A Way to Resolve Moral 解决道德危机模型.docx

The NDC Model: A Way to Resolve MoralHazard in Chinas Social Security SystemName_ _Student Number_Grade_2013_AbstractSince the mid-1990s, China has adopted a partially funded pension scheme in building its social security system. However, after nearly 10 years of operations, people found that the serious moral hazard problem of contribution defaults and loss of control concerning pension payment stemmed from this partially funded pension scheme. This institutional arrangement hasalso resulted in the so-called “adverse selection in non-market institutions”, which in turn is capable of destroying the current system.目录Abstract2I. Introduction32. Chinas Current Social Security Arrangement Is the3Institutional Source of Moral Hazard321 Examining the problem of moral hazard.42.2 Institutional defects of partially funded pension system43. The Adoption of NDC Model Can Prevent Moral Hazard54. The NDC Model Creates Institutional Conditions for Investing Social Security Fund in Capital Markets5References7I. IntroductionIn theearly 1990s, China extensively examined experiences ofother countriesand conducted a widespread discussion on the choice of models for establishing a social security system, weighing the pros and cons of many proposals. After that, a basic consensus was reached among people from all walks of life: China must adopt the partially funded pension model that combines social pooling funds with individual accounts an arrangement that adapts to Chinas specific situation.The Notional Defined Contribution (NDC) scheme has the characteristics of the PAYGO scheme and the advantage of the Defined Contribution (DC) fully funded scheme. The former funding mode fully reflects social responsibility and fairness, its macrocapability of collectiverisk control and the role of social mutual help; the mode of pension payments in the latter model more reflects individual responsibility and efficiency, micro incentive mechanism and the function of self-guarantee. In other words, the brand new, mixed NDC scheme has the merits of “social pooling” of the traditionalDB PAYGOas well as the “actuarial” payment function of the fully funded scheme. It not only fully demonstrates the macro-economic responsibility of the State in providing social mutual help, but also fully brings out the role of individual self-guarantee in improving microeconomic efficiency. It is in this sense that people take the NDC as the DC PAYGO or an updated PAYGO. It is also in this sense that the characteristics of the NDC make it conform entirely with the policy goal and intention of Chinas policy makers in the early 1990s when they adopted the mixed, partially funded pension scheme. The NDC fully adapts to Chinas specific situation.2. Chinas Current Social Security Arrangement Is theInstitutional Source of Moral Hazard Generally speaking, in this partially funded social security system, employers contribute 17 percent of their salaries for the social pooling part of the social security fund; employees contribute 11 percent to be credited into individual accounts. However, after nearly 10 years of operations, people found that the institutional arrangement that combines social pooling and individual accounts suffers from the problem of the contributions and losses of control in benefit payments. 21 Examining the problem of moral hazard. Apart from the “objective” reasons, including poor economic returns, a default in pension contributions is one of the major “subjective” (in theperspective of fund contributors) reasons forthe decline in contribution rates. Statistics show that enterprises with handsome economic returns think that they suffer losses by registering for the social security program and therefore purposely default their payment of contribution, which is equivalent to a disguised retreat from the program. The enterprises which had contributed accounted for 96.3 percent of all enterprise in 1992, which went down to 93.3 percent in 1993 and to 92.4 percent the following year. Defaulting enterprises generally resort to illegal means, such as purposely concealing the overall sum of benefit pay-outs in salaries, underpaying social pooling contributions or transferring bank accounts, to delay the payment of their due contribution.2.2 Institutional defects of partially funded pension systemApart from other reasons, the aforesaid problems concerning fund contributions with pension payments mainly stem from institutional defects of partially funded pension system. This manifests itself mainly in three ways:1） The intention of the arrangement that combines social pooling funds and individual accounts is good. But the reality presented by the arrangement has become the institutional source of the “anti-incentive” for fund contributions. The experiences from implementing the arrangement in the past years have shown that in the micro perspective, the funding mode cannot provide incentives for both personal and corporate entities. It has not brought out the role of both aspects into full play the social pooling funds and the individual accounts. Employees are not ardent about paying for their individual account, nor are employers serious about their contributions to the social pooling funds, and they dont care or check whether the other side has paid their due in full.2） In the system that combines social pooling funds and individual accounts, the scale or proportion of individual accounts is in inverse ratio to the moral hazard phenomenon and in direct ratio to the social security coverage level. The smaller the scale of individual accounts, the weaker the “incentive mechanism” and the more difficult it is to pool contributions to the fund, which, in turn, makes it more difficult to raise the coverage of the social security network. In contrast, the larger the scale of the individual account, the