PENSION REFORM IN CENTRAL AND EASTERN EUROPE AND THE ROLE OF THE ACTUARY

1. PENSION REFORM IN CENTRAL AND EASTERN EUROPE AND THE ROLE OF THE ACTUARY Chris Daykin, UK Government Actuary

2. CHARACTERISTICS OF PENSIONS IN FORMER TIMES • single state financed pension system • no employee contributions • relatively low retirement age (esp. for women) • generous conditions for special categories • high replacement ratio (but low earnings) • subsidised food and housing

3. CONTRIBUTION RATES FOR PENSION SYSTEM

4. REPLACEMENT RATES (1997)

5. PENSION PROBLEMS IN TRANSITION • decline in active population • unemployment and redundancy • inflation • poor contribution compliance • rising deficits • government cash flow difficulties

6. Pension expenditure as% of GDP Source: Phare Consensus II

7. SOME APPROACHES TO A SOLUTION • raise retirement age • abolish special categories • index only the minimum pension • introduce employee contributions • reduce first pillar benefits • introduce mandatory DC second pillar • encourage voluntary third pillar

8. MAJOR FIRST PILLAR REFORM • notional defined contribution - Latvia, Poland (following Sweden) • direct link between contributions and benefits • no invested funds • higher pension age • no special categories

9. NOTIONAL DEFINED CONTRIBUTION • clear link between contributions and benefits • still on a PAYG basis rather than funded • different revaluation approaches • need for demographic adjustment factor • annuity conversion at pension age • permits flexibility of retirement age • passes on part of longevity risk

10. MANDATORY SECOND PILLAR • Hungary 1997 • Poland 1999 • Latvia 2001 • Estonia 2002 • Croatia 2002 • Russia 2002

11. RUSSIAN SECOND PILLAR • mandatory individual accounts (DC) • higher contributions for hazardous labour • assets invested by Pension Fund of Russia • conservative investment strategy • possibility of outsourcing to private managers • retirement age 60 (M), 55 (F)

12. SECOND PILLAR CONTRIBUTION RATES First Second Hungary 22 + 2 6 Poland 16.3+16.3 7.3 Latvia 23.6+7 2 Estonia 16 + 0 4 + 2 Croatia 10.75+5.75 5 Russia 28 + 1 5 to 12

13. VOLUNTARY PRIVATE PENSIONS Hungary (mutual benefit funds) Czech Republic Slovakia Slovenia Russia (non-State pension funds)

14. REFORM IN PROGRESS Slovakia Bulgaria Lithuania Armenia Macedonia Czech Republic Azerbaijan Romania

15. ACTUARIAL ROLES IN PUBLIC SOCIAL SECURITY SCHEMES • demographic projections • estimates of future benefit outgo • estimates of future contribution income • long-term projections of financial balance • funding policy • risk management • reserve strategy and investment advice

16. PROFESSIONAL ROLE • actuary is not just a technician … • … but a professional • ideally a member of an actuarial association … • … which is a full member of IAA • IAA has issued practice guidelines for social security actuaries

17. REPORTING MECHANISM • actuary should take personal professional responsibility for the report • assumptions to be responsibility of actuary • report directly to Ministers or Parliament • signed report presented to Parliament • signed report in public domain • discuss recommendations and agree action

18. ALTERNATIVE STRUCTURES • independent actuarial review • Government Actuary or similar • in-house actuarial review • in-house review with external audit/peer review • ad hoc external studies or reviews

19. ROLE OF UK GOVERNMENT ACTUARY IN SOCIAL SECURITY • consulting service to government • five-yearly reviews of National Insurance • reports on annual up-rating • financial consequences of new legislation • costings and estimates on day-to-day basis

20. THE ROLE OF THE ACTUARY IN MANDATORY DC SCHEMES - 1 • design of scheme and impact of guarantees • viability of charging structure • individual projections to test adequacy • cash-flow projections • strategic investment policy • investment performance measurement

21. THE ROLE OF THE ACTUARY IN MANDATORY DC SCHEMES - 2 • provisions in accounts for future expenses • provisions in accounts for guarantees • capital requirements • fiscal costs of minimum pension guarantees • fiscal costs of transition

22. THE ROLE OF THE ACTUARY IN ANNUITISATION • annuity design • pricing of annuities • reserving requirements • capital requirements • asset/liability modelling • investment strategy

23. OTHER ACTUARIAL TASKS IN DC SCHEMES • advice to individuals on draw-down • individual projections to make optimal decisions • pricing of life and disability cover • actuarial management of life and disability • regulation and supervision

25. ADVANTAGES OF FUNDED COMPLEMENTARY PENSIONS • increased level of funding • introduces more discipline • may improve efficiency • makes pensions less political

26. ARGUMENTS IN FAVOUR OF FUNDING • increases level of saving • helps to develop capital markets • provides needed investment capital • helps to address ageing problems • may reduce long-term cost

27. COUNTER-ARGUMENTS • may substitute for other saving • markets may not be able to cope • may push up prices with excess demand • ageing will still have an impact • cost is only reduced in certain circumstances

28. PROBLEMS WITH PRIVATE MANAGEMENT • higher costs of disaggregated system • insolvency risk • marketing costs • possibility of mis-selling • variable investment performance • risk of fraud or mismanagement

29. PROBLEMS WITH ANNUITIES • concentration of risk • mortality uncertainty • need for very long-dated bonds • preferably index-linked • programmed withdrawal can be alternative

30. REFORM INGREDIENTS • stabilise pay-as-you-go spending • adequate safety-net with redistribution • gradually increase retirement age • encourage funded second pillar • simplify tax régime • strengthen regulation and supervision • ensure appropriate investment vehicles