharged once the contributions to the plan are paid as the investment risk resides with the member. Standard-setters overseas have addressed some of the complex accounting issues for accounting for defined benefit plans, although compromises have been made to reduce the volatility in the sponsor's profit and loss, and to limit the pension liability recognised by the sponsor in their balance sheet.

The corridor method smoothes the impact of market returns evident in actuarial gains and losses AGL , and alleviates concerns about volatility in the sponsor's profit and loss by allowing recognition of AGL outside a 10 per cent corridor if net cumulative unrecognised actuarial gains and losses exceed the greater of 10 per cent of the projected benefit obligation or 10 per cent of the fair value of plan assets.

Its arbitrary nature has been criticised. Since 1 January , Australian sponsors of defined benefit plans have been required to use accrual accounting and disclose the components of the pension expense such as normal cost, interest cost, actuarial gains, and losses and return on plan assets. This study finds that in Australia, the impact of IFRS on pension accounting for defined benefit plans was minimal in the employer's profit and loss owing to declining defined benefit plans expenses over the period and balance sheet owing to the net pension positions being, on average, close to zero.

On the other hand, the mean contribution expense for defined contribution plans as a proportion of firm profit before interest and tax is material that is, greater than 5—10 per cent of net profit over the period of the study. Further, many Australian companies in appeared to be unsure of the pension disclosure requirements for both defined benefit as well as defined contribution funds.

Similarly, the general finding reported by this study that South Korean companies to date are not opting for defined benefit plans as part of their corporate pension restructure from RAP will likely reduce the impact of IFRS for pension accounting, at least in the short term. In the long term, if South Korean companies follow the Japanese example and introduce defined benefit plans, the potential impact of pension accounting on the sponsor's balance sheet and profit and loss will likely increase.

On the other hand, it is not clear the extent to which defined contribution plans are being adopted by South Korean companies.

The history of pensions is longer in Australia than in South Korea. The accounting for the defined benefit plans by the sponsor is more problematic because the investment risk is retained by the sponsor and must be recorded in its financial accounts according to IAS Transferring a RAP to a defined benefit plan would require the sponsor to engage an actuary to calculate the accrued benefits and value the assets, and record the difference between plan assets and accrued benefits on the sponsor's balance sheet.

A review of the pension accounting practices of the top companies in Australia from pre-IFRS to shows a preference for defined contribution plans, even during profitable periods. Where defined contribution plans are the favoured option, financial literacy is an important policy consideration of governments to ensure the sustainability of pension systems, because the investment risk rests with the member.

Whether South Korean firms exhibit a preference for defined contribution plans over defined benefit plans as in Australia or a preference for defined benefit plans as in Japan depends on an assessment of the risks, including investment and longevity risks. If the RAP system is more easily replaced by defined benefit plans, then the more difficult accounting, disclosure and actuarial issues attached to defined benefit plans will be relevant to South Korean firms. If South Korean companies follow the Australian and current worldwide experience and favour defined contribution plans, the more difficult accounting and actuarial issues attached to defined benefit plans may be avoided.

Financial literacy is equally a concern for South Korean policy makers. Australian firms were not always uniform with their pension disclosures when converging with IFRS, and in some cases it took firms 1 or 2 years to understand the disclosure requirements, for example for the disclosure of actuarial assumptions.

Pension accounting research has policy implications for governments in South Korea and Australia. This is because pension reforms typically highlight first, the amount of contributions required to make the pension system sustainable into the future, and second, who bears the risks of the reforms. This creates policy challenges for governments with ageing populations, declining dependency ratios and declining asset values as a result of the recent global financial crisis.

One of the likely policy challenges for both the South Korean and Australian governments includes the trend towards defined contribution plans where the investment risk is borne by the member, who may be less equipped than the employer to bear this risk. Another policy challenge for the South Korean government may be to encourage large South Korean corporations to respond to the recent ERSA initiatives on a timely basis. Policy initiatives for the Australian government, given widespread defined contributions plans, should aim to improve the financial literacy of the general populations so that they may better handle the investment risk, and to legally enforce the defined benefit plan guarantee by the sponsor especially for the public sector.

