Download The fiscal impact of pension reform: economic effects and

The fiscal impact of pension reform:
economic effects and strategy
Ewa Lewicka
Kiev – May 27, 2004
Types of financial consequences
of pension reform
• Long-term:
– reduction of long-term pension system
liabilities (implicit debt)
• Short and medium-term:
– increase or decrease in the public finance
deficit due to pension related expenditures
(explicit debt)
What is pension system implicit
debt?
• Implicit debt is the measure of liabilities
undertaken by the pension system
– Can be measured as the present value of
future pension transfers
• In developing and industrial countries
this debt is increasing rapidly
Assessing the implicit debt
is a crucial for the reform
• It allows to measure actual obligations
towards current and future generations
• Shows the level of cash flows to be allocated
to repurchase these liabilities
• When liabilities are due, implicit debt
becomes explicit
– It influences the public sector deficit and
the public debt level
How to cope with future liabilities?
• To prevent public finance collapse:
– surplus should be generated to cover increased liabilities
of the pension system
– in OECD member countries necessary surplus is around
4 percentage points of GDP
• Pension reforms can generate such surplus
– If the reform design allows to reduce implicit debt,
• Introduction of partial funding
– Reduces implicit pension debt
– May increase explicit pension debt, if overall contribution
level is not increased
Implicit debt in selected countries
Implicit pension debt in
transition economies in 2002
350
300
200
150
• According to estimates:
100
50
Note: assuming 4% discount rate
Source: Holzmann et al (2001)
Lithuania
Estonia
Hungary
Slovakia
Ukraine
Romania
0
Slovenia
% of GDP
250
• In most of the
countries, the IPD is
much higher than
the explicit public debt
– IPD exceeds 200% of
GDP in France and Italy
– It is above 150% in
the UK and Germany
•
•
•
•
France
Netherlands
Italy
Belgium
Spain
Germany
Canada
Japan
Norway
Denmark
Korea
Portugal
USA
New Zeland
Finland
Czech Rep.
UK
Sweden
7
6
5
4
3
2
1
0
-1
-2
Poland
% of GDP
Primary balance needed to offset
the impact of ageing
Estimated annual primary balance needed to reduce the public debt to zero
by 2050
Countries that have reformed their pension systems (Poland, Sweden) or
countries that have balanced systems (the UK) have lowest primary balance
needed
Poland, following the pension reform is the only country that does not need
a primary balance to be generated
On contrary – pension reform generates surpluses
Source: OECD
Transition costs
• In multi-pillar pension systems
– A part or the entire contribution is transferred to pension
funds
– Current pension payments require financing
– A transition deficit occurs
• The size of the deficit depends on:
– the contribution amount
– number of persons covered by funded system
• Options to finance the deficit:
– current revenue from tax or other sources (for example
privatisation – as in Poland)
– pension savings or public expenditure savings
– increased explicit debt
Misunderstandings regarding reform
costs
• Transfer of a portion of contribution to funded
pension scheme is not a cost
– It reveals a portion of the implicit debt and
– It reduces future public finance obligations
• Increased funding requirements can be offset
by higher debt, purchased by pension funds
• Pension funds assets invested into equities stimulate
investment and economic growth
• It is better to turn a portion of pension liabilities into
savings now than to have much greater problems
with redeeming such obligations in the future
Short and medium term
consequences of the reforms
• In order to improve short and medium term financing of the
PAYG pension systems, the following steps can be taken:
–
–
–
–
increasing contribution levels,
improving compliance and execution,
reducing pension promise by changing retirement pension formula,
increasing the retirement age, etc.
