pension policy: reversals of funded schemespubdocs.worldbank.org/pubdocs/publicdoc/2016/5/...bg ee...
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Pension Policy: Reversals of Funded Schemes
Agnieszka Chłoń-Domińczak, Ph. D.Warsaw School of Economics
Washington DC - Warsaw, May 5th, 2016Pension Core Course
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Outline
• Pension reforms and reversals in CEE countries in two decades: from late 1990s until 2013
• Socio-economic context of pension systems: demography, labor market and pension system
• Post-reform experiences
• Performance of funded schemes
• Transition costs: plans and reality
• Fiscal situation
• Reversals of funded schemes and their impact on individual pension wealth
• Conclusions
Pension reforms in CEE countries• Economic and social transition:
• Reduced employment and rising unemployment in early 1990s
• Rising costs of pension systems, widespread early retirement
• Demographic change: sharp drop in fertility rates causing fast population ageing in the future
• Pension reforms:
• Changes in the PAYG pillar: from parametric reforms (rising retirement age, lower indexation or accrual rates) to paradigmatic reforms: introducing NDC schemes
• Changes in pension financing: introducing multi-pillar schemes
Selected features of pension systems in 8 CEE countries
Public pensionscheme
Retirement ageMandatory funded
contributionsEnactment
dateWho participates
Bulgaria DB 60/55 63/60 2% 5% 2002Mandatory for all workers
<42
Estonia DB 60/55 63/63 6% (4% +2%) 2002 Mandatory for new entrants
LatviaNotionalaccounts
60/55 62/62 2% 8% 2001Mandatory for new and
workers < 30, voluntary for 30-50
Lithuania DB 60/55 62.5/60 2.5% 5.5% 2004Voluntary for current and
new workers
Hungary DB 60/55 62/62 6% 8% 1998 Mandatory for new entrants
PolandNotional accounts
65/60 (60/55) 67/67
7.3% 1999Mandatory for new and
workers < 30, voluntary for 30-50
Romania DB 62/57 65/60 2% 3% 2008Mandatory for new and
workers < 35, voluntary for 36-45
SlovakRepublic
Points 60/53-57 62/62 9% 2005Mandatory for born after
1983
Source: A.Schwartz and O.Arias, The Inverting Pyramid (2014)
Demography – dependency rate
0
10
20
30
40
50
60
70
80
BG EE LT LV HU PL RO SK
2010 2035 2060
Source: EUROSTAT Population Projection
Demography
• All CEE countries will face significant increase in demographic dependency rate
• It will be particularly acute in those countries that currently have low fertility levels, after 2035
• Retirement ages remain lower than in „old” EU countries, which is partially explained by shorter lives….
• … but changes in retirement age are slower than the actual increase of life expectancy
Employment changes
• Divergent labor market developments:
• Initial decline and later increase in PL and SK
• Increase and decline in HU
• Cyclical changes in Baltic countries
• Loss in contribution revenues after the crisis caused by declining employment
Pension expenditure
0
2
4
6
8
10
12
14
16
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
European Union (27countries)
Bulgaria
Estonia
Latvia
Lithuania
Hungary
Poland
Romania
Slovakia
Source: EUROSTAT Espross database
Trends in pension fund assets(% GDP)
Source: OECD Pension Markets in Focus 2014
0
2
4
6
8
10
12
14
16
18
20
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
Hungary (1)Poland (4)Croatia
0
2
4
6
8
10
12
14
16
18
20
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
Czech Republic Estonia
Slovakia (2) Bulgaria
Macedonia
0
2
4
6
8
10
12
14
16
18
20
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
Slovenia LatviaRomania (3) Serbia
1. As a result of a pension reform, the assets of mandatory pension funds decreased in 2011, while voluntary pension fund assets did not change significantly.
2. The break in series in 2006 is due to the inclusion of voluntary pension plans, not included in the previous years
3. The increase of pension funds’ assets between 2011 and 2012 is due to the increase of pension funds' members, contributions and positive returns.