South Korean companies may likely follow the Japanese in their reluctance to adopt defined contribution plans, despite their apparent public support. The results of this study will have policy implications as the urgencies of ageing populations, declining dependency ratios and falling asset prices take hold in both Australia and South Korea.

The substantial tensions in society with regard to the sharing of risks and benefits for pensions between the parties in an employment contract makes pension accounting an important issue for accounting standard-setters and policy makers. Accounting standard-setters need to be cognizant of the way the social and institutional contexts allocate the risks in providing for pensions, and of how this affects accounting for the pension transaction.

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First, whereas in the second tier myopia is prevented through a mandatory provision compelling all formal labor market participants to enroll in a private or occupational pension plan, the third tier is voluntary and encouraged through tax incentives, and thus relies on consumer sovereignty to overcome the problem of myopia.

Second, responsibility for status maintenance is borne by individual participants in the third tier; however, such a responsibility is shared between the individual and the state under the second tier, thereby ensuring an intermediate level of intervention. The sociopolitical and economic environment in Ghana makes the adoption of private sector solutions for retirement income security problematic for a number of reasons.

First, similar to most African countries, Ghana lacks financial market and instruments to hold pension fund. Even if the financial market required to hold pension funds exists, the rate of inflation in Ghana makes such an arrangement undesirable.

Second, consumer ignorance and lack of knowledge about the operations of the financial markets in relation to private pensions is a threat to the success of the scheme. Third, private pension scheme necessitates effective and efficient government regulation of financial markets if they exist to shelter consumers in areas too complicated for them to insulate themselves.

For all these reasons, the design of the first tier offers a better framework for the protection of pensioners, especially because it is mandatory, centralized, monopolistic, based on defined benefit principles, and pools assets in collective portfolio while ensuring intergenerational transfers.

Beyond this, the new pension system in Ghana suffers from two major weaknesses that have implications for income security of the aged. First, similar to previous schemes, the current three-tier pension system is biased in favor of formal labor market participants and largely reflects the interest of urban working class. In all the three tiers under the new arrangement, participants in the informal labor market are expected to contribute towards their retirement income security on voluntary basis.

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There are no mechanisms in Ghana's three-tier model to deal with the problem of myopia among informal sector workers. Yet, workers in this sector are the most vulnerable, especially because they are usually on low incomes or are self-employed, work in very small unregistered or household companies, and often, but not always, on a part-time basis in industries such as agriculture, construction and services. In most cases, these informal sector workers are unorganized and come from lower income and educated groups, where their knowledge and understanding of pensions is not only limited, but also their resources for long-term savings scarce.

For the most part, as workers in the informal sector in Ghana are among the poorest, wage-related pension programs 30 such as those embedded in the country's three-tier model do not serve the retirement income security needs of the category of citizens who practice their trade in this sector. Even if the problem of myopia is attacked through compulsory requirement as done for formal sector workers — given the pressing demands for food, clothing, housing, education and health — informal sector workers might not be able to give saving for future consumption a priority owing to demands on their resources.

Thus, asking informal sector workers to voluntarily save extra money for the distant future is practically not feasible. This issue is even more complicated given that life expectancy among informal sector workers is lower than those in the formal sector. Second, although NPRA is empowered to resolve all pension-related conflicts, there are no mechanisms to protect participants in the second and third tiers against market failures and or default by fund managers despite the fact that Ghanaians are compelled by statutory regulations to invest portions of their retirement income in private market through these tiers.

In the context of Ghana where market institutions are weak, rates of inflations are usually high and unpredictable, and probability of investor fraud is high, compelling citizens to invest retirement contributions in the private market without insulating them against the possibilities of adverse market conditions by way of guaranteed minimum benefits is a risky business. The lack of an effective mechanism to compel fund managers and other institutional intermediaries to provide benefits to participants in the second and third tiers irrespective of market conditions shifts the risks associated with market volatility to participants in these tiers.

In addition, although this is a problem of poor institutional design, it is by default a disincentive to fund managers, custodians and trustees to ensure prudential management of workers retirement contributions.

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