easier it is to collect contributions to the fund and expand the coverage. These relationships are determined by the effectiveness of the contribution incentive mechanism of the current system.3) Under the current institutional arrangement that combines social pooling funds and individual accounts, raising the social security coverage level will lead to a more severe adverse selection in non-market institutions. Adverse selection refers to a kind of market failure due to information asymmetry. The compulsory social security networking obviously does not belong to the market category, and “adverse selection” should not be used in this context.3. The Adoption of NDC Model Can Prevent Moral HazardThe NDC scheme can effectively avoid the above-mentioned three institutional defects ofthe partially funded social security system.First of all, since with the NDC scheme the benefit payment is determined through“actuarial” indexing and is highly transparent, it ties the current contribution to the future pension to be received by contributors, and can give contributors a relatively more accurate expectation of future pension payments. This can produce a positive contribution incentive effect and avoid the serious problem of the moral hazard under the current system. Secondly, under the NDC arrangement, the ratio of funds put into a individual account to total funds is very high even 100 percent (Zheng Bingwen 2003a, 2003c). China can draw on the experiences of the six Asian and European countries that adopted the NDC modeland, taking into consideration Chinas concretesituation of a “lack of a credit system”, maximize the proposed scale of the individual account fund, or even put the entire fund into the individual account.Thirdly,under the NDCarrangement, the scale of individual accounts would not generally have a negative correlation with thesocial security capacity and coverage level. No matter how high the ratio of the notional accounts, the resource mobilized by the social security system can be 100 percent of the total contribution. This means that the “notional crediting” of the individual account and usage of social security resources can be conducted via two independent systems. This way, obstacles to raising the social security coverage to the national level will not exist. Lastly, the NDC can basically solve the problem of “loss of control” during the process of benefit payments. The actuarial mode of payment can have an obvious fiscal restraint effect on the overall pension sum to be paid to retirees. Irregularities that are similar to the moral hazard, such as early retirement, can be effectively controlled4. The NDC Model Creates Institutional Conditions for Investing Social Security Fund in Capital MarketsIn June 2003, a part of the assets from National Social Security Fund (NSSF) formally entered the stock market. But this mode of investment and management has its defects.Under the current conditions, if the investment can garner handsome returns, insurance buyers and the State will have the opportunity to share investment returns; if great losses are incurred from the investment, the central government will be the sole entity to directly shoulder the risks, and possibility of sharing risks with others is slim. Ultimately, however, the losses will be transferred to insurance buyers. Secondly, should an interest conflict for the State which comes into dilemma from the dual role of as a regulator and an investor occur, the capital markets will be affected, damaging the long-term healthy development of the capital markets. China should adopt the NDC investment and management strategy, which is more suitable forthis countrys realities. This mode can avoid both paying astronomical transition costs and investment losses incurred from an immature capital markets. At the current stage, it would be appropriate for the source of the social security fund that enters the market to be restricted to the sphere of “notional individual account” so the investment could be made on the basis of “clarifying notional property rights” under a NDC system. Investments under such a system are equal to getting a qualification for entering the market. Establishing a individual property-rights system before the fund enters the markets is in the long-term interest of the social security cause and also the basis for its survival and development.However, the NSSF is equivalent to a pre-set fund established by the central government for that most its part comes from the central government transfer of payment, it does not have any coherent actuarial relations with future beneficiaries that pay contributions now. So, this kind of investment fund, specifically for the purpose of getting returns from investments, should therefore be taken as a venture fund. It should not enter the domestic capital markets but be established specifically for investing in international capital markets. This is intended to avoid bringing a negative impact on the domestic market. It will avoid administrative interference in the normal operation of targeted (listed) companies and thus prevent corruption. One example is Ireland. In 2001, Ireland put the returns from the privatization of its telecom industry en bloc into establishing a National Pension Reserve Fund (NPRF), where some of the financing came from fiscal transfers and additional personal contributions. The investment strategy of the Irish fund targets overseas markets. Another example is Norway, which boasts a great oil reserve. To reduce the financial burden of pension payments for an aging society, the country transforms part of its oil reserves into financial assets, which is the equivalent of reserving part of the national wealth for generations to come. The Norwegian government established an oil fund in 1997, contributing 693 billion crowns all of which is invested in internat