Post on 08-May-2015
THE INVERTED PYRAMID: PENSION
SYSTEMS IN EUROPE AND CENTRAL ASIA FACING
DEMOGRAPHIC CHALLENGES
Team led by Anita Schwarz and Omar Arias
December 2012
1
IMPORTANT EUROPEAN ACHIEVEMENT OF
PROVIDING OLD AGE SECURITY
Over last century, increasing number of workers
insured against risks of old age, disability, and
loss of a breadwinner
Insured workers and their employers paid a
percentage of wage as contribution
When each new group of workers joins,
contribution revenue goes up, but initially since
no one from the new group is eligible for benefits,
no additional expenditures occur
Over time as the workers who have paid become
eligible for benefits, expenditures increase 2
MATURATION OF PENSION SCHEMES
THROUGHOUT EUROPE
Established around 1900s > Industrial workers
Commerce, civil servants,
salaried employees
Since 1930s >
Farmers, domestic workers,
self-employed Since 1950s - >
Baby boomers Since 1970s - >
Increased female LFP rate Since 1960s (earlier in ECA)
Since 1990s in ECA - >
Since 2010s - >
Drop in total and formal LFP rate
Post-1990s babies enter LM
Maturity expected in 1960
Extended to 1990
Extended to 2000
Extended to 2010
Extended to 2020
No Extension,
Added stress 1990-2030
No Extension,
Added stress 2010-2050
3
LABOR FORCE GREW IN LAST CENTURY
4 0.25
0.45
0.65
0.85
1.05
1.25
1.45
1.65
1.85
2.05
2.25
1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011
Labor Force Growth (source: Peter Flora, ILO)
Austria
Belgium
Bulgaria
Denmark
Finland
France
Hungary
Italy
Netherlands
Norway
Poland
Portugal
Romania
Spain
Sweden
Switzerland
UK
COVERAGE OF THE LABOR FORCE GREW AS
WELL
0.2
0.4
0.6
0.8
1
1.2
1.4
1900 1910 1920 1930 1940 1950 1960 1970
percent Pension Insurance Coverage, % Labor Force
Austria Belgium Denmark Finland
France Germany Ireland Italy
Netherlands Average Linear (Average) 5
HIGHER CONTRIBUTION RATES LED TO
FURTHER INCREASES IN REVENUE
0
20
40
60
1940 1949 1961 1977 1983 1989 1993 1997 2002 2010 2012
Contribution rates in
Northern Europe
Sweden Netherlands Finland
Norway Iceland Ireland
UK Germany Switzerland
0
10
20
30
40
50
60
1940 1949 1961 1977 1983 1989 1993 1997 2002 2010 2012
Contribution rates in
Southern Europe
France Italy Spain
Portugal Slovenia Greece
0
10
20
30
40
50
60
1940 1949 1961 1977 1983 1989 1993 1997 2002 2010 2012
Contribution rates in Central Europe and
Balkans Bulgaria
Poland
Croatia
Estonia
Latvia
Lithuania
Hungary6
POLICY CHOICES WHEN FLUSH WITH
CONTRIBUTION REVENUES
56
58
60
62
64
66
68
70
72
1970 1975 1980 1985 1990 1995 2000 2005 2010
Male Average Effective
Retirement Age
Austria Belgium
Denmark France
Germany Italy
Netherlands Spain
Sweden United Kingdom
54
56
58
60
62
64
66
68
70
72
74
1970 1975 1980 1985 1990 1995 2000 2005 2010
Female Average Effective
Retirement Age
Austria Belgium
Denmark France
Germany Italy
