1 Pension Reform in Central and Eastern Europe Elaine Fultz Senior Specialist in Social Security ILO Budapest

2 Presentation: ILO Budapest regional technical cooperation project –Regional trends –Issues and Problems

3 Regional trends: Change design features of public pension schemes Strengthen scheme financing Scale down public schemes and replace with privately managed individual savings

4 Change design features: More individualized benefits eliminate redistribution count more years of work Notional defined contribution (NDC)

5 Retirement Ages – New EU States Current lawMenWomen Czech Rep.1995,2003increasing to 63 by 2013 by 2 months/year Increasing to (depending on no. of children raised) by 4 months/year in 2013 Estonia1998, in force Increasing to 63 in 2016 by 6 months/year Hungary1996increasing to 62 in 2001 by 1 year every second year Increasing to 62 in 2009 by 1 year every second year Latvia1998increasing to 62 in 2003 by 6 months/year Increasing to 62 in 2008 by 6 months/year Lithuania1994, 2000increasing to 62.5 in 2003 by 6 months/year Increasing to 60 in 2006 by 6 months/year Poland1998 (in force, 1999) 65, with early retirement eliminated beginning in , with early retirement eliminated beginning in 2007 Slovak Rep.2003Gradual rise to age 62Same as for men Slovenia

6 Unified collections Latvia (1996) Slovenia (1996) Estonia (1999) Hungary (1999) Bulgaria (2002) Romania (2003)

7 Pension Privatization Averting the Old Age Crisis, World Bank, 1994 –Pay as you go pension schemes are unsustainable in the face of demographic aging. –Governments are corrupt, tend to over-promise. –Both problems can be circumvented by scaling down pension systems and replacing them with privately managed individual savings accounts.

8 Pension privatization in the new EU member states Countries with mandatory, commercially managed individual savings account Countries without such scheme Hungary (1998)Czech Republic Poland (1999)Lithuania Latvia (2001)Slovenia Estonia (2002) Slovak Republic (2003)

9 Issues and Problems Impact of second pillar on first Transitional financing costs –The “hole” in the financing of the public pension system created by diverting part of the contribution rate to the new private savings accounts

10 Transitional financing costs in Poland Chlon, Agnieszka, "The Polish Pension Reform of 1999," in Fultz, E., Ed., Pension Reform in Central and Eastern Europe, Vol. 1, ILO: Budapest, 2002.

11 Private Investment Returns ILO reports (Dec. 2004) Hungary3.75% average annual internal rate of efficiency over first 6 years of operations 6.6% inflation rate Poland20.3% increase in value of second pillar savings over December 1999 – June % inflation rate

12 Hungary – end of 2005 ( ) 6.8% average annual return 6.1% average inflation 0.7% positive return to workers

13 Why the low/negative returns? Poor stock market performance? Industry charges and fees?

14 Admin. charges and their impact Poland 2001 Poland new legislation Kazakhstan 2001 Kazakhstan new law Croatia 2002 Croatia draft legislation Upfront fee (% of contribu- tion) Mgmt. fee (% assets) 0.6Up to 0.54none0.6None1.2 Perform- ance fee (% of return) noneUp to 0.06% of assets None Reductions in assets Reductions in yield Chlon, Agnieszka, "Funded pensions in the transition economies of Europe and Central Asia: Design and Experience", FIAP, 2004.

15 Rethinking of Privatization Flaws in economic logic Disregard of necessary preconditions for success

16 World Bank (2001): “In the end, both types of schemes (pay as you go and funded) require a subsequent generation to fulfil the generational contract, either in the form of current contributions (in unfunded schemes) or through the purchase of accumulated assets (in funded schemes). Money put aside for retirement alone does not change this fact …”

17 World Bank (2006): Initial Conditions for Multi-Pillar Reforms Macroeconomic stability Developed banking sector A low risk for corruption

18 Many Countries Had High Inflation at Reform

19 Poor Financial Sectors Characterize Some ECA Multi-pillar Reformers

20 Many Reformers Had Poor Corruption Index at the Time of Reform

21 New understanding An old age crisis will not be averted by a change in pension financing Under any type of pension system, what matters is national economic output and the ratio of workers to pensioners. Creating a “hole” in the financing of the public pension system will make addressing the problem of demographic aging more difficult.

22 Employment rates in 2002 Chlon, Agnieszka, "Funded pensions in the transition economies of Europe and Central Asia: Design and Experience", FIAP, 2004.