Report No. 25174-IR Islamic Republic of Iran The Pension System in Iran: Challenges and Opportunities (In Two Volumes) Volume II: Technical Appendix September 2003 Middle East and North Africa Social and Human Development Group (MNSHD) Document of the World Bank CURRENCYEQUIVALENTS Unit of Currency=Iranian Rhials (IR) Average Exchange Rate (IRper US Dollar) 1Dollar =7,500 Rhials BASICINDICATORS2001 GDP =IR 666,165billion (USD 88.9billion) GDPper capita =IR 10.4million (USD 1,396million) Population=63.9 million Labor Force = 17.1 million ACRONYMS AND ABBREVIATIONS cs Contractual Savings CSRO Civil ServantsRetirementOrganization DB Defined Benefit DC Defined Contributions FF Fully Funded FFYP First Five-Year Plan GDP GrossDomestic Product IA Individual Accounts MPO Managementand PlanningOrganization MENA Middle East andNorth Africa Region MNSHD Middle East andNorth Africa Human Development NDC Notional Defined Contributions NPF National Pension Fund OECD Organization for EconomicCooperation and Development PAYG Pay-As-You-Go SSIC Social SecurityInvestmentCompany sso Social SecurityOrganization USD United StatesDollars r Vice President: Jean Louis Sarbib CountryDirector: Joseph Saba SectorDirector: Jacques Baudouy SectorManager: George Schieber Acknowledgements This report has beenpreparedby a team ledby David Robalino and comprising Albert0 Musalem and Tatyana Bogomolova. It has beenpreparedinclose collaboration with the Managing and Planning Organization of Iran, and the technical teams of the Social Security Organization and the Civil Servants Retirement Organization. The report has benefited greatly from extensive comments provided by the peer reviewers Robert Palacios and Michal Rutkowski, as well as from Dr. Mehdi Karbasian, First Vice Minister of Finance. Remaining errors and omissions are the authors' responsibility. Data for international comparisons were compiled by Massimo Sabbatini and Cheikh Fall. The report is part of a series of studies on Social Protection requested by the Government o f the Islamic Republic of Iran. Tableof Contents A.1.A.lMETHODOLOGYOFFINANCIAL .1.INTRODUCTION TO PROSTPROJECTIONS ............................................................................................ .................................................................... 1 1 A.1.2. DEMOGRAPHIC ASSUMPTIONS ....................................................................................... 4 A.1.3. ECONOMIC ASSUMPTIONS .............................................................................................. 6 A.1.4. ASSUMPTIONSFORMODELING PENSIONSYSTEM CSRO ............................................ 9 A2 SUSTAINABLERATE OFRETURNONCONTRIBUTIONSPAIDBY A PAY-AS-YOU-GO . SYSTEM .................................................................................................................................. 25 A3 REPLACEMENTRATESINTHENOTIONAL . DEFINEDCONTRIBUTIONSYSTEM .................27 ListofFigures Figure 1. ChangesinFertility Rates.......................................................................................................... General CalculationScheme...................................................................................................... 2 Figure2. 4 Figure3 ChangesinMortality Rates........................................................................................................ 5 Figure4 Figure5 Figure6 .... LaborForceParticipationRatesby Age andGender................................................................. 78 PopulationPyramids.................................................................................................................. 6 TotalUnemploymentRates....................................................................................................... Figure7. 9 Figure8. UnemploymentRatesby Age andGender................................................................................. 10 ProjectedTotalNumber of Contributors (As Percent ofthe LaborForce)............................. DistributionofNew Contributorsby Age andGender............................................................ Contributorsby Age andGenderin2001(ThousandPersons) ............................................... Figure9 11 Figure 10 .. Figure 11 . 11 Wage Distriubtionby Age andGender (Percentageof 20 Year OldMale's Wage) ...............12 Figure 12. 13 NewOld Age Retirees as PercentofPreviousYear's Contributions...................................... Disabledby Age andGenderin2001...................................................................................... Old Age Pensionersby Age andGender in2001 .................................................................... Figure 13 13 Figure 14 14 Figure 15 NewDisabledas PercentofPreviousYear's Contributors...................................................... 14 Figure 16 Lengthof Service at at Retirement,Men................................................................................. 15 Figure 17 .....Lengthof Service at Retirement,Women................................................................................ 15 Figure 18. ProjectedNumberof Beneficiaries.......................................................................................... 