romania pension project

EuropeAid/121990/D/SV/RO

21 June 2007

National Agency of Civil Servants

Implementing Civil Service Reform

2 Civil Service Reform 21 June 2007

This document was prepared within the project on Implementing Civil Service Reform in Romania (EuropeAid/121990/D/SV/RO).

This study was done to complete the requirements of the project under the following areas: ! 4.h.1. Prepare Study on Present Situation in Romania ! 4.h.4. Prepare Recommendations for Improving Pensions of the Civil Service

Prepared by

István Horváth, actuary, Eastern European pension coordinator (Mercer) Eric Szegedi, actuary (Mercer)

Controlled and supervised by

Ferenc Kertész, HR expert (Mercer) József Poór, Team leader (Mercer)


Introduction

European trends of civil service pension schemes

Analysis of Romanian pension systems

Models/solutions for civil service pension schemes in Romania

Summary and conclusions


How is Human Capital managed?

Simply …


Job Profile

Task list

Job Description

“People motivation became a strategic issue”


Highest salaries

Lowest salaries

300-150x

30-40x

8-10x

3-4x


Possible sources for HR approaches

- hybridization

Internal (public sector)

External (private sector)

“Governments need to instill greater performance orientation among public servants”

UN (2005): World Public Sector Report.New York, UN.


“Each Member State is unique with its own history, culture, legislative base and style of administration”.

(UK Presidency, 2004)


3 Pillars (PayGo + Mandatory Private + Voluntary) 12 Countries

Pillar 1 and Pillar 3 (PayGo + Voluntary) 7 Countries

Austria Ireland Belgium Netherlands Denmark Spain France Sweden Germany Switzerland Greece United Kingdom

Cyprus Malta Finland Norway Italy Portugal Luxembourg

3 Pillars (PayGo + Mandatory Private + Voluntary) 12 Countries

Pillar 1 and Pillar 3 (PayGo + Voluntary) 4 Countries

Bulgaria Lithuania Croatia Poland Estonia Romania Hungary Russia Kosovo Slovakia Latvia Slovenia

Czech Republic Turkey Serbia Ukraine

Pillar 1 (PayGo) 3 Countries

Pillar 1 and Pillar 2 (PayGo+Mandatory Private) 1 Country

Albania Bosnia and Herzegovina Montenegro

Macedonia

Western Europe

Eastern Europe


Identical Requirements for Public and Private Sector Institutions

22 Countries

Different Pension Schemes for Public and Private Sector Institutions but with

Identical Benefits 3 Countries

Malta Switzerland Eastern Europe

Austria Luxembourg Finland

Integrated Pension Schemes for Public and Private Sectors but with Separate Top-up Benefits for Public

Sector 8 Countries

Completely Separate Public Sector and Private Sector Schemes

5 Countries

Cyprus Netherlands Denmark Norway Ireland Spain Italy Sweden

Belgium Greece France Portugal Germany

Public Sector Pension Scheme Partially Integrated into National Scheme 1 Country

United Kingdom


State ! Organization’s contributions

depend on type of employment (19.5%-29.5%) capped at 5 times national avg. salary

! Employee contribution is 9.5% ! Retirement Age:

" Men – 63 (65 in 2014) " Women – 58 (60 in 2014)

! Contribution Period: " 11 years minimum (15 in

2014) " Men – 31 years (35 years in

2014) " Women – 26 years (30 years

in 2014) ! Early Retirement:

" 5 years early and no reduction of benefit if 10 + years above complete contribution period

" 5 years early and 30% reduction if at least complete contribution period

" Special social categories with no reduction in benefit

Voluntary ! Accepting Contributions

beginning May/June 2007 ! Defined contribution / Defined

benefit – guaranteed rate of return

! Maximum contribution is 15% of gross salary

! Tax free up to 400€, split equally between employee and organization

! Contributions need to be paid for minimum of 7.5 years

! Participant must be at least 60 years of age to receive benefit

! Individual participant freely chooses pension fund independent of organization where work

Mandatory ! Accepting Contributions

beginning January 1, 2008 ! Mandatory for those under 35 ! Optional for those between 35

and 45 ! Employee contribution are 2%

gradually rising by 0.5% per year to 6% in 8 years

! If participating in Pillar 2 then Pillar 1 contribution is reduced by contribution for Pillar 2 (Example: if Pillar 2 contribution is 2% then Pillar 1 contribution is 7.5%)


# 3 types ! First degree is total loss of work capacity and permanent need for supervision and care. ! Second degree is total loss of work capacity but no need for supervision and care. ! Third degree is loss of at least half of working capacity

# Subject to medical examination every 6 to 12 months until attainment of normal retirement age, except for those with irreversible affect on their work capacity.

