A REFORM PROPOSAL FOR VIETNAM PENSION SYSTEM: THE PUBLIC PENSIONS EXPERIENCE FROM THE REPUBLIC OF KOREA45493

A REFORM PROPOSAL FOR VIETNAM PENSION SYSTEM: THE PUBLIC PENSIONS - EXPERIENCE FROM THE REPUBLIC OF KOREA Phuong To Lan 1 *, You Mi Lee 2 , Ngoc Hoang Bao 1 1 Vietnam National University

A REFORM PROPOSAL FOR VIETNAM PENSION SYSTEM: THE PUBLIC

PENSIONS - EXPERIENCE FROM THE REPUBLIC OF KOREA

Phuong To Lan 1 *, You Mi Lee 2 , Ngoc Hoang Bao 1

1 Vietnam National University

ABSTRACT

With declining birth rates and increasing life expectancy, the Vietnamese

population is expected to age rapidly, making building a modern social insurance

system in Vietnam a top priority urgency The current social insurance system

faces many challenges, such as low coverage in both formal and informal sectors,

inequality between groups participating in insurance, and lack of financial

sustainability main, and weak management and implementation capacity of

insurance programs Innovation is needed to expand coverage, encourage

equality, enhance financial sustainability, and modernize social insurance

management to ensure income security for the ageing population of Vietnam

in the coming decades This paper addresses Vietnam’s pension system in

the context of an ageing population with some key challenges in retirement

policy in Vietnam and presents policy options to address these challenges from

retirement management experience from Korea The article begins with an

overview of the current pension system, describing the main features of the

system Next, the author will present major challenges and propose possible

measures to strengthen and strengthen the pension system in the future

Keywords: Pension, Pension Fund, PAYG, The pension system in Korea, Public

Pension, Pension model in Korea…

1 INTRODUCTION

The change in population structure, in particular, the ageing of the population, has a

great impact on the economic and social activities of countries, regions and the world

The proportion of elderly people in the total population has increased rapidly due

to declining birth rates and increased life expectancy The ageing of the population

requires national governments to spend more on pensions, health care, medical

services and thus affect government budgets, pension funds and the sustainability

of the financial system

* Corresponding author

Email address: phuongtl@vnu.edu.vn

The problem of the ageing population becomes serious when considering the PAYG (pay as you go) pension system with a predetermined benefit level Many recent studies by scholars such as (Hagemann, R and Nicolleti, G., 1989), (Auerbach, A

et al, 1989), (Holzmann, R., 1998), and (Holzmann, R et al, 2001) have shown that these two factors have a negative impact on the financial stability of pension funds in particular and the state budget in general in most countries around the world

In addition to being a possible cause of financial instability, the PAYG system with

a predetermined benefit level also causes inequity between generations If the proportion of the elderly population in the society increases rapidly, this problem may become more serious because the generation of future workers must contribute more to cover the costs of those who are currently enjoying benefits from the pension fund Therefore, this system is likely to collapse due to problems such as evasion

of insurance, high levels of welfare and large potential pension debt These issues have been addressed in studies conducted by such scholars as (Gokhale, J., 1996), (Feldstein, M., 1998), (Kotlikoff, L, J and Leibfritz, W., 1998), (Takayama, N et al, 1998), and (Kunieda, S., 2002)

Vietnam has begun to reach an age of the ageing population and will face similar problems arising from ageing populations like other countries today Thanks to impressive economic growth and social progress, the improved living standards of the Vietnamese people have led to a rapidly increasing life expectancy, from 40.2 years in 1950 to 64.8 and 69,2 and 76,25 in 1990 and 2001 and 2016; and the birth rate decreased from 6 children / 1 woman in 1960 to 3.4, 2.33 and 1.73 respectively

in 1990 and 2001 and 2017 (General Statistics Office, 2018) According to the UN population projection (2002) for Vietnam, by 2050, the population aged 60 and over will account for 24% of the total population; and the percentage of elderly dependents will be 42% Besides, the PAYG pension system has a predetermined level of welfare that is currently managed by the state of Vietnam, often in a financially unstable condition due to the limited number of participants, low contribution rate while the replacement rate is quite high A recent statistical assessment of Vietnam’s social insurance system shows that the insurance fund will run out in 2030 if Vietnam does not implement the reform for this system This is the risk for the Vietnamese pension system soon The paper begins with an overview of the current insurance system in Vietnam, describing the main features of the system Next, the authors will present major challenges and propose possible measures to strengthen the pension system in Vietnam in the future Finally, the authors will share the experiences in the public pension system in Korea and discuss some implications in Vietnam