15 Figure 19 Old Age PensionsDistributedby Age andGender (Percentof 50 Year Old OAP Benefit)...16 Figure20 ..16 Figure21 ReplacementRatesfor New Old Age Retirees(Percentof Average Wages) Women..........17 ReplacementRatesfor New Old Age Retirees (PercentofAverage Wages) Women..........17 Figure22 .. .. Disability PensionsDistributedby Age andGender(Percent of 50 Year Old OAP Benefit) Figure23. ReplacementRatesfor NewDisabled(Percent of Average Wage)......................................... 17 Figure24 ProjectedTotalNumber ofContributors(Percent of LaborForce)......................................... Contributorsby Age andGenderin2001(ThousandPersons) ............................................... 18 Figure25 19 Figure26 Wage Distributionby Age and Gender (Percentof 20 Year OldMale's Wage) .................... CoverageRatesby Age (Percent of Employed) ...................................................................... 20 Figure27 .... 20 Figure28. Figure29. NewOldAge Retireesas PercentofPreviousYear's Contributions...................................... Old Age Pensionersby Age andGender in2001 .................................................................... 21 22 Figure30 ProjectedNumberof Contributors........................................................................................... Figure31 .. Old Age PensionsDistributionby Age andGender (Percent 50 Year Old OAP'sBenefit) 24 ...23 Figure32 ReplacementRatesfor NewOldAge Retirees,Women............................................. ReplacementRatesfor NewOldAge Retirees, Men................................................ 24 Figure33 . 24 TechnicalAppendix A.l. Methodology ofFinancialProjections The financial projections presented in this report have been conducted using the Pension Reform Options Simulation Toolkit (PROST) model. This section describes the main features of the model and summarizes the set of assumptions used in the implementation of the simulations. The appendix i s organized in five sections. Section A.1.1 provides a short introduction to PROST. Section A.1.2 discusses demographic assumptions that apply to the financial projections o f both CSRO and SSO. Section A.1.3 is concernedwith macroeconomic assumptions. Sections A.1.4 andA.1.5 describe the data and assumptions used to model CSRO and SSO base case ("no-reform") scenarios respectively. A.l.l. Introductionto PROST PROST i s a computer-based pension model developed by the Social Protection Unit of the World Bank. The model is designed to simulate the behavior of pension systems and can assess their financial sustainability under different sets of assumptions over a long time frame. It allows to model different pension reform options - from "parametric" reforms of PAYG-defined benefit schemes to systemic reforms, such as introduction of fully funded defined contribution and/or notional defined contribution schemes. The program can be adapted to a wide range of country circumstances and can handle simulations up to 100 years and more. PROST i s programmed in visual basic, with input andoutput inExcel. The user provides country specific data on demographic, economic, and pension system related parameters and assumptions about their behavior in the future. This information i s entered inthe inputfile with six embedded worksheets: General Economic variables (GDP and wage growth, inflation, interest rate), non-age-specific pension system parameters (pension fund balance and benefit expenditures in the base year, retirement age, contribution rate, pension indexation rules, etc.) and some demographic variables. Population Base year population by age and gender along with age-specific fertility and mortality rates and immigrationinformation. Labor Age-specific and gender-specific labor force participation and unemployment rates as well as distribution o f wages and old age pensions across age and gender cohorts. Pension Age-specific and gender-specific information about pension system contributors, beneficiaries, coverage and retirement rates, 1 average years o f service at retirement, and replacement rates for new beneficiaries. Profiles Information on representative individuals, such as gender, career path, individual wages, life expectancy, etc. Reform Parameters relevant to systemic reforms to be simulated (any combination o f conventional PAYG, fully funded D C and notional DC pillars), including switching pattern, how the acquired rights will be paid, contribution rates, rules for annuitization and pension payout under D C schemes andreplacement rateshenefit formula in a PAYG pillar, indexation, etc. Inthe most simplified way the general calculation scheme can be presented as follows: Figure 1. General Calculation Scheme L L Population Labor market Contributors i \ IBeneficiaries PF revenues - PSEconomy parameters- PF expenditures PROST follows single age/gender cohorts over time and generates population projections, which, combined with labor market assumptions, are used to forecast future numbers o f contributors and beneficiaries. These inturn generate flows o f revenues and expenditures. The model then projects fiscal