Strategy Paper for Pension Policy in Ukraine

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United Nations Development Programme
Project “Support to the Social Sector Reform in Ukraine”
Strategy Paper for Pension Policy in Ukraine
Prepared by the European Centre for Social Welfare
Policy and Research
Commissioned by the UNDP in Ukraine
March 2012

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Content
_____________________________________________________________
Preface........................................................................................................................................................3
Introduction.............................................................................................................................................4
1. Identifying challenges and future pension policy goals................................................10
2. Review of international experiences of pension policy reforms...............................21
3. Pension reform scenarios for Ukraine ..................................................................................40
3.1. Short-term immediate measures, during the period 2012-2014.....................40
3.2. Medium to longer term measures – beyond 2014...................................................42
3.3. Political feasibility of pension reform options ..........................................................45
4. A synthesizing discussion...........................................................................................................48
Literature ................................................................................................................................................52

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Preface
_________________________________________________________
The work reported here is funded by the UNDP in Ukraine.
This strategy paper has four-fold objectives:
 to describe the current Ukrainian pension system (the 1st pillar) and in
the process set the context for possible future reforms (Section 1);
 to report on challenges faced by the Ukrainian pension system (with a
focus on the 1st pillar) and identify future pension policy goals (Section
2);
 to review and drawn lessons from experiences of pension reforms from
other European countries and make specific recommendations for the
future pension policy strategy in Ukraine (Section 3); and
 In light of these analyses, to make recommendations for short-term
immediate reform measures (during the period 2012-2014) and
medium- and long-term reform measures (beyond 2014) for pension
policy in Ukraine (Section 4).
A synthesizing concluding discussion is also provided at the end (Section 5).
The strategy paper is prepared by Asghar Zaidi. Alexandre Sidorenko
contributed a full section (Section 4.3: Political Feasibility of Pension Reform
Options) and also provided comments on the whole paper (during its various
versions). Very useful and substantive support was received from Katerina
Rybalchenko of the UNDP, Kyiv, not just in preparing this strategy paper but
also in facilitating two very productive missions and in the interpretations of
different views on pension policy in Ukraine. Useful comments from Bernd
Marin and Eszter Zolyomi of the European Centre on the draft version of the
paper are also gratefully acknowledged. Katrin Gasior of the European Centre
provided valuable assistance in preparing the graphs included in the paper.
Lydia Shuleva, Bernd Marin and Ella Libanova, and officials of the Ministry of
Labour and Social Policy also contributed via the discussions during the two
missions to Kiev. Written comments from Greg McTaggart (Senior
international Pension Reform Adviser, USAID Financial Sector Development
Project, FINREP), Marek Góra (Warsaw School of Economics), Natalia Goryuk
(Senior Pension Lawyer, USAID in Ukraine) and Balázs Horváth (Poverty
Reduction Practice Leader with the UNDP Bratislava Regional Centre) had
been particularly useful and are gratefully acknowledged here. All remaining
errors and interpretations remain the responsibility of the contractor: Asghar
Zaidi.

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Introduction
_________________________________________________________
Effective from 1st January 2004, Ukraine adopted the law "On Mandatory State
Pension Insurance", introducing social insurance principles in its pension
system. At the same time, supplementary non-state pensions were also
legislated for and implemented. Together, the reformed system will provide a
three-pillar pension system: the 1st pillar is a pay-as-you-go system of the
mandatory state pension insurance; the 2nd pillar will be supplementary
mandatory individual pension accounts; and the 3rd pillar is voluntary private
pension insurance. Although the introduction of the 2nd pillar has since been
postponed, the voluntary private pension insurance 3rd pillar had been in place
since 2004.
These reforms established the basis of a mixed public/private and pay-as-you-
go/funded pension system in Ukraine.1 Subsequently, there have also been
several parametric reforms, the most recent one in September 2011, which
have shaped the system into its current form. Below, we describe the 1st pillar
of the Ukrainian pension system that has been in place until the 2011 reforms,
so as to provide the necessary context for the most recent reforms and further
reforms necessary. Next, the 2011 pension reforms are described, so as to
highlight some of the necessary reform measures that have been undertaken
recently.
The 1st pillar of the Ukrainian pension system
The 1st pillar of the Ukrainian pension system is based on the pay-as-you-go
principle in which both the employer and the employee make contributions
over the employee’s whole active career. The Ministry of Labour and Social
Policy is responsible for the general coordination of the pension policy. The
regional and local social protection departments administer the various social
security schemes. The Pension Fund of Ukraine (hereafter PFU) administers all
mandatory public insurance services (including pensions).
The insured worker contributes from 2% to 5% of earnings, depending on
whether the worker contributes towards a special treatment within the same
pension scheme.2 The maximum monthly earnings used to calculate
contributions are 13,660 Hryvnias (June 2010). The employer pays 33.2% up
to the same maximum as used for the employee.3 The state bears the cost of
social benefits as well as provides the subsidies needed from central and local
1 Earlier, in 2000, the new information system were also put in place to document personified records
of insurance contribution payments for each worker, mainly for the purpose of the functioning of the
1st pillar based on insurance principles.
2 Those who contribute 5% are “special pensioners”, mainly civil servants, and they draw different
benefits from the same Fund.
3 Employer pays an additional 1.6% for unemployment, 1.5% for sickness and between 0.2% and 15%
for work injury (depending upon the sector) insurances.

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governments to the PFU. The state also contributes as employer for public
sector employees.
Within the 1st pillar, there are also special provisions for civil servants, military
personnel, legislators, judges, National Bank employees, diplomats, journalists,
scientists, local governors, war veterans and victims of the Chernobyl disaster.
These special treatments are partly financed from the additional contributions
from the same workers, and partly from the state subsidy. Within the same 1st
pillar, there are also privileges for persons in the private sector who work in
hazardous conditions (the so-called Lgotni pensii – the privileged pensions),
allowing early retirement by 5 or 10 years for those categorised as List I and
List II workers. These are funded by the employer meeting the cost of the
privilege: full cost for List II workers, and almost full cost (by now 90%) of List
I workers.
The current 1st pillar of the pension system can be seen to consist of four
categories of pension schemes: (1). Old-age pensions, (2). Disability pensions,
(3). Survivor pensions, (4). Service pensions. Then, there are also social
pensions. The salient features of these schemes are described below.
Old-age pensions
Until the latest 2011 parametric pension reforms (see below for more details),
the full pension has been payable at age 60 with at least 25 years of coverage
for men or at age 55 with at least 20 years of coverage for women. These
requirements were reduced for those workers who worked in arduous or
hazardous occupations; for mothers of five or more children; for mothers who
have children with disabilities; for war veterans with disabilities; and for some
other categories of persons. The employment period in question could include
years spent in the armed services, caring for persons with disabilities or
children younger than age 3, or being unemployed and seeking a job, if
contributions are paid for these periods. Partial pension has been payable at
age 60 for men and at age 55 for women with at least 5 years of coverage – the
monthly pension payments are then reduced in proportion to the number of
years of coverage.
The pension benefit is calculated as a product of three parameters:
I. The average last wage of all insured workers, estimated as the average
wage of which insurance contributions were paid during a preceding
calendar year; (nb. recent parametric reforms made changes by which
average wage of three last years will be used in the pension formula;
instead of the wage of a single year preceding retirement);
II. The individual coefficient of relative wage, estimated as an average of
coefficients for each month of service (a ratio of a person’s wage, of which
contributions were paid in a particular month, to all-Ukraine average wage
for the same month); and

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III. The individual coefficient of service, estimated as a sum of months of
service, multiplied by the accrual rate (1.35% for each year since October
2008) and divided by twelve. A full month of service is counted under
condition that a sum of paid contributions is not smaller than a minimum
insurance contribution (based on a minimum wage and on contribution
rate). Otherwise, service period is counted proportionally to the paid part
of a minimum contribution.
The service period relevant for the calculation of pension income is established
as 60 months before July 1, 2000, and all covered periods since July 1, 2000.
Importantly, the inclusion of all period since July 2000 has made the pension
income a function of the average lifetime salary, albeit gradually, for younger
cohorts of workers.
Other important parameters are defined as:
 Every year, beginning from March 2005, the pension income is expected
to be raised by the index equal at least to 20% of the average annual
wage growth. In practice, the ad hoc decisions had taken precedence
over this rule.
 Since 2008, the last year average wage, which is an important parameter
in the pension formula, is the average salary per insured worker in
Ukraine during 2006.
 The accrual rate is 1.35% since October 2008 (it was 1% before January
2008). This change in 2008 made it possible to move away from a flat
rate pension income (that existed earlier when pensions for most
retirees were fixed at the subsistence level) and ensured a better link of
pension income to contributions.
 Until the latest reforms, in 2011, there has been no maximum limit for
the pension income. The minimum pension is the minimum subsistence
level defined for those unable to work i.e. pensioners.4 The pension is
paid earlier to unemployed older workers from ages 58 and 6 months to
60 for men or ages 53 and 6 months to 55 for women, who meet the
coverage requirements and who were working for an enterprise that
was closed or reorganized. Such a pension stops if the beneficiary is
reemployed.
 The pension may also be deferred from 1 to 10 years after the normal
retirement age, and the pension is increased by 3% to 85%, according to
the number of months/years the pension is deferred after normal
retirement age. For instance, pension benefit is raised by 3 percent for 1
additional year of work and by 85 percent higher for 10 additional
years.5
4 The monthly minimum subsistence level is 784 Hryvnias, (October 2011); whereas the monthly
minimum wage is 985 Hryvnias (October 2011).
5 The specified rates of pension income increase were changed in the 2011 reforms. Specifically, the
Law now provides for 0.5% increase for each full month of later retirement for up to 60 months. If the