2 VIETNAM PENSION SYSTEM: CURRENT SITUATION AND CHALLENGES

A fairly bleak outlook is that Vietnam will grow old before becoming rich With

declining fertility and increasing life expectancy, the Vietnamese population is expected to age rapidly Vietnam is facing a significant challenge: The ageing population is still ahead, with the proportion of the population aged 60 and older will increase from 10% today to nearly 35% by 2050 Meanwhile, the proportion of the young population will be scaled down It is, therefore, necessary to design a strong

financial system and with long-term funding strategy and institutional arrangements for good governance and governance

With these trends, building a modern insurance system is a top priority for Vietnam

Vietnam has adopted a system of compulsory social insurance for formal sector employees since 1995 The Social Insurance Law enacted in 2006 has brought about significant changes in the calculation of retirement benefit payments, pension adjustments, and contribution rates The law also defines the rules for implementing

a voluntary insurance system and an unemployment insurance program However, despite these advances, the population’s coverage is still limited, and there are concerns about the financial sustainability of the system and equity The provision

of social insurance also needs to be modernized To address these challenges, policymakers will need evidence-based input data and policy debates that require good information and financial management systems The management of the modern information and finance system of a well-functioning Social Insurance system is important not only for proper governance and administration but also for the innovation process itself

The pension system is part of the Vietnamese social insurance system, which began

operating in 1962 Before 1995, the retirement system was a predetermined benefit system with the participation of public sector workers This system is managed by many authorities under the general supervision of the government In that system, the level of the retirement benefit is determined based on the number of years of contribution and basic income (usually the salary at the time of retirement) The benefits are paid from the social insurance fund made up of employers’ contributions (part of the salary fund) and from government subsidies The insurance fund is managed and sponsored by the government and is part of the state budget Given the complexity and difficulties arising from administrative and financial management, along with the rapid growth of the private economic sector, has led the government

to reform that system into a pension system named PAYG with a predetermined benefit level in 1995 as well as established the Vietnam Social Insurance (VSI) at the same time to manage the system under government sponsorship

Main features and shortcomings of the system Current retirement system participation

is compulsory for the following subjects: Labor in the public sector, including those working in government, Party organizations and armed forces; Labor working in state-owned enterprises (SOEs); Private enterprises have more than 10 employees, including foreign enterprises, representatives of foreign enterprises, enterprises operating in industrial parks and export processing zones, and international organizations

Besides, Vietnamese people working abroad or foreigners working in Vietnam can participate in the voluntary insurance system However, the system participation rate is very low because the number of participants is mainly from the state sector, especially state-owned enterprises, and only very few people participate in the voluntary insurance system According to Vietnam Social Insurance statistics, in 2018 the system participation rate for the public sector is about 92% for civil servants and 89% for workers working in state-owned enterprises The number of employees in the state sector participating in the system accounted for 84%, while the private

sector accounted for only 16% Pension is paid to men and women at the age of

60 and 55 respectively, with at least 20 years of contribution The pension level is adjusted according to the basic (or minimum) wage and must be at least equal to the minimum basic wage

In the current pension system, there are two types of beneficiaries, those of the system before 1995 and those of the system after 1995 Those of the previous system are paid for using the state budget, while those in the latter system are covered by the Vietnam Social Insurance The Vietnam Social Insurance is responsible for paying the entire number of beneficiaries of both systems and then it receives payments from the government through the Ministry of Finance (MoF) Besides, the dependency ratio

of the system (also known as the system’s population rate) in 2018 is only 13.64%, indicating that the number of beneficiaries is only 13.64% of the contributors This also shows the fledgling of the system Therefore, the system’s PAYG cost ratio is calculated by taking the replacement rate multiplied by the system’s population rate

of only about 3%, implying that the total payment of this system only equal to 3% of the total contribution This rate is also known as a sustainable contribution rate, the rate of contribution to balance the retirement fund

