Role of Pension reform in Financial Sector Development: opportunities for Armenia

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Role of Pension reform in Financial Sector
Development opportunities for Armenia
Anna Nechai, PhDLegal and Pension Expert
anna_nechai_at_yahoo.com
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1. In April 2005 RA Government approved
conceptual approaches of pension reform,
according to which

• The first goal of the new pension system is
• to insure that Armenian citizens are provided
  with appropriate, stable and sustainable income
  at their old age.

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2. Reaching the primary goal of pension reform
depends on the development of financial markets

•  
• Availability of the new pension system depends on
  the financial resources of individuals and of
  society
•  
• The stability of the system depends on the
  orderly financial markets and GoAs ability to
  maintain prudent fiscal and regulatory policies
•  
• Sustainability depends on the capacity to
  withstand stresses, including those originated
  from economic, demographic and political risks.

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3. At the same time, successful pension reform
will promote the development of financial markets

• The second goal of the new pension system is
  long-term positive promotion of economic growth
  through improving transparency and flexibility in
  labor markets and development of financial
  markets.
•   Funded pension systems provide emerging
  financial markets with large supplies of
  long-term capital.

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4. The pension system, which is going to reach
these goals in Armenia

• It is envisaged to create three-level (mixed)
  system in Armenia including the following
  elements 
• 1. State pension security (unfunded pillar
  financed from the State budget)
• 2. Mandatory accumulative pension insurance
  (funded pillar)
• 3. Voluntary pension insurance (funded pillar)
•  NOTE Armenia has already transferred the
  financial responsibility for social pensions
  (pension provision with guaranteed minimum
  benefit level) what the World Bank now refers to
  as Pillar 0 -- from the Social Insurance Fund to
  the State Budget

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5. Financial arrangements in Pillar II

• 1) Citizens from 16 years old entering employment
  up to 30 or 40 years old will participate only in
  the II pillar and will no longer pay social
  contributions to the solidarity system.  
• 2) Citizens over 30 (or 40) years old will have
  rights to choose and either to participate in the
  new system or stay in the existing solidarity
  one.  
• 3) Pension benefits will be calculated based on
  accumulated mandatory payments and average life
  expectancy at retirement
• 4) Existing pensioners will be paid from
  contributions to the solidarity system (while
  such contributions continue) and general taxes
  (State budget).
• Thus, any financial problems in accumulative
  system (failure to accumulate enough to pay
  minimum pensions) will be covered by State
  budget.

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6. Where to start?

• Some minimum preconditions are needed for the
  successful introduction of a funded pillar
• A solid core of sound banks and insurance
  companies
• A long-term commitment by government to pursue
  sound macroeconomic policies
• A long-term commitment by the GoA to financial
  sector reform by establishing a sound regulatory
  and supervisory framework for pensions and
  insurance products and providers
• A commitment by the GoA to maintain the
  sustainability and soundness of the unfunded
  pillar (deficits in the solidarity system may
  lead to large increases in government borrowing
  that can disrupt capital markets)

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7. The GoA has established the following
preconditions for the introduction of Pillar II

• The state budget deficit must be less than 1 of
  GDP
• Real annual economic growth in the Republic of
  Armenia must exceed 2 for several years
• The stock exchange must be a stable and orderly
  market
• State institutional structures and the legal
  framework must be in place to regulate insurance
  activity
• The personified account system must be fully
  implemented and operating smoothly.
•  
• AND Armenia will also need to improve its legal
  framework and capacity to properly regulate  
• Commercial banks (who will serve as custodians)
• insurance companies (who will provide annuities)

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8. Financial markets should be sufficiently
developed to ensure

• Diversified investment opportunities and orderly
  procedures for making investments
•  
• In Armenia in the early stages of implementing
  Pillar II, pension assets will be invested in
  low-risk assets, with the goal of gradually
  liberating guidelines in the future. Higher risk
  assets will first include mortgage bonds and then
  all capital market instruments.
•  The relatively low per capita income in Armenia
  imposes some barriers to the scale of the market.
  In such countries the portfolio of funded pension
  funds would be composed primarily of
• - government bonds banks long-term
  certificates of deposit small fractions in
  shares foreign securities.
•  As financial markets develop, investment
  regulations should allow
• - higher investments in shares foreign
  securities corporate bonds asset-backed
  securities small investments in venture capital
  companies.

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9. Financial markets should also to ensure

• Adequate skills of professional participants in
  the system
• (pension funds, insurance companies, asset
  managers, custodian banks, regulatory agencies).

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10. A sound regulatory and supervisory framework
for pension system

• It is planed that in Armenia
•  
• A regulatory body can be established either by
  creating a new entity or expanding the
  responsibilities of an existing agency. Before
  the accumulative system is implemented, the
  regulator will be a government agency but
  responsibilities may be transferred to a Self
  Regulatory Agency.
•  
• It takes a long time to develop the skills and
  capacities of regulators. The evolution of the
  pension system should not develop faster than the
  capacity of the regulators.

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11. What is needed for a successful pension
reform in Armenia (in addition to other
requirements)?

1. GoA should not underestimate the interdependence
   of pension reform and financial sector
   development in Armenias Strategy of Pension
   Reform (due to January 1, 2006).
2. The Financial sector should remember that pension
   reform must be based on the social justice as
   well as financial prudence. Pension funds must be
   managed in the interests of beneficiaries, NOT in
   the interests of economic growth.
3. The participants of the Pension system should
   remember that the financial sector must be based
   on prudent management and market rules to provide
   with appropriate financial instruments -- even
   if/when people deserve bigger pensions
   immediately.
4. Politicians should remember that pension funds
   must be defended against political pressure for
   inappropriate use.