October 3, 2008 USDAID/Armenia Comments and Recommendations on the White Paper on “Pension System Reform Program” This document comments on the White Paper of the Pension Reforms Working Group (PWG) on “Pension system reform program: Main principles, strategic directions, tactical steps and actuarial forecasts for 2008-2080.” We begin with a summary of the recommendations. 1. Summary of Recommendations Unified Tax PRWG Proposal USAID Comments USAID Recommendations Unified social tax of 26% will replace The tax rate of 26% (plus 5% To encourage job creation and income tax and social contributions. employee contribution to the Second formalization, the total burden Pillar) is high, an increase of 5% on labor from taxes and pension from the current contribution level contributions should go down for most workers. Gender issues not from current levels, to the extent examined. feasible given the need to also maintain long-term fiscal sustainability. (See Appendix 1). Zero Pillar PRWG Proposal USAID Comments USAID Recommendations Social Pension is 80% of Basic This is an appropriate level of Adopt as proposed. Pension. pension. No mention regarding how Social Social Pensions should be paid Develop business process for Pensions will be paid. through the banking system, either to electronic payment. bank accounts or by withdrawals using smart cards. First Pillar PRWG Proposal USAID Comments USAID Recommendations First Pillar pensions for those with The cost of the overall system as Further development of data to years of service prior to reform are a proposed is affordable, at 0.5% of study the overall long term fiscal total of the flat Basic Pension plus an GDP (Appendix 1). With a lower effects and labor market effects amount linked to length of service rate of contributions, the initial of the reform of proposal. (LOS). annual cost would be higher, but future liabilities might be lower. After initial years when the Basic Different indexation approaches Incentive structures and fiscal Pension catches up to the minimal present tradeoffs. Indexing Basic implications under the two consumer budget, it will be indexed to Pension to wages rather than prices approaches require further wages; LOS will be indexed to CPI. will increase pensions and cost more. analysis. First Pillar pensions for those with no This is an appropriate model, which Adopt First Pillar as proposed years of service prior to reform (new places income and length of service for new entrants. entrants) will consist only of the differentiation entirely into the Basic Pension. Second Pillar. Second Pillar PRWG Proposal USAID Comments USAID Recommendations Second Pillar is to be funded by 5% The Second Pillar collection process The full 10% should be sent employee contributions, and 5% from proposed is complex and carries a directly to individual accounts, the unified tax that is to be paid by the high level of risk due to separation of not through the Treasury, and in Treasury (subject to a ceiling). funds and data. The ceiling for those all cases individual data should who are highly compensated will travel with funds. Consider serve as a disincentive to formal system in which data is sent workforce participation. first and verified before a payment order is issued. Domestically chosen asset managers Domestic asset managers will charge It would be far less costly and will manage assets abroad as well. higher fees than firms chosen less risky to choose a pool of through international competition; international asset managers to this will add to costs and affect offer portfolio choice in returns. investments abroad. No default portfolio for participants More consideration should be given Establish a default portfolio for who do not choose asset managers, to defining the default asset the Second Pillar. and unclear direction as to their managers and portfolios, since many portfolio. will fall into this category. Overseas investment is limited to There is insufficient domestic This cap should be eliminated 30%. absorption capacity. or significantly raised. TEE (Taxed-Exempt-Exempt) tax EET tax regime stimulates Adopt EET (Exempt-Exempt- regime. participation and results in more long Taxed) regime. term tax revenue. Administrative fees and most Cap of 1% on unit redemptions is Fees should be capped in maximums are not set in legislation. very high. Administrative costs legislation. Consider A maximum of 1% is set on unit should be estimated initially to make approaches to minimize asset redemptions. sure that reform proposals do not management fees, such as use result in expensive systems requiring of a single investment pool in high fees. the early years, or international fund managers with lower fees. Third Pillar PRWG Proposal USAID Comments USAID Recommendations Individual voluntary pensions only, Premise that employer sponsored Include employer provided no employer sponsored pension funds require strong unions is pensions on a defined schemes incorrect. Also shortage of actuaries contribution basis. is not a barrier. Providers can only be licensed to sell Requiring specialized providers will Permit all licensed financial this product limit the market, not allow institutions – banks, insurance economies of scale and therefore companies, asset managers – to decrease competition. provide this product. Tax regime is not stated. EET tax regime is appropriate. 2 Management of the System PRWG Proposal USAID Comments USAID Recommendations Money flows to the Treasury while Flows of information and money Particularly for the Second individual data is to be sent to the State are complex and unclear. Pillar, individual-level data Revenue Committee (SRC). Considerable attention is needed to should be conveyed monthly, make these flows simple, efficient electronically, along with and sufficiently detailed. payments. This is critical to ensure competent reconciliation. Use of the social security card number is recommended. No single agency is in charge of Responsibility for informing Unified development of public information to the public about asset participants about asset information message and management. management choice needs to be coordinated distribution through clear. This cannot be left only to the various agencies. asset managers themselves. SRC is in charge of reconciliation. If SRC will be the agency, it must create systems and train staff urgently. State Labor Inspectorate (SLI) checks This should be done only at SSSS If it is the designated agency, documents for First Pillar Pensions request and requires no new the SRC should do all functions. compliance related to Second Pillar. SLI has no role in Second Pillar Pensions. The employers’ report to the SLI should be abolished when electronic recordkeeping is in place. Streamlining of State Employment This is an appropriate reform. Service Agency and direct Treasury However, it does not address the financing goal of one-stop-shop social services. Transferring responsibility for This could be an appropriate Implementation requires assistance benefits from local agencies streamlining reorganization. The planning for business process to SSS status of non-cash benefits is change, integration of unclear. information systems, and redundancy. The status of non- cash benefits needs to be clarified. Implementation of the Reforms PRWG Proposal USAID Comments USAID Recommendations No implementation plan or indication Successful implementation will be One high level person of responsibility for very difficult and very difficult. Reforms in other responsible for pension reform complex tasks. countries indicate that having a implementation, with authority single high level official responsible to manage the reform and to for pension reform overall is direct agencies to draft important, and that in spite of best legislation, design business 3 efforts it is difficult to coordinate processes, and design and among agencies and that there are oversee tenders for IT and other many delays. procurements. Proposed organization chart for reform is attached, Appendices 2 and 3. No implementation budget. Implementation budget is essential. Adopt implementation budget with specific items (information technology, public information) itemized. Issues for Future Discussion PRWG Proposal USAID Comments USAID Recommendations Agricultural and informal sector These are very important issues that Address these issues separately. coverage; early retirement for certain will require further policy professions (privileged pensions); consideration but need not be fully Second Pillar Pay-out (disability and developed now. annuity options). 2. General Reform Design The White Paper articulates a clear vision of the overall goals of the pension system, and the objectives and methodology of each pillar in the system. Overall pension reform objectives include: • Social safety net for the vulnerable • Sustainable pension system • Reduction of informality – changing incentive structures for contributions The PWG proposal for pension reform is as follows: o for those with at least 10 years of social tax payment, some of which are prior to the effective date of the reform, an Employment Pension (First Pillar) financed by a unified tax of 21% of wages; the First Pillar consists of two parts: 1) a flat Basic Pension, this pension is the basis for all other benefits; and 2) an amount reflecting years of contributions prior to the reform; o for those whose years of social tax payment are entirely after the effective date of reform, only the Basic Pension is to be paid