Prepared by Edgardo Ruggiero.
Approximately 88 percent of public pension expenditures are managed by the Pension Fund, and 12 percent by the Health Fund in the form of under-retirement-age disability pensions. Once a disabled person reaches retirement age, his pension is paid by the Pension Fund. The latter also pays a health insurance contribution on behalf of pensioners and the Health Fund pays the pension insurance contribution on behalf of disability pensioners below retirement age. Therefore, while pension expenditure is easily defined as total spending on benefits for old age, disability, and survivors’ pensions, no symmetrical revenue figure exists. Disability insurance, moreover, is not linked to a defined portion of either the health or pension contribution.
There are around 1.6 million old age pensions and 0.7 million disability pensions. Of the latter, about 50 percent were under age disability pensions financed by the Health Fund. The provisions financed directly by the budget are not the object of the reform and will not be discussed in detail here.
Starting with the 1997 budget, the social security funds will have to present their budgets to the Ministry of Finance before submission to Parliament. The Ministry will be able to modify the budgets before sending them to Parliament.
Though the life expectancy at birth [E(0)] of 64.5 years for males is quite close to the statutory retirement age, the female E(0) of 73.8 years is much higher than their statutory retirement age.
Thus, the expected deterioration in the underlying demographics underlines the importance that a structural pension reform be implemented (Section 4).
Employers pay 24.5 percent of gross salaries for pensions, 18 percent for health insurance, 5 percent for unemployment insurance, and 0.5 percent for the wage guarantee fund (related to bankruptcies), totalling 48 percent. Therefore, social contributions amount to (48/148) 32.4 percent of employer costs—slightly lower than the 33 percent in 1995, when the health contribution was set at 19.5 percent. Employers also withhold from wages of employees 6 percent, 4 percent, and 1.5 percent, respectively, for pension, health, and unemployment insurance.
The internal rate of return for new entrant low income workers and high income workers has been estimated at 0.54 percent and 0.73 percent per year, respectively (World Bank, 1995).
Workers having reached the statutory retirement age between January 1, 1991 and June 30, 1993, need only to have 10 years of service. Like in most Eastern European and FSU countries, special professions are entitled to earlier retirement with full pension.
Given the mandatory nature of the pension system, years in service are equivalent to contributing years.
The penalties for early retirement introduced by the reform apply to the pension benefits as defined by this schedule.
Women born after 1946 fall into the regulations of the final stage of reform (starting in the year 2009). The transitional regulations apply to all women born before 1947. Transitional regulations for men apply only to those born before 1939.
The full pension is defined as the percentage of the base wage that corresponds to the number of years in service in the benefit schedule, with no penalty applied to this percentage. For example, a worker retiring at 62 years of age after 38 (30) years of work will receive a pension equivalent to 76 (68) percent of his base wage. As in the current system, the worker has no right to a pension unless he/she has contributed for at least 10 years.
Note that a worker can always choose to stop working, even when these conditions are not met. However, if condition (i) is not met, a woman will have to wait until she reaches age 57 to receive her pension (60 for men). If condition (i) is met, but condition (ii) is not met, the worker will have to wait until he/she reaches age 62 to receive his/her pension.
For example, if a worker retires at age 57 (less than the statutory age of 62), and he has contributed for only 35 years (less than 38 years), he will incur a penalty. The penalty is calculated as follows. First, the worker has 3 years less (38-35) than the maximum expected contributing years at retirement. The monthly penalty rate that applies in this case is 0.3 percent/month or 3.6 percent/year. The penalty, in percentage terms, is 18 percent, that is: 3.6 * (62-57); where 62 is the statutory retirement age and 57 is the actual age at retirement. This early pensioner will get a pension of 55 percent (73-18) of his net wage (73 percent is the pension level as determined in the benefit schedule for 35 years of contributions). If the worker retires at age 57 having contributed for 38 years, no penalty applies, but he will retire with 76 percent of his pension—as defined by the benefit schedule.
It implies that a woman who started working at age 24 and contributed for 33 years to be able to retire at age 57, would still incur a penalty—in this particular case of 30 percent. She would then receive a pension of 41 percent of her base salary. In the previous system, with 33 years of contribution the same worker would have obtained a higher pension of 69.5 percent of her base salary. A male worker retiring at the minimum retirement age of 60, with 33 years of contributions, will receive 59 percent of his base salary, compared to 69.5 percent in the previous system. It is important to note that for women born before 1947, the service periods are reduced by 1 year (1.5 if handicapped) for each child, up to a maximum of 3 years. The same regulations apply to single male parents born before 1940.
For example, both the Czech Republic and the USA have decided to raise the statutory retirement age. The former will increase retirement age for women from age 55 to 57-61 (according to the number of children reared) from 1996 to 2007. Retirement age for men will be raised from age 60 to 62 over the same period. In the USA, the increase in statutory retirement age from age 65 to 66 (both sexes) will start in 2000 and end in 2005. Then, another increase will be implemented to age 67 from 2016 to 2022.
The actuarially fair penalties are age and sex specific. The 7.4 percent is an average estimated by the Hungarian Ministry of Finance on the basis of actual retirement profiles.
The authorities typically refer to a three pillar system, but, as discussed below, pension benefits will be de facto granted by four distinct systems.
The Czech formula indexes the benefit for two thirds to inflation, and for one third to wages. The Swiss formula uses equal weights for wages and prices.
Consider, for example, a worker that wanted to retire early with only 33 years of contribution—who therefore would pay a penalty of 0.5 percent per month of early retirement. If the flat price of a month of contributions is set at 0.3 percent of the full pension, he would find it convenient to purchase 2 years of contributions. The cost of purchasing each month (0.3 percent) would be lower than the related increase in pension benefit (0.5 percent).
The concept paper does not elaborate on how the disability scheme will be reformed, nor how the tax base will be broadened.
The projections have been prepared by the World Bank, as part of the work for the Public Sector Adjustment Loan Preparation Mission (May, 1996).
The simulations assume that the recent decline in entry pension does not continue after 1997. Therefore, the increasing deficits merely reflect the maintenance of current benefits under adverse demographic trends.
The Opt-Out refers to the fact that workers below age 40 will mandatorily have to contribute 10 percent of their wage to the second pillar. In this chapter, it is assumed that no worker older than 40 exercises the option leave the old PAYG and switch to the new system.
The target replacement rates in the first pillar are around 40 percent, compared to around 60 percent in the current PAYG. That means that new pensioners in the first pillar get lower pensions than the pensioners in the current PAYG. The former start being paid out in 2020, as the old PAYG pensioners die out.