Health and Pension Reforms in Central Europe. System of private pension provision Case of Slovenia

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1 Health and Pension Reforms in Central Europe System of private pension provision Case of Slovenia Vienna, 25. April 2008 Meta Berk Skok

2 Table of Contents 1 Summary Role within the social system Mandatory supplementary pension insurance Voluntary supplementary pension insurance Regulation Providers Mutual pension fund Pension companies Benefits / services Supplementary old-age pension Early supplementary old age pension Funding Tax incentives Current reforms and future plans Challenges and opportunities Literature:

3 1 Summary In Slovenia system of private pension provision was introduced within the pension reform adopted in the year 1999 and enforced in year The Pension and Invalidity Insurance Act enforced in year 2000 introduced a new form of private pension provision, so called supplementary pension insurance for people included in the existent mandatory pension and invalidity insurance scheme. The motive was to provide at least replacement of the gap in after retirement income from the mandatory pension and invalidity insurance scheme. Supplementary pension insurance is a form of defined contribution system where the insurance holder assumes the investment risk at the minimum guaranteed yield on the premium paid. The size of pay-outs depends therefore not only on the amount paid in but also on the yield generated by investing funds obtained from premiums. The insurance holder pays contributions and is in return guaranteed additional rights to the rights arising from mandatory pension and invalidity insurance scheme. On 30 September 2007 about 55 % of all employees were included in the supplementary pension system in mutual pension funds and insurance-like schemes. Annual contributions per member are low and can not fulfill the expectations of the system s founders. 2 Role within the social system The pension system in Slovenia is a combination of mandatory pension and invalidity insurance based on a pay-as-you-go system and supplementary pension and invalidity insurance. Mandatory insurance is financed by contributions of employers and employees, and transfers from the state budget. Transfers from the state budget are necessary to cover a growing deficit of assets to finance pensions for various groups of insured persons. The purpose of supplementary pension insurance is to guarantee supplementary social security after retirement. The Pension and Invalidity Insurance Act provides two types of supplementary insurance: mandatory supplementary pension insurance and voluntary supplementary pension insurance. Picture 1: Role of supplementary pension insurance within the pension system 2

4 2.1 Mandatory supplementary pension insurance The purpose of mandatory supplementary pension insurance is to replace the old insurance period with increase (bonus) and is intended for people working in demanding jobs and professions where due to the specifics of their work they cannot be expected to work until their full retirement age. This system provides certain categories of workers with a right to early retirement and so-called bridging over pension. 2.2 Voluntary supplementary pension insurance Voluntary supplementary insurance is primarily aimed for the younger generations of working people It is already clear that as a result of the gradual reduction in pensions paid under mandatory insurance they will have to fund part of their old-age security themselves. Voluntary supplementary pension insurance has the following characteristics: only people insured or claiming rights under mandatory pension insurance may be included; defined contribution system; premiums are paid in installments on the personal accounts of the insured persons; the insurance holder assumes the investment risk, at the minimum guaranteed yield; is established by a pension scheme (plan); The pension scheme (plan) identifies the conditions for the acquisition of rights under voluntary supplementary insurance, the kind and scope of these rights as well as the procedure for their assertion. can be provided in the form of individual or collective insurance; Individual pension scheme can be joined by any individual, who is insured under mandatory insurance; Collective pension scheme can be joined by an individual through employer, who finances (in part or fully) the premium. Each active insured person can participate in two schemes, so, it is possible to combine collective and individual supplementary insurance. by paying in premiums the insurer pays for a supplementary old-age pension as a supplement to the pension which the insured person is entitled to under mandatory pension insurance; 3

5 employee himself decides whether he wants to be included into collective insurance established by his employer; a precondition of a waiting period no longer than 1 year may be stipulated; gender equality is ensured with regards to the acquisition of the rights; contributor (employer or individual) is entitled to tax relieves; 3 Regulation Supplementary pension insurance is regulated with the same act that is regulates mandatory pension insurance - Pension and Invalidity Insurance Act. Pension companies, insurance companies, banks and Kapitalska družba are allowed to set and manage pension schemes. The structure of pension companies schemes, as well as those of insurance companies, is governed according to insurance legislation, pension schemes offered by banks and Kapitalska družba are governed by mutual fund legislation. This distinction allowed the development of parallel financial vehicles with fractured and uncoordinated supervision. Contributions to the pension schemes offering insurance-type financial vehicles are in many ways treated differently from contributions to the mutual fund-like pension schemes. Differences run the gamut e.g. valuation and accounting rules, reserve provisions, reporting, treatment in case of transferring assets into other pension schemes (i.e. portability issues), etc. There are four supervisory authorities: Ministry of Labour, Family and Social Affairs: is responsible for approval of the pension scheme (plan) and the supervision over the employees rights under approved pension scheme. Insurance supervision company: supervises the operation of pension companies and insurance companies performing voluntary supplementary pension insurance. Securities Market Agency; supervises the operation of mutual pension funds. Tax Authority: Supervision over implementation of the provisions with respect to the acquisition of tax and other reliefs. 4 Providers The providers of voluntary supplementary pension plan must obtain a license from the public authorities. Picture 1: Providers of pension plans within voluntary supplementary pension insurance 4

