The Early Retirement Age Increment in Case of Republic of Srpska Pension Fund

Introduction

The pension funds worldwide are facing sustainability problems. The main driving trends of pension crisis are considered to be increasing life expectancy, declining fertility and earlier retirement (Barr & Diamond, 2009). The countries have for decades led debates about adequate reform measures that could ensure the financial sustainability of pension system and at the same time not threaten the living standard of elder people. The pension reforms that have been launched by many countries in last few years usually include introduction of savings in pension systems, the changes in the way the pension entitlements are calculated and, inevitably, the increment of retirement age (OECD, 2013). The trend of retirement age rising is still seen as an effective solution for growing pension funds’ unsustainability. Therefore the German Central Bank recently proposed the rise of retirement age from 67 to 69 years old, while there are similar tendencies in UK. The problem with adaptation of these proposals is the political willingness. The elder people make the majority of electoral in ageing societies and the most of the developed countries already have got across and become the gerontocracies (D'Amato & Galasso, 2002).

In the Republic of Srpska, by current Law, the retirement is allowed with 57 years old for males and 55 for females and it will gradually increase on 60/58 years old until 2025 (The Law on Pension and Disability Insurance in Republic of Srpska 2011). This way the Republic of Srpska is one of the countries with the lowest retirement age in Europe, while at the same time its pension fund faces growing discordance between contributions and net pension costs. The Republic of Srpska is for a long period of time having a problem with high unemployment which was around 25,2% in 2015¹ (Republic of Srpska Institute of Statistics, 2015). All this inspired us to analyze effect retirement age increment on pension fund sustainability, in order to be able to give adequate suggestion to policy planers in Republic of Srpska.

The effects of retirement age increment will be estimated using the classical actuarial projection model previously adapted to Republic of Srpska Pension and Disability Insurance Fund (hereinafter Fund PIO RS). In this paper we will state the basic concepts and limitations of actuarial projection model for Fund PIO, while the main accent will be on the calculation of retirement age increment effects and their comparison with the earlier obtained projections with current retirement age assumption.

Pension and Disability Insurance Fund of Republic of Srpska

The Republic of Srpska is highly autonomous entity of Bosnia and Herzegovina. It has its Constitutions, Laws, Government, Institutions and it conducts its independent economic and social policy. The Fund PIO conducts the pension policy of Republic of Srpska, and according to Laws of Republic of Srpska (The Law on Pension and Disability Insurance in Republic of Srpska 2011) it is organized as public pay as you go pension scheme. The scheme is based on the principles of mutuality and solidarity, while participation is mandatory for all employees, self-employed and registered farmers on the territory of Republic of Srpska.

The revenues of Pension Fund are coming from wage contributions, voluntary insurance contributions, other Fund’s activities and budget transfers. Current contribution rate in Republic of Srpska is 18.5% on gross wage (The Law on contributions in Republic of Srpska, 2012) and contributions are main source of Pension Fund incomes, while significant budget transfers are covering war veteran pension benefits that are not acquired on the basis of contribution payment and insurance service.

The Pension Fund of Republic of Srpska provides its participants the right on pension benefit in case of old age, disability and in case of pensioner death, pension benefit is assigned to its dependent family members. There are two conditions that insured must satisfy in order to be eligible for an old age pension benefit. Those conditions are the age of insured and pension (insurance) service.

The insurer is qualified for an old age pension when:

• she is 65 years old and has 15 years of insurance service
• she is 60 years old and has 40 years of pension service (for males)
• 58 years old and has 35 years of insurance service (for females).

These norms are still not used, because of transition period until 2025 that was designed for passage to these rules together with the creation of Pension and Disability Law from 2011. These transitive norms are given in Table 1 that follows.

Table 1. Conditions for old age pension according to 2011 Pension and Disability Law in Republic of Srpska (transition period)

(Source: The Law on Pension and Disability Insurance in Republic of Srpska 2011)

The pension benefit amount depends on the level of wage earned during working period and on length of contribution period. Since 2011 Law on Pension and Disability Insurance the old age pension benefit amount is calculated using point method, where pension benefit amount is obtained when personal insured person’s points are multiplied with value of general point valid at that moment (The Law on Pension and Disability Insurance in Republic of Srpska 2011).

The Sustainability Projections

Figure 1 – Dependency ratio for Fund PIO RS from (1996 – 2015)

(Source: Authors)

The current Law on Pension and Disability Insurance passed in 2011 as a result of the Government Working group for Pension Reform in 2010 analysis of different pension reform possibilities (The Working Group for Pension System Reform, 2010). In this document, the long term projections of sustainability of Fund PIO were made for the first time. The Projections of dependency ratio and net financial result were not optimistic, so the increment of retirement age and the change of pension benefit entitlement rules were suggested as a reform steps. After the imposition of new, 2011, Law the Government did not carried out the long term analysis of Fund PIO sustainability, while dependency ratio continued to worsen (Figure 1)

The growing number of pensioners in respect to employees who support their pensions brings unsustainability to Pay-as You-go pension system. As a result of this, the Fund PIO is having growing negative net financial result which is presented as a gap between net pension benefit costs and contributions on Figure 2.

