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Providing income security in old age ? A quick review of pension reforms

Providing income security in old age ? A quick review of pension reforms . Michael Cichon Social Security Department 1 November 2011. Structure of presentation . Point One: The background noise: were paradigmatic reforms really necessary?

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Providing income security in old age ? A quick review of pension reforms

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  1. Providing income security in old age ? A quick review of pension reforms Michael Cichon Social Security Department 1 November 2011

  2. Structure of presentation Point One: The background noise: were paradigmatic reforms really necessary? Point Two: The theoretical pros and cons of paradigmatic pension reform Point Three: Pension reforms in the crisis stress test Point Four: What went wrong with pension reform in principle Point Five: Elements of generic repair strategies 2

  3. One . Was paradigmatic reform necessary?

  4. The history of pension reform: the return to and old risk coping mechanism: savings…. PARADIGMATIC reforms introducing individual savings components into national pension systems attracted most attention : 1980/81 the Pinochet reform in Chile During the 1990s and early 2000s 11 countries in Latin America introduced fully funded elements into their pension schemes Between 1997 and 2008 10 Eastern European plus some Central Asian Countries followed countries followed SWEDEN Notional defined benefits 1994 2008 Reversal in Argentina 2008 Renewed reform in Chile... 2009 – 2010 Reversals in Eastern Europe But PARAMETRIC reforms were equally prominent : Since the 1990s and many European and OECD countries largely focussing on pension age increases 4

  5. Point One: beyond the ageing hype: were paradigmatic reforms really necessary ? Projected system dependency rates -source EU 5

  6. Point One: beyond the ageing hype: were paradigmatic reforms really necessary ? Projected system dependency rates 6

  7. Point One: The need for paradigmatic reforms remains in doubt…projected cost in % of GDP 7

  8. Point One: The need for paradigmatic reforms remains in doubt…projected cost in % of GDP 8

  9. The challenge beyond the ageing hype… Projected total social expenditure in the EU…

  10. Point One: The challenge beyond the ageing hype… Projected total social expenditure in the EU… International Labour Office 10

  11. Point One: The challenge beyond the ageing hype… The 50:50 rule

  12. Point One: The challenge beyond the ageing hype…

  13. Point One: The challenge beyond the ageing hype… The 50:50 rule

  14. Two. A quick review of the theoretical pros and cons of paradigmatic pension reform

  15. Financing Social Protection: The PAYG vs. Funding debate • Pro funding • Funding would avoid ageing triggered CR increases • Create domestic resources for investment • Increase national savings rate and hence growth • DC schemes are in automatic financial equilibrium

  16. Contra funding • Future benefit levels vulnerable to inflation and capital market performance • Low compliance = low protection • No social redistribution and risk sharing • Double burden during transition or implicit debt (through borrowing) • on the level of GDP all schemes are PAYG anyway • Funded system equally vulnerable to ageing • Concentration of investment power in too few hands • ageing can be counteracted by activity rates and pension ages • Ageing will not lead to exploding social expenditure

  17. Financing Social Protection: The PAYG vs. Funding debate • On (tentative) balance: • Funded and unfundedschemesbothsubject to demographic and economicrisks; on GDP levelboth are PAYG • Bothvulnerable to badgovernance and bad management • Contribution rate stabilisation easierunderfundedschemes • Social redistribution easierunder PAYG schemes • Financing of transition costcanbedifficult • Fundingmight support economicdevelopment •  Definedbenefitschemeswith intelligent collective funding ??

  18. Three. Pensions in the crisis stress test

  19. Point Two: The crisis stress test: effects on the individual pension saver in DC schemes under different crisis scenarios 19

  20. Point Two: what we see in funded pension schemes – fund losses in 2008 ….and lost years of pension savings loss in % of value of 40 35 reserves at the end of 2007 35 30 26 30 25 22 22 25 19 loss of pension savings in 20 years (assumed 9% annual 15 8.4 7.0 increase) (8) 10 5.9 5.6 4.8 4.8 4.6 4.1 3.8 3.1 3.2 2.6 2.6 2.2 5 loss of pension savings in 0 years (assumed 5% annual increase) Quebec pension Chilean plans (1) and (7) Dutch AFPs (3) Irish Funds (2) Funds (5) Pension Pension pension Municipal US State Swedish Pension Funds (4) Fund AP1 Fund (6) Pension Norway Government 20

  21. Point Two: …what we see in funded pension schemes 21

  22. Point Two: Effect of the crisis: what we see in funded pension schemes … 22

  23. Point Two: Effect of the crisis: what we see in funded pension schemes … 23

  24. Point Three: what the crisis has shown so far • Temporary and permanent losses of pension funds which were at peak times as big be as big as the fiscal stimulus package of 5-6 trillion US $ , • Even if pension funds levels may have recovered individual losses of contribution years remained • crisis and pension reforms have increased the insecurity about future pension levels dominantly in DC schemes • Crisis amplified the systemic fiscal stress that the pardigmatic reform created • In the long run – if crisis related unemployment persists for half a decade - then DB schemes may also have to be adjusted but the burden can be shared between contributors and pensioners