# Minimum length of service needed to qualify before reaching normal retirement age.

# Conditions for disability pension at retirement age.

Type of disablement Required period of contribution Reduction of standard retirement age Severe disablement 1/3 standard period of contribution 15 years Acute disablement 2/3 standard period of contribution 10 years Medium disablement Complete period of contribution 10 years Blind People 1/3 standard period of contribution No limit

Age at onset of disability Minimum length of service <25 5 25-31 8 31-37 11 37-43 14 43-49 18 49-55 22 >55 25


# Eligibility conditions for dependent children and siblings:

! Children must be under 16 years of age. ! If the dependent child or sibling is in full-time education or training for the duration of at least five years,

the pension is payable up to the age of 26. ! Children who become disabled before the above ages are entitled to a survivor’s pension until the age of

26.

# Eligibility conditions for surviving spouse: ! If the marriage to the deceased insured person lasted at least 15 years then spouse is eligible.

! If the period of marriage was between 10 and 15 years then the spouse would receive a reduction of 0.5% per month and 6% per year would apply for the period that is less than 15 years.

! If the period of marriage was less than 10 years, then no benefit is payable with some exceptions.

# The amount of benefit is determined as in the table below.

Number of dependents % of pension

1 50% 2 75%

3 or more 100%


Number of Law 7/2006

19/2000

art 82 of 303/2004

Note: supplement in addition to Pillar 1 Normal Retirement Age 65 Service Eligibility for Pension 30 years, 14 in Parliament

Organization Contribution Amount 19.5% for normal conditions

24.5% for special conditions

29.5% for other special conditions Employee Contribution Amount 9.5% of gross income

Benefit Provider(s) amount above Pillar 1 paid by State Budget Types of Benefit Standard Retirement

Survivor's Retirement

Benefit Description 80% times average gross income for 12 months before retirement

Benefit increased by 1% for each yr of svc over 14 but max last gross salary


Current Mandatory Scheme

Pillar 1 Pillar 2

Current Mandatory + Voluntary Scheme

Pillar 1 Pillar 2 Pillar 3

(maximum contribution of 400€)

Current Mandatory + Voluntary Scheme

Pillar 1 Pillar 2 Pillar 3

(maximum contribution of 600€)

Separate Occupational Scheme

Separate Public Sector Scheme

Similar to: Parliamentary Public Servants


Participation in the State mandatory system consisting of Pillar 1 and Pillar 2. This model does not involve the implementation of any supplementary or voluntary pension scheme.

Advantages ! Maintains present costs ! No change in administration ! No changes needed in legislation ! Individual accounts for Pillar 2

funds

Disadvantages ! Inadequate income replacement (30%-50%) ! Pillar 2 only available for younger

employees ! Additional administrative burden because

of adoption of Pillar 2

Implementation ! Financial education and training of employees including publication of informational

sheet for Pillar 2 in order to understand the legislation of Pillar 2 and investment risk of Pillar 2

! Communication plan for Pillar 2 ! Fund Selection advice from internal sources or from an external provider ! Providing information on making a contract between the organization and Pillar 2

funds for payment of contributions ! Providing information for employees in applying for a Pillar 2 fund


Participation in Pillars 1 and 2 plus the voluntary 3rd Pillar. This model uses the current proscribed maximum 400€ yearly tax free contribution amount per individual split equally between the organization and the employee.

Advantages ! Same system as private sector ! European trend is to DC plans ! Retirement rights portable if employee leaves

civil service ! Gives more employee choice with fund

selection (Pillar 3) and investment risk ! Involves employee participation/responsibility

and encourages savings ! Investment return risk minimized due to

guaranteed rate of return requirements for Pillar 3 investments (Unsure if this is the case for Pillar 2 also).

