PART TWO ■ RESULTS OF THE IMPACT ANALYSIS
4. Comparative results of the social and economic impact study conducted by the Pension and Old-Age Round Table
This chapter is going to describe pension paradigms examined by the Pension and Old-Age Round Table from the aspect of their answers given to the main dichotomies, to tasks expected to be met by pension systems and to the question of selection between values. A more detailed description of the structures analysed can be found in the Enclosure. These paradigm descriptions form fundamental parts of our Report.
At this point we think it is important to repeat a basic principle that accompanied our entire work and was emphasised at every occasion, namely that we are not responsible for
comparing paradigms with each other, and for selecting the “best one” from among them.
Different structures subjected to impact analyses attempted to give different answers to the questions raised. Their “authors” - those who undertook to elaborate a given structure - are positive as it can be understood from the description they produced that the paradigm of their choice could produce the most suitable answer for the problem complex. However, the
experts did not arrive at a common consent on this matter; from the beginning of this work we undertook the position that we would not form a “majority opinion” in this respect.
Secondly it should be highlighted that there isn’t such a need or demand either. The task of the experts is to present the apparent possibilities and their consequences as much as it is possible within the given framework, and entrust decisions to the decision makers.
4.1. Criteria, options studied
In the course of its social and economic impact analyses, the Pension and Old-Age Round Table strived to review various pension paradigms. Pension systems set basically two aims for themselves: 1. replacement of the work income i.e. avoiding that the life course would be disturbed by a drastic decline in consumption at the time of retirement, and 2. mitigation of old-age poverty, i.e. provision of at least some modest old-age income to everybody, that would cover basic needs.
Pension systems worldwide try to achieve these two objectives, although centres of gravity may be different. Hungarian experts do not agree either whether or not we should strive to
given higher priority. As it has been written already, this is obviously not a purely
professional question but a matter of selection between values that should be considered by political decision-makers.
Long-term credibility and the possible highest level of participation in the system could be best facilitated by structures where the individual can be firmly assured that the expected value of what is withdrawn from him during his active life course will be returned to him after retirement in such a manner that its real value - and relative value - will be maintained. These are the so called actuarially fair systems. Here redistribution can take place only according to nothing else but the length of lives in retirement.
It is a general feature that stems from the inter-generational character of pension systems that in case the real income that successive generations can produce is not constant, reserves get generated or else they are used up. The ageing and reduction of the population of a country in itself does not necessarily connote a problem. However, there may be a situation where a) productivity does not increase at a rate sufficient for increasing the income total for the
long term at the same time notwithstanding the ageing and decreasing of population b) the reserves of the pension system are mostly (or exclusively) exposed to the domestic
economic and social processes, are dependent upon the long term development of the domestic human capital and/or are invested in domestic real capital.
If the above two cases prevail, it can be presumed that an actuarially fair system can be less and less available for successive generations.
At this point again, it is important to highlight and cannot be emphasised enough that funding, i.e. the introduction of pension funds in itself cannot be the answer for this dilemma. If the pay-as-you-go system or any part of it would be replaced by a system that exclusively or mostly invests in domestic instruments, the system will further on and similarly be exposed to negative development. An increase in the rate of system-dependency will exert a very similar impact on asset prices as on the social insurance pension, since the number of buyers of domestic securities - that could be found in the pension fund portfolios, too - will decrease while the number of sellers will increase.
The only relief would be if the pension fund could make voluminous investments and spread the risk in those parts of the world where the asset prices are exposed to demographic and employment - in other words growth - characteristics that differ from the domestic ones (subject, of course, to proper risk management).
Consumption smoothing - work income replacement - along the life course would under such circumstances raise a question in general, namely that in case mandatory withdrawal is not coupled with the expected improvement of the return on investments in one’s life course, what’s more it doesn’t even go with the maintenance of its standard, would and should then such mandatory element be maintained?
It seems to be intrinsic in human nature that most people are just moderately able to make plans and draw up concepts while bearing the responsibility for them on the long run.
Common daily problems in most cases are much more decisive than a situation that may or may not emerge after forty years, and a lot of people think that they might revert to this issue sometime later. Surely, scepticism which makes you say that “the world will change by then, rules will be modified. Where shall we be by then?” also plays a role. People think the same way not only in Hungary (although here this is a strong factor). Necessity trumps all: instead of voluntary pension saving, money should be spent on children’s shoes or lunches. Thus, even if the withdrawal is exaggerated and incorrect it is highly dubious whether it has any alternative. Loading burdens on a narrow - and potentially narrowing - contribution payer population might generate continuous tensions in the system, meanwhile any considerable reduction of the mandatory payments would in the future lead to masses of poor new pensioners who for some reasons discussed above, failed to save enough funds.
Now we turn to another basic function of the pension systems, mitigation of poverty, which means that everyone will be given a certain amount. The literature sometimes call it as the zero pillar, and thus distinguishes it from the first social insurance pillar since its source is not contribution but general tax revenue. It can, however, not be excluded that this latter one would be ringfenced (such as some reserves based on oil revenues).
