PENSION REFORM EXPERIENCES IN CENTRAL AND EASTERN EUROPE

Agnieszka Chlon-Dominczak

Ministry of Economy, Labour and Social Policy, Poland

Kiev, May 28th, 2004

Countries implementing mandatory funded pension schemes

• 1998: Hungary Kazakhstan

• 1999: Poland

• 2001: Latvia

• 2002: Croatia Estonia Bulgaria

• 2003: Russia

• 2005: Macedonia Slovakia

• 200? Lithuania Ukraine

Reasons for the multi-pillar reform

• to make the pension system sustainable in long run to reduce implicit pension

debt to diversify risk

• to make the system adjust to population ageing

• to encourage longer labour market participation

• to achieve better balance between collective and individual responsibility in the pension system

• to encourage additional savings

• to develop and strengthen financial markets

Design issues

• Most of the countries tend to leave significant pay-as-you-go pillars

• System mandatory for the young, with optional choice for older workers

(exception of Kazakhstan)

• Strong regulation and guarantees• State often involved in collection of

contributions

Contributions

• Tax treatment: usually EET• Contributions to funded tier depends on the possible of transitions costs• Contribution is usually carved-out from the existing mandatory contribution• In Estonia, those that are in the funded tier pay 2% higher contribution• In Kazakhstan, existing contrubtion was divided between funded contribution and tax

0%

5%

10%

15%

20%

25%

30%

35%

Pola

nd

Latv

ia

Bulg

aria

Hungary

Slo

vaki

a

Esto

nia

Macedonia

Cro

atia

Kazaks

hta

n

non old-age pension contribution first pillar second pillar

Contributions

• Tax treatment: usually EET• Contributions to funded tier depends on the possible of transitions costs• Contribution is usually carved-out from the existing mandatory contribution• In Estonia, those that are in the funded tier pay 2% higher contribution• In Kazakhstan, existing contrubtion was divided between funded contribution and tax

0%

5%

10%

15%

20%

25%

30%

35%

Pola

nd

Latv

ia

Slo

vaki

a

Bul

garia

Hun

gary

Esto

nia

Mac

edon

ia

Cro

atia

Kaz

aksh

tan

non old-age pension contribution first pillar second pillar

Participation in the funded pillar

18 24 30 36 42 48 54 60

Hungary

Macedonia

Estonia

Slovakia

Latvia

Poland

Croatia

Bulgaria

Kazakhstan

mandatory voluntary not allow ed

Transition costs• Size depends on:

policy choices contributions members of funded system

individual choices• Examples:

Poland: 1.6% of GDP Hungary: 0.6% of GDP

• Financing: current tax revenues savings on pensions future revenues (debt)

Contribution collection

Kazakh stan

C roa tia

S ep ara te in s titu tion

P o lan d

M aced on ia

S lovak ia

S oc ia l S ecu rity A d m in is tra to r

L a tvia

E s ton ia

B u lg aria

U n ified co llec tion w ith tax

C en tra lised

Hu n g ary

D e-cen tra lised

C on trib u tion co llec tion

Supervision

C roa tia

M aced on ia

S ep ara ted

K azakh s tan

P o lan d

P artia lly con so lid a ted

H u n g ary

B u lg aria

L a tvia

E s ton ia

S lovak ia

F u lly con so lid a ted

S u p ervis ion

Design of funded systems:• Countries tend to limit:

types of charges contribution based asset based performance based transfer fee

levels of charges for all or for selected charge types

• Charges deducted only by managers• In few cases: specific charges can be paid directly

from pension fund assets

Charge design in the region

Types of charges Country

Limits on charge structure admission fee contribution-

based fee asset management fee

performance fee

Hungary Kazakhstan Poland (2004) Latvia Croatia Bulgaria Estonia Macedonia Slovakia

Source: Agnieszka Chlon-Dominczak, Funded Pensions in Eastern Europe and Central Asia: Design and ExperiencePaper prepared for the World Bank in co-operation with FIAP (2003)

