Reforms in Central Eastern Europe: Selected issues Marek Góra Warsaw School of Economics

Projection of pension expenditure (%GDP) 2004 2025 2050 Δ(2050-2004) Belgium 10.4 13.4 15.5 5.1 Czech Republic 8.5 8.9 14.0 5.6 Denmark 9.5 12.0 12.8 3.3 Germany 11.4 11.6 13.1 1.7 Estonia 6.7 4.2 -2.5 Greece n.a. Spain 8.6 15.7 7.1 France 14.8 2.0 Ireland 4.7 7.2 11.1 6.4 Italy 14.2 14.4 14.7 0.4 Cyprus 6.9 10.8 19.8 12.9 Latvia 6.8 5.3 -1.2 Lithuania 7.6 1.8 Luxemburg 10.0 13.7 17.4 7.4 Hungary 13.0 17.1 Malta 7.0 -0.4 Netherlands 7.7 9.7 11.2 3.5 Austria 13.5 12.2 Poland 13.9 8.0 -5.9 Portugal 15.0 20.8 Slovenia 11.0 13.3 18.3 7.3 Slovakia 9.0 Finland 10.7 3.1 Sweden 10.6 0.6 UK 6.6 Countries marked according to level of expenditure: green – low and/or decreasing yellow – intermediate purple – high and/or increasing. Source: European Commission

Tradition and change in CEE Strong tradition of generous and reliable pensions paid by traditional pension systems in continental Europe. That tradition is fully internalised by the people. This makes the situation different from other regions where historically pensions were not so generous and/or reliable. CEE countries belong to that tradition, which slows down reforms. On the other hand, economic transition that itself had nothing to do with pension reform created a window of opportunity for radical reforms.

Two possible goals for pension reforms Channelling the flow of contributions from workers to retirees through financial markets, which should lead to PV(B) = PV(C) and can also generate a number of positive externalities (financial market development, increase of savings, public education, and so on). Reintroducing intergenerational equilibrium (stable proportions of GDP allocated to each generation), which leads to PV(B) = PV(C), no externalities.

Intergenerational equilibrium GDP2 GDP1 C R

Intergenerational equilibrium If C2 is the same section of GDP2 as C1 of GDP1 then welfare growth is not afected (strong). C2* GDP2 GDP2* GDP1 C1 C2 If C2* is larger section of GDP2 than C1 of GDP1 then welfare growth is weaker. C2*

The pension system (macro perspective) The pension system is a way of dividing current GDP between a part kept by the working generation and a part allocated to the retired generation. If GDPR/GDP = const.  economic neutrality (production factors remuneration not affected) Proportions of the division are subject to public choice.

The pension system (micro perspective) From the individual perspective, the pension system is a way of income allocation over life cycle. In the activity period individuals buy pension rights; after retirement they sell the rights. If PV(C) = E[PV(B)]  actuarial neutrality (decisions on income allocation over life-cycle not affected)

Reduction of pension expectations Key objective for pension reform is to reduce ex ante pension expectations expressed in relative terms. The only other option is to adjust pensions ex post, which means reduction of pension levels in absolute terms.

Pension expectations Reduction of pension expectations contributes to stronger GDP growth, hence contributes to higher welfare of both the working and the retired generation Keeping pension expectations at inflated level slows down GDP growth, hence reduces welfare of both generations and leads to the necessity to cut pensions ex post.

Pension reform designs in CEE Diversity of reform designs stemming from differences in economic approaches as well as in technical methods applied. CEE countries combine experiences coming from: Anglo-Saxon countries, Latin American countries, Scandinavia and Western Europe.

DB vs. DC in universal public systems CEE countries are pretty advanced in reforming their pension systems

Universal (mandatory) funded part of the pension system

Pension assets (universal system; projection) Source: Allianz Global Investors

Areas that need further developments Payout phase regulations Retirement age Investment regulations Returns Fees Competition

Conservative investment

High time for payout phase legislation Accumulation phase fully legislated in 1998, thou some amendments and adjustments are needed (the changes needed are mostly driven by development of the system as well as by development of the economy). Payout phase legislation has been slipping for many years. Now it is eventually at the final stage of legislation process.

Payout phase The payout phase is less developed then the accumulation phase

Accumulation phase: two individual accounts Entirely new old-age pension system (separated within social security). In the accumulation phase the system is based on individual accounts of two types. From the participant’s viewpoint the two parts of the system are very similar (almost identical), both are DC. They are managed in different way.

Public-private partnership The reform was not privatisation of the system but privatisation of pension services providers. Being partially privately managed the system itself remains public. Actually, public institution providing services in the remaining part of the system could be also privatised without any fundamental impact on the system itself. [These features of the system are often misinterpreted with respect to the new Polish system.]

Key goals Low cost for participants (in terms of contribution needed in accumulation phase to generate certain level of pension). Same rules for all participants Contributing to an increase of labour supply in elder groups (50+) Flexibility of retirement decisions Transparency Simple rules, easy to understand for participants Low administrative costs

Retirement products In consequence: No lump-sum payments No programmed withdrawals Annuities only since the system is mandated in order to reach the social goal

Annuities providers Annuities will be provided by specialised private Annuities Companies (AC) competing in the market AC will be supervised by Financial Supervision Authority and by National Actuary AC will be separated from Annuities Fund they will manage [Similar to the separation of Pension Companies and Pension Funds.] Technically payments will be delivered by ZUS together with annuities out of the other part of the system

Tables (tarifs) Annuity Companies will not be allowed to differenciate tarifs for participants according to their individual characteristics (this particularly matters for men and women). A specially designed mechanism will offset possible effects of uneven distribution of men and women served by Annuity Companies.

The social goal The difficulty of designing the payout phase is to find the most efficient way of using market for reaching the social goal. Nowadays it is not redistribution (poverty alleviation) that can be delivered more efficiently via the budget. Instead, publicly or privately run universal pension system is to provide people with a method of income allocation over life cycle that at the macro level tends to intergenerational equilibrium.

To reach the social goal we need: Individual accounts Universal coverage Universal simple rules Focusing on the sole goal of the system (income allocation) The universal system should be of reasonable size to leave enough room for voluntary, hence private per se (not only privately run) schemes