pension reform - experience of the slovak republic

FPFPII

Financial Policy InstituteMinistry of Finance of the Slovak Republicwww.finance.gov.sk/ifp

Pension reform - experience of the Slovak

Republic -March 2011

Ministry of Labour and Social Policy of Ukraine, Kiev, 16-18 March 2011

Financial Policy InstituteMinistry of Finance of the Slovak Republic

FPIFPI

www.finance.gov.sk/ifp 2

Reasons for reform

• Deficit first pillar – almost 100% coverage, mandatory,

benefit-defined, pay as you go (PAYG)

• Low motivation to pay contributions – weak links

between the level of contributions and the level of

pensions

• Problem for future – ageing of population – pressure

on expenditures in the first pillar


FPIFPI


Ageing of population

Long-term demographic determinants : fertility, length of life, migration

The age structure of population does matter, not the population size :

nowadays 6 persons in productive age on 1 in post-productive age, drop to 1.5 in future


FPIFPI1. Parametric changes – first pillar (2004)• Retirement age increase

– Prior to reform: men = 62 years, women = 53-57 depending on number of children

– After reform: men + women to 62 years on a step-by-step basis, • Pension indexation rule introduced

– Prior to reform : political decision– After reform : automatic index = 50% CPI + 50% of increase in nominal

wages• Possibility to work and to receive pension simultaneously• Possibility to receive early – old age pension

– pension reduced by 6% for every year below the retirement age– restriction introduced in 2008 (2 years before the retirement age at earliest)– in 2011 a ban to receive early old-age pension and to work simultaneously

• Possibility to retire later– Increased pension by 6% for every year worked-off

• Significant strengthening of the principle of merit for awarded pensions!



FPIFPI


Stregthening of merit principle – awarded pensions

0%2%4%6%8%

10%12%14%16%18%20%22%24%26%28%

2 09

92

499

2 89

93

299

3 69

94

099

4 49

94

899

5 59

9

6 39

97

199

7 99

98

799

9 59

9

10 4

9911

499

12 4

9913

499

14 4

99

15 4

9916

999

18 9

9920

999

200120022003200420052006

• Temporary mechanism for starting the principle of full merit – low pensions are being increased, high pensions are being reduced

• Despite this mechanism , two groups of pensioners – retired prior to reform and after reform

• After reform only higher pensions are awarded de-facto (very expensive)

Pension amount (SKK)

% of pensioners


FPIFPI2. Systemic changes (2005) – second pillar• Defined-contribution, fully-funded, • 9 p.p. of 18 percent for old-age insurance -

transferred to private accounts of savers in pension funds management companies (private)

• Mandatory for newcomers to the labour market• Voluntary for others – transitional period (till 30

June 2006)• circa 1% of GDP revenue decline for general

governement• amount of savings in economy unchanched – thus

no impacts on monetary policy



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7

Reform results – implicit debt

• Definition – current value of accumulated pension entitlements resulting from– pensions already paid out – pensions that the currently insured persons would be entitled to if

the first pillar is fully closed in the particular year

• Factors having impact on the amount of implicit debt :

– Average amount of pensions

– Retirement age compared to the expected length of life = period of pension receiving

– Method of pension benefits indexation

Inštitút finančnej politikyMinisterstvo financií SR

IFPIFP

8

Implicit debt of public finance

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

2000

2010

2020

2030

2040

2050

2060

2070

2080

[% GDP]

Prior to reform 2004Reform 2004 - pillar I (62 years)Reform 2005 - pillar II (62 years)Reform 2005 - pillar II (65 years,CPI)

The pension reform has significantly reduced implicit debt from 400% GDP to the level of 150% GDP in 2080.

– partially eliminated : parametric changes reduce the implicit debt by 80 % GDP

- partially transformed : starting of pillar II of pension reform reduces the implicit debt by 170 % GDP, but on the other hand, the explicit debt will increase by the same amount (it is just the debt transformation)

Source IFP


FPIFPI

9

Transformation costs of second pillar

• Introduction of second pillar – transforms the implicit

debt to explicit debt, i.e. the government must bear part

of the costs today

• Factors having impact on the amount of transformation

costs:

– Revenue decrease of the Social insurance agency

– Expenditure decrease of the Social insurance agency

– Interest costs – costs of financing the revenue shortfall of the

Social insurance agency


FPIFPI


Expenditure decrease of the Social

insurance agency% GDP

Grey - without introduction of the second pillar in 2005Black- with second pillar – current legislation


FPIFPI


...for the price of immediate shortfall of revenues

% GDP

-4,5%

-4,0%

-3,5%

-3,0%

-2,5%

-2,0%

-1,5%

-1,0%

-0,5%

0,0%

20

07

20

09

20

11

20

13

20

15

20

17

20

19

20

21

20

23

20

25

20

27

20

29

20

31

20

33

20

35

20

37

20

39

20

41

20

43

20

45

20

47

20

49

20

51

20

53

20

55

20

57

20

59

Decline of expenditures of the first pillar (%GDP)

Decline of revenues of the first pillar(%GDP)

Transformation costs

Transformation gains


FPIFPI


...reform beyond the scope of one generation

% GDP

-50%

-45%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

20

07

20

09

20

11

20

13

20

15

20

17

20

19

20

21

20

23

20

25

20

27

20

29

20

31

20

33

20

35

20

37

20

39

20

41

20

43

20

45

20

47

20

49

20

51

20

53

20

55

20

57

20

59

Cummulative transformation costs – free of interest

Cummulative transformation costs (real interest rate 3%)


FPIFPI

Practical experience• Problem of legislation stability

– Legislation stability is the basic pre-requisite for creating of expectations regarding the amount of future pensions

– Political consensus very important. Introduction of strong principle of merit in the Slovak Republic led to later tendency to increase low pensions

• Problem of principle of merit vs. solidarity – Is it of any importance to have 3 pillars based on principle of merit ?

Or does the strong principle of merit belong to public finance ? (high contributions high pensions)

– On the other hand, strong solidarity = attempts to avoid payment of contributions

• Problem of creating two groups of pensioners– Newly awarded old-age pensions in 2004 and 2005 were not lower

than in past– In spite of that, social pressure leading to re-calculation of low

pensions awarded prior to reform – reform overcharging



FPIFPI

Practical experience• Politically attractive to weaken the pillar II – additional income VS

– openings 2008 and 2009 – cancelled obligation to join – voluntary, default participation only in PAYG– repeated considerations regarding reduction of the rate of contributions

• Premature pensions – widely used • Indexation of pensions

– Nowadays, the existing pensioners benefit partially from growing real wages– Inflation indexation is cheaper in context of ageing costs, however there is the

problem with opening scissors between the new and old pensioners

• Fees in second pillar – Very sensitive to the level of future pensions– Higher stress on fess from revenues than on those from assets volume

• Regulation in second pillar – Too strict regulation = low revenues = lower pensions



FPIFPI


Thank you for your attention

Marek Porubsky [email protected]

pension reform - experience of the slovak republic

Economy & Finance

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