balances and calculates the implicit pension debt. The required contribution rates and affordable replacement rates for zero pension fund balance in each year o f the simulation period are also calculated. Finally, PROST produces outputs related to individuals - what an individual would contribute to the system and what he/she would get out o f it under PAYG DB and multipillar schemes. This allows bothintra- andinter-generational analysis. Depending on the characteristics o f the pension system and data availability, the user can choose the method for calculation o f some o f the variables. In particular, the number o f contributors and beneficiaries can be computed in either "Stock" or "Flow" method. With the "Stock" method, for each year the stocks o f contributorsheneficiaries 2 are calculated first and then inflows (new contributorsheneficiaries) are derived as the changes of the stocks: Inflow(a,t,s;) =stock(a,t,a) -stock(a-1,t-1,a) + outjlow(a,t,a) With the "Flow" method, inflows are calculated first and then stocks are derived as previous year's stocks in each age/gender cohort adjusted for the net inflow (inflow- outflow): Stock(a,t,a) =stock(a-1,t-1,s;)- outjlow(a,t,g) + inflow(a,t,g) where a =age, t = year, g =gender As PROST keeps track o f contribution years of service accrued by each cohort, the calculated number o f new retirees - whatever method i s used - is then adjusted so that the total length of service accruedby the cohort is equal to the total length of service claimed by the cohort at the time of retirement. After the number of new retirees i s adjusted, the stock i s recalculatedusingthe "Flow" method. The user can also choose how the benefit of new beneficiaries i s specified via - benefit formula or via age- and gender-specific replacement rates. Output produced by PROST is organized in five output modules. Each of the modules contains a number of Excel worksheets and a graphical summary on key output indicators: Population Projection Population projections and pyramids, life tables, life expectancy changes, population dependency rates, etc. Demographic Structure Labor force and employment projections, projections of contributors and beneficiaries, demographic structure of the pension system, and system dependency rates. Finances of Monopillar Macroeconomic trends, wage projections, pension benefit PAYG projections for the existing and new pensioners, revenue and expenditures of the pension system, required adjustments to contribution rates and replacement rates for zero current balance, and the implicit pension debt. Finances of Multipillar Pension benefit projections for new and existing pensioners System under each of the three pillars (conventional PAYG, notional PAYG, and funded DC), revenues and expenditures of both PAYG and funded pillars, implicit pension debt of the PAYG system after the reform, and results of the reform (compares benefit projections and financial standing under the monopillar PAYG and multipillar scenarios). 3 Individual accounts Lifetime contributions and benefits and individual related summary statistics for up to six different individuals specified inthe "Profiles" input sheet under PAYG system (statutory, with adjusted contribution rates and with adjusted benefits) and multipillar system (for those who switched to the multipillar system and those who remained inthe PAYGsystem). A.1.2. DemographicAssumptions All data requiredby PROST for population projections are obtained from the World BankPopulationprojections database: 0 Populationby age and gender in2000 as a base year population 0 Projections of fertility rates from 2000 to 2070 by age andperiod 0 Projections of survivorship probabilities from 2000 to 2070 by age, gender, and period (used for deriving age- and gender-specific mortality rates). As migration flows in Iran are negligibly small compared to the size of the population, net immigration is assumedto bezero inthe base case scenario. Inaccordancewith the above mentionedWorldBankpopulation projections for Iran, total fertility rate in the base case scenario is assumed to decline from 250 percent in 2001 (base year) to 212 percent over the next 10 years and then further decline - at a lower rate - to 207 percent by the end of the simulation period (2070). Assumptions regarding changes inage-specific fertility rates are presentedinFigure 2: Figure 2. Changes in Fertility Rates 1 14% I 12% 10% 0% 6% 4% 2Yo 0% - 2001 -2070 Source: PROST inputJIe for SSO. 4 Similar to the worldwide trends and based on the World Bank projections, mortality rates are assumed to be lower for females as compared to males, decreasing over time for both genders (Figure 3). Figure 3. Changes inMortality Rates 12% 2% 0% -=---Male, 2001- -- Male, 2070-Females,2001 - - -.Females,20701 ~ Source:PROST inputJIe for SSO. Based on the above assumptions, PROST demographic projections for Iran show increasing life expectancy at birth: by about 10 years for men and 20 years for women over the next 70 years. As a result, the difference between male and female life expectancies increases over time from 2 to 13 years which is close to what i s now normally observed aroundthe world. For more details see Table 1. 