Pension Systems in Times of Financial Crises: Serbia

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Pension Systems in Times of Financial Crises
Serbia

• Ministry of Finance
• Republic of Serbia

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Pension System before Reforms

• Based on the PAYG scheme only (where current
  workers pay out current pensioners)
• Very generous and fiscally unsustainable
• valorization and indexation rules
• only 10 best years relevant for calculating
  pension at retirement,
• pensions fully indexed to wages
• Very early retirement age (50 years for women and
  55 for men)
• Generous disability retirement rules,
  corruption-ridden
• Since 1991, the pension fund has generated debt
  uncertain timing of pension payments, in arrears
  for 2 months on average

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Pension Reforms in Serbia Started in the Early
2000s

• Significant parametric and systemic reforms to
  the public PAYG system (Pillar 1)
• Introduction of tax-preferred FF voluntary
  private pension funds (Pillar 3)
• Serbia did not introduce FF mandatory private
  pension funds (Pillar 2) Is this a good decision?

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Reasoning against Introduction of Pillar 2
Prevailed in Serbia

• High transition cost for 7 contributions,
  transition cost would last for 40 years and
  average 1.2 of GDP per year!
• Undeveloped capital markets
• High administrative and operational costs
• Risky strategy as we can all appreciate during
  days of Global Financial Crisis

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Basic PAYG Statistics

• 2.6 million contributors (1.9 employees, 0.2
  self-employed, 0.5 farmers)
• 1.6 million pensioners (1.4 employee and
  self-employed, 0.2 farmers)
• Challenging economic indicators high
  unemployment (15), a low employment rate (50),
  significant shadow economy, weak compliance from
  farmer contributors
• Deteriorating (rising) old-age dependency ratio
  from 25 in 2005 to 34 in 2035

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PAYG Parametric Reforms

• Retirement age increased by 5 years
• 65 for men and 60 for women (by end of 2010)
• Disability retirement rules tightened
• Number of disability pensioners decreased by 15,
  another 15 drop expected in coming years
• Pension Indexation Changes
• From full indexation to wages, to the Swiss
  formula (50 wages 50 inflation), finally to
  full indexation to inflation

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PAYG Systemic Reform

• Based on a change of the pension formula in order
  to enforce the link between contributions and
  benefits
• All years of service relevant for calculating
  pension at the retirement age

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PAYG Reform Savings

• Increased retirement age tightened disability
  eligibility gt improved the PAYG dependency
  ratio in the medium-to-long run
• Indexation formula less reliant on wage growth gt
  fiscal savings in the short-to-medium term
• Systemic and parametric reforms started producing
  savings gt pension spending totaled 12.1 of GDP
  in 2006 and 11.8 of GDP in 2007

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Two Steps Back Reasons behind Increased Public
Pension Spending Share in GDP

• Major reason a politically motivated ad-hoc
  pension increase in 2008
• Moving from the Swiss formula to inflation
  indexation was socially unpopular, resulting in
  the formation of the Pensioner Party which was
  the key factor in forming the Government
• Carry-over effects of the ad-hoc pension increase
  in 2008 will be felt for 2 to 3 years
• Minor reason a decline in productivity due to
  the economic crisis (we increased pensions at a
  very unfortune moment)

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Basic Pensioners Standard of Living Statistics

• Lots of jokes, but in Serbia ...
• Average pension / average wage ratio was 71 in
  March 2009
• Just like distribution of employees according to
  wages, distribution of pensioners according to
  pension benefits, is left skewed 60 of
  pensioners are receiving pension benefits below
  the average
• The poverty rate of pensioners, according to the
  Living Standards Survey, is lower compared to the
  population as a whole (5.3 against 6.6)
• The net old-age pension/net wage ratio is 80!
  Only 55 are old-age pensioners, 25 disability,
  20 survivor and only 17 of pensioners have
  full-career service!
• The net full career pension/net wage ratio is
  90!
• Although the pension contibution rate is 22 (11
  on behalf of employees and 11 on behalf of
  employers), budget subsidies account for 40 of
  pension spending!

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Serbias Response to Financial Crisis

• Nominal freeze of public pensions for 2 years
  (2009 2010), inflation indexation afterwards
• Increased pension spending decline in
  contribution revenue growth gt pressure on public
  finances requiring additional budget subsidies

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Voluntary Private Pension Funds and Financial
Crisis

• 9 pensions funds in operation, 6 of employees
  contribute, accumulated funds only 0.15 of GDP
• In 2008, the Belgrade Stock Exchange tumbled by
  75, but pension funds lost only 7
• Restrictive investment regulations and
  undeveloped capital markets resulted in
  conservative portfolios
• 50 money deposits, 30 government bonds, only
  15 equity

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Financial Crisis Impact on Pension System in
Serbia

• Not very significant, due to the dominance of
  PAYG financing
• The major adverse effect is a relative decline in
  contributions due to economic recession
• Voluntary pension funds operating for only 2
  years with conservative portfolios and
  insignificant accumulations

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Planned Future Changes to Pension System in Serbia

• Further PAYG parametric reforms
• Further increases in the retirement age
• Tightening accelerated service and early
  retirement provisions
• Introducing the automatic stabilizers (automatic
  change in the contribution rate and/or in the
  retirement age as a reaction to the replacement
  rate the financial position of the pension
  fund)
• Developing an appropriate valorization and
  indexation formula that will be fiscally
  sustainable and socially acceptable (in a way, to
  keep pace with collected contributions)
• Expansion of FF voluntary retirement saving
• Possibly extending a tax-preferred treatment to a
  broader range of (less risky) saving vehicles,
  such as long-term bank savings and life insurance
  contracts