pensions core course 2013: the inverted pyramid - pension systems in europe and central asia

32
THE INVERTED PYRAMID: PENSION SYSTEMS IN EUROPE AND CENTRAL ASIA FACING DEMOGRAPHIC CHALLENGES Team led by Anita Schwarz and Omar Arias December 2012 1

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Page 1: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

THE INVERTED PYRAMID: PENSION

SYSTEMS IN EUROPE AND CENTRAL ASIA FACING

DEMOGRAPHIC CHALLENGES

Team led by Anita Schwarz and Omar Arias

December 2012

1

Page 2: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 3: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 4: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 5: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 6: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 7: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 8: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 9: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 10: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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*

Page 11: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 12: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 13: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 14: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 15: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 16: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 17: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 18: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 19: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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"

Page 20: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 21: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 22: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 23: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 24: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 25: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 26: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 27: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 28: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 29: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 30: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 31: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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

Page 32: Pensions Core Course 2013: The Inverted Pyramid - Pension Systems in Europe and Central Asia

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