2001 2020 2040 2060 2070 Male 68.4 72.5 74.7 77.4 78.6 Female 70.8 76.9 81.1 88.0 91.8 Both genders 69.5 74.5 77.5 81.7 83.8 Due to the combined effect o f decreasing fertility and mortality rates, the Iranian population - which can currently be classified as "young" - i s projected to age pretty fast. Given the assumptions, PROST projects a steep rise inthe old age dependency rate (population over retirement age divided by population in age 15 to retirement age; retirement age = 55/60): from estimated 13 percent at the beginning to about 60 percent by the end of the simulationperiod. Population pyramids (Figure 4) illustrate the aging trend. 5 Figure4. PopulationPyramids I A.1.3. Economic Assumptions Assumptions with regard to the key macroeconomic input variables for SSO and CSRO base case scenarios can be summarized as follows: 0 In accordance with the Country Economic Memorandum 2002 prepared by the World Bank Iran Country Office, real GDP growth rate is fixed at 6 percent during the first 10 years o f the simulationperiod; then it is assumed to gradually go down to a new steady-state o f 3 percent by 2025 and remain constant thereafter. 0 Wage growth projections are based on the assumption that over the next 40 years the labor share o f GDP will grow from the current low level o f 25 percent to about 45-47 percent. To ensure that, labor productivity is assumed to grow at 4 percent (inreal terms) duringthe first 10 years; over the next 15 years its growth rate decreasesto 2.5 percent. 6 0 Analysis of all money values i s done inreal terms so inflation rate is assumed tobe zero. 0 Realinterest rate i s fixed at 5 percent throughout the whole simulation period. A more pessimistic short- to medium-term economic scenario is also examined for bothCSRO and SSO pension schemes: (1) Real GDP grows at 4 percent during the first 10 years (which is in-line with the current growthtrends inthe Iranian economy), drops to 3 percent by 2025 and remains constant throughout the rest ofthe simulation period. (2) Accordingly - to sustain the dynamics of the labor share inGDP similar to the base case scenario -productivity growth rate i s set at 3 percent inthe first 10 years, decreases to 2.5 percent by 2025. Age-specific and gender-specific labor force participation rates in the base year are derived from the 1996 census data on population and economically active population by five-year age groups andby gender (Iran Statistical Yearbook, 2000). Inthe future, it is assumed that male activity rates - which are already high, even compared to current OECD levels - will remain the same, at about 60 percent on average. As for female activity rates, the assumption i s that inthe longrunthe average labor force participation rate converges towards OECD levels: from a current low of 10-12 percent to about 35 percent by 2035 - and will remain stable thereafter. Figure 5 presents the current distribution o f the labor force participation rates by age and gender as well as the assumptions about their future changes. Figure 5. Labor Force Participation Rates by Age and Gender 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% I 1-Male LFPR,2001-2070 - FemaleLFPR,2001- FemaleLFPR, 2035-2070 1' Source: PROSToupoutfilefor SSO. 7 The total unemployment rate in Iran i s currently 15 percent (see MPO, 2000). Future changes in unemployment are estimated using a "Cobb-Douglas" production function to ensure consistency. where Q i s total output, A is total factor productivity, L is employed labor, and K is capital. Under the assumption that the average capital per worker i s constant, the growth rate o f employedlabor i s givenby: L, =(Q,-A,)/(l+ A,) where a dot over a variable denotes its growth rate. Total factor productivity i s assumed to grow at 2.4 percent inthe first 10 years in accordance with the Country Economic Memorandum 2002; it i s further assumed that its growth rate gradually slows down to about 1 percent. The estimated total employment growth rates together with the assumptions on labor force participation rates and demographic projections are then used to calculate total unemployment rates for each year of the simulationhorizon. Total unemployment rates estimated for the base case and pessimistic scenarios ("low case") are presentedon Figure 6. Figure 6. Total Unemployment Rates - - Base Case LOW Case 1 Source: Mission eafcufations. Age-specific and gender-specific unemployment rates for each year are then computed using the estimated total unemployment rates and the initial distribution o f the unemployment rates by age and gender. The latter i s derived from the 1996 census data on economically active population and unemployed by five-year age groups and by gender (Iran Statistical Yearbook, 2000) and assumed to remain invariable in the future. 8 Unemployment rates by age and gender and their changes over time in the base case scenario are showninFigure 7. Figure7. UnemploymentRatesbyAge andGender I ' 70% 60% 50% 40% I30% 20% 10% * I O% eJ 22 %? 