The total revenue of the system is only about 28% of nominal GDP in 2018 due to low wages, low participation rates, and the high rate of insurance premium evasion, especially in the private sector Revenue sources of the system include contributions from employees and employers, government’s support, investment income, and other sources Contributions to the social insurance system include 5% of the employee’s monthly salary and this amount is used to pay pension for, death and burial allowance; and 15% of the employer ‘s salary fund, of which 10% is for long term payments, such as pension, and the remaining 5% is for short term payments, such as sickness or maternity leave Government payments and support include payments for people under the system before 1995 and support the operational costs of the system such as cost for human resource training, building facilities In fact, in the context of limited financial instruments and financial assets in Vietnam, the social insurance fund’s investments are focused primarily on safe forms but very low-interest

Figure 1 Number of retirees in the system after 1995

Just as the nature of the PAYG system has a predetermined benefit level shows that the contribution and benefit of the Vietnamese pension system are currently incompatible with the number of beneficiaries of the system before 1995.

Figure 2 Number of retirees in the system before 1995

Source Ministry of Labor, War Invalids, & Social Welfare

As the nature of the PAYG system has a predetermined level of benefits, the contributions and benefits of the current pension system in Vietnam are not compatible with each other, so the pension fund may be exhausted in the future The financial instability of the pension fund is more evident in the context of a large number of people being allowed to retire early (which was once considered a way to solve the redundant labor

in enterprises state-owned enterprises) and an ageing population is predictable According to the report (Ministry of Labor, War Invalids and Social Welfare, 2016), the average retirement age is nearly 4.5 years lower than the prescribed; 57% of current retirees retired early, and 12% of current retirees retired under the age of 45 (Figure 3) This suggests that the retirement time of these people will be longer as their life expectancy increases, and thus the amount of money to pay for their retirement will increase rapidly in the future when the benefits are still indexed minimum wage this salary must naturally increase over time as the cost of living is higher

Figure 3 Population dependency ratio of Vietnam, 2000-2050

Source: United Nations Population Forecast (2012)

Management and legal framework of the system Since 1995, Vietnam Social Insurance has been responsible for performing the short-term and long-term functions that previously belonged to the Vietnam General Confederation of Labor and Ministry of Labor, War Invalids & Social Welfare Vietnam Social Insurance is organized vertically and it has branches at the district level, and local branches are responsible for both revenue and expenditure The decentralization of management in this form has increased the efficiency of manageing the number of participants in the system by updating information on the local labor situation However, this form also leads to an increase in administrative costs and can lead to negative issues such as corruption

or wrongdoing Moreover, the management cooperation between Vietnam Social Insurance and other ministries, especially the Ministry of Planning & Investment, with the function of managing various types of enterprises in the country, has not yet been effective As a result, the evasion of social insurance is still common, especially

in the private sector Along with management issues, tax regulations for the social insurance system and other types of security savings also make the problem of insurance evasion more serious For example, employer and employee contributions and benefits received from the pension system do not have to pay any income taxes, while contributions to the pension system Social security is not exempt This makes businesses find ways to evade social insurance such as reducing the number

of employees in the enterprise, signing short-term labor contracts with regular (or long-term) employees

System challenges: From a social and economic perspective, we can see that the

Vietnamese pension system faces two challenges

Financial sustainability

At first glance, the accumulated accumulation of social insurance in Vietnam makes the system seem quite financially strong In 2010, VSS accumulated a reserve of

US $ 5.78 billion, equivalent to 5% of GDP A large number of reserves results from

a relatively small number of beneficiaries compared to the number of contributors This is because:

(i) The program was only established in 1995;

(ii) The majority of Vietnam’s workforce is very young;

(iii) Requires 20 years of work to be paid

Retirement reduces the number of pensioners among current seniors VSS receives money from the general budget to support payment of allowances to public sector employees who retired before 1995