  25. Generic problems : Response…

  26. Three. What went wrong with pension reform in principle?

  27. Generic problems • Privatised schemes helped to stabilise pension contribution rates but… • In LA failed to increase coverage • Charged too high fees • In Eastern Europe: • Covering of transition cost left completely unclear (Hungary 0,8 – 1,4% of GDP for 43 years, Poland 1.5 – 2.2. % of GDP over 50 years ) • Same concern in Chile … • No provisions for the payout modalities of the second tier in Hungary and Poland… • Reform was interest driven by private insurance companies (e.g. Poland and Slovakia…) • Asset and contribution based fees reduced the savings of workers considerbaly …

  28. Generic problems : fees… • Table 3.Fees and contributions in individual accounts in Latin American countries as of June 2007 (percent) • Country Admin fee a Mandatory contribution a Fees as a percentage of contributions • Argentina 1.00 4.61 17.8 • Bolivia c 0.50 10.00 4.8 • Chile 1.71 10.00 14.6 • Colombia d 1.58 11.00 12.6 • Costa Rica 0.29 3.96 6.7 • Dom Rep 0. 0.60 7.40 7.5 • El Salvador 1.40 10.00 12.3 • México 1.02 7.48 12.0 • Peru 1.81 10.00 15.3 • Uruguay e 1.79 12.22 12.8 • SOURCE: AIOS 2007. • NOTE: AIOS = Asociación Internacional de Organismos de Supervisión de Administradoras de Fondos de Pensiones • a. As a percentage of the worker's salary. • b. The employee's contribution as a percentage of salary, except in Colombia, Dominican Republic, El Salvador and Mexico where the figure also includes the employer's contribution as a percentage of covered payroll. • c. A fee for administering the investment portfolio is also charged. • d. Fees are also charged for transferring, exiting, and making voluntary contributions. • e. A custody fee on the account balance is also charged.

  29. Generic outcome of paradigmatic reforms • Financial stabilisation of individual funded pension tiers • Increased social uncertainty for individuals • Financial destabilisation of PAYG tiers • Increased fiscal de-stabilisation

  30. Four. Generic repair strategies

  31. Point Four: Generic repair strategies …a few reminders first • Transfer schemes /pension schemes can only define entitlements to a share of present/future consumption (not absolute amounts) – no society can promise more • Markets cannot be asked to secure the income of people who cannot or can no longer operate in markets • The statement that pension schemes can only be stabilised by paradigmatic reforms is a myth… • The statement that countries can only afford a basic social safety net type welfare state in the globalised economy and an ageing society is likewise a myth…

  32. Key principles of ILC Policy recommendations for the extension of coverage : focus on outcomes not on institutional set-ups Universal coverage of basic income security and essential health care –not necessarily uniform coverage. Progressive realization of universal coverage and higher levels of security Benefit levels and poverty protection as predictable rights (i.a. through Ratification of ILO conventions) , Social and economic adequacy of benefit levels Financial and fiscal sustainability Good governance with the state as the ultimate guarantor of social security rights and benefit levels and the participatiosn of sociaL partners 32

  33. Point Four: Options for solutions combining financial and social stabilisation...are not abundant • Process: Solutions have to be found in a process of national dialogue • System wide: Adopt social floor guarantee and adhere to convention C. 102 • DC pillars: • Find innovative pension level guarantees – if second pillars have to survive... ; • reduce the size if fiscal space does not allow the financing of the transition • DB pillars: • long-term planned increases of contribution rates and definition of government subsidies • Phased increase of retirement age + reasonable relationships between time in work and time in pensions Or adopt NDC schemes with social redistribution... • Changing indexing method but protecting purchasing power of pensions

  34. What is needed… A DB Guarantee for a DC or NDC scheme… In a given country the General average premium (GAP) for a pension scheme with an accrual rate of 1.33 % be calculated at a defined point in time If a DC scheme charges a contribution that is equal to a fraction or a multiple of the GAP it has to provide for the same fraction or multiple of the accrual rate of 1.33 percent. At the age of retirement in year n her scheme has to provide a present value (or the above fraction thereof) for the total number of insurance years t (starting from 0) of contributions that is equal to If I=w then for funded schemes and at least that for NDC schemes Side comment: This means that the NDC tier in Russia may be underfunded 34

  35. A side-kick: The identity of the NDC benefit formula and the classical DB pension formula • An NDC is equivalent to a DB scheme with a linear pension formula, constant contribution rate and with actuarial reductions or increments for early or late retirement and an: • accrual rate in the equivalent DB scheme that is equal to = constant contribution rate/life expectancy (annuity factor) at normal retirement age

  36. What is needed to avoid « a waste « of the crisis … National and interntional reviews of three decades of pension reforms based on Observed experience on systemic effects of pension reforms New academic knowledge An analysis of the reasons for reform A return to basics (i.e. redefining the primary function of pension systems…securing old age income security ) A contextual view (i.e. pensions in the context of overall social budgets and their role in economic devlopments) 36

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