4P 4?J 4 a 6 4 +? @ 4 2' 2% ~ I -Male Age Un, 2001 x Male Un, 2070 1- Female Un, 2001- -0-- .FemaleUn, 2070 Source: PROST outputfde for SSO. A.1.4. Assumptionsfor ModelingCSROPensionSystem The main source o f information on the current status of the CSRO pension system i s the CSRO database kindly provided by CSRO technical staff. The following general assumptions are made to modelthe system: 0 Inthe base case scenario, the total number o f contributors inthe CSRO pension scheme i s assumedto remainconstant over the first seven years and to increase by halfo f the population growthrate each year thereafter. Also, a scenario o f closing the system to new entrants (no new entrants allowed to join the system) is modeled. Onlythe pension-related components o fthe overall budget o fthe pensionfund are examined: (a) contributions to the pension system paid by employers and employees - on the revenue side; and (b) payments to old age pensioners, disabled and survivors, health insurance premiums for retirees, and administrative costs -on the expenditure side. 9 Contributors According to CSRO, currently there are about 1.6 million civil servants covered by the system. Information about the number of contributors by age and gender in a sample set of CSRO organizations is also available. The number of contributors in the sample is pretty high-about 63 percent of the CSRO total-so the sample data are used as abasis for estimating the initialdistribution of contributors byage andgender (Figure 8). Figure8. ContributorsbyAge and Gender in2001 (ThousandPersons) 40.0 r 35.0 30.0 25.0 20.0 15.0 10.0 , 5.0 0.0 -Men - Women Source:PROST inputfilefor CSRO. Changes inthe number of contributors by age and gender over time are modeled using the "Flow" method (see Section 1 for details). Since no data on the initial age and gender distribution of new contributors are available, the shape of this distribution was assumedto be similar to the one for the SSO pension system. However, the total share o f women is set to be much higher for CSRO than for SSO - at about 40 percent (compared to about 15 percent for SSO). It is further assumed that in the future this distribution remains invariable. Figure 9 presents the assumed distribution by age and gender of new contributorsjoining the system. Based on these assumptions, PROST projects the total number of contributors in CSRO to increase from the current 1.6 million to about 2.1 millionpersons by the end o f the simulation period. However, coverage rate in terms of the country labor force is projected to decline over the next 35 to 40 years and then stabilize at about 4 percent as shown on Figure 10. Assumptions regarding the distribution of wages across age and gender is derived from the CSRO data on the average wages by age and gender for the above mentioned sample of contributors. Once again, it is assumedthat the eaming profile inthe system as awhole is similar to the one inthe sample. The sample data havebeen smoothed, and it i s 10 further assumedthat the age andgender distributionofwages doesnot changeover time. See Figure 11for the assumedearningprofile for menandwomen. Figure9. Distributionof New ContributorsbyAge andGender 6.0% 5.0% 4.0% 3.0% 2.0% 1.O% 0.0% (-Men -Women 1 I Source:PROSTinpurplefor CSRO. Figure10. ProjectedTotalNumberof Contributors (As Percentof the Labor Force) 10.0% , i 4.0% I 3.0% 2.0% Years Source:Mission calculationsbased on PROSTprojectionsfor CSRO. 11 Figure11. Wage DistriubtionbyAge and Gender (Percentageof20 Year OldMale's Wage) 1- Men- Women 1 Source: PROST inputfilefor CSRO, Beneficiaries Three categories o f beneficiaries - the main ones in the CSRO pension system - are modeled: (1) old age pensioners, (2) disabled, and (3) survivors and orphans lumped together and counted as the number o f families receivingsurvivorship pensions. The total numberofthe old age pensioners anddisabled inthe base year (419.1 and 10.4 thousand persons respectively) and their initial distribution by age and gender (Figures 12 and 13) as well as the total number o f the survivors families (125.3 thousand) are obtained from the CSRO database. Similar to contributors, future changes in the number o f old age pensioners and disabled are modeled using the "Flow" method - via setting the number o f new retirees by age and gender as percentage o f previous year's contributors. Initial retirement probabilities for both categories are derived from the CSRO data on the number o f new old age pensioners and new disabled by age and gender and the assumed age and gender distribution o f contributors. Adjustments are made to simulate actual fluctuations in the absolute number o f new old age pensioners in the first two years. Starting in 2003, it i s assumed that the retirement pattern stabilizes and by the year 2015 there i s no new retirement after age 70. Figures 14 and 15 show the assumed future retirement probabilities for oldage retirees and disabled. 12 Figure 12. Old Age PensionersbyAge and Gender in 2001 16.0 14.0 BLd 12.0 In 10.0 8.0 6.0 Q 4.0 2.0 0.0 Source: CSROdatabase. Figure13. DisabledbyAge and Genderin2001 0.30 In g 0.25 5 0.20 0.05 0.oo ,- - Men Women L Source:CSROdatabase. 