4. Due to the shift of assets in 2015, there is a drop in total assets of pension funds in Poland due to the transfer and redeeming of government bonds in pension
funds' portfolio
Investment returns in CEE fundedpensionpillars
Source: Bielawska, Chłoń-Domińczak, Stańko (2016)
Country Type of fund Starting date ofcalculations
Average annual rateof return (%)
Bulgaria mandatory 1.07.2004 -2.06
Estonia
all
2.07.2002
-0.10
conservative -0.91
balanced -0.96
progressive 0.33
aggressive 1.01.2010 1.61
Latvia
balanced
7.01.2003
-1.22
aggressive -1.65
conservative -1.75
Lithuania
conservative
15.06.2004
-0.84
stable 0.00
balanced -0.21
aggressive -0.85
Hungary
classic 1.01.1998 until end of 2007
3.39
conservative
22.03.2005
2.05
balanced 1.70
growth 0.75
Poland mandatory 1.09.1999 5.74
Romania mandatory 21.05.2008 5.97
Slovakia
conservative
22.03.2005
-0.42
balanced -1.40
aggressive -1.63
indexed 2.04.2012 1.75
Accumulated real returns (investment) in CEE funded pension pillars
• Generally not satisfactory – either minus or low positive values
• Problem with asset allocation (investment limits, return guarantees, local market capacities)
• Only three funded pension systems with satisfactory results –Hungary, Poland and Romania
• Actual investment performance cannot serve as a justification for pension reversals done in first two countries
Pre-crisis pension reform implementation challenges• Despite initial plans in most of the CEE countries pension
reforms were financed by increasing public debt
• As a result it meant that the part of the implicit pension liabilities were turned into explicit one
• Governments were not persistent in pursuing the initial reform agenda related to financing transition
• Privatization used for other purposes
• Pension savings were not generated (higher indexation of pensions, postponing increase of retirement age)
• EU accession and necessity to follow Stability and Growth Pact requirements, combined with rising deficit and public debt led to the reversals decisions
The concept of financing the transition costs• Three sources of covering the transition costs:
• financing from taxes and other budgetary revenues (burden for working generation),
• financing from savings in the existing PAYG system (burden for retired generation),
• through an increase of the general government debt (burden for future generations).
The choice of the source for financing the transition costs is a crucial decision in terms of the reform success or failure.
Expected and actual sources of financing transition costs
Country Increaseofgovernmentsector
revenues(taxes,socialsecuritycontributions)
Savingsin
existingPAYGpillar
Privatisation
revenues
Bulgaria x x
Estonia x x Latvia x x
Lithuania x x
Hungary x Poland x x
Romania x x
Slovakia x x Sources:Authors’compilationbasedonPensionReforminCentralandEasternEurope(E.Fultz,ed.,2002),ILO2002andConvergenceProgrammesofCEEcountries.
