Long Term Reform Agenda International Perspective Asta Zviniene Sr. Social Protection Specialist Human Development Department Europe and Central Asia Region World Bank October 28 th, 2010
We will look at OECD, EU, new EU10, FSU: Pension spending Raising revenue Retirement age Early retirement Generosity of benefits Income redistribution Indexation of pensions
EU Pension Spending (% of GDP) EuroStat, 2007 New EU members spend less (8% versus 12%). OECD spends 7.2%. New EU members have fewer over 65 year olds, lower contributor base
In 2010, the median ECA country will run fiscal deficits of about 5% of GDP Fiscal Balance (% GDP), 2008-2010
Borrowing costs are down, but still twice the levels before the crisis Sovereign Bond Interest Rate Spreads, BP over UST (3 mma)
What Used to Be Affordable May Not Be in the Future Relatively generous benefits for limited years of contribution Relatively low retirement ages Differential between retirement age for men and women Relatively generous early retirement provisions Wage indexation of benefits after retirement to maintain pensioner s position relative to workers
Contribution rates in the region 2009 reforms: Romania 27.5% to 31.3%; Lithuania 26.3% to 28.3%; Russia 20% to 26%; Bulgaria 18% to 16%
Formalization of labor force typically depends on per capita income Moldova Armenia Latvia Belarus Uzbekistan Singapore Region is already above the trend line
Coverage & retirement age, selected countries Coverage is typically calculated as number of contributors over population aged 20-65 Surest option to increase coverage is to increase retirement age
Recommendations on increasing revenue Contribution rates are already high, raising them is often distortive Room to increase coverage of the young is limited Surest way to increase number of contributors is to increase retirement ages If non-labor taxes are easier to collect then - shift distributive elements to the state budget (guarantees, basic pensions, state pensions, etc.) - do not subsidize earnings related pensions from budget, which introduces regressive transfers
Life Expectancy at age 65 EuroStat, 2007 Old EU members:19; new EU members: 16. Selected FSU: 15 not such a big difference! Compare with 10+ year gain in less than 40 years in OECD For pension system only life expectancy at retirement matters, not LE at birth Pension insurance when first introduced in Europe was available at age 65, when life expectancy at birth was 65
Life Expectancy at statutory target retirement age EuroStat, 2007 Men Women France, Slovakia, Slovenia draft laws in parliament to increase ret. age New EU member states and FSU can not afford retirement lengths of old EU members; even old EU members can not afford them and are starting to reform Gender difference in old member states: 4.6; new member states 5.4; FSU: 7.4 years
Belarus: majority of people at current retirement age can still work 51% 47% 30% 26% 17% 71% of early retirees continue to work (why have this scheme at all?) Disability and unemployment programs would provide a safety net
Lithuania: 50% of population continue working after reaching retirement age
Disability rates in OECD, 1999 Stock per 1000 Inflows per 1000 20-34 35-44 45-54 55-59 20-34 35-44 45-54 55-59 Poland 13 61 182 262 1.6 7.1 18.1 11.7 Norway 18 54 120 219 3.3 8.5 18.2 36.9 Netherlands 32 63 120 192 8.3 11.6 15.6 12 Sweden 15 37 60 171 1.9 5 9.6 19.8 Denmark 11 30 83 156 1.6 3.1 7 11.1 UK 31 52 89 144 9.7 12.4 17.8 22.3 Portugal 11 24 70 175 1.2 2 7.7 19.8 Switzerland 19 33 55 86 2.4 4.4 8.5 14.1 Australia 21 36 64 131 3.2 5.1 8.6 17.7 Spain 6 17 40 80 0.4 1.6 3.6 8.4 US 21 35 56 93 2.7 4.5 7.8 13.9 Austria 3 11 40 188 0.7 2.2 9.5 34.9 Germany 4 14 39 106 0.6 2.3 6.9 18.5 Mexico 0 2 7 17 0 0.1 0.3 0.7 OECD Average (14) 15 33 73 144 2.7 5 10 17.3 Expect significantly higher disability rates in the future as ret. age increases Disability certification and audit procedures are crucial and will be even more important in the future
Recommendations on retirement age Raise retirement age to 65 Equalize retirement ages for men and women Do not worry about increasing unemployment few new entrants into the labor market, older workers still employable Be prepared for pressure on disability program Plan to raise retirement age higher in the future as life expectancy rises Notional account systems automatically reduce benefits as life expectancy rises Legislate automatic adjustment in retirement age as life expectancy rises
Prevalence of Early Retirement, Poland, 2007
% Reduction Actuarial reduction per year of early retirement 8 7 6 5 4 3 2 1 0 Actuarial fairness would require reductions of about 6-7% of the pension per year of early retirement - very hard politically to implement, very few ECA countries do it - 6-7% does not seem to induce enough response from workers - allows flexibility, but may lead to socially unsustainable pension level - Some require additional contributions for privileged occupations, but does not cover early retirement