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 The pension is payable abroad for 6 months in advance, beginning in the
month the pensioner leaves the country; thereafter, only if there is a
reciprocal agreement (there are currently 21 bilateral and multilateral
agreements).
The old-age pension scheme is by far the most important since it benefits about
80% of all current pensioners in Ukraine.
Disability pensions
The disability pension is paid to three groups of persons with disabilities:
Group I receives 100% of the old-age pension; Group II (90%) and Group III
(50%). Whilst the disability pension is based on the old age pension, the
criteria for getting the disability pension are based on age at which disability
began and years of contributory service. Provided anyone satisfies the
requirements, a reduced payment is payable if the insured has at least 2 to 5
years of coverage, depending on the age when the disability began (see below
for the change of contributory requirements brought about in the 2011
pension reforms). The disability pension is payable abroad, something which
may be considered highly problematic by experts (since social assistance and
disability benefits are frequently awarded to residents only in the majority of
European countries). A caregiver’s allowance is also paid to a caregiver of a
person older than age 80 in Group I, provided the caregiver is not employed.
Survivor's pensions
The first step in determining a survivor’s pension is whether or not the
survivor is disabled – if not then the survivor’s pension is not paid. If the
person is not disabled and then subsequently becomes unemployed he/she
would then gets the survivor’s pension. Eligible recipients of survivor’s
pension can be a spouse, father, and mother of pensionable age. The surviving
children younger than age 18 (age 23 if a student or an orphan, no limit if
disabled before age 18) are also eligible.
The monthly survivor's pension is 50% of the deceased’s old-age pension for
one survivor and 100% for two or more survivors. A supplement is paid if the
survivor pension is less than 100% (for one survivor), 120% (for two
survivors), or 150% (for three survivors) of the minimum subsistence level.
Partial pension is paid if the insured had 5 to 24 years (men) or 5 to 19 years
(women) of coverage.
Privileged pensions
These pensions are known as Lgotni pensii (the privileged pensions) and they
are a special type of old-age pensions for workers in particular occupations
(such as aviators, truck drivers, lumbermen, etc., but also teachers, medical
deferral is more than 60 months, the pension is increased by 0.75% for each full month of the deferral.
Prior to the 2011 reforms, the amount of pension income increase was based on the number of years of
the deferral, not the number of months.

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doctors, railway workers and pilots). These workers can retire at a younger
age or with shorter duration of the contribution period. There are two types of
early pensions: anticipated old-age pension and length-of-service pension.
These pensions are assigned to people who have certain service length,
particularly, in difficult or hazardous job conditions (according to the list of
professions). Duration of service that gives the right to early retirement varies
from 8 (for women)/12 (for men) to 20/25 years; bridge period (number of
years before you can retire) varies from 5 to 15 years, depends on occupation
or professional category, for those categorised as List I and List II workers.
These are funded by the employers: full cost for List II, and almost full cost of
List I.
Social pensions
Social pensions are under the Law “On Pensions”, not under the Mandatory
Pension Insurance. A means-tested social old-age pension is paid to low-
income citizens who are not working and not eligible for an old-age pension,
starting at age 63 (men) or age 58 (women),6 at the level of the monthly
minimum subsistence level. These social benefits are adjusted periodically
according to changes in the national average wage and inflation. As in the case
of other benefits, a supplement is added if the social pension is less than
minimum subsistence.
The Pension reforms in 2011 put pension system on a sustainable
path
On July 8th, 2011, the Verkhovna Rada adopted the Law "On Measures for
Legislative Provision of the Pension System Reformation", which brought
about the latest parametric pension reforms in Ukraine. These reforms are
summarised as:
 The Law raises the pension qualification age for women to 60 years
(gradually, by six months each year).7
 The service period required for full pension is raised to 30 years for women
and to 35 years for men.
 The minimum contributory service period to receive any pension has been
raised from 5 to 15 years.
 The statutory retirement age for male civil servants is raised to 62 years.
 The maximum monthly wage for contribution purposes is capped at 17
times the minimum subsistence level (in December 2011, UAH 17,068).
6 The principle applied is that such social benefits are made available 3 years after the statutory
retirement age.
7 A three year transition period is set for women to opt for an old-age pension either under the old or
new pension legislation, which, if the deferred retirement is chosen, provides for a bigger pension.
Specifically, if the person defers her retirement the pension's increase will be 6 per cent for each of the
first five years, and 9 per cent beginning from the sixth year.

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 The maximum pension amount, adopted by the law, is now fixed at 10 times
the minimum subsistence level (in December, UAH 8,000).
 Pensions for civil servants will now be calculated to the amount of 80% of
the salary instead of the present 90%. The pension for public employees will
be calculated based on a salary of up to UAH 14,400. Also, the maximum
pension will be limited to ten minimum incomes.
 Changes for military personnel are also implemented making it necessary
for them to contribute for a longer period of their working lives: the law
gradually raises the length of service to 25 years for military personnel;
moreover, each six months of studies in military high schools will qualify as
one year of military service.
 Parliamentary deputies will no longer enjoy higher pension benefits
compared to other citizens. However, they will have the right to retire one
and a half years before reaching the retirement age.
This pension reform has already come into force during 2011 (on October 1st,
2011), and will contribute to improving the financial sustainability of the 1st
pillar pension and they will also be making the system more fair, with
improved incentives to work and contribute in the formal sector. These
reforms can be seen as a strong signal from the current government to bring
about appropriate policy reforms in putting the pension system on a
sustainable path.8
8 The reforms are even more remarkable given the fact that Article 22 of the Constitution bans any
contraction of existing rights and freedoms by adopting new laws. In Ukraine, social sector reforms of
these types require substantial legislative amendments, but nonetheless they can nonetheless be
questioned in courts.

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Quotes from the Ukrainian President, Viktor Yanukovych
During his interview with the journalists in Warsaw, on
September 30, 2011, the Ukrainian President Viktor
Yanukovych, said: “First of all the pension reform should make all
the pensions fair. It has been a request of the retirees and this problem
needs to be solved”. He emphasized that increasing pensions still
remains a priority for his government: “It is still a crucial problem
that needs to be solved”.
He also underlined the fact that the deficit of the Pension Fund
cannot forever be financed at the expense of the state budget:
“The share of the budget for financing the Pension Fund should be
limited. That is why we decided to increase the Pension Fund’s own
revenues and implement a three-level pension system”.
He also stressed that such way of reforming the pension system
had been chosen and successfully utilized by many developed
countries: “Our objective today is to build such [a] system. And the
sooner we do it, the faster we will reach our goal which is to improve
the social welfare of elderly people”.
1. Identifying challenges and future pension
policy goals
___________________________________________________________
This section highlights challenges that the current Ukrainian pension system
faces (with a focus on the 1st pillar) and, more significantly, outlines the policy
goals for future reforms. The priority for pension reforms, such as placing the
public pension system on a sustainable path, can be highlighted by the
statements of many high level policymakers in the current Ukrainian
government (see, for example, quotes from the Ukrainian President to
highlight the policy goals towards pension reforms and improve the social
welfare of older people). Note also that pension reform in Ukraine was one of
the main conditions for the disbursement by the International Monetary Fund
loans to the country (under the Stand-By Arrangement). Also, pension policy
reforms in Ukraine are now seen as a driving force for other social and
economic reforms, such as labour market policies towards reducing the
relative size of the shadow economy.

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The extraordinarily large public pension expenditures (16.2% of GDP in
2011) are among the most serious issues facing Ukraine today. A good
management of the 1st pillar is not only a requirement for establishing a
fiscally stable pension system in Ukraine but also a prerequisite for fulfilling
Ukraine's economic development agenda. The high public pension
expenditures have created a systemic risk to macroeconomic stability and
threaten to slow down the economic reforms. Thus, strategic pension and
labour market reforms are required, and some of them have already come
about during 2011.
The most important and overarching policy goal for Ukraine should be that
pension expenditures are brought under control and also revenues raised
through increasing the retirement age for women (already happened in the
2011 reforms) and through labour market measures promoting the
formalisation of employment.
1.1 Financial sustainability of the 1st pillar is a major policy priority
Since independence, Ukraine has undertaken very minimal reforms of the
social sector. The current most serious concern is the extraordinarily large
public pension expenditures (approximating to 16% of GDP, in 2010), which is
almost twice as large as the average public pension expenditures in EU
countries. Moreover, much of these funds are spent on relatively young and
healthy people, who would not be entitled to pensions in other European
countries. The PFU deficit (covered by the state budget) is forecasted to be
2.2% for 2012, having fallen significantly from 17.6% in 2011 and 26.6% in
2010.
It is the profound combination of parametric and systemic reforms of pensions
that will the key to control pension expenditures over the long term. Raising
taxes, or social insurance contributions, are other ways to deal with the deficit,
however these are not viable options for Ukraine for reasons of keeping labour
costs under control and promoting employment growth and such single
measures in themselves cannot solve the financial sustainability of pension
system9.
9 See Independent International Expert Commission (2010). ‘Proposals for Ukraine: 2010 – Time for
Reforms’ International Centre for Policy Studies, Kiev.

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1.2 Early retirement and low contribution period has been a
common feature
Until now, the statutory retirement age in Ukraine has been 60 for men and 55
for women – lower than in almost all other European countries (see Table 1).
The effective age of retirement is even lower for those workers who have
provisions for privileged early retirement or they become entitled to disability
pensions before the pensionable age.10
Many other European countries have also been facing the challenge of early
retirement and have brought in pension and labour market policy changes to
deal with the challenge (see below for a discussion on international
experiences of reforms).
In Ukraine, the early retirement phenomenon is particularly notable for
women, whose residual life expectancy at the time of retirement is 23.4 years,
which is comparable to many other European countries of the world (for
example, it is about 24 years in the UK, 25 years in Germany and Austria, 23
years in Poland, and 21 years in Slovakia at age 6011).12
The implication is that women in Ukraine work for a shorter period than
women in many other countries and receive pension for a longer period. Thus,
the equalisation of women’s retirement age with men to 60 in the 2011
pension reforms is the most appropriate policy measure.
The retirement age for both sexes should ultimately rise to a higher age in the
future (age 65), after it has been equalised for men and women, and in the
future it should be linked to developments in life expectancy.
10 Note that the number of workers eligible for privileged pensions has been dropping and also their
impact on Pension Fund expenditure in Ukraine is not that high as the employer has to pay for these
privileged pensions.
11 With the exception of Germany and Slovakia, age 60 can be taken as a proxy for the current statutory
retirement age for women in these countries.
12 See Expert Note (2011), ‘Problems of Rising Retirement Age in Ukraine’, The Blue Ribbon Analytical
and Advisory Centre, UNDP, Kiev.

