NDC EXPERIENCE IN EUROPEAND CENTRAL ASIA REGIONAnita M. SchwarzLead EconomistECSHDApril 2013
ECA IS THE MAIN REGION WITHEXPERIENCE IN NDCS 3 countries paying pensions on notional accountbasis Latvia Russian Feder...
ADMINISTRATIVE COMPLEXITY LIMITSIMPLEMENTATION AND TRANSPARENCY Lack of understanding by pension administratorsof how to ...
RUSSIAN EXPERIENCE Converted existing DB system into notionalcapital Provided a notional interest rate equal to growthof...
RUSSIAN OUTCOME AND POLICYRESPONSE By 2008, pensions were averaging 26% of average wage Notional interest rate – contrib...
LATVIAN EXPERIENCE Coverage increased 30% between 1997-2007 Then dropped by 8% in 2009 Real wage growth stood at 23% in...
NOTIONAL REAL INTEREST RATE RAISEDTHE LEVEL OF NEW PENSIONS2005 2006 2007 2008 2009Notional real interest rate applied to ...
LATVIAN POLICY RESPONSE Boom year revenue was spent: (pensionbuffer fund insignificant):- Partial wage indexation introdu...
POLISH EXPERIENCE Projected decline in futurebenefits despite ret age at 67 Socially unsustainableto have people pay27.5...
LESSONS FROM IMPLEMENTATIONEXPERIENCE Timing and transparency NDCs build account balances on wage bill/wage growth/GDP g...
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Pensions Core Course 2013: NDC Experience in Europe and Central Asia Region

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Pensions Core Course 2013: NDC Experience in Europe and Central Asia Region

