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

2. International Labour Office 2 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

3. International Labour Office 3 One. Was paradigmatic reform necessary?

4. International Labour Office 4 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

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

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

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

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

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

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

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

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

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

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

15. International Labour Office 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 15

16. International Labour Office 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 16

17. International Labour Office Financing Social Protection: The PAYG vs. Funding debate On (tentative) balance: – Funded and unfunded schemes both subject to demographic and economic risks; on GDP level both are PAYG – Both vulnerable to bad governance and bad management – Contribution rate stabilisation easier under funded schemes – Social redistribution easier under PAYG schemes – Financing of transition cost can be difficult – Funding might support economic development –  Defined benefit schemes with intelligent collective funding ?? 17

18. International Labour Office 18 Three. Pensions in the crisis stress test

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

20. International Labour Office 20 Point Two: what we see in funded pension schemes – fund losses in 2008 …. and lost years of pension savings

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

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

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

24. International Labour Office 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. International Labour Office 25 Generic problems : Response…

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

27. International Labour Office 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. International Labour Office 28 Generic problems : fees… Table 3. Fees and contributions in individual accounts in Latin American countries as of June 2007 (percent) CountryAdmin fee a Mandatory contribution a Fees as a percentage of contributions Argentina1.004.6117.8 Bolivia c 0.5010.004.8 Chile1.7110.0014.6 Colombia d 1.5811.0012.6 Costa Rica0.293.966.7 Dom Rep0.0.607.407.5 El Salvador1.4010.0012.3 México1.027.4812.0 Peru1.8110.0015.3 Uruguay e 1.7912.2212.8 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. International Labour Office 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. International Labour Office 30 Four. Generic repair strategies

31. International Labour Office 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. International Labour Office 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

33. International Labour Office 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. International Labour Office 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

35. International Labour Office 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. International Labour Office 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)