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Table 1: Demographic indicators related to old-age pension schemes,
2010
Notes: In Poland the retirement mentioned is not a "statutory" age but the minimum
one at which pension income can be claimed. In Sweden, full pension is obtained at 67,
but part pension can be obtained from 61.
Men Women Men Women Men Women
Austria 17.6 78.2 83.2 21 25 65 60
Belgium 17.4 77.7 83.9 20 25 65 65
Bulgaria 17.6 70.9 77.7 16 20 63 60
Croatia 17.3 73.8 80.4 18 22 65 60
Cyprus 13.2 77.9 82.6 21 24 65 65
Czech Republic 15.3 74.3 80.3 18 22 62.2 60.7
Denmark 16.7 76.7 81.4 20 23 65 65
Estonia 17.1 68.9 79.3 16 22 63 61
Finland 17.2 77.2 83.6 20 25 65 65
France 17 78.6 85.1 22 27 60 60
Germany 20.5 77.8 83.1 20 25 65 65
Greece 18.3 77.7 82.5 21 23 65 60
Hungary 16.4 70.4 78.3 16 21 62 62
Ireland 11.4 78.1 82.9 20 24 65 65
Italy 20.4 78.6 84.6 22 26 65 60
Latvia 17.4 68.7 78.1 16 21 62 62
Lithuania 16.4 67 78.3 16 21 62.5 60
Luxembourg 14 77.8 82.8 20 24 65 65
Netherlands 15.4 78.5 82.6 21 24 65 65
Poland 13.5 72.3 80.4 17 23 65 60
Portugal 17.8 76.1 82.6 20 24 65 65
Russia 12.9 61.9 74.1 14 19 60 55
Slovak Republic 12.3 71.8 79.3 17 21 62 62
Slovenia 16.4 75.4 82.6 19 24 63 61
Spain 17.2 78.6 84.7 21 26 65 65
Sweden 18.3 79.6 83.6 21 25 67 67
Switzerland 17.3 80.2 84.7 22 26 65 64
Ukraine 15.6 63.9 74.3 14 19 60 55
United Kingdom 16.6 77.8 82.3 20 24 65 60
SOURCES: United Nations Population Division, DESA . World Population Prospects: The 2008 Revision
http://esa.un.org/unpp; HDR 2009.
Life expectancy at
birth
Statutory
pensionable age
Country
Percentage
65 or older
Life expectancy at
age 60

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The situation for men is somewhat different because of their low life
expectancy; both at birth and at the time of retirement (see Table 1). The
relevant measure of life expectancy (for pensions) is indeed the life expectancy
at the age of retirement, which is also low: only 14 years, considerably lower
than that observed in the UK, Germany and Italy (18 years at age 65) and Czech
Republic and Slovakia (17.4 and 15.9, respectively, at age 62 in 2010), but
closer to Poland (15.1 at age 65).13
Moreover, the survival rate of Ukrainian men to the age of 65 is currently 52.6
per cent, while the same indicator for the countries of Western Europe is 84.9
per cent.14 Given this evidence, the retirement age for Ukrainian men should
only rise if there are clear improvements in their life expectancy at 60. It can
also be said that there should not be an increase in male retirement age until
both men and women are equalized at age 60 which is still 10 years away.
The contribution period requirement for full pension (25 for men and 20 for
women) had also been short in Ukraine until now – it should have been closer
to the full period of working life or a close proxy for it. The 2011 reforms in
increasing the contribution period (to 35 years for men, 30 years for women)
is the most appropriate reform. The contributory requirements for women
should rise further to 35 years, albeit gradually.
Many countries have recently extended the period over which lifetime
earnings are taken into account instead of just basing the benefit on a limited
number of final years or salaries of best years. For example, Finland, Poland,
Portugal, the Slovak Republic and Sweden have all been moving to a lifetime
average earnings measure. In fact, as a result of recent reforms, most OECD
countries (17 out of the 22 with the relevant kinds of scheme) will use a
lifetime earnings measure or a close proxy for it.
13 Data extracted from the Eurostat database, for the variable ‘Life expectancy by age and sex
[demo_mlexpec] ‘.
14 UN (2010) ‘World Population Ageing 2009. Profiles of Ageing’. United Nations, New York.
The 2011 reforms in raising the retirement age for women (to 60)
and also in increasing the contribution period (to 35 years for men,
30 years for women) is a good policy move and the current
Government should be given credit for this parametric reform. It can
be recommended that the contributory requirements for women
should also rise to 35 years, gradually over the next 10 years. Also,
subsequently, the future policy goal should be that changes in the
statutory retirement age and contributory requirements for the full
pension be linked to developments in the life expectancy.

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Increasing the pension system coverage by reducing the relative size
of the shadow economy is undoubtedly a major policy goal in
economic policy reforms in Ukraine. Useful lessons can be learned
from an in-depth study of similar issues in other Central and Eastern
European countries.
1.3 Formal registration of employment is low, and reporting of
wages inaccurate
It is the formally registered employment that is relevant for pension fund
purposes, as the contributions made then go towards financing the pension
system. In most European countries, employment is almost synonymous to
pension coverage. But, this is not the case in Ukraine, where those covered are
only around 70% of total number of employees15 (some of the estimates of
informal economy are close to 50%). Specific sectors, such as agricultural
workers catering, and also urban self-employed, have a much lower coverage.
Where there is coverage, it is often the case that employers only report a
payment of the minimum wage.
In many other Central and Eastern European countries, the problem at the
moment is less to do with the coverage, but that the majority of the self-
employed pay contributions at the level of the minimum wage. This practice
puts them at a high risk of receiving low pensions when they retire and hence
they rely more often on social assistance benefits, which add a further financial
burden on social benefit expenditures. Thus, strong measures are required in
Ukraine to force employers in reporting employment and truthful wages.
In many cases, the defrauding of the system is done by employers in collusion
with employees, but employees do not have many rights in the current labour
market environment. The public policy reforms in Ukraine had already been
brought about to encourage formal employment, e.g. pension system now
requires 35 years of contributions to get the minimum pension, and there has
also been an introduction of flat-tax. The removal of privileged schemes, and
thus reducing employers’ burden of financing these schemes, should provide
further incentives to employers to report employment and wages truthfully
and reduce the size of the informal economy.
15 See UNDP (2008) ‘Pension Reform: A challenge for Ukraine’, The Blue Ribbon Analytical and
Advisory Centre, Kiev.

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Strengthening of the contributory principles in the 1st pillar is another
key policy goal, and such corrections are extremely important policy
goals in making the public pension system sustainable over the long
term. For this purpose, the actuarial basis of the 1st pillar pension
scheme must improve.
It can be recommended to identify and separate out contribution-based
pensions from social non-contributory pensions, the latter to be
financed out of State subsidies. This is particularly important in order
to promote incentives for work and savings (contributions) in various
earnings-related pension schemes (1st and 3rd pillar at the moment).
1.4 Discretionary increases in minimum pensions compromise
contributory principles
Discretionary increases in minimum pensions have been common in Ukraine,
and this has generated an additional burden on the PFU. For example, only
months before the Presidential elections of early 2010, the Ukrainian
parliament raised minimum wages and pensions by 20%, a policy move
inconsistent with the overall fiscal austerity goals of the country to reduce
public expenditures16 (particularly the deficit of the PFU).
Between 2002 and 2010, the minimum pensions increased by nine times in
real terms, while average wage, which is a base for pension contributions,
increased by only 3.4 times in real terms.17
As a result of these discretionary changes, pensions of many pensioners
became lower than minimum pensions. So, many pensioners now receive
pensions at the minimum level, undermining contributory links established in
the social insurance based pension system that started in 2004. In fact, the 1st
pillar pension has become largely a flat-rate pension, which is typically a
pension of uniform amount independent of earnings. Such flat rate pensions
are a feature of systems in the Netherlands, Ireland and the United Kingdom by
design.
16 In 2008, the IMF extended a $16.4bn credit to Ukraine, but payments were frozen when the law
raising minimum wages and pensions was passed.
17 See Betliy et al (2011).

17
Comments from Balázs Horváth (Poverty Reduction Practice Leader
with the UNDP Bratislava Regional Centre) emphasise this issue in
the following way:
‘The above two recommendations are critical for a sound pension
system. Linking pensions to contributions is a key prerequisite for
changing incentives to encourage working in the formal sector; for
discouraging early retirement; and for fairness in the pension system.
There is also a need to enhance the non-contributory part, to strengthen
social safety net, its separation from the PFU, because the measures to
achieve this are very different from what is needed for the contributory
1st pillar component’.
Comments from Natalia Goryuk (Senior Pension Lawyer, USAID in
Ukraine) also point to the importance of separation of non-
contributory supplements from the contribution-based pension
entitlements of the 1st pillar:
‘The Pension Fund of Ukraine is charged with financing supplements to
pensions so that they would reach the subsistence level (minimal level).
In Ukraine such supplementary payments are effected at the expense of
insured persons’ contributions, but not at the expense of the State
Budget, as it is done in Sweden. The PFU responsibility to finance
supplementary payments to ensure that the amount of pensions is not
lower than the minimum subsistence level income has increased the
load on the PFU budget. This also contradicts the pension insurance
principles, which require pension benefits to be based on insurance
contributions. The inclusion of this issue in the Strategic Report would
help the Ukrainian government decide what to do about the PFU deficit’.
1.5 Privileged pensions and their justifiability is a major issue
The financing of privileged pension provisions in Ukraine has been a burden on
the PFU. A common opinion of experts is that these privileged pensions are a
form of ‘structured corruption’ as none of these privileges in their current form
can be fully justified. The labour market policy and collective agreements
(between employees’ and employers’ unions) should be the instruments in
dealing with any life expectancy differentials that arise because of arduous or
hazardous work (but only to the extent that the life expectancy differentials
can be proven by empirical scientific evidence).
In collective agreements, the optimal instrument for dealing with differences in
working conditions and hazards is the adjustment in the wage level. This will
lead to larger pensions through higher contributions paid within a sound
pension system. Such a measure would be more suitable rather than distorting
changes to pension rules that undermine the financial viability of the system
and also create distortions in the labour market functioning for these sectors.

