1. 1 ACTUARIAL AND FINANCIAL REVIEW OF THE GENERAL PENSION SCHEME OF LUXEMBOURG 15 February 2001 The International Financial and Actuarial Service (ILO-FACTS) ILO Social Protection Sector

2. 2 Structure of the presentation 0. International comparison 1. Assumptions of the valuation 2. Status quo results Scenario 1 Scenario 2 3. Alternative reform options 4. Conclusions and recommendations

3. 3 International comparison - retirement 65 years old with 40 years contribution

4. 4 Assumptions - Net cross-boarder workers

5. 5 Assumptions - Real GDP increase

6. 6 Assumptions - Employed (Domestic) and labour force (National)

7. 7 Status quo results 1.Scenario 1 (a)Demographic ratio (b) Financial ratio (c) PAYG cost rate (d) Reserves and funding ratio 2.Scenario 2 (a)Demographic ratio (b) Financial ratio (c) PAYG cost rate (d) Reserves and funding ratio

8. 8 Demographic ratio - Scenario 1

9. 9 Financial Ratio - Scenario 1

10. 10 PAYG cost rate - Scenario 1

11. 11 Reserves and funding ratio - Scenario 1

12. 12 Comparison between two scenarios - demographic ratio

13. 13 Financial ratio - Scenario 2

14. 14 Comparison between two scenarios - PAYG cost rate

15. 15 Reserves and funding ratio - Scenario 2

16. 16 Summary of Financial situation - Status quo 1.Sound financial situation at present, but sensitive to assumptions, especially economic ones (a)Scenario 1 Contribution rate increase necessary after 2050 (b)Scenario 2 Contribution rate increase necessary after 2010 2.Financial situation deteriorates in the second half of the projection period because of demographic reasons -Relatively large cohort of residents at present between the age of 30 – 34 -Higher number of pensioners because of present commuters

17. 17 Alternative reform options 1.Parametric reform options 1.1Yearly adjustment of pensions 1.2Increase in the level of pensions 1.3Payment of a thirteenth pension 1.4Unspecified increase of payment 1.5Higher weight to contribution periods close to retirement 1.6Change of retirement age 1.7Reduced invalidity incidence rates

18. 18 Financial effects - parametric reform options

19. 19 Alternative reform options 2.Systemic reform proposals 2.1Bonus accounts 2.2Two-tier pension scheme (introducing DC scheme) 2.3Value added contribution (VAC)

20. 20 Bonus accounts - Funding ratio comparison

21. 21 Bonus accounts - Development of account balances

22. 22 Introduction of two-tier pension scheme (DC scheme) Assumptions 1.Introduction In the year 2010 2.Contribution rate (a)First pillar (DB scheme)18% (b)Second pillar (DC scheme) 6% 3.Financial transfers between the two pillars in case of invalidity and survivorship Higher administrative cost in 2nd pillar

23. 23 Introduction of two-tier pension scheme (DC scheme) (Contd.) 4.Benefits (a)First pillar (DB pillar) -Old-age pensions annual accrual rate of 1.28% (instead of 1.78% at present) -Invalidity and survivors’ pensions same as the present scheme (b)Second pillar (DC pillar) -Old-age pensions only annual amount calculated by dividing accrued individual amount by unisex life expectancy

24. 24 Two-tier pension scheme - Development of reserves

25. 25 Two-tier pension scheme - Replacement rates

26. 26 Replacement rates of the second tier (DC tier)

27. 27 Value added contribution (VAC) Why: 1.Compensation of fiscal effects of decrease of labour income share in GDP 2.Possible increase in employment level Problems: 1.Results of research are inconclusive 2.Employment effects marginal 3.Lobbying for exemptions is highly probable 4.Administrative problems not yet solved or unclear 5.Loosen ownership rights of employers’ contributions 6.Introduction only possible in a concerted international action Conclusions: Presently not recommendable and not necessary

28. 28 Conclusions and recommendations 1. Financial situation of the scheme -Sound financial situation -Sensitive to assumptions, especially economic ones -Future demographic pressure on the scheme in either scenario

29. 29 Conclusions and recommendations (Contd.) 2. Recommendations – ‘‘DO’’s and ‘‘DON’T’’s -DO adjust benefits on annual basis -DO increase early retirement ageof 57 and 60 -DO tighten the eligibility criteria for invalidity pensions after age of 50 -DO prolong the scaled premium period to10 years with a funding ratio of 2 at its end

30. 30 Conclusions and recommendations (Contd.) -DON’T spend current surpluses and presently high reserves, except for creating ‘bonus accounts’ -DON’T increase the level of the benefits e.g.-10% increase in the flat part and accrual rate of 1.9% instead of the present rate of 1.78% -Thirteenth payment -Higher weights to contribution periods close to retirement

31. 31 Conclusions and recommendations (Contd.) -Introduction of two-tier system has no advantage for the individual. -Introduction of VAC is not necessary from a financial point of view. -It may be a good idea to introduce ‘bonus accounts’ through which ‘windfall profits’ could be distributed.

32. 32 ACTUARIAL AND FINANCIAL REVIEW OF THE GENERAL PENSION SCHEME OF LUXEMBOURG 15 February 2001 The International Financial and Actuarial Service (ILO-FACTS) ILO Social Protection Sector