Opposition to a state pension law
The proposed pension laws tabled before the Knesset can be divided into two main categories: State pension laws the purpose of which is to provide pension insurance for the citizens of the State of Israel, largely independent of their employment and pension contributions made during their lifetime. These laws are founded on the societal approach that addresses social justice and income distribution. Conversely, there are proposed laws that deal with a mandatory pension for employees in Israel alone. The main component of these laws is the guarantee of income for the employed population after retirement. The team members were in full accord in their opposition to a state pension law, and agreed that if a mandatory pension law is enacted its income distribution component should be minimal and relate only to the distribution of actuarial risks between the fund holders.
The committee members did not reach consensus with regard to the application of a mandatory occupational pension law. Two main positions were expressed during the discussions.
The first position supports a mandatory occupational pension of a scope largely matching the existing pension structure, and aims to increase both the number of people insured through pension savings and the rates of pension coverage for individuals. This position is based on the argument that there are currently market failures in pension savings that justify the existence of a mandatory pension from an economic standpoint. In addition, those who are not covered belong to the economically vulnerable sectors. Therefore, a mandatory pension is a progressive move that will improve income distribution among the older population.
The second position is opposed to the enactment of a mandatory pension law for the following reasons: The market failures are not significant and the factual basis for their existence is insufficiently established. The lack of pension coverage is not extensive, especially when deposits made to provident funds are taken into account, and stems partially from low income rates. Furthermore, there isconcern that a mandatory pension will become a state pension and an additional source of taxation and revenue for the public sector, which will cause severe damage to the economy.
The committee did not formulate an unequivocal stance on the issue of a mandatory pension law. Nevertheless, even the proposal that supports a mandatory pension law is fundamentally different from the proposals that have been tabled before the Knesset. The principles of the proposed law are presented in this document.
Labor laws define the right of workers to severance pay in the amount of the last salary for each year of work, provided that the worker was dismissed from his place of employment or retired from it at retirement age. The laws enable granting tax benefits for workers’ severance pay (up to a salary limit determined by law). Employers and workers use this legal framework and the tax benefits derived from it as part of the work agreements. Some arrangements include payments to pension and compensation funds, executive insurance plans and more, which the worker is entitled to keep even if he leaves his place of employment voluntarily. Severance pay constitutes part of the employer’s contributions to the pension funds, and totals approximately 50% of the worker’s pension savings (pension funds and provident funds).
We recommend that the arrangement of payments made toward severance pay be expanded and imposed uniformly upon all employers and employees in the labor market. In other words, there will be a mandatory contribution towards severance pay by employers for all employees – which will be recognized as a long term saving – as is currently practiced for some employees in the labor market, whether they are dismissed or leave voluntarily. Severance pay will thus become a long-term saving that can be used by the worker after retirement or during extended periods of unemployment, in accordance with existing severance pay arrangements. This arrangement will be implemented on a pure DC basis, which will be managed by the worker and not include elements of income distribution between workers.
The majority of team members support this proposal, since it makes it possible to equalize the employer’s costs over different workers in the market (for example, workers that are not citizens of the State of Israel, mutatis mutandis), and in particular regulates an important element of uncertainty in worker-employer relations that detracts from how efficiently the labor market functions.
It is customary to differentiate between defined benefit (DB) pension plans and defined contribution (DC) pension plans. The two methods are fundamentally different in the distribution of investment risks and insurance risks between the fund and the plan holders. Under the pure DB system, both the actuarial risks and the yield risks are imposed on the fund (or the government). Under the DC system, the individual assumes the yield and life-expectancy risks in the pension fund. The individual defines the contributions to the fund, and upon retiring receives the total amount of contributions with the addition of yield for the total amount of savings. He receives the amount in the form of an annuity, which is contingent on his remaining alive. A pure DC fund places the full measure of risk – both actuarial and yield – upon the individuals.
The team envisions the two methods, DB and DC, operating simultaneously in a free market subject to identical tax conditions, under stabilizing supervision and without direct intervention and/or guarantees on the part of the establishment. Individuals will be able to choose from a variety of pension plans according to their different risk preferences. The yield and interest risks will be transferred to the capital market, whereas the actuarial risks will be transferred to the insurance companies or alternatively distributed between the plan holders within the mutual funds.
The DB plans currently existing in the Israeli market are not actuarially balanced, since there is no systematic definition of those responsible for the fund’s actuarial balance. Changes in life expectancy and adjustment of the contributions according to these changes are not carried out in a systematic fashion. In order to maintain the DB plans as actuarially balanced plans, the responsibility for ongoing changes in this sphere should be regulated.
The team also recommends adjusting the retirement age according to the life expectancy of the plan holders in order to guarantee actuarial balance and a reasonable pension level for retirees.
Until 1995, the pension funds were managed according to the accumulation method, but reliant on contributions of the next generation. Over the years, these funds accumulated deep actuarial deficits, which were caused by the rise in life expectancy as well as Histadrut policy, which from the outset neither required nor facilitated actuarial balance.
In 2000 the actuarial deficit of the established pension funds reached NIS 56 billion. This deficit constitutes approximately 36% of the pension fund commitments. The unfunded pension commitments for state employees reached NIS 220 billion by the end of 2000. This commitment does not include the actuarial liability for the unfunded pension in the public sector, except for government workers.
