Pension reform - experience of the Slovak Republic

FPIFPI
Financial Policy Institute
Ministry of Finance of the Slovak Republic
www.finance.gov.sk/ifp
Pension reform
- experience of the Slovak Republic -
March 2011
Ministry of Labour and Social Policy of Ukraine,
Kiev, 16-18 March 2011

Ministry of Finance of the Slovak Republic FPIFPI
www.finance.gov.sk/ifp 2
Reasons for reform
• Deficit first pillar – almost 100% coverage, mandatory,
benefit-defined, pay as you go (PAYG)
• Low motivation to pay contributions – weak links between
the level of contributions and the level of pensions
• Problem for future – ageing of population – pressure on
expenditures in the first pillar

Ageing of population
Long-term demographic determinants : fertility, length of life, migration
The age structure of population does matter, not the population size :
nowadays 6 persons in productive age on 1 in post-productive age, drop to 1.5 in future

1. Parametric changes – first pillar (2004)
• Retirement age increase
– Prior to reform: men = 62 years, women = 53-57 depending on number of children
– After reform: men + women to 62 years on a step-by-step basis,
• Pension indexation rule introduced
– Prior to reform : political decision
– After reform : automatic index = 50% CPI + 50% of increase in nominal wages
• Possibility to work and to receive pension simultaneously
• Possibility to receive early – old age pension
– pension reduced by 6% for every year below the retirement age
– restriction introduced in 2008 (2 years before the retirement age at earliest)
– in 2011 a ban to receive early old-age pension and to work simultaneously
• Possibility to retire later
– Increased pension by 6% for every year worked-off
• Significant strengthening of the principle of merit for awarded pensions!

Stregthening of merit principle – awarded pensions
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
26%
28%
2099
2499
2899
3299
3699
4099
4499
4899
5599
6399
7199
7999
8799
9599
10499
11499
12499
13499
14499
15499
16999
18999
20999
2001
2002
2003
2004
2005
2006
• Temporary mechanism for starting the principle of full merit
– low pensions are being increased, high pensions are being reduced
• Despite this mechanism , two groups of pensioners – retired prior to reform and
after reform
• After reform only higher pensions are awarded de-facto (very expensive)
Pension
amount
(SKK)
% of
pensioners

2. Systemic changes (2005) – second pillar
• Defined-contribution, fully-funded,
• 9 p.p. of 18 percent for old-age insurance - transferred to
private accounts of savers in pension funds management
companies (private)
• Mandatory for newcomers to the labour market
• Voluntary for others – transitional period (till 30 June
2006)
• circa 1% of GDP revenue decline for general governement
• amount of savings in economy unchanched – thus no
impacts on monetary policy

7
Reform results – implicit debt
• Definition – current value of accumulated pension entitlements
resulting from
– pensions already paid out
– pensions that the currently insured persons would be entitled to if the first
pillar is fully closed in the particular year
• Factors having impact on the amount of implicit debt :
– Average amount of pensions
– Retirement age compared to the expected length of life = period of pension
receiving
– Method of pension benefits indexation

Inštitút finančnej politiky
Ministerstvo financií SR IFPIFP
8
Implicit debt of public finance
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
2000
2010
2020
2030
2040
2050
2060
2070
2080
[% GDP]
Prior to reform 2004
Reform 2004 - pillar I (62 years)
Reform 2005 - pillar II (62 years)
Reform 2005 - pillar II (65 years,CPI)
The pension reform has significantly reduced implicit debt from 400% GDP to the level
of 150% GDP in 2080.
– partially eliminated : parametric changes reduce the implicit debt by 80 % GDP
- partially transformed : starting of pillar II of pension reform reduces the implicit debt by
170 % GDP, but on the other hand, the explicit debt will increase by the same amount (it is
just the debt transformation)
Source IFP

9
Transformation costs of second pillar
• Introduction of second pillar – transforms the implicit debt to
explicit debt, i.e. the government must bear part of the costs today
• Factors having impact on the amount of transformation costs:
– Revenue decrease of the Social insurance agency
– Expenditure decrease of the Social insurance agency
– Interest costs – costs of financing the revenue shortfall of the Social
insurance agency

Expenditure decrease of the Social insurance agency
% GDP
Grey - without introduction of the second pillar in 2005
Black- with second pillar – current legislation

...for the price of immediate shortfall of revenues
% GDP
-4,5%
-4,0%
-3,5%
-3,0%
-2,5%
-2,0%
-1,5%
-1,0%
-0,5%
0,0%
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
2043
2045
2047
2049
2051
2053
2055
2057
2059
Decline of expenditures of the first pillar (%GDP)
Decline of revenues of the first pillar(%GDP)
Transformation costs
Transformation gains

...reform beyond the scope of one generation
% GDP
-50%
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
2043
2045
2047
2049
2051
2053
2055
2057
2059
Cummulative transformation costs – free of interest
Cummulative transformation costs (real interest rate 3%)

Practical experience
• Problem of legislation stability
– Legislation stability is the basic pre-requisite for creating of expectations
regarding the amount of future pensions
– Political consensus very important. Introduction of strong principle of merit
in the Slovak Republic led to later tendency to increase low pensions
• Problem of principle of merit vs. solidarity
– Is it of any importance to have 3 pillars based on principle of merit ? Or does
the strong principle of merit belong to public finance ? (high contributions
high pensions)
– On the other hand, strong solidarity = attempts to avoid payment of
contributions
• Problem of creating two groups of pensioners
– Newly awarded old-age pensions in 2004 and 2005 were not lower than in
past
– In spite of that, social pressure leading to re-calculation of low pensions
awarded prior to reform – reform overcharging

Practical experience
• Politically attractive to weaken the pillar II – additional income VS
– openings 2008 and 2009
– cancelled obligation to join – voluntary, default participation only in
PAYG
– repeated considerations regarding reduction of the rate of contributions
• Premature pensions – widely used
• Indexation of pensions
– Nowadays, the existing pensioners benefit partially from growing real wages
– Inflation indexation is cheaper in context of ageing costs, however there is the
problem with opening scissors between the new and old pensioners
• Fees in second pillar
– Very sensitive to the level of future pensions
– Higher stress on fess from revenues than on those from assets volume
• Regulation in second pillar
– Too strict regulation = low revenues = lower pensions

Thank you for your attention
Marek Porubsky
marek.porubsky@mfsr.sk

Pension reform - experience of the Slovak Republic

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