Recommendations on early retirement Eliminate early retirement Results in low pensions which then raises pressure to lift overall level of pensions Impose actuarial reductions on pensions received early Require proof of hardship / unemployment (Lithuania) Require additional contributions for early retirement, including to cover longer duration of retirement
Pension/Average Wage OECD: Average Pension / Net Average Wage for Full Career Workers looks generous, but 120 100 80 60 40 20 0 Requires 45 year career Net 60% is only 42% gross at 30% tax rate Many of these OECD schemes are not sustainable and will have to be reformed
OECD Accrual Rates Average accrual rate of <1.5% suggests that a 45% gross benefit after 30 years of service is considered reasonable in OECD. Pensions can only be higher with substantially longer careers
Recommendations on generosity OECD schemes might provide similar benefits for full pensions, but full pensions are only received after 45 years of contribution OECD schemes are also typically not sustainable and will need to be cut further Cannot compare euro equivalent of pensions across countries because cost of living, wages, and affordability vary across countries Expectations need to be adjusted so that people understand that benefit rates from the past are not applicable in today s world Individuals need to understand that higher pensions will require higher personal saving
Who benefits most from pension spending? Objective: poverty alleviation? Reduces poverty in old age Higher income individuals do not get much income replacement Objective: income replacement? Allows individuals to replace some of the income they lost due to inability to earn because of old age, disability, or death of breadwinner Some people will still be at risk of poverty during old age
Different Choices for Different Countries Source: Whitehouse, Pensions Panorama, 2007.
Different Choices for Different Countries Source: Whitehouse, Pensions Panorama, 2007.
Pension for full-career low earner Netherlands Romania Czech Republic Sweden Finland Bulgaria Slovenia Lithuania Latvia Estonia United Kingdom United States Germany Pension level (% of economy-wide average earnings) 0 5 10 15 20 25 30 35 40 45 50
Contributors of Today are Pensioners of Future Governments will need to provide some resources for the elderly without access to pensions Challenge is not to destroy incentives to contribute Options: Universal social pension Means-tested social pension Integration of elderly with or without pensions into social assistance system
Indexation OECD Price Indexed Belgium, Canada, France, Iceland, Italy, Japan, Portugal, Spain, UK, US Discretionary Austria, Greece, Luxembourg, Sweden 80% Price-20% Wage Finland 50% Price-50% Wage Switzerland Wage Indexed Denmark, Germany, Netherlands, Norway ECA Price Indexed Azerbaijan, Serbia, Turkey, Uzbekistan, Latvia, Bulgaria Discretionary Albania, Armenia, Georgia, Kazakhstan, Russia, Lithuania Dependant on GDP growth Hungary, Estonia 80% price-20% wage Poland, Ukraine 2/3 price-1/3 wage Czech Republic 50% price-50% wage Croatia, Slovak Republic, Macedonia, Moldova, Montenegro 100% wage Belarus, Bosnia, Romania, Slovenia, Tajikistan wage, 5 50-50, 5 67-33, 1 80-20,2 price, 6 discretionary, 6 dependant on GDP, 2
Recommendations on indexation Move to inflation indexation as soon as feasible Countries can legislate that some component of wage growth will be included in the exceptional years when GDP / real wage growth are high (Hungary, Estonia) Otherwise limit discretion since it creates uncertainty for pensioners
Conclusions: PAYG pillar OECD / EU pension system environment longer LE no fertility and emigration shock better coverage of the young does not need to focus so much on subsidizing minimum pension (lower poverty rates, stronger social assistance programs) OECD /EU pension scheme parameters Retirement at 65 for men and women with no subsidized early retirement privileges 45% gross replacement rate for comparable 30 year career increasingly indexed only to inflation This still leaves countries with deficits and requires reforms ECA: Trend to increase retirement ages to 65, eliminate gender differences Subsidized early retirement options unaffordable and unfair Disability program certification and audit procedures need to be strengthened Increasingly switching to price indexation, although enforcement remains an issue Design and finance poverty alleviation for the non-covered future elderly Expectations about generosity of benefits have to be adjusted downwards
Conclusions: funded pillar Diversification of risk Timing of shocks to financial asset prices considerably different than timing of crisis on PAYG benefit levels Aging of population Benefit levels will likely fall further in the future To maintain adequacy of benefits, will need to save either on voluntary or mandatory basis But need to have adequate preparation Fiscal space Adequate financial markets Adequate supervision and regulation