Robert HolzmannWorld Bank

Pension Systems and Financial Crisis: An Overview

Regional (ECA) WorkshopPension Systems in Times of Financial Crisis

Brussels, May 7, 2009

OutlineOutlineI.I. Nature of Crisis and Implications Nature of Crisis and Implications

for Pension Systemsfor Pension SystemsII.II. Pre-crisis Situation of Reformed Pre-crisis Situation of Reformed

Pension SystemsPension SystemsIII.III. Policy Actions with the Onset of Policy Actions with the Onset of

the Crisis: Legislated and the Crisis: Legislated and proposedproposed

IV.IV. Assessment of Crisis Shock and Assessment of Crisis Shock and Policy Actions on Fiscal, Policy Actions on Fiscal, Financial and Social OutcomesFinancial and Social Outcomes

V.V. Directions for Policy ActionsDirections for Policy Actions

I. Nature of Crisis and I. Nature of Crisis and Implications for Pension SystemsImplications for Pension Systems

Financial turned economic crisisFinancial turned economic crisis• pressure on pension systems world-widepressure on pension systems world-wide• low or negative GDP growth linked with low or negative GDP growth linked with

falling employment, wages, and asset falling employment, wages, and asset pricesprices

Both unfunded and funded systems Both unfunded and funded systems are adversely affected but timing and are adversely affected but timing and magnitude of impacts quite different magnitude of impacts quite different

Crisis impact on pension schemesCrisis impact on pension schemes

PAYG (first pillar)PAYG (first pillar)• Fiscal pressure primarily via lower revenue Fiscal pressure primarily via lower revenue

due to lower wages and employmentdue to lower wages and employment• Expenditure same or increase via more Expenditure same or increase via more

beneficiaries (early retirement; disability)beneficiaries (early retirement; disability)• If benefit levels unaffected, bound to lead to If benefit levels unaffected, bound to lead to

deterioration of fiscal balance of schemedeterioration of fiscal balance of scheme• Happens at a time of lower general gov. Happens at a time of lower general gov.

revenues and increased demand elsewhere revenues and increased demand elsewhere (unemployment benefits; social assistance)(unemployment benefits; social assistance)

• Transition deficit (2Transition deficit (2ndnd pillar) accentuated pillar) accentuated

Crisis impact on pension schemesCrisis impact on pension schemes

PAYG (first pillar)PAYG (first pillar)• Recent discretionary benefit increases to Recent discretionary benefit increases to

catch-up with strong wage-increasecatch-up with strong wage-increase• Recent benefit reforms to compensate Recent benefit reforms to compensate

transition generationstransition generations Funded (second pillar)Funded (second pillar)

• Direct impact on asset and benefit level, Direct impact on asset and benefit level, but limited in effect as few retiring but limited in effect as few retiring

• Fiscal impact if budget provides Fiscal impact if budget provides compensation for affected individualscompensation for affected individuals

II. Pre-crisis Situation of II. Pre-crisis Situation of Reformed Pension SystemsReformed Pension Systems

Most ECA countries have undertaken Most ECA countries have undertaken some pension reform with transitionsome pension reform with transition• 13 countries introduced 213 countries introduced 2ndnd pillar; some pillar; some

legislated but have not yet introducedlegislated but have not yet introduced• Most others did parametric reforms to Most others did parametric reforms to

address fiscal, incentive and social issuesaddress fiscal, incentive and social issues• All introduced some form of voluntary All introduced some form of voluntary

savings schemes, with diff. in regulationsavings schemes, with diff. in regulation• Many countries introduced/strengthened Many countries introduced/strengthened

social assistance and/or social pensions social assistance and/or social pensions

Pre-crisis situationPre-crisis situation Despite reform efforts, only a few Despite reform efforts, only a few

countries have been successful in countries have been successful in achieving both long-term financial achieving both long-term financial sustainability and long-term benefit sustainability and long-term benefit adequacy in the pre-crisis stateadequacy in the pre-crisis state