Netherlands Spain
Sweden United Kingdom7
DURATION OF RETIREMENT INCREASED FROM
INCREASING LIFE EXPECTANCY AND FALLING
EFFECTIVE RETIREMENT AGE
0
5
10
15
20
25
30
Belgium Spain Sweden
Ex
pe
cte
d Y
ea
rs i
n R
eti
re
me
nt
1970
1990
2009
63
57
59
64 63
65
Average Effective Retirement Age Shown on Each Bar
71
67
63
Data Sources: OECD, Eurostat
8
AND PENSION SPENDING GREW
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
Pension Spending, % GDP
Austria Belgium Denmark Finland France
Germany Ireland Italy Netherlands Norway
Sweden Switzerland United Kingdom Greece Turkey
Source: OECD, Flora
9
POVERTY RATES FOR PENSIONERS LARGELY FELL
RESULTING IN LOWER POVERTY RATES FOR THE
ELDERLY COMPARED TO THE GENERAL POPULATION
10
-5
-4
-3
-2
-1
0
1
2
3
4
5
Gap in 1987*
Gap in 2004*
NOW EUROPE IS AGING
11
0%
5%
10%
15%
20%
25%
30%
35%
Irela
nd
Icela
nd
Norw
ay
Un
ited
Kin
gd
om
Den
mark
Neth
erl
an
ds
Sw
ed
en
Fin
lan
d
Au
str
ia
Sw
itzerl
an
d
Germ
an
y
Cyp
rus
Fra
nce
Belg
ium
Slo
ven
ia
Gre
ece
Sp
ain
Port
uga
l
Ita
ly
Slo
va
kia
Lit
hu
an
ia
Pola
nd
Esto
nia
Hu
ngary
Czech
Rep
ubli
c
Rom
an
ia
Latv
ia
Cro
ati
a
Bu
lgari
a
Alb
an
ia
Mon
ten
egro
TF
YR
Mace
don
ia
Serb
ia
Bosn
ia &
Herz
egovin
a
Arm
en
ia
Rep
ubli
c of
Mold
ova
Ru
ssi
an
Fed
era
tion
Bela
rus
Uk
rain
e
Georg
ia
Taji
kis
tan
Kyrg
yzsta
n
Tu
rkm
en
ista
n
Uzbek
ista
n
Kaza
kh
sta
n
Azerb
aij
an
Tu
rkey
Northern Europe Southern Europe Central Europe Balkans "Old" countries
of FSU
Young countries
% o
f p
op
ula
tio
n o
ve
r t
he
ag
e o
f 6
5
2010 2050
BUT MORE TROUBLING IS THE PROJECTED
DECLINE IN WORKING AGE POPULATION
-50.0%
0.0%
50.0%
100.0%
150.0%
200.0%
Ger
man
yS
wit
zerl
and
Au
stri
aN
eth
erla
nds
Fin
lan
dD
enm
ark
Sw
eden
Un
ited
Kin
gd
om
No
rway
Irel
and
Icel
and
Po
rtu
gal
Slo
ven
iaIt
aly
Gre
ece
Sp
ain
Bel
giu
mF
ran
ceC
yp
rus
Bulg
aria
Rom
ania
Lat
via
Po
lan
dL
ith
uan
iaC
roat
iaS
lov
akia
Hu
ngar
yE
ston
iaC
zech
Rep
ub
lic
Bosn
ia a
nd
Her
zeg
ovin
aT
FY
R M
aced
on
iaS
erb
iaA
lban
iaM
onte
neg
ro
Geo
rgia
Rep
ub
lic
of
Mo
ldov
aU
kra
ine
Bel
arus
Russ
ian
Fed
erat
ion
Arm
enia
Aze
rbai
jan
Tu
rkey
Kaz
akh
stan
Uzb
ekis
tan
Tu
rkm
enis
tan
Ky
rgy
zsta
nT
ajik
ista
n
Northern EU Southern EU Central EU Balkans
(non-EU)
Old Countries
of FSU
Young
Countries
1970-2010
2010-2050
12
SOCIAL INSURANCE MODEL WHICH PROVIDED
GENEROUS BENEFITS FOR SO LONG CAN NO
LONGER DO SO
Contributors Pensioners
Generous Benefits
Contributors Pensioners
Not So Generous Benefits 13
LEADS TO FISCAL DEFICITS IN PENSION
SYSTEMS FAR GREATER THAN DURING
RECENT FINANCIAL CRISIS
-7%
-6%
-5%
-4%
-3%
-2%
-1%
%
2007 2017 2027 2037 2047 2057 2067
% o
f G
DP
Projected Pension System Deficits in Average CE Country
14
FACED WITH THE DEMOGRAPHIC ONSLAUGHT,
EUROPE HAS UNDERTAKEN LOTS OF PENSION
REFORM
0%
20%
40%
60%
80%
100%
120%
Northern
Europe