! Individual accounts for Pillar 2 and Pillar 3 funds

! Participation in 3rd Pillar will increase the replacement ratios (45%-50%)

! Tax free advantages

! Employee will recognize a higher net amount in overall compensation

! Helps in attraction and retention

Disadvantages ! Depends on economic environment such as inflation,

investment returns, annuity conversion risk and on longevity risk (will retirees outlive their assets)

! No ability for older workforce to accumulate adequate income for retirement due to short period of capital accumulation in 2nd and 3rd Pillar

! Pillar 2 only available for younger employees ! Lack of financial knowledge of employees and cost to

educate them

! Additional costs for the employer because of increased pension contribution amounts attributable to making contributions for 3 Pillars

! More administration in the beginning because of addition of 3rd Pillar


Implementation ! Plan Design for Pillar 3 ! Communication plan for Pillar 2 and Pillar 3 ! Fund Selection advice from internal sources or from an external provider ! Providing information on making a contract between the organization and Pillar 2

funds for payment of contributions ! Providing information for employees in applying for a Pillar 2 fund ! Financial education and training of employees including publication of

informational factsheet


Participation in Pillars 1 and 2 plus the voluntary 3rd Pillar. This model uses the hypothetical amount of a 600€ yearly tax free contribution per individual amount split equally between the organization and the employee. Advantages

! Average increase in replacement ratio of between 60% and 90%

! Good potential for adequate income replacement for younger workforce of at least 90%

! European trend is to DC plans ! Retirement rights portable if employee leaves civil

service ! Gives more employee choice with fund selection

(Pillar 3) and investment risk ! Involves employee participation/responsibility and

encourages savings ! Investment return risk minimized due to guaranteed

rate of return requirements for Pillar 3 investments (Unsure if this is the case for Pillar 2 also)

! Individual accounts for Pillar 2 and Pillar 3 funds ! Tax free advantages

! Employee will recognize a higher net amount in overall compensation

! Helps in attraction and retention due to increased contribution limits compared to private sector

Disadvantages ! Depends on economic environment such as inflation,

investment returns, annuity conversion risk and on longevity risk (will retirees outlive their assets)

! No ability for older workforce to accumulate adequate income for retirement due to short period of capital accumulation in 2nd and 3rd Pillar

! Pillar 2 only available for younger employees ! Additional costs for the employer because of increased

pension contribution amounts attributable to making contributions for 3 Pillars

! More administration in the beginning because of addition of 3rd Pillar

! Lack of financial knowledge of employees and cost to educate them

! Legislative approval due to increase in tax-free contribution levels


Implementation ! Plan Design for Pillar 3 ! Communication plan for Pillar 2 and Pillar 3 ! Fund Selection advice from internal sources or from an external provider ! Providing information on making a contract between the organization and Pillar 2

funds for payment of contributions ! Providing information for employees in applying for a Pillar 2 fund ! Financial education and training of employees including publication of

informational factsheet


Participation in a scheme similar to the Parliamentary Public Servants pension scheme.

Advantages ! Easier to predict standard of living and

income replacement level ! Maintains present costs since the

organization’s costs are the same as under present pension scheme

! Same level of income replacement for all employees

! Helps in attraction and retention due to minimum income replacement limit of 80%

Disadvantages ! Not possible to increase income replacement

level ! Inflation risk ! Administration burden ! Legislative approval needed in order to set-up

occupational plan for the civil service

Implementation ! Plan design including eligibility requirements and vesting requirements should be set. ! Communication plan ! Drafting of legal text and legislative approval ! Administration of scheme needs to be established. Will it be done in-house or externally? ! Financial education and training of employees including publication of informational factsheet


Model 4 has the least risk to the employee since they would receive a percentage of final salary regardless of the state of the economy. However, they face some risk due to any increases in inflation or adverse changes in tax legislation which could reduce the real value of money they have to spend during retirement. Model 2 and 3 have the most risk for the employee due to investment choices they need to make with regards to their contributions to Pillar 3 funds.

