Pension Schemes in the COVID-19 Crisis: Impacts and Policy Considerations, IMF COVID-19 Special Series

IMF | Fiscal Affairs | 1

Special Series on COVID-19

The Special Series notes are produced by IMF experts to help members address the economic effects of COVID-19. The views

expressed in these notes are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board,

or IMF management.

July 20, 2020

Pension Schemes in the COVID-19

Crisis: Impacts and Policy

Considerations

Csaba Feher and Ignatius de Bidegain

The economic downturn brought about by the coronavirus pandemic is leading to declining labor demand

which, despite governments’ efforts to preserve jobs, is translating into not only lower employment rates but

also lower activity rates. In particular, older workers—who are more vulnerable to the coronavirus, have

reasonably large pension entitlements, and often have a lower likelihood of re-entering employment—may

seek to permanently exit the labor force and retire. In addition to a potentially higher inflow of pension

beneficiaries, governments are introducing tax easements which reduce pension scheme contribution

revenues. These developments impact both the sustainability and the adequacy of public pension

expenditures, which may reinforce general fiscal pressures arising from the crisis. Funded pension

schemes suffer from the crisis because lower returns diminish their asset values, while low yields on public

debt instruments increase the present value of their liabilities. This can generate both explicit fiscal risks—in

the case of government guarantees—and implicit fiscal risks through lower private pension benefits or

financial strain on the sponsoring employers. This Note focuses on the impacts of the crisis on pension

systems and their policy implications and is mostly limited to discussing public pension schemes that are

overwhelmingly defined benefit and pay-as-you-go financed.

I. IMPACT OF THE CRISIS ON PENSION SCHEMES

The current crisis influences pension schemes through a number of channels. The main ones are

(1) increased likelihood of individuals exiting the labor market and claiming pension benefits; (2) labor market

effects, as contracting employment and stagnating or declining real wages may result in a declining wage tax

Please direct any questions and comments on this note to cdsupport-spending@imf.org.

Privately underwritten schemes—both defined benefit and defined contribution ones—are addressed only to the extent of their capacity to generate fiscal and

welfare risks.

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base; (3) asset price shocks negatively impacting funded pension schemes’ balance sheets; and (4) capacity of

governments and private enterprises, as underwriters of pension obligations, to maintain solvency of defined

benefit pension scheme under adverse conditions. This note discusses issues that governments can directly

impact through their pension policy.

The extent to which pension schemes can accommodate these risks, and the risk-sharing between

schemes’ underwriters and members, will vary across pension schemes. The severity of the financial and

welfare consequences suffered by scheme underwriters and members depend on the schemes’ precrisis

financial position and basic characteristics, including the relationship between their assets and liabilities

(including whether they can diverge, creating a funding gap), their capacity to access additional resources, and

the risk-sharing between members and underwriters. For instance, (1) defined benefit schemes, where liabilities

are less directly linked to assets and revenues, are more vulnerable than defined contribution schemes, where

liabilities by definition equal the value of assets; (2) private pension schemes would typically find it more difficult

to generate or access additional resources than public schemes; (3) in defined benefit schemes, the risk of

resources (from contributions or liquidating invested reserves) falling short of obligations is borne by

underwriters (that is, sponsoring employers, financial service companies or, as in the case of public schemes,

the government), whereas in a defined contribution arrangement the risk of insufficient retirement balances is

borne by the individual scheme member. These characteristics determine the impact of the crisis on pension

schemes and the types of responses governments may consider.

Economic crises may lead to an acceleration of early retirement applications and disability benefit

claims. Most contributory public pension schemes allow members to retire before the statutory retirement age,

subject to certain conditions. The two main channels for receiving pension benefits prior to the statutory

retirement age are early retirement or successfully claiming a long-term or permanent disability benefit.

