The Ukrainian pension system requires urgent resuscitation

Kharkiv, Ukraine (Irene Mei, CC BY-NC-ND)

The IMF is calling on the Ukrainian government to patch the gigantic hole in the retirement system, however, Kiev is refusing to raise the retirement age and offers other solutions.

According to the estimates of the Ministry of Social Policy, the hole in the Ukrainian pension system will reach UAH142bn this year, i.e. about USD5.44bn. This means that the situation is a worse than last year, when the sum of payments to pensioners reached UAH250bn (USD9.6bn). The Pension Fund (an equivalent of the Polish Social Insurance Institution) was only able to cover UAH112bn (USD4.3bn), or 44 per cent, from the collected contributions. The government had to cover the shortfall from the state budget. It must be remembered, however, that the pensions received by 12 million Ukrainian pensioners are very low – the average pension in 2016 was UAH1,828, which is less than USD70.

There is no one out there to pay in

This is the result of an accumulation of various factors – the declining number of working-age people, high unemployment, and the huge wave of economic emigration. All this means that the contributions paid by employees are not enough to cover Ukrainian retirees receiving pensions in the solidarity-based system. Only half of the 20 million working-age people paid pension contributions last year.

Ukraine is depopulating at a rapid pace. According to estimates of the Institute for Demography and Social Studies of the National Academy of Sciences of Ukraine (NANU), between 2013 and 2050 the population of Ukraine will fall from the current 42 million to 35 million. This process, which was already very fast, given the fact that the country had 52 million inhabitants when it proclaimed independence in 1991, has additionally accelerated in connection with the Russian aggression, the occupation of the Crimea and the war in the Donbass region.

The hole in the pension system is further deepened by economic emigrants. The NANU has estimated the number of people who permanently left the country at 3 million in the years 2014-2016.

According to Oleg Ustenko from the Blazer Foundation, who describing the situation of the Ukrainian pension system said: “The deficit of the Pension Fund is currently at 6.4 per cent of GDP. This is a catastrophic level. It will be difficult to implement a reform, but if we fail to do that, we have to be ready for the system to collapse.”

Prime Minister Volodymyr Groysman argues that Ukraine will deal with this problem in the coming years. “If a correct approach is adopted, we will close the Pension Fund deficit by 2024,” he declared in mid-February at a government meeting.

The IMF demands changes

In accordance with the memorandum signed by the Ukrainian government and the International Monetary Fund (IMF) last year, Ukraine was supposed to reform the pension system by the end of March 2017. In the original version the relevant bill was to be adopted by the parliament by the end of last year, but there were no MPs brave enough to do that.

The IMF is demanding that Kiev combine in one legislative act all the provisions concerning the pension system, which are currently scattered across many acts, and introduce statutory provisions on the gradual raising of the retirement age, the limitation of the possibility of early retirement, and restrictions on the payment of the minimum pension. The IMF’s demands include, among other things, the equalization of the retirement rules for all occupational groups, except for the military, stronger links between paid contributions and received benefits, and the elimination of special pensions.

Retirement age

The issue that generates the most controversy in Ukraine is the proposed increase in the retirement age. The IMF wants the retirement age to be raised over ten years from the current 58 years for women and 60 years for men to 63 years for both groups. These changes would be gradual. The retirement age of men would be raised by four months each year starting from July 2017, and the retirement age for women would be raised by six months each year starting from 2021, informed the Economichna Pravda in mid-January by referring to unpublished documents.

IMF representative, Gerry Rice presented a slightly more subtle vision a few weeks later. “Ukraine has agreed to carry out a pension system reform in order to reduce the deficit of the Pension Fund. One way to achieve this is to raise the retirement age or the required period of contributions to the system,” he said in early February.

