Thursday, 8 July 2010
Pension reform
OLD-AGE MATERIAL SECURITY GUARANTEES IN PLACE TODAY
Armenia has announced the startup of pension reforms: starting early next year Armenian citizens can apply to any licensed financial entity of their choice to make a first-ever contribution for future pension.
This new multistage system will cover all the layers of society: it is fair, financially sustainable and transparent.
What will happen if the new system fails to be introduced? The existing pension system runs on the so-called principle of “consent of generations” and is henceforth impractical. The government has embarked on radical reform to rule out the existing of poor pensioners while even now the State does not save on pensioners. About a quarter of State expenditures or 4,2 % of gross national product goes on the payment of pensions and other social charges. Notwithstanding, about 500 thousand pensioners remain below poverty line. The average pension is about AMD 26 thousand, and the pensioners continue to be dissatisfied with their old age standing and complain rightfully that at the best they can get only 25 percent of their former salary.
The point is that the current pension system equalizes everything by calculating pensions based on the years of seniority rather than on the size of salary.
The idea that we are going to have vulnerable pensioners in future is the cause of serious concern, especially as we consider today’s demographic statistics. Pensioners constantly grow in absolute number, and the whole body of employed breadwinners is not strong enough to keep up the needed feedback.
The authors of this program argue that if we fail to change the situation right now, we will run the risk of having low pensions for the whole period under review. Otherwise we will have to raise the tax burden continuously to embarrass both economic entities and their employees.
What is being offered? The pension age will not change: all those citizens having reached 63 years of age will continue getting the base amount of pension which over time will be made equal to 100%, then to 150% of the established consumer basket. It is very important as there are lots of people who have not been able to build up the length of service allowing for a minimum pension. Besides, the State will continue to pay retirement pensions to various groups.
All able-bodied citizens will be saving up for their future pension in two ways: voluntary and mandatory.
The mandatory funded scheme will be introduced in 2014 affecting those born after 1974. Now in focus is the voluntary scheme which will be effective as of January, 2011. The voluntary group includes all citizens over 40 who, too, will benefit from the distributive component.
A few days ago the National Assembly passed “the pension package” in the first reading. Every employed citizen is thereby supposed to make a shift from the currently applicable distributive system toward the funded one.
According to RA Deputy Minister of Finance Vardan Aramyan, all necessary legislative tools and infrastructures should be created and tested in the meantime. On the other hand, Armenia's financial structures should be brought into harmony with new market tools in an effort to set up specialized pension funds.
Pensions will be calculated by means of a more equitable and accurate formula depending on wages and contributions to the pension fund.
Mandatory funded scheme’s working mechanisms: Employees with wages below AMD 500 thousand will have to pay out 5 % of wage amount. Additional 5 % will be contributed by the State Note that State contributions shall not exceed AMD 25 thousand for salaries above 500 thousand drams.
At the same time, a uniform and single tax to the rate of 26% will be applied instead of the mix of different taxes currently applicable, which is just as much as in the working system. This amount cannot generate additional pressure for employers and employees. In Mr. Aramyan’s words, employers’ duties have been partly simplified as fewer statements will have to be filed with tax authorities. New incentives will be created preventing employers from putting the tax burden on the staff: for instance, anyone receiving 100 thousand dram in wages will be paid as much following the reform.
The State budget will be replaced by private funds to mobilize, handle and refund the amounts paid out by future pensioners. These new financial institutions, however, will not be operating like mere depositories, with their managers supposed to place the sums so mobilized in the securities markets. Thus, on the one hand, future pensioners will take a share in the development of economy as they will be given the possibility of having “long money” and, on the other hand, they will be entitled to part of interest accrued on the stocks or bonds traded on the market. In other words, at the time of retirement, they will get far greater sums than the ones saved up during employment. The fairness of the new system is also evidenced by the fact that right of succession is acknowledged for these sums.
Anytime and anyone can follow the manager handling his money and keep track of the amounts accumulated on his personal account. Should managers fall short of their duties, citizens can replace them free-of-charge only once a year. Based on risk and profitability considerations, employees can opt for the type of securities to be traded in by their own managers. The system stipulates that if anyone proves unable or unwilling to choose a manager, he or she will be aided by specially designed computer software.
By the way, at least 3 different types of portfolios will be proposed by managers ranging from moderate to risky ones. This means citizens themselves will choose a profit margin from 4-5 % to 15 %.
Today as well, there are several investment funds operational in Armenia, some of which are prepared to engage in pension fund activities with the latter being different in that the State exercises much tougher control over them.
The amounts saved up under the mandatory scheme will be repaid in 3 different ways: if a given sum as divided by the average per-month life expectancy is less than 25 % of the State-administered pension, a lump-sum refund will be made. Should the target amount range from 25 % up to the fivefold sum of the pension, it will be paid back in annuities. And lastly, the program version will be applied to the sums fivefold over the amount of pension. Economists estimate that annuities will be the most practical scheme when a person gives his savings to the insurance company of his choice which undertakes to pay a mutually agreed sum on a monthly basis until the end of the client’s life. There is an interesting exception: pensioners may get a lump-sum settlement one or two years ahead of the required age if they are found suffering from a serious disease.
The State shall guarantee that pensioners’ savings have at least the same purchasing power as they had at the time of withholding. CBA experts reassure that the State envisages warranty schemes: pension funds will be responsible for the repayment of 20 % of funded amounts, with the balance of 80 % to be settled by the State itself account taken of inflation.
The pension fund-mobilized sums may help lower interest rates on deposits and loans. By issuing stocks or bonds, entrepreneurs can attract the money needed for the settlement of pensions. The State will watch over manager misconduct or misuse. CBA Board member Aharon Chilingaryan assures that in addition to the guarantee fund, the CBA will use several other tools of control and oversight. While reportedly private, pension funds will be kept in “iron gloves,” with quantitative and financial restrictions imposed on managers as to where and when they are allowed to invest the mobilized sums.
One more advantage may be attributed to the new system. It may help curb the shade in economy. As stated above, the resources mobilized by pension funds will be placed in securities. Realizing that cost-effective resources can be borrowed from asset managers, economic entities will start issuing increasingly more securities allowing greater exposure and transparency for their earnings since it is impossible to issue and sell securities without stating turnover and profits.
Hasmik Arakelyan
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