 Early retirement. Contributory old-age pensions are conditioned on reaching the statutory retirement age

and having accrued a sufficiently long contribution record ("service history"). However, most contributory

pension schemes permit early retirement based on occupation, long service records, or individual choice

(general early retirement). Best practice requires that early retirement is linked to lower benefits in order to

balance the present value of expected pension benefits with total contributions paid. Social security

regulations reflecting actuarially neutral

adjustments typically require early retirement deductions of

between 0.3–0.6 percent per month of early retirement, which translates into benefits that are on average

between 3.6–7.2 percent lower per year of early retirement.

Lower pensions may result in higher old-age

poverty and necessitate further welfare transfers, especially since it is often less-educated, lower-earning

workers whose labor market prospects are most jeopardized by a long crisis.

Evidence from past crises indicates that the impact of economic crises on retirement patterns is determined

by two factors: while a decline in retirement wealth may push people to seek longer working careers, poor

labor market prospects among workers who have the option to claim early retirement benefits generate

incentives to exit the labor market as an alternative to unemployment. The overall impact of these factors

depends on the structure of the pension system, the ease of accessing early retirement pensions,

employment prospects, and the availability of transfers that can help workers to wait out the crisis. Whether

it is the wealth or the employment effect that dominates workers’ retirement decisions depends on the

Labor market, tax policy revenue administration, financial market, and other consequences of the crisis are discussed in other IMF publications, accessible at

the IMF COVID-19 Knowledge Hub.

Actuarial neutrality is a marginal concept (as opposed to actuarial fairness), requiring that the present value of accrued pension benefits for working an

additional year is the same as in the year before, that is, benefits increase only by the additional entitlement earned in that year or are reduced by the

entitlements lost through contributing for one year less.

For a standardized description of country-specific pension rules, including early retirement deductions, please refer to Social Security Programs Throughout

the World, a regularly updated online publication of the US Social Security Administration.

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effectiveness of government efforts to help employers maintain labor demand, the relative importance of

pension savings within expected old age income, the regulations determining the valuation of pension

savings (that is, the extent to which asset price volatilities are directly reflected in the valuation of individual

pension accounts), and the availability and generosity of welfare transfers which may encourage workers to

stay economically active even at times of increasing unemployment.

 Disability benefits. Disability pension awards differ from early retirement in that difficulty in establishing

clear and easily verifiable eligibility rules means that there is a greater role for subjectivity both in terms of

self-assessment of health status and the decision to apply for benefits, and also in terms of the

administrative process of determining eligibility. Disability benefit applications have long been observed to

be countercyclical,

displaying an uptick at times of economic crisis and increasing unemployment.

This

suggests that disability status—and subsequent benefits—is possibly used as an early retirement option and

as an alternative to unemployment. This approach is disadvantageous from macroeconomic and fiscal

perspectives in that it (1) permanently removes workers from the labor force and weakens the incentives to

seek health-appropriate employment opportunities, (2) replaces a temporary fiscal expenditure

(unemployment benefit and possibly retraining and other active labor market instruments) with a permanent

benefit thus increasing the present value of transfers per person, (3) reduces the income tax and social

contribution base permanently, and (4) reduces output. Given that longer absences from the labor market

reduce the probability of re-employment, it may also have negative welfare consequence for the individual

as it denies workers the incremental pension benefit based on future real wage increases. During crises,

governments' willingness to revise eligibility rules or the way they are applied can reinforce these behavioral

responses and aggravate their economic consequences.

While the long-term impact of these developments on baseline pension expenditures may be low, the

initial expenditure shock remains present for years and further increases the short-term fiscal pressures

arising from the crisis. An early retirement “boom” is later compensated for by smaller inflows: unless there is

a permanent reduction in the effective retirement age, the impact will disappear in 4–8 years, given that usually

there is an upper limit on early retirement. In the case of disability pensions, the marginal inflow works

differently: the additional inflow is not compensated for by lower inflow in later years and the impact may be

present for much longer, potentially decades, depending on the age distribution of the marginal beneficiaries. In

general, if increased inflows are reinforced by permanently relaxed eligibility rules then the increase in pension

spending will tend to persist over the long term. This risk is increased by political economy considerations: high

or increasing unemployment is seen as a common measure of the success of economic policies and reflects

more poorly on governments than lower labor force participation (which is rarely noticed by the electorate) or

worsening financial and dependency indicators of social security schemes.