18
The phasing out of pension privileges is indeed a daunting task. For the
legislators, the issue is to overturn an experience that suggests that now
the grant of a special pension allowance is seen as a right. The view of the
(would-be) pensioner is that the preferential pension treatment has been
an instrumental part of their choice of the profession in the first place.
The task of persuading all sides to this argument of the need for reform is
itself an arduous one!
We recommend that the Ukrainian government need to instigate a review
process through a specially established expert commission. Moreover, a
public information campaign is required, to be aimed at persuading the
general public in the necessity of phasing out the privileges in the form of
pensions. At the same time, there is a need to review employment
categories in List I and List II that deserve to continue receiving
privileged treatment for their pension entitlement. The question whether
these schemes should continue to be financed by employers should also
be looked at.
Employers in Ukraine contribute towards pensions for those professions that
lead to shortening of life expectancy (with the exception of coal miners and
those who were employed by bankrupt companies, whose pension subsidies
for early retirement are still financed by the State budget subsidies to the PFU).
The privileged pensions for coal miners had been a political decision, and the
government need to acknowledge this as a separate cost to maintain coal
industry (rather than mixing it with the state subsidy to the PFU).
Pensions for other professions, such as teachers, medical doctors, railway
employees and airline pilots, are also still financed from the State subsidy.
There are three other categories that benefit from legislated State subsidies in
their pensions: Chernobyl accident victims; children of war (those who were
under 18 on 2nd September 1945) and veterans of war. Given political
sensitivity, the future of these categories has to be addressed with a particular
caution.18
1.6 Introduction of the long-awaited 2nd pillar is the next important
policy step
The 2nd pillar introduction is expected to bring positive benefits for younger
employees to accumulate higher personal pensions than that possible just with
the current 1st pillar pension scheme only. This is despite the fact that the
introduction of the 2nd pillar, and the tax incentives implicit in it, benefit more
18 As part of annual budget laws, there is a possibility of a discretionary decision to not pay all of these
privileges owing to the lack of sufficient budgetary funds. Thus, while these rights are set out in law,
another law—the budget law—can be used to override them.

19
One of the major policy goals is to institute the 2nd pillar of
Ukraine’s pension system, by 2013. A major requisite has been
that the Pension Fund (the 1st pillar) is no longer running a
deficit, which is now a major priority for the current
Government.
"If last year the deficit of the Pension Fund amounted to 34.4 billion
UAH (4,3 billion USD), this year we are planning to lower it down to
17.8 billion UAH (2,2 billion USD) and next year – to 2.2 billion UAH
(0.3 billion USD). The Ministry has a goal to nullify this rate by 2013 in
order to launch the second level of the pension reform",
The First Deputy Minister of the
Social Policy of Ukraine, Vasyl
Nadraga, on September 9, 2011.
often higher wage earners and would ultimately lead to furthering the pension
income inequalities in the Ukrainian society.
The rate of return in the 2nd pillar schemes may surpass the rate of growth of
the economy (inherently used in determining the benefit levels in the public
PAYG schemes) – this can happen only if the pension funds are allowed to
invest abroad and annual management costs of the funds are kept to the
minimum. Thus, certain investment and management patterns and returns,
and regulations, will be required to fully benefit from using this vehicle for
private personal savings towards pensions. It can be said that the introduction
of the 2nd pillar should be geared towards developing the public policy that
lead to improving living standards of pensioners and not necessarily towards
capital market development (as is often argued by experts in the context for
the situation in other countries).
The benefits for the overall economy can nonetheless be noteworthy. The
savings made can be considered forced savings,19 and it will provide funds for
the growth of investments in the Ukrainian economy, thereby promoting
growth of GDP. According to the calculations by the Ministry of Social Policy,
the 2nd pillar pension funds are expected to have more than UAH 3.6 billion by
2013, which offers a large potential for domestic investment and should
promote economic growth. If these funds are invested in government bonds,
they will in effect finance the budget deficit, reducing the constraints on its
possible size. Thus, these savings can either boost growth or just end up
financing larger deficits, and the latter may or may not result in higher growth
(depending on the composition and effectiveness of public spending).
19 If we assume pure additionality, i.e. if households are forced to save on one component, they may
displace savings in other component, the net increment in overall savings will be negligible. This
question requires further research within the context of Ukraine and other similar countries.

20
In drafting the law for the introduction of the 2nd pillar, it would be
essential to establish guarantees to protect the contributions and
the income generation process, as well as regulations of financial
companies that will manage the funds.
It can be foreseen that the 2nd pillar funds are managed by the
government in the first phase, but later on, based on the
preferences of contributors, it could be managed by private pension
funds, provided if they offer guarantees required and a reasonably
low annual management cost. The question of guarantees in such
2nd pillar scheme has been a long and complicated one which many
governments have so far rejected. Those very few countries that
have got guarantees offer them at quite a high price.
The participation in the 2nd pillar pensions should be made
compulsory only for young workers (for example, those who are
age 30 or younger or those who enter employment for the first
time). This will ensure provision of reasonably good average
returns, despite variability of nominal returns over time. Over
decades, it is indeed more likely that the average real returns will
cumulatively be significant and positive. This cannot be said for a
short period of, say, 5-10 years (which older workers would have
before retirement) as the investment returns of past 5 years show.
1.7 PFU administration must show no negligence or misallocation to
win trust
Limited ‘formal’ employment and reporting of receipt of minimum wages by
the majority lead generally to reduced levels of pension contributions, and
these could be a sign of lack of trust in government and its institutions. Such
mistrust is also triggered by inefficient, unreliable or non-transparent
administrative routines, by low returns on pension contributions, or both, and
it encourages employees into informal employment.
However, in Ukraine, it would be wrong to conclude that the informal economy
stems from the PFU administration and an inefficient pension design.
Incentives are stacked against formal jobs for a number of additional reasons,
and one of the main reasons for the low level of accurate reporting of
employment and wages by employers is the high rate of employers’ social
insurance contributions. Most employers have to pay on average 40% as
employers’ social insurance contributions, especially in risky occupations to
fund for early retirement. The rise of informal economy has been a serious
issue in many other Central and Eastern European countries, in particular in

21
The most important elements of improvements in the administrative
structure in the context of Ukraine include the collection of
contributions and the handling of the money with transparency
(showing no negligence or misallocation). Thus, the PFU must have a
goal of generating public trust for its operations, including through
ensuring the transparency in the allocation of its resources and also
through increasing the professionalism of its staff, particularly at the
regional and local levels. Improvements in the PFU administration
can also be expected by a unification of various different funds.
the CIS countries, and Ukraine can draw useful lessons from the policy
experiences of other similar European countries.
2. Review of international experiences of
pension policy reforms
___________________________________________________________
Having identified the policy goals in the previous section, the analyses included
in this section will lead us to specific recommendations for policy reforms in
Ukraine, drawn in the light of international experiences of pension policy
reforms in the recent times (the shaded boxes are used to spell out the specific
policy recommendations for Ukraine).
2.1 Development of benefit ratios and net replacement rates in EU
countries
Evolution of the benefit ratio over time summarises the likely development of
two measures: the relative value of the average pension (total public pension
spending divided by number of pensioners) and the average wage
(approximated by the GDP per hours worked). Ceteris paribus, a decline in the
benefit ratio over time points to a fall in the generosity of public pensions
(relative to contemporary wages). Such falls in the benefit ratio may also occur
because the pension system has moved partly towards private pension
schemes, reducing the expenditures (and also the revenues) of public pension
schemes.
The results presented in Figure 1 are for EU countries, derived from the
recently completed assessment of ageing related public expenditures by the

22
European Commission.20 They show that the projected benefit ratio will be
declining in the majority of EU countries, over the next 50 years, though at a
varying level. The decline in the benefit ratio is the highest for Poland (– 54%)
and Sweden (–39%), where a stronger link between contributions and pension
entitlements have come about because of their recent pension reforms.
Figure 1: Changes in the benefit ratio % (average public pensions relative
to average economy-wide wage) across 27 EU countries, for the period
2007-2060
There are also considerable declines in Austria (– 30%), Slovakia (– 27%) and
France (– 25%). In Slovakia, this decline in public pension generosity will be
offset by other mandatory private pension schemes, but there are no such
private pension compensations possible in Austria. The magnitude of decline in
the benefit ratio is also quite sound for Estonia and Latvia. In both these
countries, the expected decline will be partially offset by the new private
pensions, although an overall decline of about 18% is still expected in Estonia.
In Greece, the benefit ratio remains among the highest in 2060, despite the fall
observed during the period 2006-2060 – the graph produced during 2009 long
before the strong cuts in pension benefits observed in Greece due to financial
crisis.
Another pertinent indicator is the change that can be expected in the average
first pension of future retirees as a proportion of the average wage as a
consequence of pension reforms. The indicator in use here is the net
20 Economic Policy Committee, (2009a), The 2009 Ageing Report: Economic and Budgetary Projections
for the EU-27 Member States (2008-2060), Joint Report prepared by the European Commission (DG
ECFIN) and the Economic Policy Committee (AWG), European Economy 2|2009.

