APPENDIX Key Elements of the Pension Reform
Pension legislation was adopted in June 2003 and the new system took effect from January 1, 2004. The system will consist of a mandatory defined-benefit, tax-financed pay-as-you go pillar; a mandatory defined-contribution, fully-funded second pillar; and voluntary fully-funded privately managed third pillar. While revisions to the first and third pillar have entered into force from 2004, the introduction of the second pillar is linked to the following conditions (i) two consecutive years of at least 2 percent real GDP growth per annum, (ii) a balanced budget of the PFU according to international accounting standards, (iii) functioning supervisory systems, and (iv) an increase of the actual minimum pension to the subsistence level.
Even without the recent hikes in pensions, the successful shift to a multi-pillar system was viewed to require a number of further adjustments. In particular, (i) the retirement age is low; (ii) the indexation to real wages is relatively generous and discretion in the indexation makes it intransparent; (iii) privileged pensions are costly; (iv) the trigger mechanism for the introduction of second pillar could delay its implementation and individual choices under second pillar are only envisaged eleven years thereafter; and (v) some institutional weaknesses of the third pillar remain.
Anusic, Zoran and Katerina Petrina, 2005, Pension Reform in Ukraine. Remedies to Recent Fiscal and Structural Challenges, World Bank, February 2005 (mimeo).
Castello-Branco, Marta, 1998, “Pension Reform in the Baltics, Russia, and other Countries of the Former Soviet Union,” IMF Working Paper 98/11 (International Monetary Fund: Washington).
Flanagan, Mark, 2005, “Ukraine: Medium-Term Fiscal Priorities,” in: Ukraine: Selected Issues, IMF Country Report No. 05/20, pp. 47–59, (International Monetary Fund: Washington).
Lindeman, David, Rutkowski, Michal, and Oleksiy Sluchynskyy, 2000, The Evolution of Pensions System in Eastern Europe and Central Asia. Opportunities, Constraints, Dilemmas and Emerging Best Practices (World Bank: Washington).
Ministry of Labor and Social Policy of Ukraine. Pension Fund of Ukraine, 2005, Mandatory State Social Insurance and Pensions in 2004. Figures and Facts (Kyiv).
Organization for Economic Co-operation and Development, 2005, Pensions at a Glance. Public Policies Across OECD Countries (Paris).
Organization for Economic Co-operation and Development, 2003, Reforming Public Pensions. Sharing the Experiences of Transition and OECD Countries (Paris).
Schiff, Jerald, Niko Hobdari, Axel Schimmelpfennig, and Roam Zytek, 2000, Pension Reform in the Baltics. Issues and Prospects, IMF Occasional Paper 200 (International Monetary Fund: Washington).
World Bank, 2005, The Development of Non-Bank Financial Institutions in Ukraine: Policy Reform Strategy and Action Plan (mimeo).
Prepared by Andrea Schaechter.
The World Bank found that headcount poverty among pensioners in 2001 was substantial at 30 percent (defined as 75 percent of equivalent adult expenditure in 1999 adjusted for inflation) but virtually identical to the poverty rate among non-pensioners (Anusic and Petrina, 2003).
Ukraine’s population shrank by 4 million since 1991 (a combination of low birth rates, falling male life expectancy, and migration). The pension fund estimates the ratio of pension age population to working age population to rise from just below 0.4 to 0.8 by 2050 (Pension Fund of Ukraine, 2005).
The self-employed pay 42 percent of their tax liabilities to the pension fund. Until 2005, the agricultural sector was under the same regime but is now officially required to contribute one fifth of the universal contribution rate which will be increased annually by 20 percent until the full contribution rate is reached.
Without reforms, the Pension Reform Working Group (2003) estimated that the replacement rate would drop to 22 percent by 2040. Wiener (2002) reports a similar estimate of 25 percent by 2050.
In July 2003, parliament adopted the Mandatory State Pension Insurance Law and the Law on Non-Government Pension Provisioning.
Revisions to the first and third pillars took effect January 1, 2004, while the second pillar is scheduled to be launched conditional on a serious of factors. See the appendix for a brief summary of the reform’s key elements.
The advantages of a multi-pillar pension system are seen as reducing labor market distortions by establishing a close link between individual contributions and benefits, increasing a country’s savings and investment path, and accelerating the development of financial markets and improve the efficiency of capital allocation (see, for example World Bank 1994 for a discussion of the rationale of a multi-pillar system, and Lindeman, Rutkowski, and Sluchynskyy 2000, OECD 2003, Schiff and others 2000, and Castello-Branco 1998 for a discussion of pension reforms in transition economies).
For an account of medium-term fiscal-structural challenges and their costs (which are estimated at about 6 percent of GDP), see Flanagan (2005).
See Chapter I.
Working beyond the statutory retirement age increases eventual pension payouts. However, it seems these incentives are not very effective in raising effective retirement ages.
The World Bank views the requirements as appropriate except for the high investment limit (50 percent) on bank deposits and banks’ savings certificates.
The World Bank views the relatively low minimum capital requirements and some of the investment limits, which allow large exposure to bank deposits and money market instruments but restrict investment in Ukrainian government securities, as problematic.