The crisis also impacts the financial position of defined benefit pension schemes, irrespective of

whether they are funded or pay-as-you-go financed, or privately or publicly underwritten. In the case of

contributory defined benefit schemes, the most immediate effect is the reduction of contribution revenues, driven

by the contracting wage tax base.

This will result in a deteriorating social security balance and a declining

funding ratio

in both public or private defined benefit (DB) schemes. While lower wages and higher

See Maestas, Mullen, and Strand (2015) and Benítez-Silva, Disney, and Jiménez-Martin (2009).

Similar countercyclicality was also typical of early retirement, until the 1980s when fiscal pressures forced governments to tighten early retirement rules.

Reforming disability systems is more difficult, however, exactly because of the more subjective nature of determining eligibility.

Non-contributory defined benefit schemes, such as civil service schemes in numerous low-income countries or non-contributory basic pensions, are shielded

from the direct impact of a contracting wage tax base. At the same time, governments may find it more difficult, in times of crises, to allocate the subsidies

needed for observing pension obligations accrued by these schemes.

In the case of pay-as-you-go defined benefit schemes, “worsening funding ratio” means an increase of unfunded, “implicit’ pension liability.

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unemployment also impact pension scheme liabilities through the reduction in future benefits, this reduction is

more evenly distributed over time and is influenced by the combined effect of the age distribution of contributors,

contribution histories, and the pension formula. Thus, while the revenue impact is immediate, the compensating

effect of lower expenditures happens in the future and its magnitude is likely to be smaller, in present value

terms, due to the various non-linearities present in DB security schemes.

Asset price shocks reduce the value of pension reserves in funded defined benefit schemes, negatively

impacting funding ratios. Ideally, funding ratios—the relationship between a defined benefit scheme’s assets

and liabilities measured over the same horizon—should fluctuate around 100 percent, without permanently

remaining below full funding.

Should funding ratios stay below 100 percent, regulations and underwriters’

fiduciary obligations will call for an action plan aiming to re-establish, within reasonable time, healthy funding

ratios.

In the absence of a rebound of asset values, this may happen through a negotiated reduction of

liabilities or by increasing the pension schemes’ reserves at the expense of the sponsoring entity. Funded

pension schemes are also hurt by the current environment of low-yield government bonds which negatively

impacts discount rates applied to future payment obligations. If funding gaps grow relative to regulatory

benchmarks, employers sponsoring pension schemes may need to transfer additional resources to those

schemes which, in turn, may have adverse consequences on their own financial position and viability. If the

sponsoring employer is the government itself—as in funded pension schemes for public employees—the current

funding shortfall or the resulting future scheme deficits will translate into lower spending elsewhere or a higher

government deficit, leading to higher taxes or growing public debt.

In addition to declining funding levels, many funded DB schemes in the public and private sectors alike

have negative operating cash flows, that is, the income from contributions and portfolio returns is

smaller than the cash paid out. For example, for US state pension funds the ratio of operating cash flow to

assets dropped from an average of –1.9 percent in 2000 to –3.2 percent in 2017, with five states exhibiting

average cash flows below –5 percent.

Whereas the funding gaps—and their reflection in cash flows—will

eventually necessitate intervention by scheme sponsors by either reducing future payouts or increasing scheme

resources (possibly through bailing them out using the sponsor’s own funds), liquidating assets at a time of

depressed market values will result in even higher loss of public wealth, and later, require larger adjustments.