23
‘Theoretical Replacement Rate’ (TRR), and it is the change in the TRR that is
adopted by EU member States to reflect the impact of pension reforms in the
respective countries.21 The calculations for the TRR reported here cover
pension entitlements from public pensions and mandatory private schemes as
well as other private schemes with a significant role in the pension incomes of
future retirees (such as occupational pension schemes in the Netherlands).
Figure 2: Changes in the theoretical replacement rate (net), for the period
2006-2046, for a stylised full career male worker on average wages
retiring at 65
Source: Updates of Current and Prospective Theoretical Pension Replacement Rates
2006-2046 (Annex Country fiches), December 8th, 2009. Notes: In the base case
scenario, the TRR is calculated for a male worker entering into the labour market in 2006,
staying in employment for a full career (40 contribution years), earning average wage,
retiring at 65 and accumulating pension rights under the reformed pension system. The
first pension income entitlement for this hypothetical worker is divided by the projected
average wage in the immediate previous time period to calculate the TRR. This
prospective TRR is then compared with the base TRR for someone who would have
accumulated pension rights under the current pension policies and have retired in 2006.
The change therefore approximates how pension reforms will affect future pension
entitlements.
Figure 2 displays the change in the TRR from the current situation to the
prospective situation in 2046. There are wide variations across EU states. The
TRR (net) is projected to decline in twelve countries, and the most notable fall
is observed for the Czech Republic (– 21% percentage points, p.p.), Portugal (–
20 p.p.), and Poland (– 19 p.p.). Closely behind them are Sweden (– 13 p.p.),
Spain and Latvia (– 12 p.p.) and Ireland and Finland (– 11 p.p.). This decline in
21 Social Protection Committee (2009).

24
Lessons drawn from this international experience are that the public
pension spending (liability) is on the decline in many countries,
particularly in the Central and Eastern bloc of EU countries. This is
partly due to restrictions in early retirement and phasing out of other
pension privileges, but mainly because of a shift towards private
pension schemes. For instance, of the eight countries where a strong
decline in the benefit ratio is expected, four of them (Estonia, Latvia,
Poland and Sweden) have introduced individual pension accounts as a
substitute for part of their previous public pensions. Italy is the other
country with a strong decline in the benefit ratio, and it has introduced
the system of notional accounts (as in Latvia, Poland and Sweden).
Poland offers a good example of such reforms and provides a clear path
for pension reforms in Ukraine (as was the case for Bulgaria in its 2002
reforms). The new Polish pension system consists of public-private
partnership: public (following the design of NDC and FDC schemes) and
private. The public schemes are strongly regulated and participation is
standardised, while the private schemes are left for workers to decide.
NDC and FDC have the same social goal, namely income allocation over
the life-cycle. When viewed in terms of a multi-pillar system, the Polish
system has the 1st pillar, using Notional Defined-Contribution type
social insurance principles, which is supplemented by the 2nd pillar in
the form of a mandatory private individual pension accounts.
These reforms also point to greater risks of poverty in old age,
especially if private pension schemes fail to deliver the returns (and
protection) that will compensate for a smaller role of public pension
incomes. Thus, it is recommended that the reformed system continue to
provide a guaranteed minimum pension, to be paid if the total amount
of pension from all different schemes (public and private) is less than
the legal minimum old-age pension. Given the nature of reforms, and if
the workers’ career is not extended, such guaranteed minimum
pensions will be taken up by a large fraction of future retirees.
However, If the current generation of workers will adjust their
retirement behaviour to developments in longevity, they can be
expected to receive higher pensions.
the TRR is a reflection of reforms that have taken place in these countries over
the recent past, which has lowered public pension benefits of future retirees.
For Poland, it is expected that some of the decline in the public pension income
will be compensated by an increase in private pension incomes.
An increase in the TRR is expected for eight EU states, and the most notable of
them is Romania (+ 52 p.p.). Other significant increases are observed for
Bulgaria (+ 15 p.p.), Cyprus (+ 14 p.p.) and Estonia (+ 12 p.p.). Notably, these
are the countries where the base TRR (in 2006) was relatively low.

25
2.2 The retirement age and bonus/malus incentives for working life
extension
Majority of European countries have increased their statutory age for
retirement, although in some of them (e.g. Portugal and Switzerland), only
women’s pension age has risen. In the future, only two of the OECD member
countries will have a pension age less than 65 for men. More importantly, there
are seven countries that will have a pensionable age greater than 65. On
December 22, 2011, Italy's parliament approved the new government's
austerity and growth package (including pension reforms). In the growth
package, an increase is announced in the retirement age, starting in 2012, from
age 65 to 66 years for men and from age 60 to 62 for women and then
gradually to age 66 in 2018. The retirement age in Italy will increase to 67 for
all workers in 2022—4 years earlier than scheduled, and 2 years more,
compared with the Law passed previously. In Poland, the current plan (as
announced by the Prime Minister) is to increase retirement age for men and
women to 67 - the increase from the current retirement age of 65 for men and
60 for women would come about incrementally, by three months each year. At
this rate, men would retire at 67 in 2020 and women in 2040.
Many of these countries have also introduced measures to encourage
extending working lives, by tightening the qualifying conditions for early
retirement, by increasing the service period required and/or the minimum
eligibility age (Austria, Belgium, Denmark, France, Greece, Hungary and Italy).
For example, the Netherlands introduced changes by removing tax incentives
for occupational early retirement schemes. Austria, Finland, France, Germany,
Italy, Portugal and the Czech Republic increased (or introduced) the penalty in
benefits (the malus) for early retirement, while bonus for late retirement were
also introduced or enhanced in some countries (e.g. in Belgium, Finland,
France, Spain, the Czech Republic, and the United Kingdom).22 In Belgium and
Finland, there is even a bonus to people who work between 62 and 65 (in the
form of a higher accrual rate).
The average penalty across OECD countries is 4.4% for each year of early
retirement. The largest penalty (malus) for a European country is for Finland
(in their Defined Benefit type scheme, 7%). However, larger adjustments can
happen in the Czech Republic (close to 9%; for people who retire at the earliest
possible ages) and in Spain (7.5%; for people with a smaller number of
contribution years). In some cases – Belgium, France, Germany, Greece and
Luxembourg – there is pension benefit penalty provided a certain number of
years of contributions were paid.23
22 References: OECD (2009; 2011), Zaidi and Grech (2007); Martin and Whitehouse (2008);
Whitehouse (2009a). Note here that NDC and FDC do not require any discretional adjustment as they
automatically adjust the account value with the life expectancy at the time of retirement.
23 OECD (2011, pp. 112).

26
Majority of European countries now have age 65 as the statutory
retirement age, equalised for men and women (prospectively in some
countries). There are also countries that have introduced automatic
linkage of future changes in pensionable age to life expectancy
developments.
The 2011 reforms in Ukraine had already made a move towards
equalisation of men and women’s retirement age. The automatic link
to life expectancy improvements is the next reform Ukraine should
consider. Also, in view of the international experience, the
bonus/malus adjustments in pension benefits should at least be
around 5 to 7% for each year for a deferral in retirement and for an
early retirement, respectively.
The pension benefit bonus on offer is on average 4.8% per year of deferral in
OCED countries. The United Kingdom offers one of the highest: 10.4% (and a
lump-sum amount including deferred pension plus interest can now also be
claimed instead of an increment in the pension annuity). The rules differ
regarding whether people can combine work and also receive pensions after
the statutory retirement age and thus people’s financial incentives to remain in
work is combination of these two sets of rules. 24
2.3 Up-rating of pension incomes by price inflation only
The indexation reform is principally a choice between a lower initial pension
combined with earnings indexation and a higher starting benefit combined
with price indexation. In addition to changes in the benefit ratio and the net
theoretical replacement rates (as outlined above), the indexation procedures
have also changed in many pension systems in European countries.
In the majority of cases, a move towards a less generous method (of price
indexation only) is made so as to improve financial sustainability of the public
pension systems. A good example of changes that have happened is Hungary:
pensions were indexed to earnings’ growth until 1990s, moved to a 50:50 split
of earnings and price indexation in the reform of the late 1990s, and most
recently moved to price indexation only.
Some countries (e.g. Austria, Greece, Italy and Portugal) offer an interesting
policy of progressive indexation, under which higher pensions rise more
slowly than lower pensions.25 For example, in Italy, smaller pensions are price
indexed while larger benefits are increased by only 75% of price inflation. A
detailed analysis using OECD pension models reveals that the impact of the
progressive indexation on the overall public expenditure savings from this
policy is tiny in Italy and Portugal (Whitehouse 2009b), although there are
24 Ibid.
25 See Whitehouse (2009b).

27
The most common international experience is price indexation, and it
is (in some countries) supplemented by wage growth elements only in
times of prosperity. As had been argued by OECD pension experts
(Whitehouse 2009b, pp. 35), the price indexation of pensions can be
seen to be most appropriate in developed OECD countries, not just for
distributional reasons but also for the fact that it offers greater
flexibility for pensioners. This is what we also recommended for
Ukraine’s for its next pension policy reforms.
In all circumstances, it is advisable to avoid discretionary higher levels
of indexation, as it puts pressure on public spending and compromises
the contributory principles of the 1st pillar public PAYG scheme.
It should not be ruled out that an income growth higher than price
inflation is offered in times of prosperity (say, in the period where
annual economic growth has reached 8-10% or more).
obvious political attractions in such policies. The impacts in Austria and Greece
are somewhat larger.
However, as has been the case in Ukraine, discretionary policies overruled the
legislated rules of annual indexation in many countries (in the majority of
cases to satisfy demands of older pensioners and reduce their risk of poverty,
but also to win political favours in times of elections).
Such ad-hoc adjustments, although more common in the periods of economic
expansion, create an unnecessary burden on public expenditures – an example
is Hungary where such handouts have been common in the recent years (until
the public finance crisis of 2010/2011).
Moreover, some countries have introduced conditional indexation on the basis
of demographic developments (e.g. Germany, Portugal and Sweden, where
pension benefit level and growth can be lower in the case of a continued life
expectancy gains), or use above-inflation rises in pension payments only if
economic growth is rapid (e.g. Hungary and Portugal).
Table 2 summarises the indexation rules situation across EU member States.