Southern
Europe
Central
Europe
Balkans
(non-EU)
"Old"
countries of
FSU
Young
countries
pe
rce
nt
of
co
un
trie
s i
n e
ach
su
b-r
eg
ion
Parametric Pension Reforms 1995-2010
Increase in Contribution Rate
Indexation Reforms
Extension of Averaging Period
Years of Service Reforms
Decrease in Contribution Rate
Increase in Retirement Age
Changes to Benefit rate
15
ADOPTED A SMORGASBORD OF STRUCTURAL
REFORMS
Point System Notional
Accounts
Funded
Defined
Contribution
Universal
Pension
Germany
France (pvt sector)
Romania
Slovak Republic
Estonia
Bosnia, RS
Croatia
Montenegro
Serbia
Sweden
Italy
Latvia
Poland
Azerbaijan
Kyrgyz Rep
Russian Fed
Turkmenistan
Sweden
Denmark
Poland
Hungary
Slovak Rep
Lithuania
Latvia
Estonia
Bulgaria
Romania
Croatia
FYR Macedonia
Kazakhstan
Kosovo
Kyrgyz Rep
Russian Fed
Ireland
UK
Netherlands
Denmark
Czech Republic
Georgia
Kazakhstan
Kosovo
16
IMPACT OF REFORMS - RETIREMENT AGES WENT UP,
BUT SO DID LIFE EXPECTANCY – DURATION OF
RETIREMENT DID NOT CHANGE MUCH
17
-4
-2
0
2
4
6
8
Icela
nd
Au
str
ia
Neth
erl
an
ds
Sw
ed
en
Germ
an
y
Fin
lan
d
Irela
nd
Un
ited
Kin
gd
om
Sw
itzerl
an
d
Den
mark
Norw
ay
Belg
ium
Slo
ven
ia
Sp
ain
Fra
nce
Port
uga
l
Gre
ece
Cyp
rus
Ita
ly
Bu
lgari
a
Rom
an
ia
Lit
hu
an
ia
Pola
nd
Slo
va
kia
Czech
Rep
ubli
c
Latv
ia
Hu
ngary
Esto
nia
Cro
ati
a
Northern Europe Southern Europe Central Europe
Ye
ars
Change in Duration of Retirement from 2001-2009
Source: Eurostat
change in effective retirement age change in life expectancy at effective retirement age
NO EFFECTIVE DECLINE IN GENEROSITY
(2001-2008)
-40.0%
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
Germ
an
y
Au
str
ia
Neth
erl
an
ds
Sw
itzerl
an
d
Fin
lan
d
Un
ited
Kin
gd
om
Den
mark
Norw
ay
Sw
ed
en
Icela
nd
Irela
nd
Slo
ven
ia
Ita
ly
Gre
ece
Sp
ain
Belg
ium
Fra
nce
Cyp
rus
Port
uga
l
Latv
ia
Pola
nd
Lit
hu
an
ia
Slo
va
k R
ep
ubli
c
Czech
Rep
ubli
c
Esto
nia
Rom
an
ia
Hu
ngary
Northern Europe Southern Europe Central Europe
pe
rce
nt
ch
an
ge
be
twe
en
20
01
an
d 2
00
8
Changes in Generosity Levels (01-08): Growth in
Pension Spending as % of GDP relative to growth in
share of elderly population
18
GROWTH IN PENSION SPENDING PER ELDERLY
PERSON RELATIVE TO GROWTH IN GDP PER
CAPITA, 2001-09
19
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
Germ
an
y
Au
stri
a
Neth
erl
an
ds
Sw
itzerl
an
d
Fin
lan
d
Un
ited
Kin
gd
om
Den
ma
rk
Norw
ay
Sw
ed
en
Icela
nd
Irela
nd
Slo
ven
ia
Italy
Sp
ain
Gre
ece
Belg
ium
Fra
nce
Cyp
rus
Port
uga
l
La
tvia
Cro
ati
a
Pola
nd
Bu
lga
ria
Lit
hu
an
ia
Slo
vak
ia
Czech
Rep
ub
lic
Est
on
ia
Rom
an
ia
Hu
nga
ry
Mon
ten
egro
Ma
ced
on
ia
Alb
an
ia
Serb
ia
Bela
rus
Ru
ssia
Arm
en
ia
Mold
ova
Ka
za
kh
sta
n
Tu
rkey
Kyrg
yzst
an
Azerb
aij
an
Ta
jik
ista
n
Northern Europe Southern Europe Central Europe Balkans "Old" FSU "Young"
ARE EASY SOLUTIONS POSSIBLE?
