The Grim Outlook for Pensions and Pensioners

5 July 2011, 17:14

Deputy Prime Minister Serhiy Tihipko recently went public with extremely revealing data: as of April 1, 2011, the number of pensioners in Ukraine (13.8 million) is almost equal to the number of contributors to the Pension Fund (14 million). These statistics are even more stunning when compared to late 2010: the former group has grown by 60,000, while the latter has shrunk by 400,000. More interesting than a long list of possible causes is the question about how the government is going to resolve this problem in light of the fact that the Pension Fund (PF) deficit soared to UAH 34.5 billion in 2010 and no prerequisites for any significant improvement are to be seen anywhere.


On May 31, 2011, following a long public discussion and under pressure from the public, the Verkhovna Rada killed the government-sponsored bill “On Measures to Secure Legislative Provision of Pension System Reform” (submitted in late 2010). However, the Cabinet of Ministers submitted a new version of this document later that same night, and VR Speaker Volodymyr Lytvyn said that the parliament would begin considering the reanimated draft law on June 14-15. The cover letter emphasizes that “the main result expected of this law is a balance of the pay-as-you-go pension security system in the mid-term perspective.” So how exactly does the government plan to achieve this goal?
The bill adjusts some key parameters of the pension system, including retirement age, minimum insurance age, maximum pension size, retirement conditions for different segments of the population and so on. Most of these measures are dictated by the horrible financial situation the Pension Fund is currently in and which, in turn, has been caused by many years of procrastination with regard to true pension reform. 
The reader will remember than pension reform was launched in Ukraine back in 1998 with a special presidential address to the Verkhovna Rada. This first step was followed by a number of laws and legislative acts in 2003 which introduced a three-level pension system patterned after other countries. Unfortunately, the process was later halted: the government paid only marginal attention to private pensions (the third level), while the mandatory defined-contribution system (second level) remained on paper only. As a result, the serious pension reform for which the government was fully responsible suffered a double blow – from both the economy and society.


The ageing population is forcing the government to increase the PF budget, but it is impossible to raise the “pension tax” on wages – it is already one of the highest in the world and any further increase would lead to a dead end even without any crisis. At the same time, limiting pension spending, raising the retirement age and other similar measures have no popular support, especially against the backdrop of profligacy in other areas of public spending. This is another dead end – a societal, or, from the standpoint of politicians, electoral cul-de-sac.

Every Ukrainian government in the past 20 years has been more concerned with the next election than with real reforms. This has kept all those in power regularly subsidizing the PF from the state budget. Starting from 2004, the volume of these transfers has grown almost exponentially, soaring to UAH 72 billion in 2010 – an unheard-of sum representing 30% of the national budget. This is precisely how much all other sectors failed to receive collectively and this is the additional burden companies and hired workers have had to carry. However, the most curious items of budget spending did not suffer for it. For example, the government paid out UAH 335 billion in tender-based purchases in 2010, almost twice as much as in 2009.

Thus, we have a vicious circle which is getting smaller: growing pension spending, no adequate sources of financing, money transfers from the national budget (a drowning man’s straw), an increasing tax burden, a sluggish economy, and as a result, smaller PF receipts and problems with pension payments.

The decline of the pay-as-you-go pension system will become inevitable over time. In the mid-1980s, European and other countries ran into similar problems.


A variety of measures were employed to solve the problem in other countries: raising the retirement age (Germany, Greece, Italy, Portugal and Great Britain); increasing the minimum qualifying age for a full pension (Germany, Greece, Italy and others); introducing tougher conditions for early retirement (France and Germany); indexing payments (Austria, Finland, France, Germany, Greece, Italy and the Netherlands). Countries also cut the period during which a greater length of employment qualified pensioners for higher future payments (Austria, Finland, France, Italy, the Netherlands, Portugal and Great Britain). Pension privileges were slashed in Finland, Greece, Italy and Portugal. Paradoxically, the above measures which offered merely a temporary relief were never called “reforms” in these countries, unlike in Ukraine. As they fixed parameters of the existing pension system, developed countries concurrently carried out reforms to fundamentally change its nature through a transition to a new mechanism.

What Ukraine needs is not temporary relief, but a way out of several dead ends into which the pay-as-you-go system has led it and from which “it is catching the living by the heel,” as one analyst put it. Permanent pension spending growth is caused not by anyone's evil mind or even an “IMF plot.” It arises from the political and economical nature of the current system. It appeared in conditions of rapid industrial growth and a pyramid-like demographic structure – there were many more contributors to the PF than pensioners.