13 Figure 14. New OldAge Retireesas PercentofPreviousYear's Contributions I I 100% 80% 60% 40% 20% 0% Source: PROSTinputfilefor CSRO. Figure 15. New Disabledas Percentof PreviousYear's Contributors 0.4% 0.4% 0.3% 0.3% 0.2% 0.2% 0.1Yo 0.1% 0.0% 1 -Men -Women I Source:PROSTinputfilefor CSRO. As mentioned in Section 1, future numbers of new old age retirees calculated by PROST are also affected by length of service accrued by each cohort ineach year of the simulation period. For these calculations PROST uses input data and assumptions on the age- and gender-specific length of service at the moment of retirement. The required input data for the base year are derived using the data on entry pensions received bynew old age retirees in 2001 contained in the CSRO database and the annual accrual rate of 3.3 percent set by law. It i s further assumed that the base year distributions gradually 14 change as presented on Figures 16 (for men) and 17 (for women) by the year 2035 and remaininvariable thereafter. Figure 16. Length of Service at Figure 17. Length of Service at Retirement, M e n at Retirement, Women 35 30 B ::]=I E 25 ::20 0 L , 1-2001 -2035-2070 1 '-2M)l -2035-2070 The third beneficiary category - survivors - is modeled by assuming that the share o f the total number of families receiving survivorship pension in the total number o f CSRO contributors and beneficiaries remains constant throughout the simulation period(at about six percent). Based on the above assumptions, in the base case scenario PROST projects changes inthe number o f beneficiaries as shown on Figure 18. Figure 18. Projected Number of Beneficiaries 7 I 2,500 I Years 1W Old Age W Disabled F?9 Survivors 1 Source:PROSToutputfilefor CSRO. 15 The initial distribution o f pensions across old age pensioners and disabled o f different age and gender i s obtained by smoothing the CSRO data on age- and gender- specific average pensions received by current old age pensioners and disabled. As pensions are indexed to inflation, the older pensioners have lower pensions than the younger ones (Figures 19 and20). PROST calculates further changes inthe level o f benefits for each age and gender cohort using the indexation rules and the level o f pensions received by new retirees. As set by law, inthe base case scenario pensions are assumedto be fully indexedto inflation. The size o f the entry benefit for newlyretired-both old age pensioners anddisabled -is modeledby setting directly the replacement rates interms o f the current covered average wage. Figure19. OldAge Pensions Figure20. DisabilityPensions DistributedbyAge andGender (Percentof 50 Year OldOAP's Benefit) 1Wh 80% Bo% , -Men -Women1 I-Men -Women , ~ Source: PROST inputfilefor CSRO. Initial replacement rates for old age pensioners and disabled are derived by smoothing CSRO actual data on average entry pensions received by new retirees o f different age and gender in 2001. Future replacement rates for new old age retirees are calculated based on the assumptions about changes inthe length o f service at retirement and annual accrual rate (constant at 3.3 percent in the base case scenario) - to ensure consistency among these input variables. Output data on average wages and wages by age and gender are then used to recalculate replacement rates in terms o f average wage. Figures 21 and 22 present the replacement rates for new old age retirees at the beginning and at the end o f the simulation period. For new disabled, age- and gender-specific replacement rates are assumed to remain the same throughout the simulation period (Figure 23). The average survivorship benefit is also assumed to be constant interms o f the average covered wage (57 percent per family). 16 Figure 21. and Figure 22. Replacement Rates for New Old Age Retirees (Percent of Average Wages) M e n Women 100% 80% 60% Source:PROSTinputjlefor CSRO. Figure 23. Replacement Rates for New Disabled (Percent of Average Wage) 80% I 1 50% 40% - - Men Women Source:PROSTinputjlefor CSRO. A.1.5. Assumptions for ModelingSSO PensionSystem Data on the current status o f the SSO pension system were kindly provided by SSO technical staff. Apart from the old age, disability and survivorship benefits, the SSO pension fund is heavily engaged ina number ofnon-pension-related programs, e.g. social assistance and health. For modeling purposes, only expenditures and revenues related to the "long-term" payments (those made to beneficiaries on a long-term basis) are examined: 0 On the expenditure side - (a) payments to the old age pensioners, disabled, and survivors; (b) child and family allowances, and (c) some miscellaneous payments. 