Behind the scenes of pension reform


This week the Parliament is planning to consider pension reform which has to change fundamentally the approach to social savings.

The mechanism of the accumulation system is not new. It exists all over the world for decades already. Quite often we are saying that in Europe and in the US people has a decent pension which allows them traveling, buying a new house or moving to another state, hence, living a full life, not worse than during their employment. All that became possible only thanks to the pension accumulation system which functions there for several decades already. 

Unlike them, we still have a solidary system, when people of working age provide for now-pensioners vs. save for their future pension. The Pension Fund accumulates deductions, moreover, does not redistribute the money immediately but often gets into debts because the deductions from salaries are not enough to fulfill all pension obligations.

Of course, we cannot say that the accumulation system is a panacea. It may also be influenced by the economic crisis or a sudden inflation. In any case, it is a financial instrument, which depends on the overall financial and economic level of the country as well as stock market development. However, it is the only instrument which is capable if not to ensure an increase of pension expenditures and high pensions, but at least to save deposits made by workers at their adequate value, which cannot be ensured by the solidary system.

The examples of the countries, like Sweden, which have conventionally funded system are appealed to quite often in the discussions around the pension reform. This system can be also defined as solidary system – the same one which exists in our country – when the people which are working now provide for the pensioners. However, their payments are tied to personified accounts and inflation index, which provide the balance. It is important to understand that such level of social protection obliges to make huge payments to the pension and insurance funds. Currently we cannot afford such fiscal pressure. As we know, Sweden is one of the countries in the world which has the highest fiscal pressure – 55%. Nevertheless, the state has one of the highest levels of welfare and its people feel truly protected. As in Sweden, in Ukraine, people pay taxes, however, get one of the lowest level of protection in the world. That is why we urgently need the reform.

Current pension reform provides transition to the accumulation system. Moreover, the Ukrainian model suggests the index of replacement equal to 0.45-0.5, which is considered enough. According to this index, if a working person was getting a salary of 10,000 UAH and was paying income taxes, he/she will get a pension equal to 5,000 UAH, hence, twice as less. Currently, our solidary pension system applies the index of 0.2; that is why it is difficult to call it socially just.   

It is calculated that the solidary system can provide high replacement ratio only if the pressure on the Wage Fund is equal to at least 35%. However, because of such high bar of deductions Ukrainian salaries went into shadow sector. Instead, accumulation system will allow having the pressure on the Wage Fund at the level of 12-14% thanks to the investment profit – as this money is saved, invested in economy, in shares, in bank. This is three times less than a current percentage of deductions and pressure on the Wage Fund, per each person. It is clear that in most countries of the world the biggest share of pension burden is bared by the employers. This makes pressure on business and restrains its development. Therefore, in the present situation, it is the accumulation system which is capable of getting the country out of crisis and ensuring that future generations will have pensions and appropriate level of protection.

We can frequently hear the question: when current pensioners will start getting European pensions? Unfortunately, it will be possible only due to indexing, which, in turn, depends on the economic growth of the country. It is irresponsible to promise that our pensioners will get European pensions in the current conditions, because it will never happen. In our reality, the first payments by the accumulation system will start after 2020. However, only people who are at the moment around 35 years old will be able to get completely accumulation pensions as in the European countries.

According to the bill #2767, pensions of the second level will start being paid to a small number of people only 5 years after the reform. This system will be obligatory only for the people older than 35 (who will get pensions at least in 25 years) and for people aged 36-55 it is voluntary. Besides, the pension amount in the solidary level will constantly increase thanks to indexation, this will prevent socio-economic inequality. In this context, it is very important to remember about social justice, which can be achieved thanks to entire introduction of earnings- or deductions-related pensions.   

Risks of system reload

The transition to accumulation system (payment of the 2nd level) provides a simple redistribution of payments: it was 32% prior to solidary (payment of the 1st level), and will be 30% prior to solidary one + 2% prior to accumulation one. A general scheme of distributing insurance contributions upon the introduction of the 2nd level will be the following:

Redistribution of payments to the Pension Fund

 

Payments to the 2nd level (paid by the employee)

Payments to 1st level (paid by the employer)

2017

2%

36,5%

2018

3%

35,5%

2019

4%

34,5%

2020

5%

33,5%

2021

6%

32,5%

2022 and later

7%

31,5%

 
It is obvious and inevitable that during the first years after reforming our pension system will require additional funds to cover a “cash gap”, which could be compensated from different sources. First, those are internal capacities of existing pension system: release of solidary system from unusual for it expenses (currently for over 7 million pensioners the pension will be “pulled” to the minimal level, which in fact should be a component of social protection and has to be financed from the state budget and not from the Single Contribution). According to the Pension Fund’s estimations, today this amount is over 37 billion UAH. Of course, in case of “throwing” this money to the state budget a general need to finance the pension system does not disappear. If we acknowledge that “pulling” pensions to the minimal level is a part of welfare services, then only poor (as defined by the current legislation) will be able to claim such overpay.

Second, the sources of covering state expenses on launching the 2nd accumulation level may be privatization, increase of the retirement age, external loans, introduction of the temporary tax (for example excise) etc.

Pros and cons of the Ukrainian system

One of the disadvantages of the reform offered by the Ministry of Social Policy is the idea of creating a separate organization – the State Accumulation Pension Fund. There is no such casus in the European countries. The monopolists in the sphere of pensions exist only in several countries of the world – Kazakhstan, Russia, Singapore and Bolivia. The principle when “the state is the owner of pensions” will lead to serious expenditures from the state budget for administering the accumulation system, to lack of alternatives for the fund clients to carry on its own investment policy (obviously, most of the savings will be invested into the state securities), creation of another unequal conditions for the participants of accumulation level. The most important is that there is a hidden risk of nationalization. How can we rule out such situation when the state accumulates money and then uses it to solve other problems during the crisis?

Polish Institution of Social Security (Zakład Ubezpieczeń Społecznych) can serve as a good example for Ukraine. Among other functions which it performs, it collects contributions to the accumulation system and personifies them. These functions can be actually perfectly performed by the Pension Fund of Ukraine, which keeps personified records of all ensured persons in the system of compulsory state insurance since 2000.

Another problem is that in order to optimize pension system, it is necessary to make an inventory of all pension cases. In other words, to check every pensioner: whether this person exists, how much money he/she paid to the Pension Fund, if the payments were charged etc. There is no Single Register of the pensioners in Ukraine, even in the Pension Fund. All pensions are registered on papers. For instance, in Georgia, according to their key reformer Kakh Bendukidze, when the new government conducted an inventory, it was found that 30% of violations were the cases of “dead souls” or wrongly transferred money. Now, the Pension Fund is auditing all cases and expects that it will be able to save 10% of the budget.

Overall, the Verkhovna Rada has to clearly understand that it is impossible to postpone pension reform. Despite the nuances, the law should be adopted and revised in the second reading. It is also important to understand that the success of the pension reform is possible only in connection with the economic growth and financial stabilization of the country.

Already now, the state has to start working according to the principle of supporting exclusively poor citizens. In this context, it is essential that the new bill developed by the Ministry of Social Policy cancels all special pensions and introduces the practice when a person gets pension based on the deduction he/she has made to the Pension Fund during one’s employment period.


The article was published at the business portal  Delo.ua