Source: Bielawska, Chłoń-Domińczak and Stańko (2016)
Transition costs
CountryPeriodcoveredinthe
assessmentTransitioncost(%GDP)
Bulgaria 2001-201216,0
Estonia 2001-20129,9
Latvia 2005-20128,9
Lithuania 2005-20128,0
Hungary 2003-20126,2
Poland 2004-20125,0
Romania 2001-20124,9
Slovakia 2008-20121,6
Source: Bielawska, Chłoń-Domińczak and Stańko (2016)
Decomposition of financing transitioncosts by country (% of GDP)
Source: Bielawska, Chłoń-Domińczak and Stańko (2016)
Decomposition of financing transitioncosts by country (% of GDP)
Source: Bielawska, Chłoń-Domińczak and Stańko (2016)
Total transition costs by source of financing
BGEE
LV
LT
HU
PL
RO
SK
Taxes
Pension system savings
Public debt
Source: Bielawska, Chłoń-Domińczak and Stańko (2016)
Financial and fiscal crisis
• Rising public deficit and debt levels
• Falling capacity to finance transition costs
• For the EU countries: excessive deficit procedures
• Negative or low returns and high administrative costs
• Low levels of trust towards pension funds
• Short-term assessment perspective
Economic and fiscal situation of CEE countries after reform implementationSpecification Country
Economic slowdown or recessionin years following reform implementation
Poland (2000 – 2001)Romania (2009 – 2010)
GGS deficit above 3% GDP Poland, Hungary
GGS deficit close to 3% GDP Slovakia
GGS deficit below 3% GDP or GGSsurplus
Latvia, Bulgaria, Estonia, Lithuania, Romania
Fiscal situation – generalgovernment deficit and debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
-10.0
-9.0
-8.0
-7.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
HU
GG deficit GG debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
-8.0
-7.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
PL
GG deficit GG debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
SK
GG deficit GG debt
0
10
20
30
40
50
60
-10.0
-9.0
-8.0
-7.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
RO
GG deficit GG debt
Fiscal situation – generalgovernment deficit and debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
-10.0
-9.0
-8.0
-7.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
LT
GG deficit GG debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
-10.0
-9.0
-8.0
-7.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
LV
GG deficit GG debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
EE
GG deficit GG debt
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
BG
GG deficit GG debt
Expectations and facts about financing transition costs• In all countries transition costs were higher then expected
• … but were not the main drivers of GGS excessive deficits
• Expected privatization revenues were used also for other purposes
• Only few countries successfully implemented changes in existing PAYG part of pension system in line with reform projections (Estonia, Bulgaria, Latvia)
• Reasonable fiscal policy was run by countries with tight national fiscal rules
Changes in funded DC schemes after 2008Reversals
Bulgaria No change.
Estonia
Temporary reduction with off-set. 6% contribution rate cut to 0% between June 2009 and January 2011 and shifted to PAYG. Gradual increase from 2011. Rate set at 3% in January 2011 and 6% in January 2012. In 2014-2017 at 8% to offset missed contributions
LatviaPartial reduction.8% contribution rate reduced to 2% in May 2009. Rates increased to 4% from 2013
Lithuania
Partial reduction.5.5% contribution rate reduced to 2% in July 2009. Rates further lowered to 1.5% in January 2012 and 2.5% in 2013. Change to 3% (2%+ 1%) January 2014, voluntary participation. Additional contribution at 2% in 2016-2019.
HungaryPermanent reversal.Contribution rate reduced to 0% in January 2011 assets transferred to the mandatory PAYG system.
Poland
Permanent reduction and partial reversal.Contribution rate reduced to 2.3% in May 2011. From February 2014 contribution at 2.92%, in February 2014 assets invested in government bonds transferred to PAYG scheme and redeemed. In 2014 system made opt-out and opt-in in specified time slots. Assets from FF transferred gradually to PAYG 10 years prior to retirement.
RomaniaTemporary reduction.Reduction in planned growth path of contribution rate from 2% to 6%. Rate froze at 2%, started to increase from 2011 at annual rate of 0,5pp.
SlovakiaPermanent reduction.9% contribution reduced to 4% in 2013. Funded scheme opt-out and opt-in system.
Source: A.Schwartz and O.Arias, The Inverting Pyramid (2014) updated by authors
Contributionchanges
Estonia Latvia
Lituania Poland
Romania Slovakia
• Difference in initial contribution levels
• But also difference in the reduction of contribution rates
• Permanent change in Latvia, Poland and Slovakia
Assessing the impact of reversals on individual pension wealth: assumptions
• Based on the Ageing Working Group (AWG) assumptions:
• GDP growth: 1.2-1.6 per cent annually
• Wage growth: 2.0– 2.4. per cent annually
• Financial market rate of return: 3.0
• Life expectancy at 65: based on Eurostat population projection
• There is a significant amount of uncertainty due to possible deviations from the assumptions !
