Social security systems are a given around the globe. Tim Kelsey FCIPPAIPA, global payroll consultant at Kelsey’s Payroll Services looks at the many ways these systems impact payroll operations

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This is a subject to start with a motivational quote: “I see no reason why every child from the day he is born, shouldn’t be a member of the social security system. When he begins to grow up, he should know he will have old-age benefits direct from the insurance system to which he will belong all his life. If he is out of work, he gets a benefit. If he is sick, or crippled, he gets a benefit … From the cradle to the grave, they ought to be in a social insurance system.” These words were spoken by American President, Franklin Delano Roosevelt, in the 1930s as he strove to introduce the concept of social security to the USA. The quote neatly summarises what the purpose of social security coverage is. We will look at how this coverage is achieved worldwide, and what role we, as payroll professionals, play in its successful delivery.

 

Different insurances for different life event risks

As great as Roosevelt’s quote was, the modern concept of social security was invented by the Germans 60 years earlier. The German model has been widely copied over the decades, and now forms the basis of social security systems around the globe. The principle is based on the concept of having different pots of money to cover different life event risks. Thus, the German system has the following insurances:

pension insurance – to provide a pension

unemployment insurance – to provide out of work benefits

health insurance – to provide access to medical services

long-term nursing care insurance – to provide supported living for the frail and the elderly

work accident insurance – to provide work insurance coverage.

Each of these insurances is based on the principle of an equal contribution provided by two contributors, with the employee and employer making a matching contribution. So, pension insurance, for example, is charged at a rate of 9.3% paid by both employee and employer.

There are many challenges for payroll here. Firstly, all the contributions need to be calculated separately and shown on payslips as individual values. Not all the contributions are matching ones. The work accident contribution is an employer-only contribution, with premiums set by reference to industry risk and the track record of the employer – so those in more dangerous industries or with a poor safety record pay more.

The long-term nursing care contribution charges an additional 0.25% premium on all employees aged 23 and above who haven’t had children, and while the standard contribution rate of 1.525% paid by both employee and employer is observed over most of Germany, in Saxony, employers pay 1.025% and employees pay 2.025%.

 

The challenges of income ceilings

A further challenge is the application of income ceilings to cap contributions. In Germany, these vary between the different types of insurance but also between the different areas of Germany – for the purposes of pension and unemployment insurance, this is set as an annual ceiling of €84,600 in west Germany but reduces to €81,000 in east Germany. At least this feature of German payroll is set to disappear by 2025, as the German government works to harmonise these ceilings. Thank goodness for decent payroll software which will hold all the necessary indicators to ensure the correct calculation is performed.

The question of income ceilings is worth considering further. In the UK, things are straightforward with our earnings ceilings operating on a per pay period basis – so we only need to consider how much the employee has earned for this pay period when calculating National Insurance (NI). France and the Netherlands have similar insurance systems to Germany and require a complicated annual ceiling to be applied to a running total to date. The impact of this calculation can mean that employees with variable pay, which spikes with high bonuses and falls in other periods, pay a much lower contribution, followed by a subsequent increase. Think of calculations of NI for directors with no annual alternative method, but for all employees, and imagine trying to explain those peaks and troughs in the social security deduction to querying employees.

As an aside, we should also consider the impact of such models on expatriate employees. Consider the position in Japan, which has a system based on the German model, with separate insurances as follows:

employee pension insurance

employment insurance

health and nursing care insurance

worker’s accident compensation (employer only)

child rearing insurance (employer only).

The UK and Japan have a bilateral agreement on social security that ensures an assignee doesn’t have to pay two lots of social insurance, but unfortunately it only refers to pension insurance. So, when a Japanese assignee arrives in the UK on a work assignment with their certificate of insurance issued by Hello Work, the certificate will exempt the individual from UK NI. But when the British assignee arrives in Tokyo with the equivalent certificate, it will only exempt them from employee pension insurance, and in principle, the other insurances may apply (in practice this doesn’t always occur, because some of the other insurances are only charged once the employer’s headcount in Japan reaches five employees). Perhaps, this could be classed as an unexpected payroll outcome.

Let’s return to the subject of calculation of contributions. We often have a rate of contribution expressed as a set percentage, and an earnings cap. Unlike the UK, most of the rest of the world genuinely caps both employee and employer contributions to a stated maximum income figure to reflect the fact there’s also a cap on the benefits provided. But you can see, using the Germany example, that 18.6% of annual income up to €84,600 is a decent pension pot. However, some countries make that ceiling a little more challenging to work with. We return to Japan to look at the concept of standard monthly remuneration.

Employee pension insurance rates are set at 9.15% for the employee, with a matching contribution from the employer. However, this isn’t calculated on the employee’s monthly gross pay. Instead, contributions are standardised across a table with 32 monthly salary grades ranging from ¥88,000 to ¥650,000. Although the Japanese financial year runs 1 January to 31 December, the setting of standard monthly remuneration considers pay in the period April – June, which then sets the new monthly salary grade that will be used in the period September – August. Consider the following example:

Example

An employee earns the following:

• April – basic salary of ¥395,500

• May – basic salary ¥395,500 plus overtime of ¥ 56,500

• June – basic salary of ¥395,500 plus a newly awarded car allowance of ¥20,000

• average monthly remuneration is ¥395,500 + ¥452,000 + ¥415,500 = ¥1,263,000 / 3 = ¥421,000

• this places the employee in salary grade 24 in pay range ¥395,000 – ¥425,000

• contributions are calculated based on ¥410,000 – mid-point on salary grade 24

• the employee contributes ¥37,515 (9.15% of ¥410,000) with a matching contribution from the employer.