Due to fears of social protests, the government is, at least officially, opposing the demands to raise the retirement age. According to a survey conducted by USAID, over 90 per cent of Ukrainians oppose the raising of the retirement age. “I’m certain that the current authorities will not take any steps to raise the retirement age,” commented Deputy Prime Minister Pavlo Rozenko, recalling that the raising of the retirement age under the government of Yanukovych did not bring positive results in 2011. “The deficit of the Pension Fund has significantly increased compared to 2011. Back then it was UAH40bn (USD1.5bn), and now it has reached over UAH140bn (USD5.4bn). As a result of the raising of the retirement age the deficit increased instead of decreasing,” said Mr Rozenko.

In his opinion, the proper approach to solving the problem is to increase workers’ income, and consequently, the pension contributions. One of the steps towards this goal was the decision to raise the minimum wage, which was enacted last autumn.

The government is focusing on length of time in employment

“The main indicator is when a person worked and paid his or her contributions. If you worked and paid contributions long enough, you will get a pension. There will be no simple retirement age increase, as we believe this is not the right approach,” commented Finance Minister Olexander Danyluk.

One alternative to raising the retirement age could be the government proposal for buying the lacking length of time in employment. According to a proposal presented by the Ministry of Social Policy in mid-January, the right to pension would depend on a length of time in employment of at least 15 years. Everyone could buy these lacking 15 years by paying UAH130,000, i.e. less than USD5,000, to the Pension Fund.

The only problem is that this solution makes no economic sense for future pensioners. The amount of the surcharge is currently more or less the equivalent of about one hundred minimum pension payouts – this is what the average Ukrainian pensioner would receive from the state if they retired at 63 and reached the average life expectancy of 71.4 years. In reality, paying a surcharge for the required period of contributions to the system means supporting a failed pension scheme at a zero interest rate. As evidenced by the simulations published by Pavel Sebastyanovich from the association of small and medium-sized entrepreneurs “Nova Krayina”, investing this money in the most secure securities with a minimal interest rate would give a better financial result.

It is also unlikely that the situation will be improved by private pension funds. Firstly, Ukrainians who are currently tightening their belts and limiting their spending to basic necessities simply cannot afford to save money. Secondly, the level of confidence in financial institutions is extremely low. As a result, Ukrainians have only paid in a total of UAH2.5bn (USD95.9m) to the 66 pension funds operating in the country.

Ukrainians won’t work on retirement

Simultaneously with an increase in the length of time in employment with contributions paid to the system, the Ministry of Social Policy wants to introduce a full ban on combining pension and work. This is supposed to free up jobs for the younger generations currently affected by unemployment.

“All over the world there is a simple principle applied – either you get a pension or a salary. After the pension reform is implemented, when the pensions become sufficiently high, we need to set out a rule – you work, earn money and retire a little later, but with a higher pension, or you retire right away, but you can no longer work,” explained the Minister of Social Policy of Ukraine Andrey Reva. He also announced draconian penalties for those employers who would like to employ retirees unofficially.

According to Andriy Pavlovsky, the former head of the parliamentary committee for social policy, it is a misunderstanding to discuss raising the retirement age to 63 years, when the average life expectancy of a Ukrainian man is currently 62. “Most Ukrainians will simply not live long enough to retire,” he argues

Mr Pavlovsky points out that according to experts’ calculations, the possible rise of the retirement age will not have any considerable financial effects, but it will aggravate the problems of the labor market by blocking jobs for the young people entering the market. It will also lead to “wage dumping” – a situation in which people in pre-retirement age will agree to grossly depressed wages just in order to remain employed until retirement.

In his opinion, the government’s proposed ban on work for pensioners is also unacceptable, because more than 7 million retirees receive benefits below the official minimum subsistence level.

He believes that the hole in the Pension Fund could be easily patched through the implementation of necessary systemic reforms: limiting the shadow economy, which currently covers more than 50 per cent of the Ukrainian economy, stopping the oligarchs from siphoning billions of dollars a year to tax havens, and conducting a thorough review of the public programs financed from the budget.

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