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Pension Reform in Central and Eastern Europe

Elaine Fultz

Senior Specialist in Social Security

ILO Budapest

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Presentation:

• ILO Budapest regional technical cooperation project– Regional trends

– Issues and Problems

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Regional trends:

• Change design features of public pension schemes

• Strengthen scheme financing

• Scale down public schemes and replace with privately managed individual savings

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Change design features:

More individualized benefits

•eliminate redistribution

•count more years of work

•Notional defined contribution (NDC)

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Retirement Ages – New EU States Current law Men Women

Czech Rep. 1995,2003 increasing to 63 by 2013 by 2 months/year

Increasing to 59-63 (depending on no. of children raised) by 4 months/year in 2013

Estonia 1998, in force 2000

63 Increasing to 63 in 2016 by 6 months/year

Hungary 1996 increasing to 62 in 2001 by 1 year every second year

Increasing to 62 in 2009 by 1 year every second year

Latvia 1998 increasing to 62 in 2003 by 6 months/year

Increasing to 62 in 2008 by 6 months/year

Lithuania 1994, 2000 increasing to 62.5 in 2003 by 6 months/year

Increasing to 60 in 2006 by 6 months/year

Poland 1998

(in force, 1999)

65, with early retirement eliminated beginning in 2007

60, with early retirement eliminated beginning in 2007

Slovak Rep. 2003 Gradual rise to age 62 Same as for men

Slovenia 1999 63 61

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Unified collections

Latvia (1996)Slovenia (1996)Estonia (1999)

Hungary (1999)Bulgaria (2002)Romania (2003)

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Pension Privatization

• Averting the Old Age Crisis, World Bank, 1994– Pay as you go pension schemes are

unsustainable in the face of demographic aging.– Governments are corrupt, tend to over-promise.– Both problems can be circumvented by scaling

down pension systems and replacing them with privately managed individual savings accounts.

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Pension privatization in the new EU member states

Countries with mandatory, commercially managed individual savings account

Countries without such scheme

Hungary (1998) Czech Republic

Poland (1999) Lithuania

Latvia (2001) Slovenia

Estonia (2002)

Slovak Republic (2003)

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Issues and Problems

• Impact of second pillar on first

• Transitional financing costs– The “hole” in the financing of the public

pension system created by diverting part of the contribution rate to the new private savings accounts

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Transitional financing costs in Poland

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

year

% GDP

privatisation revenues credit public pillar savings

Chlon, Agnieszka, "The Polish Pension Reform of 1999," in Fultz, E., Ed., Pension Reform in Central and Eastern Europe, Vol. 1, ILO: Budapest, 2002.

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Private Investment ReturnsILO reports (Dec. 2004)

• Hungary 3.75% average annual internal rate of efficiency over first 6 years of operations 6.6% inflation rate

• Poland 20.3% increase in value of second pillar savings over December 1999 – June 2004 24% inflation rate

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Hungary – end of 2005(1998-2004)

• 6.8% average annual return

• 6.1% average inflation

• 0.7% positive return to workers

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Why the low/negative returns?

• Poor stock market performance?• Industry charges and fees?

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Admin. charges and their impact Poland 2001

Poland new legislation

Kazakhstan 2001

Kazakhstan new law

Croatia 2002

Croatia draft legislation

Upfront fee (% of contribu-tion)

8.5 7.0 1 0 0.8 0.8

Mgmt. fee (% assets)

0.6 Up to 0.54 none 0.6 None 1.2

Perform-

ance fee (% of return)

none Up to 0.06% of assets

10 15 25 None

Reductions in assets

17.4 14.4 10.3 16.5 29.3 26.4

Reductions in yield

0.82 0.65 0.37 1.13 1.61 1.19

Chlon, Agnieszka, "Funded pensions in the transition economies of Europe and Central Asia: Design and Experience", FIAP, 2004.

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Rethinking of Privatization

• Flaws in economic logic

• Disregard of necessary preconditions for success

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World Bank (2001):

“In the end, both types of schemes (pay as you go and funded) require a subsequent generation to fulfil the generational contract, either in the form of current contributions (in unfunded schemes) or through the purchase of accumulated assets (in funded schemes). Money put aside for retirement alone does not change this fact …”

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World Bank (2006): Initial Conditions for Multi-Pillar Reforms

• Macroeconomic stability

• Developed banking sector

• A low risk for corruption

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Many Countries Had High Inflation at Reform

-5 5 15 25 35 45 55 65 75 85 95

EcuadorPeru

UruguayLatvia

MexicoColombiaRomania

RussiaHungary

KazakhstanPoland

NicaraguaArgentina

Costa RicaDominican Republic

CroatiaBolivia

EstoniaBulgariaUkraine

FYR Macedonia

Percentage increase in CPI

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Poor Financial Sectors Characterize Some ECA Multi-pillar Reformers

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

Russia

KazakhstanUkraine

Romania

Bulgaria Latvia

FYR Macedonia

CroatiaPoland

Estonia

Slovak RepublicHungary

EBRD rating at time of reform

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Many Reformers Had Poor Corruption Index at the Time of

Reform

KazakhstanEcuador

NicaraguaUkraine

RussiaLatvia

El SalvadorColombia

MexicoBolivia

RomaniaArgentinaBulgariaPeru

CroatiaSlovakia

PolandHungary

Costa Rica

FYR Macedonia

Dominican Republic

0 25 50 75 100World Bank Institute "Control of Corruption"

percentile (closest year to reform)

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New understanding

• An old age crisis will not be averted by a change in pension financing

• Under any type of pension system, what matters is national economic output and the ratio of workers to pensioners.

• Creating a “hole” in the financing of the public pension system will make addressing the problem of demographic aging more difficult.

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Employment rates in 2002

0

1020

3040

5060

70

Esto

nia

Latvi

a

Hung

ary

Polan

d

Bulg

aria

Kaza

khsta

n

Croa

tia

Mac

edon

ia

Employment rate(15-64) Employment rate (55-64)

EU average (15-64)

EU average (55-64)

Chlon, Agnieszka, "Funded pensions in the transition economies of Europe and Central Asia: Design and Experience", FIAP, 2004.