Key Issues in Debates on Modern Pension Systems

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Key Issues in Debates on Modern Pension Systems

• Michal Rutkowski
• Sector Manager and Head, Social Protection
• Europe and Central Asia Region
• The World Bank
• Istanbul, May 16, 2003

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Agenda

• Introduction
• Ongoing pension reform
• The inheritance
• Reform trends
• Conclusions

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Impact of Demographic and Economic Trends on
Social Protection

• Enhanced expenditure pressure
• Old-age income provisions
• Health provisions
• Long-term care
• Reduced expenditure pressure
• Child care
• Maternity benefits
• Unemployment benefits

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Ongoing Pension Reform (I)

• Ultimate objective Better income replacement
  and poverty alleviation for the elderly.
• This requires
• Providing fiscal sustainability
• short-term fiscal balance
• long-term financial viability
• incentives to pay contributions
• Reducing economic distortions/creating economic
  externalities
• labor market effects
• saving and capital stock effects
• financial market effects

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Ongoing Pension Reform (II)

• Addressing distributive concerns
• Intra-generational equity
• Redistribution to well-off
• Sector privileges
• backloading
• Gender bias
• Inter-generational equity
• Compensating for the past
• Burdening the future

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Ongoing Pension Reform (III)

• Securing against political risk
• over-commitment in benefit level
• excessive responsiveness to short-term and
  long-term budget conditions
• depletion of financial reserves
• Reacting to demographic changes and alignment
  with changing needs of the economy
• need to reduce myopia and increase choices
• need to benefit from the development of the
  capital market and to deepen it

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Main Design Features of Inherited Systems

• PAYG monopoly
• Widespread sector privileges
• Low retirement age
• Short wage calculation period
• Redistribution combined with insurance
• Separate farmers system
• Generous replacement rates given the level of
  income

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REFORMING THE PENSIONS SYSTEMS
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Main Reform Options (I)

• PAYG Reform
• Defined Benefit only
• Notional Defined Contribution

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PAYG DB-only Reform Options

• Adjusting the Contribution Rate
• Adjusting the Budget Transfer Rate
• Adjusting the Replacement Rate
• Reduction of accrual periods
• Lengthening of assessment periods
• Elimination of sector privileges
• Actuarially fair adjustments for late/early
  retirements
• Incorporating demographic and fiscal factors in
  the benefit formula
• Indexation changes
• Adjusting the pension coverage ratio
• Retirement age increases
• Increasing labor force participation
• Consolidation of the system (removing sector
  privileges and separate funds)
• Administrative adjustments

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Notional Defined Contribution

• Contributions based on individual earnings create
  account values
• Account balances earn a rate of return. Rate of
  return mirrors the rate of growth of total
  contributions.
• Accumulated account values are annuitized at the
  time of retirement
• Annuities are calculated on the basis of
  accumulated capital and life expectancy at the
  age of retirement.

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Main Reform Options (II)

• Shift to Funded System
• (Funded Defined Contributions)
• Repaying (or making explicit) the implicit debt
• Financial infrastructure and regulatory capacity
• Financial market fluctuations and risk
• Advantages of a funded pillar

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Main Reform Options (III)

• Multi-pillar System
• Risk diversification (Security through
  Diversity)
• Reducing transition costs
• Reform externalities on labor and financial
  market

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Different Systems Exposure to Risks
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Multipillar Pension Systems in the year 1985
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Multipillar Pension Systems in the Year 2000
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Multipillar Pension Systems in the Year 2010
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What do we mean today by a modern pension system?

• It is a multi-pillar system that is adequate,
  sustainable, growth-friendly and meets
  distributional concerns
• With minimum pensions and predominantly DC
  benefits
• Funded by mandatory and voluntary contributions
• Transparent and automatically adjustable
• Administered by both the public and the private
  sector
• Helping transition economies to catch up with EU
  countries
• Different for each country