Calculating pension wealth change
• Pension wealth change:
• The difference between future value of accumulated contributions paid to the FF tier after change and before the change
plus
• The difference between future value of accrued pension rights in the PAYG tier after change and before the change
Change in pension wealth for average wage earner
-30
-20
-10
0
10
20
30
40
50
60
PL LV EE RO LT SK
% o
f av
era
ge a
nn
ual
wag
e
50 year old 40 year old 30 year old
Summary – context of reform reversals
Fer
tili
ty
Dep
end
ency
rate
Em
plo
ym
en
t
Pen
sio
n
exp
end
itu
re
Pen
sion
ers
Per
form
an
ce o
f
fun
ded
Pen
sio
n
fun
d r
etu
rns
Gov
ern
men
t
def
icit
Gov
ern
men
t d
ebt
Pension system
changes after crisis
Bulgaria - - + + + - - + No change
Estonia - - + + + - + + Temporary reduction with
offset
Latvia -- -- - - - - -- - Partial reduction
Lithuania - - -- + + - -- - Partial reduction
Hungary -- - - -- - + - -- Permanent reversal
Poland -- -- ++ -- - + -- -- Permanent reduction and
partial reversal
Slovakia -- -- ++ - - - -- -- Permanent reduction
Conclusions
• Each of the analyzed countries is characterized by different combination of socio-economic factors taken into account
• Reversals of pension reforms were caused by a set of socio-economic factors, including most importantly
• poor fiscal situation
• rising pressure from current pension system expenditure
• Countries that introduced permanent changes also faced pressures from rising expenditure and number of beneficiaries in the pension system
• Performance of pension funds had little impact on reversal decisions
• Permanent reversals and reductions were made in countries with highest demographic pressures foreseen in next decades
Conclusions
• Reversals of the multi-pillar scheme have different outcomes on expected pension levels, which depends mainly on the design of the PAYG scheme
• In the case of higher pension expectations, the change leads also to higher level of implicit liabilities, which means that the change increases total public liabilities (Slovakia)
• In the case of lower pension expectations, the change leads to similar level of public liabilities, but there is an efficiency loss
Conclusions
• The design of the matching part of the pay-as-you-go system affects the potential pension wealth, which may have influenced some of the individual decisions (in those countries which left a choice to pension system participants)
• Recent modifications in funded systems increased the reliance of future pension income on wage-based financing, which will be more difficult to achieve given projected labour supply shortages due to the population ageing in the future
Lessons learnt
• These findings should be seen only as one of the outcomes of the recent wave of pension systems changes. One should not forget that the change in the proportion of contributions affects the risk diversification of financing future pensions.
• The changes also could have resulted in a loss of society trust towards state-organised pension system and reliability of accumulated pension savings.
Lessons learnt
• Explicit and implicit debt are not treated equally in financial/political world
• transition costs generate new debt, explicit/implicit debt priced very differently by financial markets
• Implicit debt theoretical: depends on future policy, not to be actually paid (implicit financing)
• Explicit debt real: current and real liability, often against foreigninvestors
• More realistic assessment of privatization benefits
• Higher returns expectation were optimistic (and defeated by bond financing), transaction costs of individual accounts high
• No evidence of pulling workers from shadow economy
Lessons learnt
• Diversification: reducing risks by investing in a variety of uncorrelated assets (micro-level)
• but pension system exposed to macro-level shocks (not about uncorrelated risks)
• Private pillars not immune to regulatory risks/shocks
• inflation tax, tax on interest, other regulatory tools, default on bonds, a possibility of nationalization
• The future of pension financing remains a challenge:
• „demographically old but not yet economically rich
Thank you
Research included in this presentation was financed from research grant number UMO-2012/05/B/HS4/04206 from National Science Centre in Poland
Retreat from mandatory pension funds in countries of the Eastern and Central Europe in result of financial and fiscal crisis: Causes, effects and recommendations for fiscal rules
(Bielawska, Chłoń-Domińczak, Stańko, 2016)