Increase the working age population
Fertility increases
No evidence that policy measures work
Even if they did, the impact of increased fertility would
come too late
Immigration
Governments need to consider revamping immigration
policies
Both of these extend the pyramid
Eventually the additional children will get old and
need benefits as will the immigrants
Only long-term solution if fertility continues to grow
and immigrants continuously flow in 20
INCREASE LABOR FORCE PARTICIPATION – NOT
MUCH ROOM IN PRIME WORKING AGES
21
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Irela
nd
Un
ited
Kin
gd
om
Neth
erl
an
ds
Germ
an
y
Norw
ay
Au
str
ia
Icela
nd
Fin
lan
d
Den
mark
Sw
itzerl
an
d
Sw
ed
en
Ita
ly
Sp
ain
Gre
ece
Cyp
rus
Belg
ium
Port
uga
l
Fra
nce
Slo
ven
ia
Rom
an
ia
Cro
ati
a
Hu
ngary
Pola
nd
Lit
hu
an
ia
Bu
lgari
a
Latv
ia
Esto
nia
Slo
va
kia
Czech
Rep
ubli
c
Mace
don
ia, T
FY
R
Serb
ia
Georg
ia
Uk
rain
e
Mold
ova,
Rep
ubli
c of
Ru
ssi
an
Fed
era
tion
Tu
rkey
Kyrg
yzsta
n
Kaza
kh
sta
n
Northern Europe Southern Europe Central Europe BK OC YC
Labor Fore Participation Rates for the 40-44 age
cohort
total male female
INCREASE COVERAGE THROUGH
FORMALIZATION OF THE LABOR FORCE
Countries commonly blame informality of labor markets
Brought the problem forward, but not the root cause
Increased formality helps in short run, but makes long run deficit worse
Shown in results from CGE model
If the system is unaffordably generous, adding more workers adds revenue today, but makes the long term deficits worse
Only improves long run if the government cheats workers, giving them low rates of return on contribution
Hard to induce workers out of informality if the government is cheating workers 22
INCREASE PRODUCTIVITY
Limited impact if labor becomes more productive
and results in higher wages
Higher wages result in higher contributions
Benefits after retirement typically not indexed fully
to wage growth, providing some gains
Might be possible to tax growth from technical
change that is not reflected in wage growth
23
ROOM FOR USING OTHER FISCAL
RESOURCES IS LIMITED
Consumption taxes are the main source of tax revenue in most countries On average VAT accounts for about 45
percent of government revenue
Standard VAT rates between 18 and 27 percent
Some room for base broadening and improved administration
Corporate and Personal income taxes vary in importance On average income taxes account for 20
percent of government revenue
Substantial variation in rates, base and yield
Payroll Contributions also vary On average social contributions account for
25 percent of government revenue
Other taxes Estate Taxes
Property Taxes
Other fiscal costs will also rise with aging
Need to leave room for saving
0 10 20 30 40
AzerbaijanArmenia
TajikistanKosovo
Kyrgiz RepublicKazahkstan
AlbaniaRussiaTurkey
GeorgiaMacedoniaLithuaniaRomania
EstoniaLatvia
SlovakiaBulgariaMoldova
PolandCroatia
UkraineCzech Republic
MontenegroBosnia & Herzegovina
SerbiaSloveniaBelarus
Hungary
Percent of GDP
Income Taxes
Taxes on
Goods and
ServicesOther Taxes
Social
Security
Contributions
24
LEFT WITH HARDER SOLUTIONS
People will need to work longer
Benefits might need to be reduced
People will need to save more
People need to understand these choices
25
POTENTIAL FOR “ACTIVE AGING” IS HUGE IN
ECA REGION