0% 20% 40% 60% 80% 100% 120% 140% 160%

Kazakhstan

Poland

Croatia

Macedonia

Hungary

% of assets

Corporate bonds, equity and investment fundsMunicipal bondsshort-term bank depositsreal estate

Investment limits

Min 50% in state bonds

Min 50% in state bonds

Foreign investment

• In Estonia: only investment in specified categories of foreign investment, no quantitative limit

0%

10%

20%

30%

40%

50%

60%S

lova

kia

Hu

ng

ary

La

tvia

Ma

ced

on

ia

Cro

atia

Ka

zakh

sta

n

Po

lan

d

Bu

lga

ria

Guarantees

• Rate of return guarantees: Relative to pension sector

Kazakhstan Poland Croatia Slovakia

Relative to benchmark: Hungary

• No rate of return guarantee: Latvia Bulgaria Estonia Macedonia

• Financing of guarantees: Mandatory reserves

Hungary Kazakhstan Poland Bulgaria Estonia

Guarantee funds Hungary Poland Estonia

Payouts

• Mandatory annuity: Hungary (pension fund or insurance company) Poland (providers not decided yet) Croatia (specialised companies) Bulgaria (licensed companies) Estonia (licensed insurance companies) Slovakia (insurance company)

• Several options: Latvia (various annuity types - joint, variable, deferrals) Macedonia (annuity or scheduled withdrawal) Kazakhstan (once the system matures - annuities, currently lump-

sums are allowed)

Transparency and accountability

• Annual statements financial statements investment structure shareholders structure

• Valuation of assets• Information for participants

individual accounts (by mail, also by Internet or telephone)

• Web site• Publishing investment results

Assets(USD MLN)

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

1998 1999 2000 2001 2002

mil

lio

n U

SD

Hungary Kazakhstan Poland

Investments in 2002

0%

20%

40%

60%

80%

100%

Pol

and

Kaz

akhs

tan

Hun

gary

Bul

garia

Cro

atia

GDS Equity Others

c

Concentration in 2002

0%

20%

40%

60%

80%

100%

1 2 3 4 5 6 7 8 9 10

% o

f to

tal

me

mb

ers

Bulgaria

Estonia

Croatia

Latvia

Kazakshtan

PolandHungary

• Significant share of state funds in Latvia (76%) and Kazakhstan (46%)

Early experience with charges

• Charge levels are different across countries

• They reflect the legal design, supervision practices and competition

• Economies of scale are hardly observed

Early experience with costs

• Costs of initial year high: driven by sales and advertising

• Reductions in following years• Some costs imposed by the law

costs of guarantees and mandatory reserves costs of reporting costs of supervision

ConclusionsMEMBERS AND MARKET STRUCTURE

• Overswitching or underestimation? distrust to the public system belief in private savings?

• Large concentration: biggest funds: bank or insurance backing

more efficient sales? earlier presence on the market?

• Little changes between funds design worked? outflow from public managers

ConclusionsASSETS AND INVESTMENT

• Assets will be growing at a fast pace• Increased investment in equity would be

desirable to diversify risk within pension system, not

only within funded pillar

• Necessity to increase foreign investment limits

ConclusionsCOSTS AND CHARGES

• Costs still relatively high

• Necessity to work on the cost reduction:eliminating excessive guarantees increasing client’s awareness

Conclusions• Multi-pillar schemes – a new blueprint for the region?

Implemented in 8 countries 2 more are joining in 2005 Considered in further two

• Political economy considerations: limitations of intra-generational redistribution by a shift to the DC increasing public deficit (particularly important in the new EU member

countries) lower public control over private asset managers winners and losers

• Experiences up to now: high participation fast increase of pension savings concerns regarding transition financing

Issues for the future

• Elements of success:prudent supervisionprudent investments

equity foreign investments

transparency and accountabilitykeeping costs low re-thinking guarantees