Declining asset prices also negatively impact defined contribution schemes, but in this case the risk of

insufficient assets is borne by scheme members. Since the liabilities of defined contribution schemes equal

the value their assets, there is no risk of obligations exceeding assets (although efficient asset-liability

management remains important for matching maturities and ensuring liquidity). At the same time, lower asset

values translate into lower benefits for members who retire—or otherwise liquidate their account balances—

during a slump. This, in turn, may result in higher old-age poverty and additional welfare spending in later years,

especially in countries where defined contribution schemes play a dominant role. An issue specific to defined

contribution schemes is that from a purely technical perspective it is much easier to liquidate savings and

Benefit formula non-linearities in service time and wages are an important standard feature of public DB schemes, enabling redistribution both across scheme

members and between taxpayers within and outside such schemes. These non-linearities often make pensions relatively higher for workers with shorter and/or

lower contribution histories. Therefore, since benefit reductions are not proportional to the reduction of contribution revenues, the pension scheme’s long-term

financial position may worsen.

Funding levels or ratios can only be interpreted in a DB setup. Pure defined contribution (DC) schemes (functioning without performance guarantees and

assuming no risks developing independently of assets (such as longevity) are by design fully funded as their liabilities are limited to the current value of their

assets both at the aggregate and the individual level

In the United States, the funding ratio of the 100 largest public DB pension schemes declined from an already low 75 percent to 66 percent in the first quarter

of 2020, with the aggregate funding gap (the difference between the value of assets and the present value of corresponding obligations) of the same schemes

increasing by almost USD 500 billion to USD 1.8 trillion in the same period (Milliman Pension Funding Index).

This problem is becoming particularly pressing in poorly designed African civil service schemes but also in the United States, where public employee

schemes operated by states have been facing large, potentially irreversible deterioration of their funding levels.

All figures in the paragraph are taken from Milliman Pension Funding Index.

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withdraw them early than it is in the case of defined benefit arrangements. Governments should exercise

caution when considering supplementing or substituting budget-financed welfare transfers with policy measures

that allow early withdrawal from defined contribution pension schemes.

Further fiscal risks may arise from government guarantees supporting private pension scheme benefit

obligations (in DB) or investment performance (in DC). If the guarantor’s liquidity is ultimately ensured by

the government, once the guarantee schemes’ reserves are exhausted the government needs to step in.

Examples of such guarantee schemes include the Pension Benefit Guaranty Corporation (PBGC) in the United

States and the Pension Protection Fund (PPF) in the United Kingdom. It is worth noting that in addition to these

explicit guarantees, nonbank financial institutions may be viewed as being “too big to fail” or systematically too

important to allow their bankruptcy.

II. IMPACT OF PENSION POLICY RESPONSES

In many countries, policy responses to the current crisis have reduced current contribution revenues

through permitting deferred payment or temporary reductions of social security contributions. Deferral

periods span 3–6 months and may be generally applicable or available to a subset of enterprises such as small

and medium enterprises or companies in hard-hit sectors (for example, tourism). As of late April, more than 50

countries introduced contribution deferment in their social security systems.

Temporary contribution deferment

or exemption is occasionally conditional on retaining workers in paid employment, although with reduced

working hours and wages (as, for instance, in Spain).

Contributions have also been reduced through temporary lowering of contribution rates or the pension

base (China, Finland, Malaysia, Norway, Russia, Sweden). These measures are introduced to reduce labor

costs directly borne by employers, thereby keeping companies from going out of business and allowing them to

retain their workers in paid employment. It is important to note that lower contribution rates—unless

accompanied by actuarially neutral reductions in benefit accrual rates—increase the unfunded liabilities of

defined benefit pension schemes. These, in the future, may translate into additional scheme deficits and subsidy

needs.

While the measures mentioned above are all temporary, their introduction and possible extension

(depending on the speed of recovery) raises important issues that need to be addressed by detailed

implementation regulations. It is important that regulations clearly set out how crisis measures will evolve as

economies emerge from the crisis so that long-term fiscal costs and undesirable incentives do not persist.