28
Table 2: Pension Indexation in EU Member States26
Variable EU Member State
Wage growth Denmark, Slovenia, and Sweden.
Prices and wages Bulgaria, Cyprus, Estonia, Finland,
Luxembourg, Malta, Poland, Romania,
Slovakia, and the Czech Republic.
Prices only Austria, Belgium, Hungary, France, Italy,
Latvia, Spain, and the United Kingdom.
Prices and GDP growth
(partially)
Portugal.
Discretionary Austria, Greece, Ireland and Lithuania.
Progressive Austria, Greece, Italy, and Portugal.
Notes: Belgium: prices+partial adjustment to living standards. Hungary:
prices+partial adjustment to net earnings growth in case of high GDP growth.
Notably, the indexation of pension incomes with prices only leads to an erosion
of the value of pension income relative to wages. This would make sense only if
the consumption needs of elderly suppose to decline. But, with healthcare costs
soaring and increasingly becoming the responsibility of individuals, rather
than the state, this will be an issue. Since women live longer than men, the
erosion of the value of pensions during old age affects women more than men.
Results for 15 EU countries, presented in Figure 3, show that the age group of
75+ is worse off compared to the younger group aged 65-74, for both men and
women.27 In all EU15 bloc of countries (except for the Netherlands), the
subgroup of females aged 75 or above shows the highest poverty rate of the
four groups considered. At 63%, the poverty rate for females aged 75+ is
particularly high in Ireland (in 2003).
In addition, Austria, Finland, Greece, Portugal, and the UK show poverty rates
of at least 30% for females aged 75+. Next to the Netherlands, Germany and
Luxembourg show the lowest at-risk-of poverty rates in this group. For males
aged 75+, poverty rates of 30% or more are only found in Greece, Ireland and
Portugal, of which only Greece and Portugal also have high poverty rates for
females aged 65-74 and only Greece has a poverty rate of 30% for males aged
65-74.
26 2009 Ageing Report, and Joint Report on Social Protection and Social Inclusion 2009.
27 Zaidi (2006).

29
Figure 3:
Proportion of elderly population at risk of poverty, using 60% of median
income as the poverty line, by gender and age (in 15 European Union
countries), during 2003
One significant policy development is that many countries have recently
embarked on a further strengthening of their targeted minimum pension, state
non-contributory pensions and social assistance benefits – this has a positive
impact on the reduction of poverty amongst the elderly. The most notable
result is observed for Ireland: it went through a drastic decline in the poverty
risk for the elderly over the five years period 2004-2008. This trend is a direct

30
result of the fact that all forms of state pensions increased substantially over
this period, in excess of growth in gross earnings. In particular, non-
contributory and widowers’ pensions increased considerably, reaching close to
32% of average earnings in 2007 and closing the gap between the contributory
and non-contributory pension to only about 4.5%.
Portugal also observed a notable decline in the poverty risk for the older
population during the period 2004-2008: from 29% to 22%. This is partly due
to the fact that a means-tested solidarity supplement to pensions
(Complemento Solidário para idosos) was introduced during 2006. Belgium
experienced a decline late in the same period, and this can be attributed to the
fact that the minimum income guarantee for retirees (GRAPA – Garantie de
revenue aux personnes agées) increased in 2007. 28
2.4 Phasing out privileged pensions and strengthening contributory
principles
The privileged pension treatment in Ukraine is generally granted for three
types of workers:
1. those who work in hazardous or arduous jobs and thus (likely to)
experience lower life expectancy than the rest of the population (such as
those who work in underground mining);
2. those who cannot be expected to serve for very long in their occupations
(such as teachers; pilots); and
3. those with ‘special’ services to the nation (such as the war veterans,
judges and civil servants).
These privileges result in such workers being made eligible for earlier (and/or
more generous) access to pension benefits than otherwise available in that
country’s general pension scheme. The pertinent questions are: how to define
and justify objectively for the groups to enjoy privileged pension treatment,
and how to fund these privileges and these issues have been addressed by
many countries that currently have such schemes. Another pertinent question
is to ask whether the pension system is the optimal policy instrument to deal
with differences in occupations? Why is it not the wage, or mark-ups on wages,
that can be used which would be a more direct approach and will leave the
pension system undistorted.
Table 3 lists as many as 18 OECD member countries which have special
pension schemes offering special privileged pensions.29 The most common
form is that of a collective concession, where a whole sector (such as
underground mine workers, sailors, airline workers and artists) had been
granted a special treatment in the calculation of pensions and thus provisions
towards earlier retirement.
28 Zaidi (2010).
29 Ibid, pp. 13

31
Table 3: Special privileged pension schemes across OECD countries
A number of broad conclusions emerge from experts’ opinions on this issue:
• These schemes are justified only for very narrowly defined subgroups of
workers, who continue to face the risk of a premature mortality due to
exposure to hazardous or arduous working conditions;
• In general, there is a weak case for maintaining such special pension
schemes. The international experience is that the continuance of these
schemes owes more to institutional resistance to change (and a strong
lobby) rather than the usefulness of these schemes as a supplementary
(and justifiable) public pension scheme.
• It can be argued that in cases where such work-related health risks are
recognised, they can be better dealt with some well targeted
conventional social policies, such as disability pensions or work-related
sickness benefits (using a rigorous ability-to-work test), on case-by-case
bases.
• If privileges of early retirement ought to be continued for some
occupations or jobs, they should be financed based on contributions by

32
Ukrainian government need to instigate a review process through a
specially established expert commission, whose remit will be to look at
each applicable special pension scheme on a case-by-case basis as well
as examine their history and justifications. Such a review process
should look into whether the current privileged schemes are indeed
the best way to compensate for experiences in risk-bearing and
arduous occupations or in rewarding special services. The conclusions
should also be drawn about how such schemes are affecting the
competitive functioning of certain sectors in the labour market. The
review process should be inclusive in bringing together all social
partners so as to seek a viable long-term solution.
It would be worth looking into what was proposed by the 2003 law
that privileged pensions be transferred out of the 1st pillar into the 3rd
pillar, with contributions paid by employers and employees. The real
problem is that those employers in the sectors offering privileged
pensions pay the contribution rate that is already very high – in some
instances social insurance contribution rate is up around 60% for
these employers. If an additional contribution burden is added to these
employers, it will bankrupt many of these companies.
The on-going reform process in France provides a good illustration of
an attempted change and the difficulties encountered. A number of
special public-sector schemes provided supplementary benefits to
certain categories of workers recruited prior to 31st December 2008.
As from 2009, the circumstances of such workers will be determined
in negotiations by the social partners and on a case-by-case basis. For
a detailed review of recent reform actions in other countries in
phasing out the privileged pension, see OECD’s review ‘Should Pension
Systems Recognise Hazardous and Arduous Work?’ (Zaidi and
Whitehouse 2009).
employers and also employees. This is the direction many countries
have moved (including Ukraine in making employers pay for early
retirement in some of the sectors).
2.5 Pension contribution redistribution from employers to
employees
The total contribution rate for old-age, disability and survivors’ pension in
Ukraine is one of the highest among the European countries (as shown in Table
4). Most notably, for these schemes, the share of employers’ contribution is by
far the largest in Ukraine than anywhere else (although in general higher
employers’ contribution rates are the norms in the former socialist Central and
Eastern European countries – see also Figure 4). The Netherlands offer the
other polar position, where the pension contribution rate is much higher for
the employees than for employers.

33
Our recommendation is that the distribution between employees and
employers in Ukraine should follow what is observed in Germany, i.e. a
50:50 division between employers and employees for pension
contributions. Such a policy reform will have to be cost neutral to
employers. Also, employers should be required to compensate
employees with the equivalent amount to pay for higher employee
contributions. The challenge will lie in the implementation of this policy
reform. A collective agreement process (and/or a state legislation) may
be required to ensure that the reform process of redistribution of pension
contributions from employer to employees is implemented smoothly and
is fair to both employers and employees.
Looking at the total contribution rate for all social security programmes (in
Table 4), there are four countries in which the contribution rate is clearly
higher than that observed for Ukraine (39.15%): they are the Czech Republic
(45%), Hungary (44%), Austria (42.35%) and France (42.48%). The average
contribution rate for all social security programmes in Ukraine (39.15%) is
close to that observed for Germany (38.86%), but the distribution between
employers and employees is drastically different (almost 50:50 for Germany,
whereas in Ukraine 93% of all contributions come from the employer).
There are many strong arguments to prefer higher contributions from
employees in comparison to contributions from employers. For example, a
move towards higher employees’ contribution will make them appreciate
better their pension rights that are accumulated by a ‘formal’ attachment with
the labour market. Thus, it can be recommended that Ukraine should
redistribute in favour of a higher contribution from employees, and follow
what is observed in Germany, i.e. a 50:50 division between employers and
employees for pension contributions.
Figure 4: Contribution rates for employers and employees for Old-age,
disability, and survivors’ schemes, 2010
0
5
10
15
20
25
30
35
IE CY BG LU BE FR SK SE DE HR GR FI NO EE AT CH UK SI NL PL RU LT CZ ES IT LV HUUA PO
Employer
Employee

