Russian Pension system and its comparison to the Chilean Pension system
Provision of social welfare to Soviet population was a critical problem prior to collapse of Soviet Union. Russian government developed a pension plan that was financed on pay as you go (PAYG) basis via the transfer of resources from state owned corporations to communal insurance section.(Williamson, Howling & Maroto, 2006) . The previous pension scheme was made up of two segments; public and voluntary components that created a modest social security system.
The public component offered generous pension to employees in formal sector whereas the voluntary component provided some privileged groups an avenue to augment their pension income. Under the voluntary component, lowest age for retirement was pegged at 60 years and 55 years for men and women respectively. Beneficiaries of the scheme were also required to have worked for a minimum period of 20 years (Williamson, Howling & Maroto, 2006). The old pension system attracted a large number of elderly in Russia because it was generous and all-inclusive.
For instance, the earliest pensions were paid to Red Army veterans beginning in 1924. By 1940, about two million people were benefiting from the pension and five decades later, the number had increased to 43.9 million. Women were major beneficiaries under the old pension system as it offered them credit for periods spend out of work due to maternity leave. It also balanced differences in men’s and women’s pensions by considering traditional gender roles. The system provided for early retirement packages for people with erratic work histories brought about by injury, sickness or child care leave (Williamson, Howling & Maroto, 2006).
However, the system had numerous flaws that made it unsustainable. For example, the eligibility model gave privileges to some groups that abused it. There was great inequality in the benefit structure as senior members of the party benefited more at the expense of others. The system also gave little room for personal choice. Retiring employees were classified according to their aggregate income level and previous work experience. They were not given freedom to seek for alternative pension financing (Williamson, Howling & Maroto, 2006).
However, financial instability was the prominent flaw in the system especially during economic transmission that took place after the demise of communism. This weakness was attributed to the fact that Soviet pension system was devised for a command economy under government control. The system could thus not be maintained when Russian economy shifted to a market-based model between in late 1990s. As a result, pensioners did not receive benefits in time and payments were sometimes delayed up to three to six months. Whereas pension benefits were close to 100% in late 1980s, the rate declined significantly to 40% during the 1990s (Williamson, Howling & Maroto, 2006).
Government efforts to restructure the pension system became too costly in long run. It thus became apparent that the system was unsustainable. As birth rate declined and unemployment rate increased during the 1990s, Russian policy makers concluded that the pension scheme needed comprehensive changes to make it efficient and provide cover to all citizens (Williamson, Howling & Maroto, 2006).
The pension reform model currently implemented by Russian government is based on the three-pillar World Bank model of social pension reform. The first is a pay as you go pillar and is financed by government. The second pillar comprises two parts, both of which are mandatory: a pay as you go distinct contribution component and a state funded contribution component. Voluntary pillar is the third, also known as contribution insurance pillar (Williamson, Howling & Maroto, 2006).
The first pillar is made up of Basic pension component and Insurance component. The first is a government-financed pay as you go component with prominent redistributive aspect towards low income employees as it offers a flat rate benefit. Six percent of the identical social security tax is divided into the basic pension which is indexed to inflation. Insurance component is funded on a pay as you go basis (Allianz Global Investors, 2010). The rate of contribution varies on the basis of age of workers.
Those born before 1966 give 14% from the uniform social security tax to the insurance part while younger workers pay 7% since another similar rate is paid into the compulsory second pillar. These contributions are fused in the insurance part that is indexed to inflation. Under the first pillar, contributions are fully tax deductible as company outlays and benefits are rewarded in form of lifelong untaxed payment (Allianz Global Investors, 2010).
The second mandatory pillar, known as Occupational Pensions complements the basic and insurance part as the third ingredient of the mandatory pension system. Workers born after 1967 pay 7% of the identical social security tax to the funded part while those born prior to 1966 are exempted. In contrast to the old pension system, each worker has prerogative rights to decide if contributions will be allotted to Non-state Pension Fund (NPF) or the Pension Fund of the Russian Federation under the current system. Also, tax on contributions is treated as company expenses (Allianz Global Investors, 2010). The threshold for eligibility for retired pensioners has also been relaxed. For example, apart from attaining retirement age, it is essential to have five years of employment duration as a replacement for the previous requirement which demanded men to have worked for at least 25 years and 20 years for women (Gurvich, 2004, p.17). Consequently, more employees are able to enrol and benefit from the new pension system.
