What Makes Pension Reform So Important for Every Ukrainian Today?

April 20, 2017

Satu Kahkonen, World Bank Country Director for Belarus, Moldova, and Ukraine The article was first published by Novoye Vremya

I noticed them first on the Saturday after I had moved to my apartment in Kyiv: elderly men and women going through garbage bins on the street in search of bottles and other things salvageable and valuable. They have showed up thereafter every Saturday. Soon after my first encounter with them, I realized that they are pensioners looking for ways to survive. That made me look into the pension system in Ukraine. And what I saw was not good.

The government in Ukraine spends more on pensions than almost any other country in the world. In 2016, pension expenditures amounted to 11 percent of GDP. These are exceptionally high shares. Yet, the pension for two-thirds of pensioners is so low that they require a subsistence top-up, even with 35 years of contributions to the formal pension system. The point of retirement has become for many the start of a survival race, as the average old age pension is only about $2 per day. Pension benefits are low, differentiation of pensions according to contributions is minimal, and mechanisms for adjustment to the cost of living are inadequate.

Simply put, the social contract is broken. Those who join the workforce do not see any benefit from participating in the pension system beyond the minimal requirement, because they see the majority receiving a flat pension at the subsistence level irrespective of their contributions. Also, due to eroded trust between the people and government, many are avoiding social security contributions. I am not surprised at such a situation, because the current pension formula is not clear to an average citizen.

These are some of the reasons why Ukraine urgently needs pension reform. Without it, future generations of pensioners will receive even lower pensions and fall deeper into poverty.

Let us look at the fundamentals. Ukraine has about 12 million pension beneficiaries in various categories and about 14 million contributors (some contributing only part of the year). Demographic projections indicate that, going forward, the cohorts entering retirement will be considerably larger than the young cohorts entering the labor market. As a result, the system dependency will worsen. Estimates indicate that in about 20 to 25 years, the ratio of contributors to pensioners may fall to two-thirds. Therefore, providing adequate pensions will be an even bigger challenge.

Another problem is that the structure of pension expenditures is heavily influenced by the costs of various categorical benefits, privileges, and the minimum subsistence top-ups, which together constitute over one-quarter of total pension expenditures. This translates into a heavy fiscal burden and creates non-transparent subsidies between different programs of the Pension Fund.

Based on best and tested international practices, we see several areas in which action should be taken to improve the sustainability and adequacy of pensions.

First, the retirement formula has to be clear, transparent and motivating. Pension contributions should be strongly tied to pension benefits. When a person will be sure that there is a direct link between what s/he contributes to the pension system and what s/he gets as a benefit, and that her/his participation guarantees a decent pension, s/he will be motivated to step out of the shadow and pay due contributions.

Second, the pension system needs to generate fiscal savings to improve the adequacy of pensions and prevent pensioners from falling into poverty. One of the key mechanisms to achieve this is raising the retirement age. So far, there has been resistance to that idea. But, the Ukrainian pension age is relatively low, even after the gradual increase in the retirement age for women from 55 to 60 that was initiated in 2011 and which will be completed by 2021. Most countries in Europe have had to undergo much more substantial increases.

Given that life expectancy is increasing, raising the retirement age should not be seen as a dramatic step, especially if it is yielding higher pensions to people in a fair and transparent manner. This should not be seen as just a change in the system, but as a change in mentality.

Recent proposals by the government suggest establishing a flexible retirement age, linking it to the length of the formal career of an individual. We welcome such an initiative, as it seems to be a fair and transparent mechanism to reward participation in the system and achieve financial savings.

Third, the accounting of the Pension Fund needs to be rationalized. To properly understand and analyze finances of the pension program, one needs to separate all payments that are not related to insurance pensions, but rather to various categorical benefits and special privileges. Those belong to social assistance instead of pensions, and in many instances should be means-tested.

Finally, minimum guarantees need to be well designed and should not distort incentives to participate in the system. Also, pension indexation, as a way of adjusting to the increasing costs of living, needs to be applied consistently.

Ukrainians are talented and hardworking. As they contribute to society with their hard work, they must feel secure about their future and get what they deserve when they retire. The social contract needs to be restored, and the pension system is a fundamental part of this.

The World Bank wants to help Ukrainian seniors feel dignified, not like a burden on society. A miracle won’t happen and Ukrainian seniors won’t become rich overnight. But when I return to Ukraine in 10 years, I hope that I won’t meet seniors going through garbage bins and begging to survive until their next pension payment.