Measuring Political Risk of Hungarian Social Security System Is there a really good reform? Juraj Kopecsni

To provide a theoretical model for measuring political risk in PAYG and funded pension schemes Empirically quantifies that risk Governments can change the structure of the state scheme Analyze changes in the household’s social security wealth The importance of political risk is often underestimated or neglected

During pension reforms there are several changes within rules and legislation, which have different impact on social security wealth Policy makers have no clear picture about impacts of these changes without such risk analysis The pension reform can lead to the worsened rather than improved situation

Literature McHale (2001), Blake (2003) – show the impact of particular law changes on measure of participants life time benefits Shoven and Slavov (2006) – defined a political risk as variation in IRR

Why Hungary? In Hungary pension reforms are the most advanced among transition countries Multi-pillar system was adopted in 1998 with a mandatory fully funded pillar Eight years of implementation have passed, which raises a natural interest in the Hungarian reform experience Shows how to possible avoid the political risk

Methodology According to McHale (2001) political risk is easy to describe but is hard to quantify Measure the political risk as the reduction in social security wealth for an average worker resulting various reforms in Hungary Given reform will affect different people differently, depending on gender, age, wage distribution or age- earnings profile

Assumptions: The worker’s age-earnings profile is estimated The worker stars to work at age 20 The workers retires at the standard retirement age and are eligible for full social security benefits In calculation of expected social security wealth we use probability of survivor derived from mortality tables The discount rate is 4% Projected inflation is 2%, Projected gross and net wage growth is 5% Annuities from 2 nd pillar are unisex with Swiss indexation Projected Interest rate of contribution is weighted average net real interest rate of all pension funds during plus projected inflation

where SSW - social security wealth a – year of birth, cohort f – discount rate T – year of the reformw – gross nominal wage R – year of retirementd – mortality rate t – current yeari – indexation rate B – initial pension

Reform 1993 Retirement age is postponed for Female from 55 to 60 Initial pension benefit is calculated: Before – among last 5 working years 4 best years After – from 1988 the whole working period

Reform 1997 Taxation of Employer is decreased from 24.5% to 24% Retirement age is postponed for Male and Female to 62 Retirement age for Female cohorts is shifted back by 1 year Factor at calculation of initial pension benefit is increased

Reform 1998 Taxation of Employer is decreased gradually from 24% to 22% Taxation of Employee is increased gradually from 6% to 9% After 2012 the initial pension is calculated from gross wage instead of net wage Indexation Before - nominal net wage growth with 1 year lag After – 30%CPI + 70% net nominal wage growth in %CPI + 50% net nominal wage growth from 2001

Reform 2003 Taxation of Employee is increased from 8% to 8.5% Contribution of Employee to the 2 nd pillar is increased from 6% to 7% In 2003 additional 25% of monthly pension benefit In 2004 additional 50% of monthly pension benefit In 2005 additional 75% of monthly pension benefit From 2006 additional 100% of monthly pension benefit

Conclusion Reform 1993 – affects negatively workers close to retirement and positively younger ones Reform 1997 – the higher factor at calculation of initial benefit and positive change in taxation is not enough to compensate the effect of postponed retirement age. On the other hand reform affects positively female cohorts , because they can enjoy earlier retirement age.

Reform 1998 – affects negatively already retired persons and for those who are close to retirement age. On the other hand affects positively cohort 1951 or younger, no matter when worker is in the pure 1. pillar or in the mixed system. However workers in pure 1. pillar are better off. Reform 2003 – affects positively all cohorts. Cohorts utilized the additional benefit gradually. Younger cohorts utilized fully the 13 th monthly benefit, which means 8.3% higher pension benefit. In additionally cohorts from 1951 in the mixed system has higher benefit, because the contribution rate increased by 1%

Working on … Compute changes in SSW for various education level and age group Compute IRR for various age group under existing legislation for each reform Do analysis also for the Czech and Slovak social security system Sensitivity analysis through key parameters