6 The pension scheme can be implemented by pension funds or insurance company holding the permit to perform life insurance operations in conformity with the law governing insurance. Pension funds may be formed as a mutual fund (open end and closed end) or pension company. 4.1 Mutual pension fund Is a pool of assets financed through the collection of premiums or resulting from the management of these funds. A mutual pension fund does not have legal personality. It is owned exclusively by insurance holder. There are two types of mutual pension funds: closed or open mutual pension fund. A closed mutual pension fund is a mutual pension fund that has the membership requirement that an insurance holder must work for an employer, who finance the pension scheme. There is currently one closed mutual pension fund in Slovenia Closed mutual pension fund for public employees of Republic of Slovenia. An open mutual pension fund is a mutual pension fund that does not have the membership requirement that an insurance holder must work for an employer. 4.2 Pension companies Pension company is a specialized form of insurance company. A pension company may only provide the services connected to perform voluntary supplementary insurance. 5 Benefits / services Person, insured under voluntary supplementary pension insurance, is entitled to: supplementary oldage pension and early supplementary old age pension. 5.1 Supplementary old-age pension Conditions for acquiring supplementary old age pension are: the age of 58 years (equal for women and men), asserted of the right to an old age pension from mandatory pension and invalidity system, membership in the scheme for at least ten years. Supplementary old age pension is paid in the form of life-time monthly pension annuity. The amount of supplementary old age pension is determined not only on the premium paid, but also on the yield generated by investing the funds obtained from premiums and actuarial principles (gender, age, actuarial tables, etc). 5

7 5.2 Early supplementary old age pension Early old-age pension is paid in the form of monthly pension annuity until person is entitled to oldage pension. Conditions for acquiring early supplementary old age pension are: the age of 53 years (equal for women and men), no longer covered by the mandatory pension insurance (usually it means lost job), membership in the scheme for at least 15 years. 6 Funding Funding for supplementary pension and invalidity insurance is based on defined contribution system where the insurance holder assumes the investment risk at the minimum guaranteed yield on net premium paid. Contributions to mandatory supplementary pension insurance can be financed solely by employers. Contributions to voluntary supplementary pension insurance can be financed by employers for his employees or by employees themselves. In Slovenia around 98 percent of all contributions in voluntary supplementary pension insurance are financed by employers. 7 Tax incentives Pension scheme (plane) must be approved by the Ministry of Labour, Family and Social Affairs in order to get tax incentives. Maximum tax relief is up to the 24% of contributions that have been paid for mandatory pension insurance in that year and not more than 2.526,23 euro per employee/insurance holder (in 2008) per year. Each person can participate in two schemes, so, it is possible to combine collective and individual supplementary insurance. In this latter case, the priority in tax relief is given to the employer. Collective insurance Employer, financing contributions for his employees, is entitled to tax (tax on profit) relieves in the year the contributions are paid. Contributions made by employer are not part of the employees wage and are therefore not taxed by social security contributions or other taxes. Individual insurance - Yearly tax basis for assessment of personal income tax may be reduced for the value of contributions that the insured person has paid for supplementary pension insurance to a provider based and registered in Slovenia or other EU member state. The annual amount of supplementary old-age pension is a part of insured person's base for the personal income tax in the corresponding year. 8 Current reforms and future plans The main drawback of the entire private pension system is a lack of competition. Beneficiaries cannot select pension vehicles but are told that the selected pension scheme provides optimal benefits. There is some competition among pension scheme providers. However, because of the mandatory minimum return (guarantee) that is embedded in the system, competition is the area of costs, not returns. Although cost efficiency is an important determinant of future beneficiaries wealth, returns 6

8 are much more important. Minimum guarantees are keeping pension scheme providers away from strategic asset allocations that would be reasonable for the beneficiaries. Government should foster professional asset management, competition, cost efficiency, simplicity, transparency and regular reporting in addition to allowing flexible product design based on prudent investment principles. The financial vehicle best equipped for this task would be a structure resembling that of a mutual fund, optimally an umbrella fund which offers sub-funds with different investment policies suited for various desired strategic asset allocations or for various age cohorts. New and optimal tax allowance (incentive to contribute to the funded pension system) should take into account desired goals of the voluntary supplementary pension system, fiscal stance and capacity. Supplementary pensions should at least be able to fill the gap in after retirement income left by the mandatory pension and invalidity insurance. 9 Challenges and opportunities 55% of active population already participating in the voluntary supplementary pension system is success, but it also means, that the other 45% is still without supplementary insurance, while pension reform effects everybody. Further work is needed on incentives for employers and individuals on entering the supplementary pension schemes. 10 Literature: Berk S. Aleš, The Contemporary Issues and Challenges in a Supplementary Pension System: The Slovenian Case Kidrič Dušan, Practical Lessons in Pension in Pension Reform: Sharing the Experiences of Transition and OECD Countries POGACAR Peter, Pension Reform in Slovenia. Historical Developments, Estimated Results and Prospects Rangus Andraž, The framework of the economic and social reforms aimed at increasing the welfare in Slovenia Insurance Supervision Agency Annual Report. Ljubljana: Insurance Supervision Agency. Ministry of Finance Pravilnik o izracunu povprecne donosnosti do dospetja drzavnih vrednostnih papirjev. Ljubljana: Ministrstvo za finance, EVA: , Republic of Slovenia. Stability Program (in Slovene). December Ljubljana: Republic of Slovenia. Securities Market Agency Report on the Situation on the Securities Market in Ljubljana: Securities Market Agency. 7

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