The treatment of deferred contribution liabilities needs to be regulated, especially in terms of (1) how long

companies are given to become current on their contributions, (2) whether both employer and employee

contributions are deferred, and (3) should companies going out of business without becoming current on their

contribution liabilities, the ranking of social security agencies in the order of creditors and the responsibility for

unpaid contributions remaining after liquidation. It is important to operate reliable registries of contribution

arrears, and to separate those arrears that are permissible under special, COVID-related regulations from those

that emerged before the crisis or may be accrued after the expiration of the temporary easements. The period

allowed for becoming current on unpaid contributions needs to take into account a company’s capacity to pay

without jeopardizing their commercial viability but also without imposing undue fiscal stress on the pension

schemes—for instance, permitting 12 months to work-off contributions unpaid for a quarter would seem

For instance, Argentina, Egypt, India, Kosovo, Tunisia, Turkey, Ukraine. For a list of countries and measures, please refer to the online Annex 1 of the April

2020 Fiscal Monitor and its regularly updated online version, as well as the International Labour Organization’s webpage dedicated to social insurance

responses to the crisis.

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reasonable. It is also crucial for policymakers to consider, ex ante, what indicator they may wish to use to trigger

the return to normal tax payment schedules.

It is equally important to clarify how pension entitlements accumulate (including service time counting

toward eligibility) during the period of deferment, both in the cases where contributions are paid after the

deferment period and here contributions remain unpaid. This requires specifying if and how wages not yet

covered by paid contributions count toward newly assessed pensions. Government decisions to permit late

payment of contributions should not lead to lower pensions or delayed retirement. Special regulations may be

needed to credit service time and covered wages during the period of tax easements. It is also necessary to

regulate how government-encouraged part-time employment should count toward service time and the pension

calculation base. While no specific recommendation can be made in this regard, it is important to inform both

employers and workers about special rules and procedures.

On the expenditure side, some countries have increased pension benefits in response to the crisis.

the case of social security pensions without a regular and rules-based benefit indexation regime, these

increases are difficult to tell apart from ad hoc pension increases that the government may have in any case

considered. If the last increases happened more than a year ago, these measures may simply ensure that

benefits maintain their real value. In countries with regular and adequate pension indexation rules, the additional

increases may have a weaker foundation in welfare considerations—especially since it is the working-age

population that bears the brunt of the economic impact of the crisis—and been implemented without full

attention to future costs. It is therefore important to ensure that any increases are carefully rationalized and not

the result of opportunistic political agendas.

As a general principle, ad hoc benefit increases should be avoided, and systematic indexation rules

should continue to be observed. Since elderly people are indeed more susceptible to COVID-19, their cost of

living would increase beyond the consumer price index—which is typically a lower bound for regular benefit

indexation—if private health expenditure grows in response to the epidemic. Even in such cases, however,

additional transfers may be best introduced in a temporary and targeted manner, for example, instead of paying

higher benefits to all elderly citizens, only the people suffering from the viral infection could receive higher

transfers, possibly in the form of subsidized or free treatment.

III. POLICY CONSIDERATIONS

Governments need to avoid using the pension system to address the negative consequences of the

crisis and to implement temporary regulatory changes only sparingly. Pension systems do not lend

themselves easily to addressing short- and medium-term economic problems, including the current crisis, since

they respond slowly to changing macroeconomic and demographic circumstances yet generate long-term

obligations and expectations. Responses to temporary shocks, therefore, need to be limited in time to avoid

inadvertently setting the pension system on a course—in terms of sustainability, adequacy and efficiency—

which does not reflect policymakers’ objectives, expectations of society, or the constraints faced by the country.

It is equally important to directly address specific economic problems where they arise, instead of relying on the

pension system, for example, addressing rising unemployment through labor market policies and employer

support, increasing poverty through well-designed welfare transfers, and public health issues via improved

access, quality, and affordability of public health care.

Benefit payments have been brought forward in a number of countries (among them Australia, Colombia, India, Kosovo, Turkey), and administrative

easements were also introduced in numerous jurisdictions to make it easier to claim benefits without travel and with a smaller number of in-person interactions.

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Early retirement and disability pensions should not be used for accommodating temporary labor market

pressures. Where existing rules are adequate, these should be implemented as intended. Where they are

poorly designed, undesirable consequences should be avoided where possible and reformed over the medium

term.