We are issuing a warning pertaining to the lack of data, and recommend calculating the full extent of commitments by the government and other public bodies as of today in order to prepare for fulfilling these commitments in future. Furthermore, the team recommends that civil service employees be enrolled in an unfundedpension without delay.
The monies of the new pension funds are currently invested mainly in earmarked government bonds. Approximately 70% of the accumulated monies of the new funds are invested in earmarked bonds with an effective annual yield rate of 5.05%. Of the remaining 30%, approximately 60% are invested in government bonds on the free market.
In the course of its discussions the team addressed the issue of transferring the monies of the new pension funds from earmarked bonds to investments in the capital market. The main goals of the reform are to increase the efficiency of the capital market and gradually extricate the government from involvement in managing the pension monies.
The team agrees to the principle of transferring the pension fund monies to the capital market, while providing a safety net for minimal yield, subject to the rules and principles of market discipline. Furthermore, the team members are in accord regarding the importance of implementing the reform in stages, due to the limited active management existing today and mainly due to the safety net mechanisms that need to be created for this market and public supervision of these investments. The team accepted the principle of transferring the monies of the new pension funds to the business capital market, under conditions that will not harm the plan holders and will improve the expected yield from the deposits.
The improvement of anticipated yield is made possible by the existence of higher yield for risky assets (equity premium). This yield will be divided between the plan holders and the market agencies providing the safety net. This will facilitate both increasing the efficiency of the capital market and the gradual exit of the government from its involvement in the investments of the new pension funds.
The Histadrut pension funds currently hold 75% of the assets of the new pension funds (which were established subsequent to the 1995 reform). The distribution of plan holders between the funds also reflects the high level of centralization in the pension funds. Of 550,000 plan holders insured in the new pension funds, approximately 450,000 (80%) are insured in Histadrut funds.
The team reached the conclusion that the present institutional structure of the industry is unsuited to the changes it is expected to undergo, with the Histadrut funds holding the majority of pension savings in the old and new funds. The Histadrut funds are characterized by over-intervention on the part of political institutions and conflicts of interest that result from the close contact with the trade unions. In the team’s opinion this structure should be changed so as to be characterized by greater professionalism and managerial efficiency.
One of the main reasons for the low level of competitiveness is the marketing channels of pension funds. In order to increase competition between the pension funds and reduce the degree of centralization in this market, the team regards local and foreign business firms as a key factor in marketing pension funds. The integration of business firms into the Israeli pension market will facilitate expanding the framework of insurance plans to include both DB funds and DC funds. In our assessment, these plans can be marketed alongside executive insurance plans, which are currently managed by insurance companies.
The team recommends examining the possibility of allowing the banks to market pensions plans without having ownership rights and under close supervision. It is possible to separate the roles of the banks, as marketers on one hand and investment portfolio managers on the other. This can be achieved by requiring separate management of the plan holders’ monies by means of investment portfolio managers, under the bank or fund manager’s operative supervision. It should be noted that this recommendation is contingent upon regulation of the centralization issue in the banking sphere and capital market in general, and the potential centralization in the marketing of funds by the banks in particular (like the centralization in the marketing of provident funds), and contingent upon regulating consultation for fund plan holders, provided by professional and independent pension consultants.
If the tax benefits for provident funds and pension funds are identical, it will be possible to regard the provident funds (pure DC plans) and the pension funds (including a combination of savings and allowances) as belonging to the same market, that is, the long term savings market. Expanding the possibility for marketing pension funds by the provident funds will reduce the existing centralization in the pension fund sphere, and create effective competition with the Histadrut funds. On the other hand, the independence of the provident funds in management and marketing should be increased, separate from their ownership by the banks.
The team recommends minimizing the political intervention of the trade unions in the funds’ management, and granting salaried employees and self-employed individuals the freedom to choose a pension fund and move freely between funds during the deposit period.
Further to the addition of bodies for the marketing and management of pension funds, the team would like to point out the following factors that would improve the level of competitiveness between the pension funds and enable new pension funds to compete with Histadrut pension funds:
- Complete the separation between established funds and new funds.
- Freedom for each salaried employee to choose his or her desired fund.
- Guarantee managerial independence for the pension funds, and the ability to actively manage investments for the benefit of plan holders, including participation in the board of directors.
- Guarantee transparency of fund performance, including a method of value assessment for non-negotiable investments in a manner that will prevent subsidization among plan holders. The value assessment will also include the derivatives portfolio to be acquired by the fund for protection against changes in the interest rate.
- Guarantee the possibility of moving from one fund to another at fair prices, in such a fashion that the market provides an incentive for efficient management for the benefit of plan holders.
For the purpose of implementing the reforms mentioned above, the team recommends comprehensive reforms in the sphere of pension consultancy, including the establishment of a supervisory body separate from the government whose main roles will be: supervision of the pension funds and their commitments to the plan holders,; pension consultancy which will be contingent on an appropriate license similar to the financial investment consultancy law, a pension regulation law that will guarantee conformity of interests between plan holder and fund manager through an investment committee and directorial accountability, and limitations on the service charges that can be collected as long as the funds are eligible for a government subsidy, through tax reductions or other means. This body should be integrated with supervision of the entire body of long-term savings in the market, such as provident funds and insurance companies, and coordinated with supervision of the current activity in the capital market.