Pension Systems in Times of Financial Crises: Serbia Ministry of Finance Republic of Serbia

Pension System before Reforms Based on the PAYG scheme only (where current workers pay out current pensioners) Very generous and fiscally unsustainable valorization and indexation rules: only 10 best years relevant for calculating pension at retirement, pensions fully indexed to wages Very early retirement age (50 years for women and 55 for men) Generous disability retirement rules, corruption-ridden Since 1991, the pension fund has generated debt; uncertain timing of pension payments, in arrears for 2 months on average

Pension Reforms in Serbia Started in the Early 2000’s Significant parametric and systemic reforms to the public PAYG system (Pillar 1) Introduction of tax-preferred FF voluntary private pension funds (Pillar 3) Serbia did not introduce FF mandatory private pension funds (Pillar 2); Is this a good decision?

Reasoning against Introduction of Pillar 2 Prevailed in Serbia High transition cost: for 7% contributions, transition cost would last for 40 years and average 1.2% of GDP per year! Undeveloped capital markets High administrative and operational costs Risky strategy … as we can all appreciate during days of Global Financial Crisis

Basic PAYG Statistics 2.6 million contributors (1.9 employees, 0.2 self-employed, 0.5 farmers) 1.6 million pensioners (1.4 employee and self-employed, 0.2 farmers) Challenging economic indicators: high unemployment (15%), a low employment rate (50%), significant shadow economy, weak compliance from farmer contributors Deteriorating (rising) old-age dependency ratio: from 25% in 2005 to 34% in 2035

PAYG Parametric Reforms Retirement age increased by 5 years 65 for men and 60 for women (by end of 2010) Disability retirement rules tightened Number of disability pensioners decreased by 15%, another 15% drop expected in coming years Pension Indexation Changes From full indexation to wages, to the Swiss formula (50% wages 50% inflation), finally to full indexation to inflation

PAYG Systemic Reform Based on a change of the pension formula in order to enforce the link between contributions and benefits All years of service relevant for calculating pension at the retirement age

PAYG Reform Savings Increased retirement age + tightened disability eligibility => improved the PAYG dependency ratio in the medium-to-long run Indexation formula less reliant on wage growth => fiscal savings in the short-to-medium term Systemic and parametric reforms started producing savings => pension spending totaled 12.1% of GDP in 2006 and 11.8% of GDP in 2007

Two Steps Back: Reasons behind Increased Public Pension Spending Share in GDP Major reason: a politically motivated ad-hoc pension increase in 2008 Moving from the Swiss formula to inflation indexation was socially unpopular, resulting in the formation of the Pensioner Party which was the key factor in forming the Government Carry-over effects of the ad-hoc pension increase in 2008 will be felt for 2 to 3 years Minor reason: a decline in productivity due to the economic crisis (we increased pensions at a very unfortune moment)

Basic Pensioners’ Standard of Living Statistics Lots of jokes, but in Serbia ... Average pension / average wage ratio was 71% in March 2009 Just like distribution of employees according to wages, distribution of pensioners according to pension benefits, is “left skewed” – 60% of pensioners are receiving pension benefits below the average The poverty rate of pensioners, according to the Living Standards Survey, is lower compared to the population as a whole (5.3% against 6.6%) The net old-age pension/net wage ratio is 80%! Only 55% are old-age pensioners, 25% disability, 20% survivor and only 17% of pensioners have full-career service! The net full career pension/net wage ratio is 90%! Although the pension contibution rate is 22% (11% on behalf of employees and 11% on behalf of employers), budget subsidies account for 40% of pension spending!

Serbia’s Response to Financial Crisis Nominal freeze of public pensions for 2 years (2009 & 2010), inflation indexation afterwards Increased pension spending + decline in contribution revenue growth => pressure on public finances requiring additional budget subsidies

Voluntary Private Pension Funds and Financial Crisis 9 pensions funds in operation, 6% of employees contribute, accumulated funds only 0.15% of GDP In 2008, the Belgrade Stock Exchange tumbled by 75%, but pension funds lost only 7% Restrictive investment regulations and undeveloped capital markets resulted in conservative portfolios 50% money deposits, 30% government bonds, only 15% equity

Financial Crisis Impact on Pension System in Serbia Not very significant, due to the dominance of PAYG financing The major adverse effect is a relative decline in contributions due to economic recession Voluntary pension funds operating for only 2 years with conservative portfolios and insignificant accumulations

Planned Future Changes to Pension System in Serbia Further PAYG parametric reforms Further increases in the retirement age Tightening accelerated service and early retirement provisions Introducing the automatic stabilizers (automatic change in the contribution rate and/or in the retirement age as a reaction to the replacement rate – the financial position of the pension fund) Developing an appropriate valorization and indexation formula that will be fiscally sustainable and socially acceptable (in a way, to keep pace with collected contributions) Expansion of FF voluntary retirement saving Possibly extending a tax-preferred treatment to a broader range of (less risky) saving vehicles, such as long-term bank savings and life insurance contracts