17 Non-pension expenditures constitute about 20 percent o f the "long-term" expenditures and are assumed to remain at that level over the whole simulation period. Administrative costs are ignoredas they are related to the whole fund. 0 On the revenue side -only contributions earmarked for these type of expenditures (18 percent contribution rate out o f the total 33 percent paid to the SSO hnd by employers and employees). Similar to CSRO, the SSO pension system i s simulated under the scenarios o f (1) keeping it open to new entrants throughout the simulation period, and (2) closing it to new contributors from the beginning o f the simulationperiod. Contributors According to SSO, about 6.1 million people are currently contributing to the system. SSO also provided data on the composition o f the stock o f contributors by age (butnot by gender). The initial distributionofcontributors by age andgender (Figure 24) is derived from the available information and the assumption that women constitute around 15 percent o f the total number o f contributors. This assumption is based on the recent trends inthe female employment inIran (Iran Statistical Yearbook, 2000). Figure24. ContributorsbyAge and Gender in2001 (ThousandPersons) 200 150 100 50 0 I-Men -Women 1 Source: PROST inputfilefor SSO. 18 Total number of SSO contributors and its age and gender distributionare modeled using the "Stock" method (see section 1 for details) with coverage rates linked to employment. The initial age-specific coverage rates are based on the estimated initial age distribution of contributors as well as demographic and labor market assumptions describedin Sections 2 and 3. Future changes in coverage rates are based on the assumptionthat inthe longrun the total coverage rate for all contributory pension systems inIran will converge towards prevailing international patterns in terms of the relationship between coverage and per capita income (see Palacios and Pallares, 2000). Under the base case assumptions on GDP per capita growth (taking into account purchasing power parity) and assuming that the share of SSO inthe total coverage does not change, the number of SSO contributors as a proportion of the labor force will remain stagnant at the current level of about 35 percent over the next decade and then will gradually increase to about 48-50 percent by the end of the simulation horizon as shown on Figure 25. Figure 25. Projected Total Number of Contributors (Percent of Labor Force) 60% 50% 40% 30% ~ 20% 10% Years Source: Mission calculationsbased on PROSTprojectionsfor SSO. Driven by the above assumptions, age-specific coverage rates remain constant during the first 10 years and then gradually increase by about 20 percent over the next 60 years. The age profile of coverage i s assumed to keep its current shape throughout the whole simulationperiod (Figure 26). 19 Figure26. CoverageRatesbyAge (Percent of Employed) '-2001-2010- 2070 1 I Source: PROSTinputjilefor SSO. Figure27. Wage Distributionby Age and Gender (Percentof 20 Year OldMale's Wage) 250% 200% 150% 100% 50% -Men - Women Source: PROST inputfilefor SSO. Information on the age- and gender-specific wages of the SSO contributors i s not available, and it i s assumed that for the young and middle age groups SSO earning profile i s similar to the one for CSRO. However, for older age groups (50 and above) the decline i s less steep compared to the CSRO curve (Figure 11). Similar to modeling the CSRO pension system, the SSO earning profile i s assumed to remain invariable over time for both genders. Figure 27 presents the assumed age distribution o f wages for men and women interms o f a 20 year old male. 20 Beneficiades The same three categories of beneficiaries as in the case of CSRO are simulated for SSO: (1) old age pensioners, (2) disabled, and (3) families receiving survivorship pensions. Traditionally, old age pensioners are modeledby tracking the beneficiaries over time from the moment o f retirement until the pensioner dies. However, the disabled - differently from the CSRO simulations - are modeled by specifying directly the total number in each year of the simulation period, same as the total number of survivors families. In the base year - according to SSO - there were 419.1 thousand old age pensioners, 69 thousand disabled, and 286.7 thousand families receiving survivorship benefits. The initial age and gender distribution o f the stock of old age pensioners was obtainedby slightly smoothingthe SSO actual data (Figure 28). Figure28. OldAge PensionersbyAge and Gender in2001 I 30.0 j 25.0 ~ 20.0 = 15.0 e B 10.0 5.0 0.0 ~ men -Women Source: PROST inputfilefor SSO. The "Flow" method i s used to compute further changes in the number of old age pensioners. In the input file retirement rates are specified as the flow of new old age retirees by age and gender relative to the previous year's contributors. Initial retirement probabilities are based on the SSO data which were smoothed and slightly adjusted to ensure that projected rates of growth o f the number of old age pensioners and pension expenditures are consistent with the past trends. Inthe base case scenario retirement rates are assumed to remain invariable over time (see Figure 29 for the assumed retirement rates for menandwomen). 