Situation aggravated by advanced and Situation aggravated by advanced and projected further demographic agingprojected further demographic aging

Stark trade-off between financial Stark trade-off between financial sustainability and benefit adequacy is sustainability and benefit adequacy is result of low effective retirement ageresult of low effective retirement age

Post-Reform Pension System Fiscal Balances as a Percent of GDP BULGARIA CROATIA CZECH REPUBLIC

-10

-5

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Deficit

Revenue

Expenditure

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09

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14

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19

20

24

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29

20

34

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39

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44

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49P

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Deficit

Revenue

Expenditure

HUNGARY POLAND ROMANIA

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SERBIA SLOVAKIA SLOVENIA

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Deficit

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Expenditure

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Deficit

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Expenditure

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Pre-crisis situationPre-crisis situation

Projected benefits of reformed systems Projected benefits of reformed systems remain often generous (as measured by remain often generous (as measured by gross and net replacement rate) gross and net replacement rate)

Projected replacement rates in multi-Projected replacement rates in multi-pillar schemes based on conservative pillar schemes based on conservative assumption of net interest rate-wage assumption of net interest rate-wage growth differential of 1.5%growth differential of 1.5%

Performance of pension funds since Performance of pension funds since inception has in many cases not yet inception has in many cases not yet lived-up to expectationslived-up to expectations

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Earnings as Multiple of Average Wage

Rep

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Bulgaria

Romania

Poland

Slovak Republic

Hungary

Slovenia

Croatia

Czech Republic

Low Benchmark

High Benchmark

Middle Benchmark

Chart 1: Gross Replacement Rates for Male Full Career Workers

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0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0

Earnings as Multiple of Average Wage

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Hungary

Romania

Bulgaria

Poland

Slovak Republic

Slovenia

Croatia

Czech Republic

ECA Ave

World Ave

Ave Poverty Line

Low, Middle and High Benchmarks

Chart 2: Net Replacement Rates for Male Full Career Workers

Table 1: Rate of Return of Pension Funds since Inception till end 2007 (in real terms and as differential over GDP growth) Year of Inception Real Rate of

Return RoR over GDP growth

Bulgaria 2002 3.2 0.5 Estonia 2002 4.9 0.6 Hungary 1998 2.6 0.6 Latvia 2001 -3.5 -0.3 Lithuania 2004 5.7 0.7 Poland 1999 8.9 2.2 Slovakia 2005 0.9 0.1 Sources: World Bank staff using data from national sources

II. Policy Actions with the Onset of the II. Policy Actions with the Onset of the Crisis: Legislated and proposedCrisis: Legislated and proposed

As fiscal impact of crisis was felt quickly, As fiscal impact of crisis was felt quickly, many countries initiated or proposed deficit-many countries initiated or proposed deficit-reducing measuresreducing measures

Revenue increasing measuresRevenue increasing measures• (Re-) increase in contribution rate(Re-) increase in contribution rate• Diversion of 2Diversion of 2ndnd pillar contributions pillar contributions• Delaying movement to second pillarDelaying movement to second pillar

Expenditure reducing measuresExpenditure reducing measures• Changes in indexationChanges in indexation• Increase in retirement ageIncrease in retirement age• Elimination of early retirement optionElimination of early retirement option

Table 2: Policy Actions In ECA Countries – Legislated and Considered

Policy Action Legislated Considered Increase in Overall Contribution Rate

-Romania: From 27.5% in 2008 to 31.3%. - Russia: From 20% to 26%, and moving contributions from basic pension to NDC pension.

Adjustment to Second Pillar Contribution Rate

-Romania: Contribution rates to the second pillar frozen at 2% (instead of legislated increase to 2.5%) -Lithuania: Second pillar contribution rates reduced from 5.5% to 3% 2009 and 2010, to go back to 5.5% in 2011.