• Financing transition costs from savings in the PAYG pension
system increases current financing burden – reaching the
balanced scheme requires more time
– pension system savings and costs should not increase the burden
of the present productive generation
– these should spread some of the burden also to the future
generations
• Financial gains will depend upon the reform type
– each country planning pension reform should compare effects,
knowing the reform effects gained in a given country
The new pension system
in Poland:
•
New Polish pension system is:
– defined contribution
– with two accounts: nonfinancial and financial
•
•
The old-age contribution was
divided into:
– NDC
– FDC
•
•
12.22% of wage
7.3% of wage
Rates of return:
– In the NDC are linked to the
wage fund growth
– In the FDC depend on the
financial market returns
Persons below 30 (in 1999)
have both NDC and FDC
accounts
Persons aged 30 to 50 had
a choice of one (NDC) or two
(NDC+FDC) accounts
– 53% of them chose to have
two accounts
•
Persons over 50 years of age
are in the old system
The new pension system
in Poland:
• Actual retirement age was raised
– from 55 for women and 59 for men to 60 for women and 65
for men
– early retirement was eliminated
– equalisation of retirement ages for men and women
at the age of 65 by 2023 was recently proposed
• All pension rights accrued under old pension scheme
form the initial capital, credited to the NDC account
– Initial capital is indexed the same way as NDC accounts
• State guarantees include:
– Minimum pension guarantee that tops-up the pension from
both NDC and FDC account
– State becomes a final guarantor of the minimum rate
of return under the FDC component
State budget subsidies to Social
Insurance Fund
per cent of GDP
3.5
3.0
2.5
1.23
2.0
1.15
1.5
1.06
1.0
0.5
1.82
0.37
1.02
1.17
0.64
0.64
1999
2000
0.0
1998
2001
2002
year
supplementary subsidy
subsidy covering transfer to FDC
Source: ZUS
Poland –Long-term effects
• Estimated value of pension liabilities
as per cent of GDP until the year 2050:
– Before the reform
– After the reform
462%
194%
– Reduction of liabilities
268%
Demographic and system
dependency rates
5,0
productive / postproductive
4,5
4,0
insured / pensioners (old-age)
3,5
3,0
2,5
2,0
1,5
insured / pensioners (all pensions)
1,0
0,5
2050
2048
2046
2044
2042
2040
2038
2036
2034
2032
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
2002
0,0
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
02 04 06 08 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50
Note: Projection for three various demographic scenarios (including baseline, higher fertility and lower mortality)
Source: ZUS (2004)
Pensioners by the type of the pension
system
6
2
0
0
9
2050
2048
2046
2044
2042
2040
2038
2036
2034
2024
2022
2020
2018
2016
2014
2012
2006
2004
2002
0
2010
1
2008
old system
PAYG DB
2032
newnew
system
system
one pillar
NDC
(PAYG)
2030
2
new
new system
system
NDC+ +FDC
FDC
NDC
2028
3
2014
2026
4
mln
2
0
1
4
2009
5
Source: ZUS (2004)
Expenditure and revenue of the
pension system
26%
expenditure
24%
22%
20%
18%
16%
14%
12%
exp
endi
ture
s
contri
bution
2049
surplus
contribution income
2050
2048
2046
2044
2042
2040
2038
2036
2034
2032
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
2010
2008
2006
2004
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
02 04 06 08 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50
2002
10%
2
su
0
rpl
4
us
Note: expenditure of the pension system covers both the old pension system and the NDC pensions
Source: ZUS (2004)
Summary of medium-term financial
effects of the reform
• Full transition to the new pension system will take several
decades
• Calculations show that the deficit in the system will be reduced
and after a transition period, the system will be financially
stabilised
– further improvements are expected due to the changes
proposed in 2004 in pension indexation and retirement age
• The deficit is temporarily increased by creation
of the buffer fund - the Demographic Reserve Fund
– In 2004 0.15 percentage points of contribution is transferred
to the DRF
– At the end of 2003, assets of DRF were about 0.4% of GDP,
invested mainly in government bonds
– DRF will be used to finance deficits in the old-age NDC
scheme after 2009
Summary
• Designing pension reforms should be preceded by:
– assessing the implicit debt
– communicating the level of pension obligations to the society
• It is necessary to ensure that financial consequences of the
reform, both negative and positive, do not burden a single
generation of working people but are allocated evenly
• Multi-pillar systems provide an opportunity to faster reduction
of the public debt and can generate higher pensions, compared
to the parametric changes under the PAYG systems
• The sooner the PAYG systems are balanced out the sooner
burden for the working population is decreased
• The size of the funded system:
– should be the result of an assessment of the capacity to finance the
gap in the PAYG part
– it requires appropriate financial market infrastructure