34
Table 4: Contribution rates for employers and employees for Old-age,
disability, and survivors schemes, and for all social security schemes,
2010 (in % of payroll)
Employee Employer Total Employee Employer Total
Austria 10.25 12.55 22.80 17.20 25.15 42.35
Belgium 7.50 8.86 16.36 13.07 24.77 37.84
Bulgaria 7.10 8.90 16.00 12.10 16.80 28.9 a
Croatia 20.00 0.00 20.00 20.00 16.70 36.7 a
Cyprus 6.80 6.80 13.60 6.80 6.80 13.6 a
Czech Republic 6.50 21.50 28.00 11.00 34 b 45 e
Estonia 2.00 20.00 22.00 2.60 33.30 35.9 a
Finland 4.50 17.10 21.60 7.10 20.38 27.48 a
France 6.65 c 9.9 c 16.55 c 9.80 32.68 b 42.48 b
Germany 9.95 9.95 19.90 19.25 19.61 38.86 a
Greece 6.67 13.33 20.00 11.55 22.10 33.65
Hungary 9.50 24.00 33.50 17.00 27.00 d 44.00 a,d
Ireland 4.00 8.50 12.50 4.00 8.50 12.5 e
Italy 9.19 23.81 33.00 9.19 30.17 39.36
Latvia 9.00 24.09 33.09 9.00 24.09 33.09 a
Lithuania 3.00 23.30 26.30 9.00 30.98 39.98
Luxembourg 8.00 8.00 16.00 12.35 11.40 23.75 a
Netherlands 19.00 5.70 24.70 22.5 d 17.50 40 a,h
Norway 7.80 14.10 21.90 7.80 14.10 21.9 a
Poland 11.26 14.26 25.52 22.71 17.61 40.32 a
Portugal 11.00 23.75 34.75 11.00 23.75 34.75
Russia 0.00 26.00 26.00 0.00 34.20 34.2 f
Slovak Republic 4.00 14.00 18.00 10.40 27.20 37.6 a
Slovenia 15.50 8.85 24.35 22.10 16.10 38.20 a
Spain 4.70 23.60 28.30 6.25 31.08 37.33 a
Sweden 7 c 11.91 18.91 7.00 23.43 l 30.43 a
Switzerland 11.90 11.90 23.80 13.05 13.15 b 26.20 b
Ukraine 2.00 32.20 34.20 2.85 36.30 39.15
United Kingdom 11.00 12.80 23.80 11.00 12.80 23.8 a
d. Plus flat-rate contributions for medical benefits.
e. Government pays for most of the cost of family allowance benefits.
Country
Old age, disability and survivors
programmes
All social security programmes
a. Government pays the total cost of family allowances
Notes: In many countries, the contributions are subject to a ceiling on some benefits.
b. Employers pay the total or most of the cost of work injury benefits.
c. Contributions finance old-age benefits only. Additional contributions are required for survivor
and disability benefits.

35
2.6 Adjustment of pension contribution rates
In dealing with the challenges arising due to population ageing and the ensuing
rising age-related public expenditures, policy makers must also make a choice
between three options:
 raising the pension contribution rate,
 provide incentives and the environment suitable to longer working
careers, or
 introduce cuts in retirement income generosity.
The second option will include the possibility of claiming pensions but also
continuing to work, maybe part-time, and continue paying pension
contribution. The third option would also include closing of alternative early
retirement pathways.
Obviously, a combination of these three policy options could also be pursued,
so as to meet the objectives of improving the long-term sustainability of
pension systems and maintain the adequacy of pension incomes. The evidence
presented above shows that many European countries have introduced
reforms that have improved incentives for longer working lives and/or
reduced public pension income generosity.
Figure 5 presents trends in the contribution rate for the old-age, disability and
survivors programmes in European countries for the period 2002-2010. No
change is observed during the whole decade of 2000s in eleven countries (out
of 31 reported here): Austria, Belgium, France, Greece, Luxembourg, Malta,
Norway, Portugal, Spain, Slovenia and Switzerland (bars shown in yellow).
Such a trend is particularly notable for Belgium, France and Luxembourg,
where the pension insurance rate is low relative to other countries. Another
four countries show less than 1 p.p. change: Croatia, Finland, Germany and
Italy. Cyprus and Lithuania and Slovakia observe a change by only 1 p.p.
Bulgaria stands out as the country where the largest fall in the contribution
rate is observed: it had one of the highest rates during 2002 (31%), and a fall of
8 p.p. occurred during the 2002-2010 period. It is a special case, since a new
system consisting of a social insurance first pillar plus a second pillar of
individual accounts was implemented in January 2002 (coverage under the
first pillar is universal, but the mandatory individual account system covers all
employees born after December 31, 1959). For the individual account system,
the insured person also has to bear 1% per year of accumulated funds as
annual administrative fees. Such additional costs (mainly to the insured
person) are also observed in other countries where the individual account
system had been introduced (e.g. Slovakia and Poland).

36
Recent trends observed in the European countries suggest that
many countries have opted to limit any rise in the pension
contribution rates. This policy choice has its merits, as it leads to a
higher scope for the individual choice in determining the most
appropriate level of pension insurance for individuals concerned.
Moreover, pension contribution rate rises are also politically
difficult to implement as they are termed equivalent to a rising
taxes.
Given already high contribution rate, no further increases in
pension contribution rate are recommended for Ukraine. When
feasible given the deficit situation in the Pension Fund, Ukraine
should consider reducing the pension contribution rates, so as to
reduce labour costs, improve competitiveness and employment
growth.
Figure 5: Changes in the pension contribution rates, between 2002 and
2010, in European countries
Notes: Includes Old-age, Disability, and Survivors; Sickness and Maternity; Work
Injury; Unemployment; and Family Allowances. In some countries, the rate may not
cover all of these programs. In some cases, only certain groups, such as wage
earners, are represented. The contribution rate in most instances is flat rate. In
other cases, it varies with the wage class. When the contribution rate varies, either
the average or the lowest rate in the range is used. They refer to the contribution
rate by employees; however, the self-employed may have to contribute at a higher
rate than employees, thereby making up for the employer’s share.

37
2.7 Measures in de-shadowing informal labour market
It is estimated that the economic activity in the informal shadow economy
approximates in excess of one-third of GDP in Ukraine, and the issue is
particularly serious in some sectors, e.g. extractive industry; catering; real-
estate and manufacturing.30 The experience of other countries with respect to
the problem of shadow economy shows that the shadow economy in Ukraine
as a share of GDP is one of the largest among transition economies.31
From the experience of other countries, Ehrke et al. (2011) point out that there
are three factors responsible for a high informal labour market in Ukraine:
1. The social insurance contributions are high, and they outweigh the
positive effect of the low 15% flat-rate personal income tax;
2. Non-professional functioning, including corruption, of social security
administration in enforcing penalties for the ‘cheats’ prevents benefits
from any recent labour market reforms to improve reporting of
employment; and
3. Lack of trust and low provisions of public goods lead to low motivation
to contribute to public sector initiatives.
It is beyond the scope of this study to address all these issues, so we point to
the considerations under the 1st point only. High pension contributions by the
employer are indeed one of the major elements in raising costs of labour in
Ukraine. High labour costs encourage informal employment in which a large
share of wages is paid in shadow. Even when employment is reported,
contributions are paid for minimum wages for the majority of workers. These
two aspects subsequently undermine revenues of the PFU.
Also, by linking pension levels to actual contributions paid, the incentive for
formal work would be raised. In the context of a global shift (also seen in
Ukraine) of “responsibility” for generating income in old age from the state to
individuals, this can be a particularly powerful channel for lowering the
relative share of the informal economy and for moving away from paying
contributions at a reported income of minimum wage only.
However, the generous indexation of minimum pensions guarantee have
reduced work incentives for employees, as most people expect to receive the
guaranteed minimum pension after retirement (currently 65% of pensioners).
The pension receipts have become a flat rate benefit, and thus there is no
strong relationship between the levels of contribution and expected benefits.
Also, employees do not benefit from demanding ‘official wages’ for their work,
especially since the official wages are likely to be lower than those paid in the
under-the-table transactions.
30 See Ehrke et al (2011).
31 See Schneider et al. (2009).

38
A move towards reducing overall social security contributions, and
also moving the contribution burden away from employer to
employees, is recommended for Ukraine. It will achieve the desired
objective of reducing labour costs and also improving incentives to
employees to participate in the formal work.
We agree with experts’ opinion on this topic, viz. Ehrke et al. (2011),
that ‘no quick victory over the shadow economy is possible.
Policymakers can realistically expect only a gradual reduction of the
problem. But, given the enormous dimension [and significance] of the
problem, also gradual improvements count a lot.’
2.8 Coverage and treatment of self-employed (including agricultural
workers)
An efficient and effective social insurance servicing of self-employed and
agricultural workers will include not just coverage by an appropriate pension
scheme but also providing them with advice and activities in the prevention of
occupational injuries and appropriate health care and rehabilitation services in
case of sickness or disability. Broadly speaking, two kinds of social insurance
services are required:
(1) Old-age Pension Insurance; and
(2) Accident, Health and Maternity Insurance.
These services should cover not just the principal person (e.g. the farmer, who
is using his/her own land for the agricultural production), but also all co-
workers (whether family members or others). Here, we address issues
concerning old-age pension insurance only.
The basic requirement for the coverage is: reporting of an accurate income and
wages generated from the activities, for all workers, irrespective of its level in a
single period. A suitable incentive structure should be in place, so that the
insurers could see the advantage in participating in the system. The penalty
structure should enable the threat so as to minimize the cheating with the
system.
Poland offers a good example in the social insurance treatment of agricultural
workers.32 The Agricultural Social Insurance Fund (KRUS) is established as an
institution to realize and implement all tasks connected with social insurance
of agricultural farmers (such as contributions collection, allocation and
payment of insurance benefits and their supplements). It is an independent,
specialized organization which serves as a real manager of farmers' social
insurance. The corresponding Law provides two forms of coverage: the
covering by insurance takes place either on the strength of a law (obligatorily)
32 Information reported here is drawn from http://www.krus.gov.pl.

