Pension Systems in Times of Financial Crises: Serbia Ministry of Finance

1. Pension Systems in Times of Financial Crises: Serbia Ministry of Finance Republic of Serbia

2. 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

3. Pension Reforms in Serbia Started in the Early 2000’s • 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?

4. 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

5. 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

6. 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

7. 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

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

9. 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)

10. 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!

12. Serbia’s 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 => pressure on public finances requiring additional budget subsidies

13. 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

14. 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

15. 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