Social protection

Pension system: difficult choices to overcome a major crisis

The pension fund in Viet Nam faces a crisis, but the required reforms are not popular. ILO Viet Nam specialist on social protection, Carlos Galian, analyses the difficult choices for the Government.

Analysis | 14 October 2013
An aging population is part of the reason why Viet Nam needs a pension reform. © UN Viet Nam 
The Government of Viet Nam and the National Assembly are planning to reform the Social Insurance Law by 2014. The combination of design flaws and a very rapid ageing process has weakened the Vietnamese pension system so deeply that significant structural reforms are urgently required. Unfortunately, as it is often the case, those changes will not be popular. However, resisting reform could lead to a crisis in the future.

Requested by the Government, the International Labour Organization (ILO) has published the final actuarial valuation report, which indicates that the Vietnamese pension system faces a major crisis. If no reform is urgently passed, by 2021, the Vietnam Social Security (VSS) contribution income will equal its expenditure. The whole pension fund would be completely wiped out by 2034. In other words, all Vietnamese male workers under 39 years old and all Vietnamese female workers under 34 will not receive any pension benefit after retirement.

Moreover, civil servants and private employees who are in their forties, after a couple of years receiving pensions, will also stop benefiting from them. Only current pensioners and workers just about to retire will probably receive a monthly pension benefit until they die.

Obviously the social impact would be significant. According to the National Economics University, pension benefits account for more than one third of recipients’ household income. Letting the pension tap die would increase poverty among the elderly. Beyond the visible social impact, other problems would need to be considered.

First, knowing that pensions are at risk, young workers and employers would have even higher incentives to evade social insurance contributions. Rationally, young workers would be worse off contributing 8 per cent of their income through their careers, so they might find arrangements with their employers to avoid social insurance payments. Paradoxically, increased evasion would translate into deeper problems for the Social insurance fund, meaning that the collapse of the pension’s system could arrive even earlier than 2034.

Second, VSS liquidity problems could lead to economic distress. At first, VSS will stop having surpluses to allocate in banks, purchase bonds or fund the budget deficit, as it does currently. Then, after 2021, VSS will need to liquidate its assets and claim its debts: selling Government bonds, withdrawing bank deposits or claiming Government debt. Obviously, any of these options shall be avoided.

With these perspectives in sight, the Party, the Government, and the National Assembly are aware of the need to reform the pension system. In June 2012, Party Resolution 15 stated that the Social Insurance Law should be changed to address the long term financial sustainability of the fund. In order to achieve the right balance between financial sustainability and workers’ protection, the Government should carefully assess the weaknesses of the pension system so that it can identify the right reforms.

The Vietnamese pension system is characterized by short working lives and increasing life expectancy. According to VSS, the average retirement age is 54, after contributing between 25 and 30 years. Most importantly, the actual retirement age has not increased in the last decades. In contrast, Vietnamese are living much longer. A Vietnamese born in 1990 expected to live up to 66 years. Today, she or he would expect to live 75 years. In the next decades life expectancy will increase even further, until 78 years. On average, retired workers will currently receive pensions for about 20 years and, as their life expectancy increases, their pension life will also increase. So, in summary, workers contribute between 25 and 30 years and claim pensions for 20 years, and rising. This working and pension life ratio is unsustainable.

Additionally, pensioners receive much more from the pension fund than what they contributed. The current pension formula leads to high replacement rates, that is, the share of the pension in relation with their real career average wage. According to the ILO analysis, civil servants replacement rates are over 100 per cent, meaning that they get higher pensions than their average real wages. Usually, pension systems provide between 40 and 60 per cent replacement rates. The ILO Convention on Social insurance states that replacement rates should be above 40 per cent to ensure well-being for pensioners. Hence, the Vietnamese replacement rate is way higher than the minimum rate set in the ILO Convention. Actually, it is the highest the ILO experts have ever found.

Inequality is another worrying feature of the pension system. Different workers are treated differently: military, civil servants and private employees. Unequal treatment leads to two problems: pension jealousy –causing unrest among groups that contribute more than what they receive- and evasion –harmed groups will have incentives to evade and not join the social insurance system. The current pension system has clear losers: private sector workers. Maybe that is why coverage expansion is lagging behind in the private sector. Unless all groups are treated equally evasion will probably characterize the Vietnamese pension system.

Actions needed 

Understanding the causes of the financial imbalance leads to the required reforms. The ILO has advised the Government to consider increasing very gradually the retirement age of male and female workers to 65 years by 2036; changing the pension formula, removing the 75 per cent cap, and set a flat accrual rate of 1.5 percent or 2 per cent annually; revalorizing pensions for both civil servants and private sector employees in line with wage increase; including a proper annual actuarial reduction factor (5-6 per cent); defining a multipillar pension system, including a supplementary scheme and a clear linkage with the old age social allowances under Decree 13.

These reforms would make the scheme financially viable, the pension level predictable for scheme members and provide work incentives for members in line with the increase of the retirement age.

Social insurance reform is like driving a big boat: the captain cannot wait until the last moment to turn."
According to the ILO, other changes would not probably address the financial sustainability in the medium term. For example, expanding coverage will not structurally improve the financial situation. It is an objective in itself and the Government needs to consider a comprehensive strategy, including business registration and taxation strategies, but it does not solve the problem: more workers join, more contributions in the short term, but also more pensions to be paid. Similarly, increasing the contribution rate from the current 22 per cent will not fix the system.

According to our estimates, the imbalance in the fund is so important that contribution rates would need to be over 40 per cent in the next two decades. The impact on businesses and workers under the economic slowdown would be too negative.

To sum up, the Government and the National Assembly need to solve a huge challenge: the pension fund faces a crisis, but the required reforms are not popular. Few societies welcome working longer at first. However, the alternative would be even worse. Without a major change of direction now, either Viet Nam will need an even more unpopular reform in five or ten years or most workers under 40 years will not receive any pension after contributing for their whole careers.

The Vietnamese policy makers have consistently shown their reflexes to adapt to rapidly changing economic conditions. However, social insurance reform is like driving a big boat: the captain cannot wait until the last moment to turn. Rather, it should start turning even before seeing the obstacle in front. Unfortunately, the ILO report to the Government shows that the obstacle is rather close, just in front of us. So a change of direction is needed now.