0%
5%
10%
15%
20%
25%
30%
35%
Geo
rgia
Kaza
kh
sta
nS
wed
enK
yrg
yzs
tan
Irel
an
dE
ston
iaU
nit
ed K
ingd
om
Latv
iaA
zerb
aij
an
Ger
man
yL
ith
uan
iaF
inla
nd
Den
mark
Mold
ova
Po
rtu
ga
lN
eth
erla
nd
sS
pain
Bu
lga
ria
Ru
ssia
n F
eder
ati
on
Cze
ch R
epu
bli
cA
ust
ria
Slo
vak
iaU
kra
ine
Lu
xem
bou
rgR
om
an
iaG
reec
eF
ran
ceIt
aly
Ser
bia
Cro
ati
aB
elgiu
mS
loven
iaH
un
gary
Tu
rkey
Po
lan
d
Potential to increase Labor Force among 45-64
year olds
45-49 50-54 55-59 60-64Data Source: ILO 26
RETIREMENT AGES WOULD HAVE TO RISE
SIGNIFICANTLY EVEN TO MAINTAIN 1970
DURATION OF RETIREMENT
27 0
5
10
15
20
25
30
Belgium Spain Sweden
Ex
pe
cte
d Y
ea
rs i
n R
eti
re
me
nt
1970
1990
2009
2009 adj
72 71
67
64
74
71
65
63 63 63
57
59
Average Effective Retirement Age Shown on Each Bar
WORKING LONGER
Policies to encourage active aging Opportunities for effective skills upgrading throughout
working-life
Adapting workplace to enable productive employment of older workers
Removing barriers and disincentives to work while receiving a pension or to work part-time
Facilitating labor mobility
May be trade-offs between actively recruiting immigrants and having current workers work longer
Will need to recognize and provide for those who are unable to work longer
Tying retirement ages to life expectancy may not be enough Only corrects for longevity increases, not working age
population declining 28
MAY NEED TO CONSIDER REDUCING
BENEFITS
Will countries be able to afford much more than
prevention of old age poverty?
If not, should we even bother with income
differentiated pensions?
Should we continue to distinguish between
contributory and noncontributory pensions?
Need for less drastic changes if we can start now
But there will be limits to benefit reduction given
the need to maintain adequate benefits
At the minimum, bring the elderly up to the poverty
line
29
SAVINGS BECOME CRITICAL FOR
MAINTAINING BENEFIT ADEQUACY
Voluntary savings programs have not been successful
Building up public reserves dedicated to aging not even successful during boom years
Mandatory savings (second pillars) experienced problems related to industrial organization of the pension fund industry
Could not withstand fiscal pressures in the PAYG system
Opt-out models for voluntary savings may be more successful
Additional contributions by employees for savings may result in more robust systems 30
POLICIES TO ENCOURAGE SAVINGS
Centralizing business areas with scale economies
Creating competition in the portfolio management
industry
Designing portfolio benchmarks for pension funds in
the form of lifecycle strategies
Designing payout structures that insure proper risk
allocation of investments, inflation, and longevity
risks
Considering the introduction of guarantees on the
value of the contributions, if necessary, to make
viable some rational risk taking by pension fund
managers
Designing sustainable models for the payout phase 31
POLITICAL ECONOMY
People still believe that benefits can become more generous
“Stealth” reforms – introducing automatic changes without explaining
them to people don’t work
As soon as they start to have impact, people clamor for reversals
Social contract has to be renegotiated
May not be fair to preserve pensions for baby boomers while
punishing later generations
32