However, despite the large reserves of Vietnam’s pension system, it is not financially sustainable in the long run The current value of the properties of Vietnam Social Insurance is lower than the present value of payment obligations of Vietnam Social Insurance This is due to:

(i) The rapid decline in fertility and the forecasting of Vietnam’s ageing population will greatly increase the dependency ratio of the system defined as the number

of beneficiaries Per contributor from its current value of 0.11 (excluding retirees before 1995) to around 0.50 by 2050;

(ii) The low retirement age (average 54.3 years of age) compared to life expectancy;(iii) Relatively high income allowances reflecting the high rates of benefit accrued from each year of employment, especially for women and public sector workers Moreover, VSS’s interest rate is lower than the inflation rate This issue will be discussed in more detail below.

Figure 4 Retirement funds are not financially sustainable in the long run

Source ILSSA, 2009

The average retirement age is low

Vietnamese workers retire early compared to life expectancy Because Vietnamese people live longer, their time to receive pensions will be relatively longer than in other Asian countries Early retirement is quite common in the public sector, with women

on average retiring at age 51 and men Gender is 54 As a result, a longer pension period puts pressure on the system

Figure 5 Vietnamese workers retire early and there is a big gap between life expectancy

and retirement age

Source Vietnamese Women’s retirement age Gender equality and sustainability of Social

Insurance Fund, World Bank, 2009

Pension payment increased

In a country where workers’ incomes are rising rapidly, adjusting pension income to the rate of increase of minimum wages (public sector wages) is putting enormous pressure on pay and ability to pay Future payment of the system This trend is even clearer when there has been an attempt to unify minimum wages between the domestic and foreign-invested sectors, as required by WTO accession However, the pessimistic scenario and the results are shown below may be delayed if some policy changes are made An example of a policy change is a pension change at a rate lower than the wage increase

Figure 6 Position of Vietnam’s pension fund if pension is adjusted based on CPI

Pension system - Basic situation

Source ILSSA, 2009

The pension is high compared to the salary of the insured The maximum rate of pension benefits up to 75% of the current salary of social insurance in Vietnam is not affordable according to international standards Men who retire after 30 years of work and women who retire after 25 years of work will receive up to 75% of the salary used to calculate benefits Because public sector wages are expressed relative to the minimum wage, pension benefits are close to the final salary before retirement

As the green seamless line in Figure 4 shows, employees with more than 20 years

of insurance benefit are more generous than their contributions The important implication is that unless the return on investment of the pension fund is higher than the savings interest rate, the current pension system is financially imbalanced However, the return on investment from pension funds is not and will not be high enough (or in other cases, they will be too risky because the expected high return has

a positive relationship with high risk) to pay for that benefit level

Similarly, setting a minimum retirement pension to be the minimum wage will cause financial sustainability problems Insurance contributors are based on a minimum wage but are entitled to a pension equal to a higher minimum wage than a formula-based pension For example, workers who have paid for the minimum wage for 20 years will receive 55% (or 60% for women) of the minimum wage when they reach retirement age By law, they are guaranteed a pension equal to 100% of the minimum

wage The fact that reporting inadequate wages will result in a large number of people receiving minimum pensions and in the future will cause financial sustainability.

Lack of VSS investment and long-term payment strategy

VSS’s current low return on investment reflects a too risky investment strategy As mentioned above, Vietnam has accumulated a considerable pension reserve fund, totalling nearly US $ 5.78 billion in 2010 Currently, VSS management is not diversified and its portfolio is large Include only fixed-income assets This investment strategy

is less risky but offers a low rate of return, sometimes lower than inflation

Figure 7 Investment profits of VSS are still lower and lower than GDP growth and inflation

Profits of investment fund of VSS, 2003-2010 Source The author calculated according to the data of VSS

Moreover, the capacity to invest funds in VSS is limited It seems that the fund will not meet its future mission/ability if VSS’s investment objectives are not clearly set and if the investment process is not in progress Although the Social Insurance Law 2006 allows VSS management more autonomy and flexibility in developing investment policies and portfolio expansion, VSS funds need to have a clear change direction and stronger investment management capacity to improve fund management implementation