21 Figure 29. New Old Age Retirees as Percent of Previous Year's Contributions 120% 100% 80% 60% 40% 20% 0% - - Age Men Women Source: PROST inputfilefor SSO. The current average length o f service at retirement in SSO is roughlyestimatedto be about 20 years. As no information i s available about its age and gender profile, inthe base year it i s set at a flat level of 21.5 years for everybody retiring at legal retirement age or above (60+ for men, 55+ for women). This flat level was calibrated to simulate reasonable level of old age pensions in the first few years of the simulation period. For those retiring before the legal retirement age, length of service i s assumed to be the following: (1) Men-20 years for ages under 50,25 years for ages 50-59 (2) Women-20 years for ages under 45,25 years for ages 45-54. These assumptions are based on the current regulations allowing early retirement with minimum 30 years o f contribution or 20 years continuously. In the future - with no changes inearly retirement arrangements inthe base case scenario - length of service for ages under 60 for men and 55 for women i s assumed to remain unchanged. However, for ages 60+/55+ length of service i s assumed to increase gradually to 25 years over the next 20 years to reflect a recent change inlegislationaccordingto which the minimumnumber of contribution years is being increased from 10 to 20 years by 0.5 year every year (see Table 5 inSection 3.3 of the Report). The total number of beneficiaries under the other two categories - disabled and survivors - is modeled as a constant share of the total number o f contributors and beneficiaries in each year of the simulation period: about 1 percent for disabled and 4.2 percent for survivors. PROST projections of the future growth of the number of beneficiariesineach of the three categories are presented on Figure 30. 22 Figure30. ProjectedNumberofContributors 18,000 I 1 1 1 ~ R4Old Age Disabled ElSurvivors Source:PROSToutputfilefor SSO. Age-specific and gender-specific pensions are modeled only for the old age pensioners category. Benefits for disabled and survivors are specified as an average replacement rate across the whole stock of beneficiaries under the respective category in each year. Inthe base case scenario average replacement rates for disabled and survivors (per family) do not change over time, remaining at 57 percent and 62 percent respectively (interms ofthe coveredaverage wage). Age-specific and gender-specific benefits for old age pensioners are projected usingthe initialpensioner profile, indexationrules andreplacement rates for new old age retirees. The initial pensioner profile (Figure 31) for the existing old age pensioners is based on the SSO data about average pensions receivedby beneficiaries in each age and gender cohort in 2001. Benefits are assumed to be fully indexedto inflation, as currently set by law. No data on initial distribution of entry pensions by age and gender i s available. Similar to CSRO, replacement rates for new old age retirees are derived using the input datdassumptions about the length of service at retirement and annual accrual rate (3.3 percent in the base case scenario) as well as PROST projections of individual and average wages. The assumed replacement rates for newly retired in the first and endingyear for menandwomen are shown on Figures 32 and 33. 23 Figure31. OldAge PensionsDistributionby Age and Gender (Percent of50 Year OldOAP's Benefit) " 20% I - 1 Source: PROST inputjlefor SSO. Figure32. Figure33. ReplacementRatesfor New OldAge Retirees(Percent ofAverage Wage) Men Women I 100%I I 90% 80% 70% 60% 50% Source: PROST inputfilefor SSO. 24 A2. SustainableRate of Returnon ContributionsPaidby a Pay-As-You-GoSystem Consider the case o f an overlapping generations model where each generation lives two periods, contributing to a pay-as-you-go system when young and receiving pensions when old. For each generation the rate o freturn on contributions is givenby: where wois the wage at time 0, g is the growth rate of wages, c is the contribution rate (assumed to be constant), and Q is the equilibrium replacement rate assumed to adjust over time to guarantee financial equilibrium. The equilibrium replacement rate can be derived from the equilibrium condition ina pay-as-you-system: L'CWO (1+g)' = (1+9)' , (4) where Li s the number o f workers in generation t (our proxy for the labor force). This condition states that the contributions of generations t shouldbe equal to the pensions of generation t-1. Therefore we can write: a,=(1+ l)c , (5) where 1is the growthrate ofthe labor force. The sustainable rate of return o fthe system can thus be written as: rt =(l+l)(l+g)-1 =g+l+lg for allt, which is exactly the growthrate o f the wage bill W=L*w. 25 A3. ReplacementRatesinthe NotionalDefinedContribution System A worker joining the NDC system at time 0, facing an average growthrate of its wage o f g*100 percent per year and contribution c* 100 percent to the NDC system, receiving a rate of return equal to r*100 percent, and retiring at time R, will have accumulated a capital given by: This capital needs to be sufficient to pay a pension p to the individual until his death. This pension therefore needs to verify: t=l where 6=l/(l+r) i s the discount factor. This implies that the pension is given by: p=KR. i-e 1-8D-R+l ' (9) Hence the replacement rate i s given by: The replacement rate increases when the contribution rate (c) increases, when the rate of return on savings (gs)increases, andthe growthrate of wages (gw)decreases, when the discount factor for pensionbenefits (r)decreases, when the retirement age (R) increases, and when life expectancy (D) decreases. 27