the fiscal impact of pension reform: economic effects and strategy
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The fiscal impact of pension reform: economic effects and strategy. Ewa Lewicka Kiev – May 27, 2004. Types of financial consequences of pension reform. Long-term: reduction of long-term pension system liabilities (implicit debt) Short and medium-term: - PowerPoint PPT PresentationTRANSCRIPT
The fiscal impact of pension reform: economic effects and strategy
Ewa LewickaKiev – May 27, 2004
Types of financial consequences of pension reform
• Long-term: – reduction of long-term pension
system liabilities (implicit debt)
• Short and medium-term: – increase or decrease in the public
finance deficit due to pension related expenditures (explicit debt)
What is pension system implicit debt?
• Implicit debt is the measure of liabilities undertaken by the pension system– Can be measured as the present
value of future pension transfers
• In developing and industrial countries this debt is increasing rapidly
Assessing the implicit debt is a crucial for the reform
• It allows to measure actual obligations towards current and future generations
• Shows the level of cash flows to be allocated to repurchase these liabilities
• When liabilities are due, implicit debt becomes explicit– It influences the public sector deficit and
the public debt level
How to cope with future liabilities?
• To prevent public finance collapse:– surplus should be generated to cover increased liabilities
of the pension system– in OECD member countries necessary surplus is around
4 percentage points of GDP
• Pension reforms can generate such surplus– If the reform design allows to reduce implicit debt,
• Introduction of partial funding– Reduces implicit pension debt– May increase explicit pension debt, if overall contribution
level is not increased
Implicit debt in selected countries
0
50
100
150
200
250
300
350
Slo
venia
Rom
ania
Ukra
ine
Slo
vakia
Hungary
Esto
nia
Lit
huania
% o
f G
DP
• In most of the countries, the IPD is much higher than the explicit public debt
• According to estimates:– IPD exceeds 200% of
GDP in France and Italy– It is above 150% in
the UK and Germany
Implicit pension debt in transition economies in 2002
Note: assuming 4% discount rateSource: Holzmann et al (2001)
Primary balance needed to offset the impact of ageing
-2-101234567
Pola
nd
Swed
en
UK
Czec
h Re
p.
Finl
and
New
Zela
nd
USA
Portu
gal
Kore
a
Denm
ark
Norw
ay
Japa
n
Cana
da
Ger
man
y
Spai
n
Belg
ium
Italy
Neth
erla
nds
Fran
ce
% o
f GDP
• Estimated annual primary balance needed to reduce the public debt to zero by 2050
• Countries that have reformed their pension systems (Poland, Sweden) or countries that have balanced systems (the UK) have lowest primary balance needed
• Poland, following the pension reform is the only country that does not need a primary balance to be generated
• On contrary – pension reform generates surpluses
Source: OECD
Transition costs
• In multi-pillar pension systems– A part or the entire contribution is transferred to
pension funds– Current pension payments require financing– A transition deficit occurs
• The size of the deficit depends on:– the contribution amount – number of persons covered by funded system
• Options to finance the deficit: – current revenue from tax or other sources (for
example privatisation – as in Poland)– pension savings or public expenditure savings– increased explicit debt
Misunderstandings regarding reform costs
• Transfer of a portion of contribution to funded pension scheme is not a cost – It reveals a portion of the implicit debt and– It reduces future public finance obligations
• Increased funding requirements can be offset by higher debt, purchased by pension funds
• Pension funds assets invested into equities stimulate investment and economic growth
• It is better to turn a portion of pension liabilities into savings now than to have much greater problems with redeeming such obligations in the future
Short and medium term consequences of the reforms
• In order to improve short and medium term financing of the PAYG pension systems, the following steps can be taken:– increasing contribution levels, – improving compliance and execution, – reducing pension promise by changing retirement pension
formula, – increasing the retirement age, etc.
