1. NDC EXPERIENCE IN EUROPE
AND CENTRAL ASIA REGION
Anita M. Schwarz
Lead Economist
ECSHD
April 2013

2. ECA IS THE MAIN REGION WITH
EXPERIENCE IN NDCS
 3 countries paying pensions on notional account
basis
 Latvia
 Russian Federation
 Azerbaijan
 2 countries not yet paying full pensions on a
notional account basis
 Poland
 Kyrgyz Republic
 Turkmenistan (?)
2

3. ADMINISTRATIVE COMPLEXITY LIMITS
IMPLEMENTATION AND TRANSPARENCY
 Lack of understanding by pension administrators
of how to administer a notional account system
 Azerbaijan only provides notional interest rate equal
to inflation on contributions made after 2006
 Average pension is only 38% higher than minimum pension
 Kyrgyz Republic only provides notional interest on
new contributions made in a particular year, not on
the balance in the notional account
 In both systems, flat basic pension comprises
significant part of the overall benefit
 Administrative issues in Russian Federation
 Difficulties in managing the large amount of
information over large population and wide
geographic area 3

4. RUSSIAN EXPERIENCE
 Converted existing DB system into notional
capital
 Provided a notional interest rate equal to growth
of contribution revenue per pensioner – even
more conservative than Latvia and Poland, but in
line with what the pension fund collects in
revenue and what it pays out in pensions
 Initially legislated a life expectancy of 12 years in
2002, which was supposed to rise to 16 years by
2010 and to 19 years by 2013
4

5. RUSSIAN OUTCOME AND POLICY
RESPONSE
 By 2008, pensions were averaging 26% of average wage
 Notional interest rate – contribution revenue per pensioner
 Contribution split between notional, basic, and funded for cohorts born after
1967
 As contributors born after 1967 increased in the labor force, contribution
revenue to public system fell
 Basic pension was indexed to inflation only; notional part indexed to
contribution revenue per pensioner – neither could keep up with 20%
annual real wage growth pre-crisis
 Ad hoc policy response
 Arbitrary increases to notional capital awarded to those with years of
service prior to 1993
 Arbitrary increase in basic pension – sizable, raising average pension
to 40% of average wage from the previous 26%
 Increase in contribution rate to 26%, followed by subsequent decrease
to 22%
 Life expectancy was not raised as legislated
 Latest – reduction in funded pillar to help finance deficits in public
system from 6% to 2%
 Weakened (almost decimated) link between contributions and
benefits
5

6. LATVIAN EXPERIENCE
 Coverage increased 30% between 1997-2007
 Then dropped by 8% in 2009
 Real wage growth stood at 23% in 2007
 Then dropped to -14% in 2009
 Cohort of 18 year olds in 2016 will be 47% the
size of the 18 year old cohort in 2006
 Fertility shock of early 1990’s has persisted,
reducing the parent age cohort and making a
quick turnaround almost impossible
 Emigration – 15% of 20-40 year olds born in
Latvia are no longer living there 6

7. NOTIONAL REAL INTEREST RATE RAISED
THE LEVEL OF NEW PENSIONS
2005 2006 2007 2008 2009
Notional real interest rate applied to new retirees 11% 11% 13% 21% 28%
Average newly assigned old age pension adjusted
to 2009 prices, LVL 127 146 161 180 215
Growth of newly assigned pension in real terms 100% 115% 127% 142% 169%
7

8. LATVIAN POLICY RESPONSE
 Boom year revenue was spent: (pension
buffer fund insignificant):
- Partial wage indexation introduced
- Additional pension benefits introduced
(initially income tested; designed to benefit
older pensioners more)
- Other SI benefits increased (from the same
revenue pot)
 After the bust:
- Pensions not indexed to deflation
- Observed life expectancy increases not
applied to pension formula (would have
decreased new pensions)
- Grab for contributions going to funded –
reduction in contribution from 6% to 2%
 All of these break the supposedly tight
self-correcting NDC mechanism:
 - Deficit projected until 2060 8
 Do people respond to
incentives to retire later?
 In 2009, Latvian notional
real interest rate was 28%
 Postponing retirement by
one year would have
increased annual pension by
28% throughout retirement
period
 Overwhelming majority of
people still retired at
minimum retirement age
 Is the NDC transparent?
 Pension statements
stopped being sent in 2009
due to “lack of funds” just
as the notional interest
rate became negative

9. POLISH EXPERIENCE
 Projected decline in future
benefits despite ret age at 67
 Socially unsustainable
to have people pay
27.52% of wage in
contributions for 40-45
years and receive only
25-30% of average wage
in retirement
 How will policy adjust to
the political challenge
 Grab at revenue going
to funded system –
reduction from 7.3% to
2.3%
 Flat increases in
benefits in 2012
0.0%
20.0%
40.0%
60.0%
80.0%
2011
2016
2021
2026
2031
2036
2041
2046
2051
2056
2061
2066
2071
Projected Male Average Old Age Pension
Benefits as % of Average Wage
1998 Reform 2011 Reform
2012 Rev 1
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
2011
2016
2021
2026
2031
2036
2041
2046
2051
2056
2061
2066
2071
Projected Female Average Old Age Pension
Benefits as % of Average Wage
1998 Reform 2011 Reform
2012 Rev 1
9

10. LESSONS FROM IMPLEMENTATION
EXPERIENCE
 Timing and transparency
 NDCs build account balances on wage bill/wage growth/GDP growth outcomes during
a worker’s working years, but the revenue capacity of the social insurance fund can be
entirely different by the time a person retires
 But since the account balance is transparent, it ties the policymaker’s hands
 Can build a demographic reserve like the Swedes have done, but the experience in all
of these countries is at the first sign of any kind of fiscal trouble, that money
disappears – Poland, Latvia, Ireland
 Pension systems follow Murphy’s law – whatever can go wrong, will go wrong!
And it’s hard to predict what it will be.
 Latvian and Russian NDCs – one ended up with too high pensions; the other with too
low pensions
 When adjustments need to be made (and they will need to be made due to the
inherent volatility in developing countries), NDCs leave fewer tools in the
policymaker’s toolbox to address adjustments – more likely to lead to ad hoc
measures
 Political economy of “stealth” reforms
 Easy to pass legislatively, but when they begin to bite, political process demands
remedies – can involve throwing out the whole system, adding on ad hoc measures
which effectively undo the links, not undertaking automatic adjustment mechanisms
 Doesn’t imply that NDCs aren’t a useful pension structure
 ECA experience does show that they are not necessarily better than other PAYG
systems 10