Five insights on pension reforms for the 21st century

Globally, the number of people aged 65 or older is increasing as a share of the population, which raises the question: will these older adults receive a predictable and adequate pensions? That question is one that has enormous consequences for old-age poverty, labor markets, gender equity, and the macro economies of emerging market economies, which need to rapidly rethink pension needs and solvency as more people are living longer. 

Designing pension reform in developing countries

Sharing lessons learned is vital for developing countries in addressing the challenges of pension reform. Here are key insights from a thought leadership workshop, hosted by Armenia, that mobilized experts and practitioners from 13 countries from the Europe and Central Asia region.

1. If it ain't broke, don't fix it: Balancing coverage, adequacy, and sustainability of pension schemes is tough. And as the proportion and electoral influence of the elderly population grows, pensions will become a more pressing concern for policymakers. Ad-hoc pension increases not linked with contributions or flexibility in pension withdrawals are examples of distortions to contributory schemes introduced by policymakers. This can be an inefficient method of targeting scarce fiscal resources and can discourage individuals from contributing. Politicians should resist the urge to use pension schemes to meet objectives -such as winning consensus among specific subsets of the retired population- they weren’t designed for.
2. A ‘short-term pain but long-term gain’ perspective is essential: Pension reforms, such as raising the retirement age, imposing early retirement penalties, streamlining special pension schemes, or adjusting how pension payments are regularly increased to keep up with inflation or wage growth, can provide fiscal relief and address inequities in the system. However, they don’t solve deeper issues like poor incentives for working-age individuals to contribute, outmigration, drops in the labor force at older ages, or high medical costs during old age. A long-term vision and bold coordinated policy action is needed for that. These include systemic reforms that encompass tax policy, social assistance, and labor market reforms.
3. Implementing pension reforms is a marathon requiring champions in the government:  Implementing a reform while being mindful of the country's political realities, social expectations, and the regulatory capacity of institutions is critical. A poorly designed but well-implemented reform can be better than a well-designed but poorly implemented one. Champions in the government can make a convincing case for the reform and also determine ‘sweeteners’ to include, via discussion with critical stakeholders. In Armenia, the government matched individual contributions one-to-one up to a cap and reduced other labor-related taxes while launching the new defined contribution scheme; these so called “sweeteners” need to be used effectively by reform champions in government.
4. Stay the course: Reforms will have winners and losers relative to the status quo. Without wide support from political parties and consensus across different age groups, even well-intentioned reforms can be reversed over time as witnessed in the case of Poland, Hungary, North Macedonia, and Croatia, to name a few.
5. Global megatrends urge a rethink in system design: Aging, migration, climate change, pandemics, and the changing nature of work directly influence pension systems and the needs of pensioners. For example, the elderly are more vulnerable to temperature fluctuations and depend on timely and adequate payments to adapt to the changing climate. The rise in non-standard employment and, in the case of women, the gaps in contribution history because of care responsibilities which disproportionably fall on women can result in lower or no pension benefits. Solutions to coverage expansion of self-employed, gig workers, part time employees need to be a policy priority, even in countries that have relatively high formal employment.

The payroll-financed contributory design with roots in Bismarckian Germany, where most people are stable employees and where employees and employers pay into a pension based on their paycheck, is outdated due to changes in the global economy and it is probably not suitable for the 21st century. 

Knowledge sharing for better reforms

In addition to the lessons noted above, there are new lessons and opportunities emerging as more countries tackle pension reforms. Recommendations from the  World Bank’s ‘Protecting All’ white paper and the experiences of successful reforms in recent years, include:

• Establishing trust and predictability in pension systems requires strong governance arrangements and ensuring policy accountability.
• Payroll-based financing for pensions systems may need to be complemented with non-contributory financing sources. The link between different sources of financing needs to be carefully considered to retain an incentive to contribute.
• Urgent progress is needed on the productive longevity agenda which can result in longer working careers and greater pension contributions and entitlements, as retirement ages increase.
• Pension management can be enhanced with cloud services to store data, robo-advisors offering personalized investment advice, and blockchain technology ensuring the security and transparency of transactions.
• Pension calculators, which use an individual’s past contributions to estimate future benefit, can aid in pension communication efforts and transparency.

The World Bank is helping its client countries find solutions and adopt best practices on pension reform—and in the process better ensuring a more inclusive, resilient future for us all. 

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