Today growing pension spending cannot be financed by either raising the “pension tax” rate (it seems to have peaked) or increased subsidies from the national budget. The effects of raising the retirement age and other parameter-correcting measures will last only for a little while.

Deep-seated contradictions within Ukraine’s traditional system pension make it utterly unstable and vulnerable. Thus, the reform should above all be geared toward a switch to a modern multilevel system which has served well in Sweden, Poland, Switzerland, Denmark, Australia, South Africa, Great Britain and many other countries.


The government-sponsored bill which parliament will consider in June consists of two parts. The first one pertains to adjusting some key parameters of the pay-as-you-go system, namely the retirement age and increasing it for various segments of the population; the procedure and formula for calculating pensions; a pension cap; changes to the indexing scheme and other things. The discussion has understandably been focused on the parts which affect the most citizens.

The second part of the bill is about the future of pension reform. It describes changes to legislation which will usher in the so-called second level – mandatory defined-contribution retirement insurance, something which was supposed to be completed back in 2007.

The government’s proposals in the first – “parametric” – part of the bill boil down to one thing: making people work longer, paying them less and for a shorter period at that. Citizens are expected to resign themselves to the difficulties and grin and bear it without complaint. Unfortunately, the sponsors of the bill are ashamed to say this out loud. But is there really anything wrong with it if you give it a thought? There is in fact nothing shameful about it – this is the situation we are in now after we have wasted precious time. When the new pension system was introduced in Ukraine in 2003, the burden on our PF was among the smallest in Europe. This would have been the perfect time to launch pension reform. Instead, the government(s) did nothing until the situation deteriorated to the point of a social disaster.

The second – “reformist” – part of the bill concerns various aspects of the defined-contribution system which was announced back in 2003. These points are quite thorough and detailed, especially with regard to how the system will operate and be regulated. The authors’ job was not that hard, because the main proposals were voiced a number of years ago but reform been up in the air since then. It looks like this is not going to change.

For example, under Article 1 of the Draft Law “On Measures for Legislative Provision of the Pension System Reform,” contributions to the Superannuation Pension Fund is to be introduced (surprise!) “in the year in which the Pension Fund of Ukraine starts operating without a deficit.” It is wishful thinking to believe this will happen any time soon. Look again at the 2010 deficit of UAH 34.5 billion. Moreover, the “introduction” cannot occur automatically but will require a “manual mode,” i.e., a separate law. This is not to mention a lack of any serious proposals to make the third level work which could greatly relieve the pay-as-you-go system. Non-government funds will be able to participate in the second-level system no sooner than two years after its possible launch which cannot occur before a victory over the deficit.

Thus, both the reformists themselves and their active opponents can relax for now. The government has put pension reform (not to be confused with parameter-fixing measures) on the back burner. Instead, it is itching to raise the retirement age – the date that is to take effect has been moved from January 1, 2012, to September 1, 2011. The draft law caps pensions paid to “special” categories at 10 subsistence wages (UAH 7,640 at present). However, there is grave doubt that the Cabinet of Ministers will tweak the existing system of pension calculations under the pay-as-you-go system if only because it is regulated by as many as 30 laws. The Ukrainian Week has shown (Issue 8, 2011) that the determining factors here are not only a person’s salary and length of service but above all his status. In other words, the system is unfair and a person’s social status determines the legislatively fixed calculation algorithm and hence the size of retirement benefits.

What regards balancing the PF budget, the main problem is the disbalance between the country’s macroeconomic indices which have been irresponsibly skewed to favor pensioners as “the most disciplined electorate” before elections. In the past six years, Ukraine’s GDP grew 3.1 times and an average wage 3.8 times, while pensions increased 5.5 times. As a result, the wage replacement rate grew 1.5 times from 30% in 2004 to 47% in 2010. This creates a huge gap between PF receipts and expenses. The latter are paid from the national budget on the backs of all taxpayers.

There are very good reasons to eradicate these status-related Soviet vestiges in the pay-as-you-go system, which the USSR patterned after the mechanism Otto von Bismarck introduced in Germany in 1889. Now there is an urgent need to implement instead a three-level system with a powerful defined-contribution component — something other countries did long ago.


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