Mitigation of poverty entails redistribution because it ensures pension benefits for those who did not (or not completely) earn them by paying their contributions. This is also true when they are covered by general tax revenues and the scope of such taxpayers is wider than the scope of contribution payers or the scope of personal income tax-payers (for instance everybody pays value added tax). The basic level pension to some extent serves as a counterincentive to contribution payment.
This counterincentive could be mitigated by a system where a basic benefit is disbursed to everybody and on the top of that pension is paid in proportion with the contributions paid. In
structure of the system will be reorganised. At the same time the differences among benefits according to differing service periods and incomes will be reduced, thus such a structure would only have some moderate impacts when also serving as an incentive.
The international practice knows general benefits that are either provided on civic (pensioner) right or means-tested. Argument in support of this latter could be its theoretically superior fairness (who is not indigent would receive nothing) and therefore counterincentive impact is somewhat mitigated. At the same time, however, means-testing is very complicated, could easily be cheated and needs huge administrative forces - therefore all impacts should be evaluated together.
We deem it worthwhile to repeat the table of the World Bank that has already been shown in the summary elaborated at the start of the Round Table at the beginning of 2007. As it is properly shown by the large X (primary factor) and the small x (secondary factor) in Table 1, the underprivileged and constantly indigent layers, the informal and the formal sectors could within the frames of the pension system most efficiently be managed with characteristically differing means and through characteristically differing channels. The mandatory system elements are able to reach chiefly these latter ones, since the payment inclination of the grey economy is very low, and that of the constantly indigent could in practice be neglected. In the case of these latter ones only social approach is worthwhile for consideration, whilst in the case of the informal sector voluntary forms are more significant than mandatory ones. These aspects should reasonably be kept in mind in the course of planning, since in the last twenty years in Hungary a society is getting shape with these three segments representing similar weights and it should better not be declared that the majority of people can be found in the formal sector that the classic pay-as-you-go system could be the best fitted to.
Table 1. Multi-pillar pension taxonomy
1. X Public pension plan, publicly
managed, DB or NDC * mandated
contributions (perhaps with financial reserves)
2. X occupational or personal pension
plans, funded DB of funded DC** mandated financial assets
3. x X X occupational or personal pension
plans, funded DB of funded DC** voluntary financial assets
4. x X X homeownership, family support
and so forth voluntary financial assets
* DB – defined benefit system, pension calculated characteristically on the basis of predetermined rules, as a function of the years of service and the contributions paid. NDC – notional defined contribution, detailed description see later.
** DC –defined contribution system, payments made during the accrual period are invested and the future pension depends upon the yields.
Source: World Bank
At this point let us revert to what has been discussed in sub-section 2.4 regarding the possible time span of the impact analysis to be conducted by the Round Table. On the basis of the data available, the aspects of predictability and the issues intrinsic in transition we opted for a thorough examination of the period ending in 2050, thus detailed social impact analysis covers the population borne between 1954 and 1989. The macro-economic impact analysis could (with certain restrictions) be extended until the end of the century. As it has already several times and at many places emphasised, the result is not a forecast but a prediction of limited confidence.
Also, we should revert to the aspects summarised in sub-section 2.3 concerning the constraints put by absence of feedbacks and labour demand prognoses, on the scope of conclusions that could be drawn in the current phase of our work. What we are unable to build into the model is exactly this very important aspect: future development of contribution payment ability and inclination, and the impact that various pension paradigms could exercise on them. These impacts are outlined in detail in Enclosures 12 to 15. Further development of the model to this direction could be one of the most important tasks of the body that - in the possession of proper grounding and resources - could continue the work of the Round Table (see Enclosure 21).
Despite numerous constraints and uncertainties and the fact that it cannot be deemed to be
deficit and other indices all based on similar data. Each paradigm presents data related to distribution of pension, relative pension level and the number of those not receiving proper pension. The essence of the impact analysis is the comparison of these data with the basic version and with each other.
Enclosure 9 contains a summary concerning the cogency of the paradigmatic reforms and the substance of each paradigm. Prior to the presentation of the paradigms investigated and the discussion of the respective results of each version, Enclosure 10 is going to present some statements of general character that should expediently be observed in the course of the planning of an efficient pension reform or pension system. Both enclosures are extracted from the First Report of the Round Table.
4.2. Versions of pension structures studied by the Pension and Old-Age Round Table
In consideration of all deliberations, basic principles and aspects of approaching, the versions of pension systems investigated by the Pension and Old-Age Round Table are built up of the following elements.
1. Mandatory contributory pension grounded on insurance principle
Basic principle: mandatory contributions; pensions fully determined by contributions;
redistribution is based exclusively on mortality Versions:
a) contribution based social insurance – point system basis
– notional defined contribution (NDC) basis b) funded private system (with individual accounts) 2. Tax-financed basic pension
Basic principle: defined old age benefit starting in advanced years (earliest at the age of 65 to 70), financed from the budget (and not from wage contributions).
Versions:
a) on civic right (under general conditions) b) means-tested
The paradigms subjected to analyses contain the elements listed, as follows.