NPF have been permitted to play a part in the mandatory system as separate legal organizations since 2004. They play a vital role in gathering pension money and investing it before dispensing contributions to beneficiaries’ personal accounts. Every worker is given an insurance certificate with a unique code that solves identification issues usually related to decentralized second pillar pension (Allianz Global Investors, 2010). This way, contributions are directly connected to workers irrespective of the contributor.
The Voluntary Occupational Pension is the third pillar and is made available to public and private businesses and individuals. Providers of this scheme are insurance firms and NPFs. The law does not control portability of pension rights under the third pillar. This implies that employers can directly enter into an agreement with NPFs. Contributions are made in lump sum from employers to workers’ account. Therefore, portability relies on agreement between NPFs and employers. As regards tax treatment, employers’ contributions amounting to 12% of the payroll are not taxed as long as benefits are remunerated in form of an annuity (Allianz Global Investors, 2010).
The current trend of an aging population threatens to afflict the pension model in Russia. The working age population in the country is projected to decline significantly in years to come due to declining fertility and high life expectancy (Allianz Global Investors, 2010). For example, percentage of aged population (above 60 and 55 for men and women respectively) is rising from 20.8% and is expected to reach 37.9% by 2050. On the other hand, share of working age population is failing from 62.2% and is projected to reach 48.8% by 2050 (Gurvich, 2004, p.17). These estimates highlight severe problems that the pension system will encounter in the future.
Russian Pension System and the Chilean Model
The Chilean Pension system is based on private account and mandatory individual account. Unlike the Russian pension model, the Chilean one is sustainable and was even proposed as a basis model for modernizing Social Security System in the United States. The individual capital account concept under the Chilean model is quite appealing to many retirees who concur that the state is often not able to maintain adequate assets to fund a retirement system (Insurance & Pension, 2005). The model thus provides protection to individual accounts against political interference, a vital element that does not feature in the Russian model.
The versatile nature of the system has enabled the model to serve pensioners for more than two decades. The fact that it has been self sustainable for a long time has inspired confidence from many quarters. One aspect of the Chilean pension system that is similar to the Russian model is the way risks are diversified. Under the former, risks are shared while in the latter, basic pensions are indexed to inflation (Insurance & Pension, 2005). Thus both systems ensure that pensioners’ benefits are not eroded by economic variables such as inflation.
Whereas Russian pension model consists of three pillars, the Chilean model is managed under seven private sector pension administrators. The first pillar of the Chilean model is the government, which funds the entire public assistance pensions offered to the aged poor. The second pillar comprises the private sector pension managers who run the obligatory Social Security savings thereby alleviating burden on the government. The third pillar is made up of Chile’s labour force that makes voluntary savings either to augment its pensions or opt for early retirement (Insurance & Pension, 2005).
The Russian and Chilean model allow establishment of direct connection between contributions to the systems and benefits accruing from it. The major virtue of Chilean model is its impact on country’s gross domestic product. The system acts like a virtuous circle that creates wealth to all participants. For example, Social Security savings of Chilean labour force is about US$59.9 billion, equivalent to 60.1% of the country’s gross domestic product. Moreover, the overall rate of return on investment for pension funds has been 10.4% more than the average annual inflation rate in last two decades (Insurance & Pension, 2005). The amassing of savings in individual accounts produces long-term resources for the economy.
Gurvich, E. (2004). The Distributional Aspects of the Russia’s Pension System. Retrieved May
12, 2010 from http://www.eeg.ru/downloads/publications/analytics/a20042511.pdf.
Insurance & Pension. (2005). Chile’s Pension Reform: An Inspiration to Others. Retrieved May
12, 2010 from http://www.wharton.universia.net/index.cfm?fa=viewCat&CID=5&language=english
Williamson, J.B., Howling, S.A., & Maroto, M.L. (2006). The Political Economy of Pension
Reform in Russia: Why Partial Privatization? MA: Department of Sociology, Boston College, Chestnut Hill.
Allianz Global Investors. (2010). Russia: Pension System Design. London: AP Information