  1. 1. NDC EXPERIENCE IN EUROPEAND CENTRAL ASIA REGIONAnita M. SchwarzLead EconomistECSHDApril 2013
  2. 2. ECA IS THE MAIN REGION WITHEXPERIENCE IN NDCS 3 countries paying pensions on notional accountbasis Latvia Russian Federation Azerbaijan 2 countries not yet paying full pensions on anotional account basis Poland Kyrgyz Republic Turkmenistan (?)2
  3. 3. ADMINISTRATIVE COMPLEXITY LIMITSIMPLEMENTATION AND TRANSPARENCY Lack of understanding by pension administratorsof how to administer a notional account system Azerbaijan only provides notional interest rate equalto inflation on contributions made after 2006 Average pension is only 38% higher than minimum pension Kyrgyz Republic only provides notional interest onnew contributions made in a particular year, not onthe balance in the notional account In both systems, flat basic pension comprisessignificant part of the overall benefit Administrative issues in Russian Federation Difficulties in managing the large amount ofinformation over large population and widegeographic area 3
  4. 4. RUSSIAN EXPERIENCE Converted existing DB system into notionalcapital Provided a notional interest rate equal to growthof contribution revenue per pensioner – evenmore conservative than Latvia and Poland, but inline with what the pension fund collects inrevenue and what it pays out in pensions Initially legislated a life expectancy of 12 years in2002, which was supposed to rise to 16 years by2010 and to 19 years by 20134
  5. 5. RUSSIAN OUTCOME AND POLICYRESPONSE By 2008, pensions were averaging 26% of average wage Notional interest rate – contribution revenue per pensioner Contribution split between notional, basic, and funded for cohorts born after1967 As contributors born after 1967 increased in the labor force, contributionrevenue to public system fell Basic pension was indexed to inflation only; notional part indexed tocontribution revenue per pensioner – neither could keep up with 20%annual real wage growth pre-crisis Ad hoc policy response Arbitrary increases to notional capital awarded to those with years ofservice prior to 1993 Arbitrary increase in basic pension – sizable, raising average pensionto 40% of average wage from the previous 26% Increase in contribution rate to 26%, followed by subsequent decreaseto 22% Life expectancy was not raised as legislated Latest – reduction in funded pillar to help finance deficits in publicsystem from 6% to 2% Weakened (almost decimated) link between contributions andbenefits5
  6. 6. LATVIAN EXPERIENCE Coverage increased 30% between 1997-2007 Then dropped by 8% in 2009 Real wage growth stood at 23% in 2007 Then dropped to -14% in 2009 Cohort of 18 year olds in 2016 will be 47% thesize of the 18 year old cohort in 2006 Fertility shock of early 1990’s has persisted,reducing the parent age cohort and making aquick turnaround almost impossible Emigration – 15% of 20-40 year olds born inLatvia are no longer living there 6
  7. 7. NOTIONAL REAL INTEREST RATE RAISEDTHE LEVEL OF NEW PENSIONS2005 2006 2007 2008 2009Notional real interest rate applied to new retirees 11% 11% 13% 21% 28%Average newly assigned old age pension adjustedto 2009 prices, LVL 127 146 161 180 215Growth of newly assigned pension in real terms 100% 115% 127% 142% 169%7
  8. 8. LATVIAN POLICY RESPONSE Boom year revenue was spent: (pensionbuffer fund insignificant):- Partial wage indexation introduced- Additional pension benefits introduced(initially income tested; designed to benefitolder pensioners more)- Other SI benefits increased (from the samerevenue pot) After the bust:- Pensions not indexed to deflation- Observed life expectancy increases notapplied to pension formula (would havedecreased new pensions)- Grab for contributions going to funded –reduction in contribution from 6% to 2% All of these break the supposedly tightself-correcting NDC mechanism: - Deficit projected until 2060 8 Do people respond toincentives to retire later? In 2009, Latvian notionalreal interest rate was 28% Postponing retirement byone year would haveincreased annual pension by28% throughout retirementperiod Overwhelming majority ofpeople still retired atminimum retirement age Is the NDC transparent? Pension statementsstopped being sent in 2009due to “lack of funds” justas the notional interestrate became negative
  9. 9. POLISH EXPERIENCE Projected decline in futurebenefits despite ret age at 67 Socially unsustainableto have people pay27.52% of wage incontributions for 40-45years and receive only25-30% of average wagein retirement How will policy adjust tothe political challenge Grab at revenue goingto funded system –reduction from 7.3% to2.3% Flat increases inbenefits in 20120.0%20.0%40.0%60.0%80.0%2011201620212026203120362041204620512056206120662071Projected Male Average Old Age PensionBenefits as % of Average Wage1998 Reform 2011 Reform2012 Rev 10.0%10.0%20.0%30.0%40.0%50.0%2011201620212026203120362041204620512056206120662071Projected Female Average Old Age PensionBenefits as % of Average Wage1998 Reform 2011 Reform2012 Rev 19
  10. 10. LESSONS FROM IMPLEMENTATIONEXPERIENCE Timing and transparency NDCs build account balances on wage bill/wage growth/GDP growth outcomes duringa worker’s working years, but the revenue capacity of the social insurance fund can beentirely different by the time a person retires But since the account balance is transparent, it ties the policymaker’s hands Can build a demographic reserve like the Swedes have done, but the experience in allof these countries is at the first sign of any kind of fiscal trouble, that moneydisappears – Poland, Latvia, Ireland Pension systems follow Murphy’s law – whatever can go wrong, will go wrong!And it’s hard to predict what it will be. Latvian and Russian NDCs – one ended up with too high pensions; the other with toolow pensions When adjustments need to be made (and they will need to be made due to theinherent volatility in developing countries), NDCs leave fewer tools in thepolicymaker’s toolbox to address adjustments – more likely to lead to ad hocmeasures Political economy of “stealth” reforms Easy to pass legislatively, but when they begin to bite, political process demandsremedies – can involve throwing out the whole system, adding on ad hoc measureswhich effectively undo the links, not undertaking automatic adjustment mechanisms Doesn’t imply that NDCs aren’t a useful pension structure ECA experience does show that they are not necessarily better than other PAYGsystems 10

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