39
or on demand (voluntarily). The obligation of payment of contributions must
be fulfilled by the owner of the farm who conducts the agricultural activity on
his own account.
The following persons are covered in the obligatorily scheme of farmers' social
insurance:
 The owner of the farm (the farmer), possessing above 1 hectare of
arable land (or a special section of agricultural production, according to
the interpretation of tax regulations);
 The farmer's spouse who works continuously on the farm, or keeps the
house which is directly connected with a farm;
 A household member, who is at least 16 years old, remains a farmer in
the common household or lives on the farm or in the neighbourhood,
works constantly on the farm and is not employed by a farmer as a
worker, and if those persons are not covered by other social insurance
and do not have right to old-age pension or disability pension from the
farmers' social insurance or other social insurance.
There are some exceptions to this rule for those who conduct agricultural
activity or work on the farm and at the same time conduct non-agricultural
economic activity. The pension income drawn from this insurance includes:
 old-age pension (or disability pension in case of inability to work);
 farmer training pension;
 survivors' pension;
 pensions from the farmers' social insurance for private farmers and
their families; and
 some pension supplements (such as supplement for orphans in
survivor’s pension; and cash supplement for the soldiers from
supplementary military service who had been forced to work in coal-
mines, quarries and uranium ores-mines).
There is a separate fund within KRUS, the Pension Fund, which is created from
pension insurance contributions and also financed by supplementary subsidies
from the national budget. The Fund finances pension benefits, pension from
other social insurance, paid together with benefits of pension insurance and
supplements. The farmers own contribution cover about 10% of expenditures
on benefits and the rest is covered by the national budget subsidies.
The United Kingdom has recently introduced, and then changed33, the way
employers and employees arrange their pensions. In a bid to encourage better
coverage, a new law introduces ‘auto-enrolment’, where employers have to
sign their employees up to a pension, unless the employee opts out of it, rather
than the other way around. Now, employees are entitled to an automatic
33 The new compulsory scheme, NEST, is due to start in 2012. The change made is the UK government
has deferred enrolment in NEST for employers of under 50 employees only.

40
Ukraine should initiate a special expert committee to understand and
resolve the issues involved in registering and covering the self-
employmed as well as rural agricultural workers in the public social
insurance system. Important lessons can be drawn from other
countries, in particular Poland and the UK.
Ukraine should consider adopting the automatic enrolment principle
for pension schemes, in registering all self-employed and agricultural
workers for a minimal level of employment, wages and contributions.
The interaction between entitlement to minimum pensions and the
social assistance should also be analysed.
pension scheme if they work for three months, and they earn £10,000 or more
(per annum). The implication of a high threshold is that the casual workers will
be excluded from the coverage.
3. Pension reform scenarios for Ukraine
___________________________________________________________
3.1. Short-term immediate measures, during the period 2012-2014
Setting up an independent expert commission to review special pension
schemes
An immediate action is required in devising the best possible way to phase out
the pension privileges available to many workers within the 1st pillar. Our
recommendation is that the Ukrainian Government should, without delay,
instigate a review process through a specially established commission
consisting of independent experts. The remit of such a commission will be to
review each applicable privileged pension (eligible for List I and List II
workers) on a case-by-case basis while keeping the systemic implications in
mind, as well as examine their historical origin and possible justifications.
The Commission should look into whether the current privileged pensions are
indeed the best way to compensate for experiences in risk-bearing and
arduous occupations (or in rewarding special services). The Commission
should involve social partners and come up with a viable long-term solution.
The Commission should also contract a study for a detailed review of reforms
of such type in other European countries, in particular in CIS and EU countries.
It should provide a costing of how much privileged pensions cost in Ukraine. A
template of such a study is provided by OECD’s 2009 study ‘Should Pension
Systems Recognise Hazardous and Arduous Work?’

41
Reducing pension contribution and changing its distribution while
maintaining wages
Currently Ukraine has one of the highest social insurance rates in the European
countries. In the first instance, Ukraine should consider reducing the overall
pension contribution burden, provided there is a fiscal space for it. Bulgaria
offers an example where the largest fall in the contribution rate is observed in
recent times: it had one of the highest rates during 2002 (31%), and a fall of 8
p.p. occurred during the 2002-2010 period.
The Ukrainian Government should also modify the distribution between
employees and employers for their pension contribution. We recommend that
Ukraine should adopt the model observed in Germany (and also in Switzerland,
and (approximately) in Poland and the UK), i.e. a 50:50 division between
employers and employees for pension contribution. Such reform should start
immediately (in 2012/2013), albeit the change towards the ultimate 50:50
division will have to be implemented gradually, to be completed by 2020.
Most important element of this reform would be that the employers will be
required to compensate employees with the equivalent amount to pay for
higher employee contributions, so that the take-home wages could be
maintained at their current levels. The reform will also be required to be cost
neutral for employers. Experience of Kazakhstan for example was that
employers in public sector passed on the wage increase but not in private
sector.
Thus, the challenge lies in the implementation of this policy. A state legislation,
along with a collective agreement between employers and trade unions, will be
required to ensure that the reform process of redistribution of pension
contributions from employer to employees is implemented efficiently and
fairly. Also, the purpose of this reform is the signal to employees that the future
pension entitlements are linked to one’s own lifetime contributions – if such a
signal would be missing, the impact of changes in the contribution distribution
between employees and employers would not have its desired effects.
Improving coverage and de-shadowing the labour market
A move towards reducing overall social security contributions, and also
moving the contribution burden away from employer to employees, is the
recommended path for the pension policy in Ukraine – it should start during
2012/2013. Such a policy change will achieve the desired objective of
improving incentives to employees to participate in the formal work.
The model followed in Bulgaria, in improving the formal participation of
workers across different sectors, is recommended. This involves defining
minimum wages that are different for different sectors, and thus higher
minimum wages are expected for workers of certain types (e.g. professionals).
We understand that the implementation of such a policy has already started –
the Government should aim to implement this over the short run. Such policy
reforms can bring a gradual reduction of the problem (although the results

42
obtained in Bulgaria had been impressive!), but given the enormous
significance of the problem, this gradual improvement should be a satisfactory
outcome over the short run. The Ukrainian government would want to watch
out that this approach may open the door to all kinds of creative
interpretations of “professions”. Also, it may not be sufficient to stop at inter-
profession differentiation only, but also to look into the possibility of applying
a regional differentiation.
Improving procedures of pension income up-rating
The inflation only up-rating of pensions is viewed by experts as the most
appropriate form of adjustment of retirement incomes, particularly in view of
the budgetary pressures of current times. This ‘price-indexation’ policy is also
our recommendation for Ukraine, subject to a revision (say) after 2015.
In all circumstances, it is advisable to avoid discretionary higher levels of
indexation, as it puts pressure on public spending and compromises the
contributory principles of the 1st pillar public PAYG scheme. It should not be
ruled out that an income growth higher than price inflation is offered in times
of prosperity (say, in the period where annual economic growth has reached 8-
10% or more).
Given the policy of higher-than-price growth of pension income in the past
decade or so, the Ukrainian authorities should also consider the policy of no
growth in pension incomes for a single year (if at all allowed by the law!). This
policy option will undoubtedly hurt income adequacy of current pensioners,
and should only be considered if it is absolutely essential in bringing down the
deficit of the 1st pillar public PAYG scheme considerably (e.g. down to the levels
that set up the conditions for the launch of the 2nd pillar).
It is also worth considering the policy of age-specific pension indexation, so
that relatively young retirees will get lower pension increases than the most
elderly pensioners. Such a policy instrument would help deal with the high
risk of poverty among oldest old pensioners, especially women.
3.2 Medium to longer term measures – beyond 2014
Over the medium to long term, Ukraine should aim to strengthen its multi-
pillar system, as was envisaged in the 2004 pension reforms. The launch of a
mandatory 2nd pillar, along the lines of the 2nd pillar of the new pension system
in Poland, would reinvigorate the pension system (as was already envisaged in
the 2004 reforms in Ukraine).
The most important effect of these reforms is the diversification of
mechanisms (and risks) of pension provision, between public and private
schemes and between PAYG and funded pension schemes. Thus, the new Polish
pension system (as well as selected features of the reformed Swedish, Latvian
and Italian and Austrian and German pension systems), and the pension
reforms processes that led to their current form, offer a good model for
Ukraine.

43
First pillar to become a defined contribution type PAYG scheme
In our recommendation, the 1st pillar of Ukrainian pension system should
implement changes to adopt the social insurance principles of the Notional
Defined Contribution (NDC) type PAYG schemes.34 Indeed, as argued in detail
in Whitehouse (2010), changes in the conventional PAYG can achieve the
desired objectives, but without necessarily adopting a notional accounts
system. Four countries (Italy, Latvia, Poland and Sweden) have introduced
NDC schemes in their 1st pillar, and they provide insights about what should be
suitable parametric adjustments for the 1st pillar in Ukraine.35 The pension
system design followed in Austria and Germany also offer useful insights on
how to adjust the classical PAYG system so as to mimic the good principles of
the NDC system.
Four desirable features of the NDC can be highlighted here:
1. The pension income entitlements are based on average ‘lifetime’ wages,
rather than a subset of best or final years’ wages;
2. Benefits are adjusted for early or deferred retirement on the basis of
actuarial fairness;
3. Benefits are adjusted as life expectancy increases, so as to reflect the
longer duration for which benefits would be paid; and
4. The recognition of periods outside employment (such as unemployment,
periods of maternity and parental leave) is achieved by crediting
notional personal accounts with additional contributions paid from
general public revenues on annual basis.
For Ukraine, the main reform element would be the factors determining the
pension annuity calculations at the time of retirement. The pension formula
currently in use in Ukraine has three parameters (as outlined in Section 1): (i)
The average last wage of all insured workers; (ii). The individual coefficient of
the relative wage, and (iii). The individual coefficient of service.
To mimic the social insurance principles of the NDC type scheme, an
adjustment in the first parameter is required. The assessment period, used in
the second and third parameter, has gradually been extended towards the
whole working lifetime, (given the fact that the full service period since July 1,
2000 will be taken into the calculations for a new retiree).
Four parametric reforms are recommended here:
1. An adjustment is recommended in the parameter: the average last wage
of all insured workers, which is applied to adjust the wage for pension
calculation purposes (used specifically to in order to adjust the wage as
of the date of pension awarding). Already, an appropriate change has
happened by which average wage of three last years will be included in
34 See Góra and Palmer (2004) for a description of distinctions between NDC and FDC pension
schemes.
35 See, for example, Palmer et al. (2009).

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Strategy Paper for Pension Policy in Ukraine