Pension Systems and Financial Crisis: An Overview

1. Pension Systems and Financial Crisis: An Overview Regional (ECA) Workshop Pension Systems in Times of Financial Crisis Brussels, May 7, 2009 Robert Holzmann World Bank

2. Outline • Nature of Crisis and Implications for Pension Systems • Pre-crisis Situation of Reformed Pension Systems • Policy Actions with the Onset of the Crisis: Legislated and proposed • Assessment of Crisis Shock and Policy Actions on Fiscal, Financial and Social Outcomes • Directions for Policy Actions

3. I. Nature of Crisis and Implications for Pension Systems • Financial turned economic crisis • pressure on pension systems world-wide • low or negative GDP growth linked with falling employment, wages, and asset prices • Both unfunded and funded systems are adversely affected but timing and magnitude of impacts quite different

4. Crisis impact on pension schemes • PAYG (first pillar) • Fiscal pressure primarily via lower revenue due to lower wages and employment • Expenditure same or increase via more beneficiaries (early retirement; disability) • If benefit levels unaffected, bound to lead to deterioration of fiscal balance of scheme • Happens at a time of lower general gov. revenues and increased demand elsewhere (unemployment benefits; social assistance) • Transition deficit (2nd pillar) accentuated

5. Crisis impact on pension schemes • PAYG (first pillar) • Recent discretionary benefit increases to catch-up with strong wage-increase • Recent benefit reforms to compensate transition generations • Funded (second pillar) • Direct impact on asset and benefit level, but limited in effect as few retiring • Fiscal impact if budget provides compensation for affected individuals

6. II. Pre-crisis Situation of Reformed Pension Systems • Most ECA countries have undertaken some pension reform with transition • 13 countries introduced 2nd pillar; some legislated but have not yet introduced • Most others did parametric reforms to address fiscal, incentive and social issues • All introduced some form of voluntary savings schemes, with diff. in regulation • Many countries introduced/strengthened social assistance and/or social pensions

7. Pre-crisis situation • Despite reform efforts, only a few countries have been successful in achieving both long-term financial sustainability and long-term benefit adequacy in the pre-crisis state • Situation aggravated by advanced and projected further demographic aging • Stark trade-off between financial sustainability and benefit adequacy is result of low effective retirement age

9. Pre-crisis situation Projected benefits of reformed systems remain often generous (as measured by gross and net replacement rate) Projected replacement rates in multi-pillar schemes based on conservative assumption of net interest rate-wage growth differential of 1.5% Performance of pension funds since inception has in many cases not yet lived-up to expectations

10. Chart 1: Gross Replacement Rates for Male Full Career Workers

11. Chart 2: Net Replacement Rates for Male Full Career Workers

13. II. Policy Actions with the Onset of the Crisis: Legislated and proposed • As fiscal impact of crisis was felt quickly, many countries initiated or proposed deficit-reducing measures • Revenue increasing measures • (Re-) increase in contribution rate • Diversion of 2nd pillar contributions • Delaying movement to second pillar • Expenditure reducing measures • Changes in indexation • Increase in retirement age • Elimination of early retirement option

15. IV. Assessment of Crisis Shock and Policy Actions: Preview • Fiscal outcomes: • Depends very much on assumptions on depth and length of crisis/transitional reduction in wages and employment • While fall in wages and employment will eventually translate into lower future benefits and expenditure, transitional fiscal gap can be large and are policy dependent • Financial sector outcomes: • Crisis as well as policy reaction to the crisis have an effect on the size and structure of the financial sector and its ability to deliver expected rates of return for funded benefits • Social Outcomes • Assessment of both replacement rate as well as benefit level (compared to other groups) is important • Short-term impact is largely determined by selected price indexation (1st pillar) and changes in asset values (2nd pillar) • Medium and long-term impact is more difficult to assess as depending on real developments (wage and employment growth path) as well as structure of pension benefit system

16. V. Directions for Policy Actions • Actions will need to be country specific and useful to consider in a short and long term framework, and by ranking the policy options • General recommendations for the short run: • Avoid hasty actions that promise quick fixes for the fiscal pressure but risk doing harm in the long term to fiscal sustainability and/or benefit adequacy • Avoid irreversible decisions that are based on incomplete information about the state of the world • General recommendation for the long-run: • Use the crisis as an opportunity to initiate or complete reform to exit stronger from it