-Latvia: Diverting part of contributions from second to first pillar. -Estonia: Diverting 4% of 2nd pillar contributions to 1st pillar

Allowing Opting in/out of Second Pillar

- Slovak Republic: First option (Jan –June 2008) and second option (Jan – June 2009) to switch in/out of the second pillar.

-Croatia: Allowing second pillar participants (age between 40-50 ) to switch back to the first pillar, with the individual saving accounts transferred to treasury in exchange for the full first-pillar guaranteed pension benefit. ,

Making Second Pillar Voluntary to New Entrants

-Slovak Republic: Second pillar participation for new participants voluntary as of January 2008.

Changing Indexation/ Minimum &Basic Pension

-Serbia : Suspension of indexation for 2009 per GoS agreement with the IMF

-Latvia: Elimination of wage indexing of contributory pensions. -Hungary: Switch to Swiss or pure inflation indexation depending on the GDP growth.

Increase in Retirement Age

-Ukraine: Increase in retirement age to 62 for both men and women -Hungary: Increase in retirement age from 62 to 65 by 2016.

Measures to Address Early Retirement

-Poland: Elimination of numerous early retirement schemes (previously available to some 1 million people) . -Hungary: Increase in penalties for early retirement and introduction of bonuses for delayed retirement.

-Ukraine: Gradual elimination of special and early pension regimes

Source: World Bank staff based on country information.

IV. Assessment of Crisis Shock IV. Assessment of Crisis Shock and Policy Actions: Previewand Policy Actions: Preview

Fiscal outcomes:Fiscal outcomes:• Depends very much on assumptions on depth and length of Depends very much on assumptions on depth and length of

crisis/transitional reduction in wages and employmentcrisis/transitional reduction in wages and employment• While fall in wages and employment will eventually translate While fall in wages and employment will eventually translate

into lower future benefits and expenditure, transitional fiscal into lower future benefits and expenditure, transitional fiscal gap can be large and are policy dependentgap can be large and are policy dependent

Financial sector outcomes:Financial sector outcomes:• Crisis as well as policy reaction to the crisis have an effect on Crisis as well as policy reaction to the crisis have an effect on

the size and structure of the financial sector and its ability to the size and structure of the financial sector and its ability to deliver expected rates of return for funded benefitsdeliver expected rates of return for funded benefits

Social OutcomesSocial Outcomes• Assessment of both replacement rate as well as benefit level Assessment of both replacement rate as well as benefit level

(compared to other groups) is important(compared to other groups) is important• Short-term impact is largely determined by selected price Short-term impact is largely determined by selected price

indexation (1indexation (1stst pillar) and changes in asset values (2 pillar) and changes in asset values (2ndnd pillar) pillar)• Medium and long-term impact is more difficult to assess as Medium and long-term impact is more difficult to assess as

depending on real developments (wage and employment depending on real developments (wage and employment growth path) as well as structure of pension benefit systemgrowth path) as well as structure of pension benefit system

V. Directions for Policy ActionsV. Directions for Policy Actions Actions will need to be country specific and Actions will need to be country specific and

useful to consider in a short and long term useful to consider in a short and long term framework, and by ranking the policy optionsframework, and by ranking the policy options

General recommendations for the short run:General recommendations for the short run:• Avoid hasty actions that promise quick fixes for Avoid hasty actions that promise quick fixes for

the fiscal pressure but risk doing harm in the long the fiscal pressure but risk doing harm in the long term to fiscal sustainability and/or benefit term to fiscal sustainability and/or benefit adequacyadequacy

• Avoid irreversible decisions that are based on Avoid irreversible decisions that are based on incomplete information about the state of the incomplete information about the state of the worldworld

General recommendation for the long-run:General recommendation for the long-run:• Use the crisis as an opportunity to initiate or Use the crisis as an opportunity to initiate or

complete reform to exit stronger from itcomplete reform to exit stronger from it