 Early retirement. Early retirement provisions need to reflect actuarial neutrality to limit incentives to exit the

labor market early and to avoid implicitly subsidizing early retirees. Limiting, in terms of months or total

reductions, the length of early retirement will also help governments close the gap between statutory and

effective retirement ages, improving system dependency ratios and resulting in higher average pensions. As

the age-specific life expectancy of elderly people improves, it is also important to reflect these developments

in regular—and, preferably, automatic—retirement increases which, however, can only yield the expected

labor market and fiscal results if early retirement conditions are also revised.

 Disability benefits. As the recession continues, increasing unemployment will exert pressure on

administrators of disability benefits schemes to take a more lenient approach to assessing both new claims

and reassessing existing beneficiaries. Governments need to ensure that primary care physicians and

medical/occupational staff—who play a crucial “gatekeeper” function in terms of determining the transition

from short-term disability (sickness) to prolonged sick-leave and on to disability claims—apply assessment

criteria with the same level of stringency as before the crisis. It is also important to resist the politically

convenient but economically counterproductive option of substituting unemployment benefits with

permanent disability pensions in the case of workers who could, once the recession eases, successfully

seek employment.

It is important that ongoing pension policy reforms aimed at containing pension spending are not

stalled or reversed, especially since fiscal pressures are likely to be greater after the crisis. Most

governments have so far refrained from changing pension policy in response to the crisis. It is crucial that, even

if recovery proves slower than expected, no major changes are introduced without careful analyses of their fiscal

and welfare impacts. It is equally important that reforms introduced in the past or currently under implementation

(in particular, systematic benefit indexation, retirement age increases, lengthening calculation periods, revising

accrual rates, and the application of various types of automatic adjustments) are fully implemented since the

pandemic-induced recession will most likely further worsen the sustainability of public pension systems, making

reforms even more important than prior to the crisis.

Permitting early access retirement savings in defined contribution schemes may affect the adequacy of

future retirement income and needs to be regulated in a manner which ensures that remaining account

balances are sufficient to meet governments’ pension policy objectives even under adverse conditions.

Allowing early, partial, or full withdrawals may result in lower pensions or lead to realized value losses

liquidating savings at depressed asset prices.

The decision to allow early withdrawals should carefully

consider how much such withdrawals reduce expected total pensions. In multi-pillar systems where there are

one or more DB components (including basic, non-contributory old-age benefits) ensuring an adequate pension

benefit, early withdrawal rules may be more permissive. In countries where private, mandatory DC schemes

dominate retirement incomes, the impact of early withdrawals may be more problematic and require caution.

Consequently, while permitting partial early withdrawals from DC retirement accounts is a permissible policy

option, such measures should be designed conservatively, taking into account their likely welfare and fiscal

consequences.

Changes in asset prices are reflected in pension scheme accounts and individual account values continuously—however, they are only “locked in” as a

permanent welfare loss if assets are liquidated at times of depressed asset prices.

For a more comprehensive discussion of policy and regulatory considerations concerning defined contribution pension schemes, see Yermo and Severinson

(2020).

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REFERENCES

Benítez-Silva, Hugo, Richard Disney, and Sergi Jiménez-Martín. 2009. “Disability, Capacity for Work and the Business Cycle: An

International Perspective.” Organisation for Economic Co-operation and Development, Paris.

Maestas, Nicole, Kathleen J. Mullen, and Alexander Strand. 2015. “Disability Insurance and the Great Recession.” American Economic

Review 105 (5): 177–82.

Organisation for Economic Co-operation and Development (OECD). 2020. “Retirement Savings in Time of COVID-19.” Paris.

Yermo, Juan, and Clara Severinson. 2020. “The Impact of the Financial Crisis on Defined Benefit Plans and the Need for Counter-Cyclical

Funding Regulations.” OECD Working Papers on Finance, Insurance and Private Pensions, No. 3, Organisation for Economic Co-

operation and Development, Paris.