• Financing transition costs from savings in the PAYG pension system increases current financing burden – reaching the balanced scheme requires more time– pension system savings and costs should not increase the
burden of the present productive generation– these should spread some of the burden also to the future
generations• Financial gains will depend upon the reform type
– each country planning pension reform should compare effects, knowing the reform effects gained in a given country
The new pension system in Poland:
• New Polish pension system is:– defined contribution– with two accounts: non-
financial and financial
• The old-age contribution was divided into:– NDC 12.22% of wage– FDC 7.3% of wage
• Rates of return:– In the NDC are linked to the
wage fund growth– In the FDC depend on the
financial market returns
• Persons below 30 (in 1999) have both NDC and FDC accounts
• Persons aged 30 to 50 had a choice of one (NDC) or two (NDC+FDC) accounts– 53% of them chose to have
two accounts
• Persons over 50 years of age are in the old system
The new pension system in Poland:
• Actual retirement age was raised – from 55 for women and 59 for men to 60 for women and
65 for men– early retirement was eliminated– equalisation of retirement ages for men and women
at the age of 65 by 2023 was recently proposed
• All pension rights accrued under old pension scheme form the initial capital, credited to the NDC account– Initial capital is indexed the same way as NDC accounts
• State guarantees include:– Minimum pension guarantee that tops-up the pension
from both NDC and FDC account– State becomes a final guarantor of the minimum rate
of return under the FDC component
State budget subsidies to Social Insurance Fund
1.020.64 0.64
1.17
1.820.371.06
1.15
1.23
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1998 1999 2000 2001 2002
year
pe
r c
en
t o
f G
DP
supplementary subsidy subsidy covering transfer to FDC
Source: ZUS
Poland –Long-term effects
• Estimated value of pension liabilities as per cent of GDP until the year 2050:
– Before the reform 462%– After the reform 194%
– Reduction of liabilities 268%
Demographic and system dependency rates
0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0
2002 20
04 2006 20
08 2010 20
12 2014 20
16 2018 20
20 2022 20
24 2026 20
28 2030 20
32 2034 20
36 2038 20
40 2042 20
44 2046 20
48 2050
0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
insured / pensioners (old-age)
productive / postproductive
insured / pensioners (all pensions)
Note: Projection for three various demographic scenarios (including baseline, higher fertility and lower mortality)
Source: ZUS (2004)
Pensioners by the type of the pension system
old system
2009
new system one pillar (PAYG)
new system NDC + FDC
2014
0 1 2 3 4 5 6
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
mln
old system PAYG DB
2009
new system NDC
new system NDC + FDC
2014
Source: ZUS (2004)
Expenditure and revenue of the pension system
10% 12% 14% 16% 18% 20% 22% 24% 26%
2002 20
04 2006 20
08 2010 20
12 2014 20
16 2018 20
20 2022 20
24 2026 20
28 2030 20
32 2034 20
36 2038 20
40 2042 20
44 2046 20
48 2050
204
surplus
expenditures
contribution
10% 12% 14% 16% 18% 20% 22% 24% 26%
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
2049 surplus
expenditure
contribution income
Note: expenditure of the pension system covers both the old pension system and the NDC pensions
Source: ZUS (2004)
Summary of medium-term financial effects of the reform
• Full transition to the new pension system will take several decades
• Calculations show that the deficit in the system will be reduced and after a transition period, the system will be financially stabilised– further improvements are expected due to the
changes proposed in 2004 in pension indexation and retirement age
• The deficit is temporarily increased by creation of the buffer fund - the Demographic Reserve Fund– In 2004 0.15 percentage points of contribution is
transferred to the DRF– At the end of 2003, assets of DRF were about 0.4%
of GDP, invested mainly in government bonds– DRF will be used to finance deficits in the old-age
NDC scheme after 2009
Summary
• Designing pension reforms should be preceded by:– assessing the implicit debt – communicating the level of pension obligations to the society
• It is necessary to ensure that financial consequences of the reform, both negative and positive, do not burden a single generation of working people but are allocated evenly
• Multi-pillar systems provide an opportunity to faster reduction of the public debt and can generate higher pensions, compared to the parametric changes under the PAYG systems
• The sooner the PAYG systems are balanced out the sooner burden for the working population is decreased
• The size of the funded system:– should be the result of an assessment of the capacity to
finance the gap in the PAYG part– it requires appropriate financial market infrastructure