Pension Reform Sectoral Analysis

Maxim BorodaPACT, 8 June 2011

Need for reform

Pension reform is one of the most urgently needed in Ukraine, because the country’s social policy is extremely ineffective:

in terms of the GDP share of public spending for social benefits, Ukraine is among the most socially-oriented of European countries: Finland, Sweden and France

in terms of the level of effectiveness of this spending, it is low beyond compare

in 2010, the Pension Fund deficit was UAH 34.4 billion or about 3.4% of GDP, whereas for most European countries it remains below 2.5% of GDP

Goal of reform

To switch from the current PAYGO system to a three-pillar pension system:

First pillar — PAYGO mandatory state system: contributions go into the Pension Fund to be immediately paid out

Second pillar — accumulative mandatory state system: a portion of mandatory contributions is channeled into the personal accounts

Third pillar — accumulative voluntary private system for individuals and legal entities/employers

ProblemsThe existing pension system is incompatible with current political, economic, social and demographic realities:

a PAYGO system could function in a command economy, but it is ineffective in a market economy with a shrinking population

Ukraine’s pensioners have the option to keep working, including in the public sector, while getting a full salary and full pension

the retirement age remains unchanged in Ukraine since 1928, when the life expectancy was 43 for men and 47 for women

the five-year difference between men’s and women’s pensionable ages was instituted in Germany at the end of the 19th century

the system for calculating pensions is extremely complicated and opaque: there is no direct relationship between the size of contributions and the size of pension

Cost of non-doingShort-term risks:

the bankruptcy of the Pension Fund: the Pension Fund deficit was already running at 14% in 2010 and continues to rise – de facto, Pension Fund has been bankrupt a long time already, because of a permanent deficit covered by the State Budgetdelays in pension payments: A cash shortfall in the Pension Fund and State Budget could lead to delays in paying benefitsthe loss of the next IMF tranche: would jeopardize the State Budget, the country’s financial and monetary stability, and Ukraine’s credit rating

Long-term cost – the total collapse of the pension system: by 2025, nearly a quarter of Ukraine’s population will be over 60, while by 2050, nearly a third will.

Policy decisions: regulatory

raising the minimum term of contributing to insurance for a basic old age pension from the current 5 to 15 years

providing incentives for people to retire at a later date by increasing the coefficient for calculating each year of extra service or every year that the person postpones retirement

reducing the add-on benefits for early retirement and for contributions

matching the retirement age for women and men

bringing the retirement age gradually to the European level – 65 years

Policy decisions: institutional

delegating the function of collecting and administrating the revenues of the second pillar of the pension system to the Pension Fund

providing the option for channeling contributions to the second pillar of the pension system into non-state pension funds

diversifying the types of private, non-state pension insurance plans

Policy decisions: financial

taking away inappropriate expenditures, such as funding early and privileged pensions, from the PAYGO system

limiting the maximum pension size provided by the PAYGO system

gradually shifting the share of the contribution for pension insurance from employers to their employees

instituting a single social contribution

Policy decisions: analysis

The main dilemma is that some of the PAYGO contributions will have to be channeled to the state accumulative pillar, which will lead to additional expenditures in the State Budget, given the current Pension Fund deficit

Making it impossible for individuals to both get a pension and be paid for work, starting with public sector employees, together with the institution of a progressive coefficient for calculating surplus service years will set up the conditions necessary to get people themselves interested in simply working longer

Analysis of stakeholder positions

Government: interested in successful pension reforms which will stabilize the Pension Fund and reduce public spending, however the risk that voters will be hostile could destroy political will to carry it out

Business: interested in reducing the payroll burden of contributions to the Pension Fund and increasing supply of labor force by raising the pensionable age and the length of service

Working-age population: will feel the negative impact of pension reforms, as it limits state social guarantees – 86% of the population is not in favor of raising the pensionable age

Pensioners: target group and beneficiaries for pension reforms, but share the hostile attitude of the general population towards raising the pensionable age and service years

Obstacles to policy

The positions of working age voters is a major obstacle to carrying out pension reforms, determined by two major factors:

low level of awareness about pension reform: only 4% of Ukrainians are aware of the intention to institute the accumulative pillar of the pension system

low level of trust in the pension system: 70% of Ukrainians do not believe that they will have enough income to survive on, once they retire

Reform timetable

Pension reform was first launched in 2004, with the adoption of the Laws “On mandatory state pension insurance” and “On non-state pension provision”

The introduction of the mandatory accumulative system, was planned for 2007, but was then postponed until 2009, and never took place in the end

Of the measures in the first stage of reform (to end of 2010) only a fixed pension contribution for entrepreneurs was instituted

Of the measures in the second stage of reform (to end of 2012) only a single social contribution was instituted

European framework Pension provision is not part of the harmonized areas of EU legislation, however, the EC published a Green Paper “Towards adequate, sustainable and secure European pension systems” in July 2010, which launched the process of public consultations regarding the establishment of a common approach to pension-related policy

Ukraine has made a commitment to gradually harmonize its legislation with EU acquis communautaire, thus reforming the pension system has to match the common approach used by the EU

Pension systems of most EU countries have in common the combination of PAYGO and accumulative components

The model of pension provision that is supposed to be instituted in Ukraine is similar to the one that is in Poland now, which means it will also correspond to EU practice

Civil society impact

CSO Interest group Position on reform Influence throughInstitutional

influence

Associations of pensioners

pensioners (14 million)

Con activism public hearings

Union confederations

Hired labor (most of the working age

population) Con lobbying, activism social dialog

Employer associations

Business Pro lobbying social dialog

Think-tanks and the expert community

Pro-European part of Ukrainian

societyPro

consultations,advocacy

community councils, working

groupsInternational

organizations and projects

Ukraine’s international

partnersPro

consultations,advocacy

Working groups under Economic

Reform Committee

RecommendationsObstacles Recommendations

The available assessments of the cost of pension reform and the cost of not doing it are not accepted at face value by Ukrainians because they have been provided by stakeholders

Ensure the preparation of unbiased, objective assessments of the cost of pension reform and the cost of not doing it

Pensioners are currently not represented by capable CSOs and are excluded from public debate on pension reform

Build the capacity of CSOs that represent the interests of pensioners to publicly formulate and properly defend their positions regarding state policy, especially in on pension issues

The absence of official public documents on state pension policy makes it hard to understand it and limits the possibilities for meaningful debate on them

Initiate cooperation between the Government and CSOs to prepare public documents on state pension policy: Green Papers raising problems and White Papers offering solutions

Public debate of pension reform is taking place without any structure or regularity, which makes it difficult for the Government to identify interest groups, to analyze their positions, and to take them into account

Organize the process of debate in such a manner that will allow the Government to identify all interest groups and to engage them

Public awareness of pension reform in Ukraine is very low, which makes it possible to use inaccurate and distorted facts

Ensure that information and advocacy campaigns are run with the aim of disseminating information on the need for pension reform and the cost of not doing it to all groups of the population