 

The employee’s standard monthly remuneration only needs to be re-calculated in the April – March year if a pay increase pushes them up two salary grades or more. You need the information on standard monthly remuneration, otherwise the deductions taken for social insurance won’t correspond to the published percentages. This approach isn’t unique to Japan, with the Philippines, Malaysia and Trinidad all deploying similar systems.

So far, we have looked at systems where the contribution liability is fairly balanced between employee and employer. But this won’t always be the case. Take the case of Sweden, where the employer contribution is an eye watering 31.42% of uncapped salary spread over seven different insurance funds. By contrast, the employee contribution is set at 7% earmarked for pension insurance and is capped to annual income of approximately £46,000. It doesn’t even make it onto the payslip as it’s automatically included in Swedish tax tables. A similar approach is taken in the Netherlands and Norway, with social security simply being part of an all-inclusive number featuring on the payslip as ‘tax’.

 

Opting to opt out?

In the UK, we don’t currently have the option to ‘opt out’ of NI as an employee, but that’s certainly an option in other countries. While we might be able to opt out of the state scheme though, we won’t be able to excuse ourselves from paying contributions all together. Take Germany as an example again. All employees who earn more than €64,350 (known as the JAEG threshold) have the choice of being publicly or privately insured. Around 85% of Germans choose to be publicly insured – but they must pick one insurance company from approximately 130 companies operating in the public sphere. Each is allowed to charge a small supplementary premium on top of the standard premium of 7.3%, with the average charge for employee of 0.65% – so this is often the differentiator. Many Germans choose public insurance even as high earners because it automatically includes family cover. But high earning young single professionals may well choose private insurance because premiums are matched to risk, and as this demographic doesn’t get sick as often as older workers, it could save them money.

The private insurance option, however, involves the employee in some work. The employer is obliged to contribute a matching employer premium but capped to no more than what they would have paid in the public scheme. The administration is pushed onto the employee, with the employer paying the value of their contribution to the employee as a tax-free payment, and the employee then obliged to pass on the joint premium to the insurer. See how simple UK NI is in comparison – no need for employees to shop around for the best deal or to have an intimate knowledge of all the different insurance options out there.

 

Influencing employer behaviour with social security schemes

The social security regime can also be used by countries to prod companies into certain behaviours. Consider the Nordic countries of Sweden and Norway. Both offer regional discounts to companies hiring employees in the north of their country. Life near the Arctic Circle can be tough, so to encourage employment, its cost is made much cheaper.

Perhaps Belgium wins the competition for the most complex system of discounts and rebates when it comes to the employer’s share of contributions. There are targeted schemes aimed at encouraging the employment of young people, older employees, people from the disabled community, and many other targeted groups, with varying schemes between the federal regions of Belgium. There’s also a standard rebate scheme designed to favour small employers, which pays out six months after the end of the financial year. All of this makes an accurate estimate of employer social security contributions a challenge for financial planning.

This year, we’ve seen the UK NI net expand with the introduction of the health and social care levy – a move Japan, Germany and Jersey had already implemented some years ago. But if our government is casting its eye around the globe for ideas, what else might it pick up on? One area of interest focuses on the concept of a targeted bankruptcy fund, designed to cover final salary, accrued holiday pay and missing pension contributions, should an employer suddenly slip into bankruptcy leaving unpaid employees in its wake. Such schemes are provided by all our European neighbours and go a long way to helping with the unexpected stress of suddenly losing your job and livelihood.

Another feature the government may be considering in the wake of the Covid pandemic is improving the savings ratio amongst employees. Many countries have mandatory savings schemes collected as part of the social security system, such as the Infonavit fund in Mexico, which requires a 5% employer contribution in a fund marked for home purchases.

China has a similar fund which requires joint employee and employer contributions. Should funds not be used for a home purchase, the accrued amount may be paid out as a cash sum on retirement. Such funds aren’t always popular with employees though.

The National Housing Fund in Nigeria mandates a compulsory 2.5% of basic salary and offers a statutory return rate of 4% per annum. The trouble is that inflation is currently running at 18% in Nigeria – so the compulsory savings immediately begin to lose value. And for that reason, many employers ignore the requirement to make the deductions, with the ensuing compliance risk that goes with this.

 

Reporting requirements

Finally, consider the position of reporting. In the UK, we wrap reporting of NI in with tax as one full payment submission (FPS). In many countries, reporting for social security purposes will be entirely separate from tax, and may be significantly more complex than the FPS. Consider the Platnik reporting requirements in Poland, which require comprehensive details of new hires and leavers to be filed within seven days of the event, plus details of many human resource management (HRM) events, such as sick and maternity leave. The Belgian system requires a quarterly report to be filed, which, in effect, creates the social security record, but must also include data on working time, to allow for monitoring of labour law compliance. We end back in Germany, where employers must produce a comprehensive report of pay, contributions and HRM data and file this two days before pay day. This is not one report, but a report to each of the 130 insurance companies your employees have selected. Now that is what I call challenging! 

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