It is not clear who the true owner of the fund’s assets is, as reflected in reporting responsibilities VSS is under the supervision of the Management Council, headed

by the Minister of Finance This structure recognizes that the State is ultimately the guarantor of retirement rights However, creating this mechanism still does not solve the existing conflict of interest

VSS and the Government As a manager of the insured’s contribution, VSS needs

to find a way to implement the most profitable investment strategy In contrast, the government’s concern is to obtain funds at the lowest cost From this perspective, the surplus of insurance contributions is a tax that provides for the budget and can sustain growth Insurance insurers in Vietnam believe that they are assured of their future pensions by the Government so they feel no need to be bothered and there

is no need for information on VSS activities The uncertainty about who is the real owner of the fund and its ability to pay in the future is probably the reason why VSS

funds are only responsible for reporting to the Management Board and a number

of Government agencies (Ministry of Finance, the Ministry of Labor, War Invalids, & Social Welfare, the National Assembly and the Government Inspectorate) if required, without reporting to its members who contribute to the fund

Figure 8 The current reporting relationship shows the accountability of

VSS to the govern ment

Fair

There is inequality between the participating groups and the Vietnamese pension system is far from the insurance standard In an equitable retirement pension system, participants’ pension benefits are closely linked to the time and amount of contributions and the average life expectancy of the insured at the time they retire This principle applies regardless of gender and / or region (public and private) where the insured works However, in Vietnam, pension benefits vary by gender and region

in a few ways

Figure 9 Compared to the statistic benchmark insurance line, the system’s pension is very

unfair

Source World Bank, Vietnam Development Report 2012

There are gender differences, female workers have better benefits than their male counterparts

Employees in the public sector have better retirement benefits than sector peers As mentioned above, different principles apply to calculate pensions, averageing the last 10-year salaries for the public sector, compared to the private sector lifetime average For private-sector workers, historical wages are calculated by using changes in the consumer price index For public sector employees, historical wages are expressed relative to the minimum wage for the purpose of calculating benefits at the time of benefit Looking at the Figure below, we see that the system benefits vary greatly between the public and private sectors, far from the market benchmark or the case of high insurance premiums.

private-As discussed above, women receive 3% of their salary each year after 15 years of service, compared to 2% for men Moreover, women enjoy retirement benefits five years earlier than men Because women’s average life expectancy is higher than men’s, they will on average benefit from the pension system for longer periods than men.The level and criteria for disability pensions offer little protection The right to a disability pension is very limited and pension benefits are lower than the retirement benefits for participants who can retire early Only women 45 years of age and older and men 50 years of age and older with 20 years of premium payment are entitled to

a disability pension if they lose 61% or more of their ability to work Pension benefits are calculated similarly to other pension benefits, but the pension as a percentage of the average pension of the pensioner is reduced by 1% for each year of retirement prior to the standard retirement year People with disabilities are at higher risk of poverty and require more help and medical care than others Reducing pension benefits and limiting disability pensions for the elderly are contrary to the state’s duty for social security to protect workers from income shocks and falling into poverty

Coverage

Although the pension system has grown rapidly over the past two decades, only a small percentage of the working population is enrolled in insurance An analysis of the Enterprise Census data shows that in 2005 the official sector employed about 6.2 million people (excluding public and military administration); 3.7 million (60%) are insured, 1.2 million (19%) work under short-term contracts and are not insured, and 1.3 million (21%) work in enterprises hide and pay social insurance premiums With the continuous development of the private sector since 2000, coverage has steadily increased About 9.4 million people registered in VSS in 2010 (including the Participation sector The level of participation in the compulsory insurance system

is low, in part because of the combination of evasion, policy design, and lack of awareness, and want income in the short term This low range of participation is not only due to the fact that evasion is quite common, as in many low-middle income countries, but also due to Farmers and self-employed people who are not required to

be insured still account for a large proportion of the Vietnamese workforce Unstable income, based on a regular salary, accounting for one-fifth of the labour population.9 Moreover, enterprises with fewer than 10 workers are not legally registered with the tax authorities and may have a wrong opinion thinking that they are also exempt from registering the number of employees in their enterprises with VSS.10

The widespread use of short-term labour contracts also limits the coverage of the