Long-run Pension System Reforms in Europe and Central Asia Anita M. Schwarz Lead Economist Human Development Department Europe and Central Asia Region World Bank May 2009

Population in Region is Aging

What Used to Be Affordable May Not Be in the Future u Relatively low retirement ages –Differential between retirement age for men and women u Relatively generous early retirement provisions u Wage indexation of benefits after retirement to maintain pensioner’s position relative to workers u Relatively generous benefits for limited years of contribution

Most OECD Countries Set Retirement Age at 65

Most Have Equalized or are Equalizing Retirement Ages for Men and Women u Only France has retirement age below 65 for men and women u Only Austria, Greece, Italy, and Switzerland maintain retirement age differences between men and women

ECA Region Retirement Ages

Retirement Age Recommendations u Raise retirement age to 65 u Equalize retirement ages for men and women u Plan to raise higher in the future as life expectancy rises –Notional account systems automatically reduce benefits as life expectancy rises –Legislate automatic adjustment in retirement age as life expectancy rises

Prevalence of Early Retirement

Few Penalties for Early Retirement u A few countries impose actuarial reductions on early pensions; most do not –Actuarial fairness would require reductions of about 6-7% of the pension per year of early retirement u Some require additional contributions for privileged occupations, but does not cover early retirement

Recommendations u Eliminate early retirement –Results in low pensions which then raises pressure to lift overall level of pensions u Impose actuarial reductions on pensions received early u Require additional contributions for early retirement, including to cover longer duration of retirement

Should Pensioners Share in Worker Wage Growth? u General view in the region that when wages rise, pensions should rise proportionately u Also the view originally in Europe – pensioners should share in growth u Found to be too expensive as the number of pensioners grew with aging u Now the prevalent approach is protecting the retiree’s purchasing power through inflation indexation and encouraging additional savings if the retiree wants more –Preferable to lowering the initial pension for the retiree and then adjusting to wage growth because pensioner needs typically do not increase over retirement period

OECD Indexation u Price Indexed –Belgium, Canada, France, Iceland, Italy, Japan, Portugal, Spain, UK, US u Discretionary –Austria, Greece, Luxembourg, Sweden u 80% Price-20% Wage –Finland u 50% Price-50% Wage –Switzerland u Wage Indexed –Denmark, Germany, Netherlands, Norway

ECA Indexation u Price Indexed –Azerbaijan, Serbia (?), Turkey, Uzbekistan u Discretionary –Albania, Armenia, Georgia, Kazakhstan, Russia u 80% price-20% wage –Poland, Ukraine u 2/3 price-1/3 wage –Czech Republic u 50% price-50% wage –Croatia, Estonia, Hungary, Slovak Republic, Bulgaria, Latvia, Macedonia, Moldova, Montenegro u 100% wage –Belarus, Bosnia, Romania, Slovenia, Tajikistan

Recommendation u Move to inflation indexation as soon as feasible u Countries can legislate that some component of wage growth will be included in the exceptional years when real wage growth exceeds 10% u Otherwise limit discretion since it creates uncertainty for pensioners

Generosity Varies in Region u Some schemes provide modest benefits u Others provide quite generous benefits, particularly in relation to years of contribution – 50-60% of gross wage for as few as years of service u OECD schemes might provide similar benefits for full pensions, but full pensions are only received after 45 years of contribution –OECD schemes are also typically not sustainable and will need to be cut further u Cannot compare euro equivalent of pensions across countries because cost of living, wages, and affordability vary across countries

OECD Accrual Rates Average accrual rate is <1.5% suggesting that a 45% benefit after 30 years of service is more appropriate than the 60-70% currently expected

Recommendation u Expectations need to be adjusted so that people understand that benefit rates from the past are not applicable in today’s world u Individuals need to understand that higher pensions will require higher personal saving

New Problem: Low Contributor Coverage Leads to Low Coverage of Future Elderly OECD Coverage ECA Coverage in Selected Countries

Contributors of Today are Pensioners of Future u Governments will need to provide some resources for the elderly without access to pensions u Options: –Universal social pension –Means-tested social pension –Integration of elderly with or without pensions into social assistance system

Future of Multipillar Reforms u Diversification of risk –Timing of shocks to financial asset prices considerably different than timing of crisis on PAYG benefit levels u Aging of population –Benefit levels will likely fall further in the future –To maintain adequacy of benefits, will need to save either on voluntary or mandatory basis u But need to have adequate preparation –Fiscal space –Adequate financial markets –Adequate supervision and regulation

Concluding Recommendations u Raise and equalize retirement ages u Curb early retirement u Focus indexation on protecting the purchasing power of the elderly u Publicize realistic expectations for future pensions u Design and finance poverty alleviation for the non-covered future elderly u Careful planning necessary if adopting second pillars