Least Risk More Risk


Cost is defined as how much the organization will have to contribute to the employees’ pension scheme

Based on: ! Average Age of Civil Service ! Ratio of Females to Males ! Average Salary ! Average Current Service ! Rate of Future Contributions ! Rates of Return ! Discount Rate and Salary Inflation ! Average Future Working Service

In analyzing the difference in costs between the models: ! Model 3 was the most expensive under all the scenarios. ! Models 1 and 4 had the same cost in all the scenarios since the contribution

amounts were identical. ! In half of the scenarios the cost was almost the same among all the models.


! The replacement ratio is the ratio of how much of an employee’s income will be replaced in retirement by each of the 4 pension models proposed.

! The replacement ratio was based on an average employee and therefore the actual amount can fluctuate depending on salary level.

! In general someone with a lower salary will have a higher replacement rate than someone with a higher salary.

! Model 4 provides a level income stream of 80% income replacement for all employees. ! In most scenarios models 2 and 3 provided better income replacement ratio based on

the assumed average civil service salary. ! These results could vary though depending on the position and salary of the individual

employee. Higher salaried employees will have less of their income replaced by models 1, 2, and 3 then lowered salaried employees who would have high income replacement.


Criteria Model 1 Model 2 Model 3 Model 4 Cost for Organization Same as Present High Highest Same as Present

Income Replacement Amount Lowest High Highest Low

Risk for Employee Low High Highest Lowest

Legislative Approval No No Yes Yes

Administrative Burden Low High High Highest

Longevity Risk Low to High High High Lowest

Demographic Risk (older workforce, high level of female workers)

Slight Yes Yes Yes

Shared Responsibility Slight Yes Yes No

Attraction and Retention Potential

Low High Highest High

European Trend No Yes Yes No


Criteria Weight of Each

Criteria Model 1 Model 2 Model 3 Model 4 Cost for Organization 25% 4 2 1 4

Income Replacement Amount

20% 1 4 4 2

Risk for Employee 20% 3 3 2 4

Legislative Approval 5% 2 2 1 1

Administrative Burden 10% 2 2 2 1

Longevity Risk 5% 2 2 2 3

Demographic Risk (older workforce, high level of female workers)

5%

3 2 2 2

Shared Responsibility 4% 1 4 4 1

Attraction and Retention Potential

4% 1 4 4 3

European Trend 2% 1 4 4 1

Weighted total 2,45 2,80 2,30 2,78

Unweighted total 20 29 26 22


Economic Factors: ! Inflation, investment risk, annuity conversion risk, potential future adverse tax changes

Demographic Factors ! Average Age of employees

! Longevity Risk - life expectancy ! Gender - potential for more part-time workers and lower salary

Other Factors

# Role in attraction and retention of employees, and how it affect employees behaviors (Is it a motivation tool?, Is it valued and measured? Is it a shared responsibility? Is it understood?).

# Reaction of Public Trade Unions - "SED LEX", the confederacy of civil servants trade unions

# Adequacy of health care

! Will the retiree be able to depend solely on state provided health care? Will the retiree be required to make co-payments or additional contributions for adequate state health care? Should the retiree consider financing part of their health care with private care?


We recommend for the Romanian civil service Models 2 and 4

We recommend Model 2 as the best model ! It will provide compatibility with the private sector

! It will be in line with trends in Eastern Europe.

! Costs will be moderate while providing the potential for adequate income replacement during retirement.

! It will help employees see that providing for their retirement needs is a shared responsibility between the state and themselves and will encourage them to save for the future.


Legal Documents

Passage of Appropriate Legislation

Plan Rules document based on legislation

If III Pillar is chosen then Recommendation of Funds and Contracts with Funds

Communication Materials Presentations Audit

Leaflets for all employees - Description of new pension plan - Details on how to join the plan FAQ document for local administrators Fund characteristics

Presentations for all employees Training for group leaders

Typically 2 or 3 years after implementation

Employee satisfaction Provider performance Documentation


Goal: Select the best funds with the highest likelihood of achieving policy goals

Discover Analyze Decide


Thank you for your kind attention!