Reaping the benefits of pension reform

Since January 2004, old age pensions in Slovakia have been redefined, to better reflect the personal contribution of employees and, on average, assign them a higher value. However, differences between older and new pensions have sparked significant criticism. As a result, further changes have been introduced to the recently adopted legislation. Following these changes, pension levels are likely to be lower after 1 July 2005.

Provisions of the new model

On 1 January 2004, a new Act No. 461/2003 Coll. of Laws on Social Insurance came into force, which revised the way in which pensions are set up (SK0404102F). Since then, pensions have been higher than those set up according to the old system. In the previous model, the maximum level was limited to about SKK 9,000. Since the new legislation, a definite, relatively small group of people now receive a much higher pension. Now, some pensions are worth SKK 20,000-30,000, or higher. At the end of 2003, some 77% of pensions were in the range SKK 5,600-8,999; in comparison, in the first quarter of 2005, up to 91% of these pensions ranged from SKK 5,600-10,999. According to information from the Social Insurance Agency (Sociálny poisťovňa, SP), nearly 4,850 pensioners hold pensions ranging from SKK 11,000-15,999 (the average wage in the first quarter of 2005 was SKK 16,022); some1,265 pensions range from SKK 16,000-20,999 and almost 500 recipients receive even higher pensions. In total, more than 1 million people are in receipt of pensions in Slovakia.

The authors of pension reform consider the new system to be much more equitable than the previous one, which was designed during the totalitarian political regime. In particular, the new system takes the pensioners’ contribution to the social insurance fund during employment into account in a more equitable way. Moreover, following the new model, absolute limits for a maximum level of pension have been cancelled.

According to the results of a recent opinion poll, the majority of respondents perceive the new pensions model as being more favourable for employees. Nevertheless, it is likely that those whose pensions were set up under the old system are less enthusiastic about the pension reform, particularly as differences in the level of their pension depends on the date they applied for their old age pension, i.e. before or after 1 January 2004.

Opposition to the reform

From the outset, opposition political parties have criticised this reform, largely due to the fact that the new system has brought about substantial differences between pension levels regulated under the old and new system. They claim that the new system is socially unfair and have questioned its sustainability, especially considering the SP’s availability of financial resources. Since the beginning of 2005, the new system has also been criticised by some of the current government’s coalition parties and by other experts, who have pointed out that the reforms have created large differences in pensions of the so-called 'old' and 'new' pensioners. These 'new' pensions continue to grow through annual adjustment by the agreed fixed percentage. Apart from the social injustice argument, they have also argued that there are economic risks associated with the new system, as it will require more resources than was originally intended. It has been predicted that the SP will not be able to finance these higher pensions in the long term and that, in such a case, the deficit would have to be covered by the state.

Legally, the old age pension should be annually adjusted, to take into account inflation and increases in the average wage. To achieve this, a mechanism was created, by which pensions are adjusted by a fixed percentage, calculated according to two components: one half of the inflation rate and one half of the increase in the average wage. All old age pensions have been increased by the percentage fixed in this way in 2004. As a result, the value of the average pension has increased from SKK 6,503 at the beginning of 2004 to SKK 7,046 by the end of that year. For 2005, the increase of all pensions by the same percentage was approved - that is by 8.85% from 1 July 2005.

Changes in the system for adjusting pensions

The increase in pensions by a fixed percentage contributes to a larger gap between the low and the high pension rates. As criticism of the new model has persisted, the Ministry of Labour, Social Affairs and Family (ကMinisterstvo práce, sociálnych vecí a rodiny Slovenskej republiky, MPSVR SR) has proposed changes to the planned system of adjusting pensions. Following these changes, pensions should be adjusted so that lower pensions would increase at a greater percentage than high ones. The proposed changes to the existing model were decided upon following a long discussion in parliament, which endorsed the changes quickly at the end of May, along with other amendments (changes are included in the Act on parental allowance, which was also discussed at that time in the parliament). The endorsed changes came into effect on 1 July 2005.

According to these changes, the lowest pensions (up to SKK 3,906) will increase by 10.2%, and pensions between SKK 3,957 and SKK 10,937 will increase by 8.85%. Pensions between SKK 10,938 and SKK 15,824 will increase less and higher pensions will not increase at all. The adopted differentiation aims to reduce the widening gap between low and high pensions.

Changes will also be adopted in relation to the setting of pension levels. In the original model, the full personal contributions of employees to the social insurance fund are taken into account when determining the total value of the pensions from 2007. Following the endorsed changes, this will be possible only from 2012. There have also been changes to the period, during which employees’ income was taken as a basis for calculating pensions. This period was extended for ten more years. Until recently, the income of the employee has been taken into account only since 1994, now it can be taken into account from 1984.

Commentary

The endorsement of these changes will have two potential consequences. First, those who receive pensions that are higher than the average nominal wage in 2004 will not receive increases in 2005. Second, those who have applied for the approval of their old age pension up to 30 June 2005 will have their pensions set according to the original model; those who send their application after this date will have their pensions set according to the changed system of calculation and their pensions will be relatively lower.

The approved changes may actually contribute to the slowing down of the growth of pensions, thus leading to lower demands on the financial resources of the SP. However, the percentage of those who receive pensions higher than SKK 11,000 is less than 0.6%. Therefore, it can be assumed that the problem of the 'socially unfair' large differences also has economic roots. According to available information, the SP could face problems in relation to available resources required to pay for these pensions in the long term.

However, this problem has also arisen from a reduction in resources after the implementation of the second pension pillar on 1 January 2005. The new model is based on resources from contributions of employees which represent 9% plus 9% of their wage. While contributions to the basic pension pillar, of 9% of wages, are being administered by the public Social Insurance Agency, the second part of the contribution, i.e. the additional 9%, is being administered by private social insurance companies. These companies promise their clients, i.e. future pensioners, higher pensions than they would receive if they contributed only to the basic pension pillar. According to available information, it was originally assumed that in 2005, about half a million people would join the second pension pillar. The reality, nevertheless, has surpassed these expectations, and in the first half of 2005, approximately twice that number joined. However, these people are contributing to the basic pension pillar with only half of the original amount, which has reduced the amount of financial resources available to the SP.

The implementation of pension reforms is considered by the current government coalition as an indisputable success. In a recent opinion poll, the majority of respondents also considered this to be the case. Nevertheless, changes to the new system of setting pension levels, just one and half years after its original implementation may cast a shadow over these results. (Ludovít Cziria, Bratislava Centre for Work and Family Studies)

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