0. The current (2006) “unchanged”. (NY2006; this is not a paradigm proposal for investigation, it is just the basis for comparison)
1. Social insurance pillar (contributory pension) operated in a system that from the actuarial aspect is correct, is based on point system and individual record management (short name:
NYpont).
2. Reduced contributory pension, point system (the significance of the funded pillar is also reduced proportionally) coupled with appropriately reduced wage contribution; uniform basic pension from the age of 65 (short name: NYp+a).
3. Social insurance pillar operated in the notional defined contribution (NDC) system. At the age of 70 it is completed with a guaranteed minimum pension if the notional defined contribution pension would not reach that level. The inbuilt equalising mechanism would automatically stabilise the system and create a constant cross-sectional balance (short name: NYndc).
4. Exclusively private pension on the long run – in such manner that the role played by the pay-as-you-go (first) pillar is gradually diminishing and that of the funded (second) pillar gradually increases and the long transitory period would be survived by the second pillar only – meanwhile the first pillar goes on as a notional defined contribution (NDC) system. In this model, too, the guaranteed minimum pension is introduced at the age of 70 (short name: NDCtbki).
5. Exclusively basic pension on the long run – following a long and gradual transformation, a uniform basic pension only (coupled with the gradual diminishing of the social insurance and the funded pillars) (short name: CSAKa).
Paradigms investigated are classified on Figure 1 and in Table 2 in accordance with the list above. The current system (NY2006) is not a new paradigm subjected to analysis: it is just the basis for comparison. This table and figure are showing the end-status following the
Figure 1. Categorisation of paradigms subjected to impact analysis Pay-as-you-go and funded elements are included on the long run Funded
system only on the long run Contributory pension only Contributory pension and basic or minimum
pension
Table 2. Components of the paradigms subjected to impact analysis Paradigm versions subjected to impact
analysis NYpont NYp+a NYndc NDCtbki CSAKa
Basic pension indicated with darker grey, whilst other surviving system components are indicated in lighter grey. Note that the relative weight of the funded pillar to the social insurance pillar will over time be transformed compared to the starting conditions in the NDCtbki version only, and not in the others (which does not mean that its absolute weight would remain unchanged, since it decreases in NYp+a and in CSAKa and in this latter it will even cease). This has already been mentioned in the Introduction: a properly operated funded pillar with risks distributed internationally might reduce the risk of being exposed to the domestic employment and demographical conditions, but since we were unable to properly model this, no paradigm variations were grounded on it.
4.3. Parameters set for the paradigms
This chapter is going to discuss shortly to what extent are the substantial properties of the paradigms investigated independent from their scalable parameters, what were the principles our impact analysis was based on.
In the course of the impact analysis we tried to achieve that the comparison among paradigms would to the least extent be disturbed by differences between individual parameters and rules. In the course of the process we had to learn, however, that perfect uniformity cannot be achieved, because diverting certain factors from their actual position would be very much paradigmatic. An example could be a feature that lets participants retire under a certain higher age on condition that they have already achieved a minimum pension level, and thus encourages and enforces longer work career. Or when a paradigm is targeted on the rapid creation of the stable equilibrium, or an approach that calibrates the contributions to be accrued with the application of an equitable contribution rate - where actual contribution collections can cover actual benefit payments thereby assuring cross-sectional balance - that would be sufficient on the long run.
Thus the overall pictures presented by the paradigms show at certain distinguished points ample differences not because differences in input parameters, although in certain cases this may produce impacts, too. This will be highlighted there and then. In this spirit, our approach to the calibration of paradigms allowed for significant differences in for instance the size of the system (total volume of pension benefits) where the reduction of the system size was intrinsic target.
All in all it would be important that the decision maker would favour one version or the other not on the basis that it assesses less contribution or guarantees more pension benefit. As the Introduction has already explained, firstly it should be discovered whether on the basis of this volume of preparatory work could decision makers narrow the scope of possibilities worthwhile for consideration, or they would rather need further analyses and details. That is, in the next round the parameters of each paradigm could be fine-tuned and alternative scenarios run.
At this point we should refer to points 4 to 7 of sub-chapter 1.1. Our activities aimed at the design and analyses of paradigms duly kept in mind that although parametric changes could
achieve lots of results, these options have their own limits, and this is why we should think over the logics of the possible structures, too.20
This is, however, true the other way round: sometimes someone should produce the economic value that would cover pension benefits. No matter if they are the successive generations or the taxpayers, none of the paradigms could offer rectification if the equilibrium would severely fail. If in the course of one’s life career one would work for a relatively short period and would not allocate reserves (including mandatory contributions) and would like to live too long on high allowances, then there is no pension system that could arrange for all
This is, however, true the other way round: sometimes someone should produce the economic value that would cover pension benefits. No matter if they are the successive generations or the taxpayers, none of the paradigms could offer rectification if the equilibrium would severely fail. If in the course of one’s life career one would work for a relatively short period and would not allocate reserves (including mandatory contributions) and would like to live too long on high allowances, then there is no pension system that could arrange for all