Figure 2 - Net pension benefits and contribution revenues as share of GDP, 2001-2015

(Source: Authors’ calculation and official data sources²)

As far as it is known to the authors, the first projections of Fund PIO sustainability and the first actuarial model adopted for Fund PIO of Republic of Srpska were developed in 2016 (Bosnjak, 2016). This actuarial projection model is the classical actuarial open group model, adapted to scarce cross-section data on registered employees and pensioners in Fund PIO RS. In original article, the base year for projections was 2014, while dataset contained the cross-sectional information on age, sex, value of salary or pension, date of employment or retirement and type of contract for all employees and pensioners from end of December 2014. Further, due to nonexistence of mortality tables for republic of Srpska, as in original article we used the mortality tables of Republic of Serbia (Statistical Office of the Republic of Serbia, 2014), while the model assumes that the whole population of Republic of Srpska will develop according to official projections made for the purpose of 2010 Strategy of pension reform, which assume that fertility rate in Republic of Srpska in projected period will decrease from 1,3 to 1. Using the same methodology presented in article we had repeated the calculations with the updated dataset from end of December 2015, thus using the 2015 as base year for projections. These updated projections are presented on Figure 3.

Figure 3 – Projected number of employees and pensioners in Fund PIO RS (2015-2066)

(Source: Authors)

As we can see from the Figure 3, the gap between number of employees and number of pension benefit users will gradually decrease leading to unsustainability growth which is visible through dependency ratio projections on Figure 4.

Figure 4 – Dependency ratio projections (2015-2066)

(Source: Authors)

As we can see the projections indicate that the sustainability will worsen in future. There is ongoing debate about reform steps that could improve the future expectations and ensure the long-term sustainability of Fund PIO. In following part, we will present and analyze two frequently addressed suggestions.

Pension Reform Suggestions

Generally, there are multiple measures and their combinations that have been proposed as pension crisis solutions by different researchers and policy planners for different situations. The scientists agree that there is no unique and the best solution for pension system design given that there are multiple objectives that one pension system has to meet. Barr and Diamond (Barr & Diamond, 2009) state that those objectives are consumption smoothing, insurance, income redistribution, poverty prevention, fairness, neutrality, sustainability, etc. Many of these objectives cannot be fulfilled at the same time, so society and pension planners have to make choice on which fundaments will they build their pension system.

The same choices must be made when we speak about pension system reform. The society has to decide on which objectives does it want to focus on and to undertake reform steps into that direction. The newest steps in pension system reform of developed countries are exposed in OECD pensions at a Glance overview of pension systems (OECD, 2013), where it is stated that in last few years almost all countries have undertaken some reform steps. Most commonly those were parametric reforms like retirement age increase, inclusion of new population cohorts into pension insurance scheme (like agriculture workers, self-employed, housewives…) or change of pension benefits value calculation methodology.

The Retirement Age Rising

Given that we are operating with actuarial projection model which is adapted only for calculation of future number of employees and pension benefit users and on the basis of previous discussion regarding the pensionable age development trends, we can come out with simple suggestion for parametric reform that is imposing itself. We simply suggest the lifting of age limit for old age pension retirement from 60 years for males and 58 for females to 62 years old for both sexes and 40 years of pension insurance service or 65 years old and 15 years of pension insurance service. This would prolong the period of contributions accumulation and thus improve the life standard of pensioners.

Although highly unpopular, this measure is necessary in order to stabilize the pension fund’s financing gap and provide the higher pensions. Other, wealthier and more developed European countries have increased the pensionable age even above 62/65 years old and many of them are to gradually set retirement age to 67-70 years old in next decade. The opponents of this reform measure often claim that the higher retirement age is preventing the employment of young people, since the work places are being “occupied” by older, nonproductive workers for longer periods. Nevertheless, many researchers have been studying this problem and they claim that the common belief that early retirement will set free the work places for younger workers and reduce the youth unemployment is not consistent with empirical evidence.

Peter Diamond (Diamond P. , 2006) in his study found that the evidence over many decades’ shows that early retirement does not reduces unemployment. The same results are presented for youth unemployment in Gruber and Wise conference report (Gruber & Wise, 2010), which is the collection of researches for set of developed countries on the effects of early retirement policies on youth employment. These and many other researches support the idea that the size of economy and number of work places is not fixed, but that it grows and develops. Also there are findings that the higher number of older workers in economy is connected with job creation, due to older workers experience and increment of labor force supply (Diamond P. , 2006).

In order to analyze the effects of retirement age increment on employees and pensioners expected numerosity, we will have to modify the relevant retirement probabilities which will be directly influenced by retirement age change. Therewith, we will also have to modify and recalculate the probabilities of old age retirement, disability retirement and family pension retirement due to our proposal that early retirement should be raised on 62 years old for both sexes. This reform suggestion will influence the future number of pension benefit users and employees, too.

The Projections Under New Retirement Age

In this section, we will apply the proposed increment of early retirement age on our projection model in order to observe its effects and their dynamics. As we mentioned it is necessary to modify the old age retirement probabilities in accordance with the parametric reform we suggested. The calculation methodology of new retirement probabilities and their value are explained here, while the calculation methodology of pension benefit users’ numerosity projections and employees remains the same. Here we present the influence of retirement age of 62 years old on dependency ratio and financing gap of Fund PIO of Republic of Srpska.

The most important change in calculation of projected number of pension benefit users according to new early retirement age of 62, we had suggested, is to estimate new old age retirement probabilities. We calculated those probabilities as ratios between adjusted average number of retired persons in last three years and registered insured persons in 2015 for each age and sex group separately. The data we use is the same data we used for dependency ratio projections, while the methodology is the same as in Bosnjak paper (Bosnjak, 2016), apart from the adjustment of average number of newly retired to the change in retirement age we suggest. This adjustment is done on such way that number of people retired in age from 55 to 61 was reduced on 5% of total average number of retired males for males and 1% of average number of retired females for females. We have chosen to leave the possibility of earlier retirement for certain number of persons because there are some groups of protected professions, who are allowed to retire earlier as miners, physical workers, etc. The percentages of workers who we “allowed” to retire earlier than 62 is taken from official employment by industry sectors 2015 data, and they represent the percentage of employed in mining sector in total number of employed persons in Republic of Srpska (Republic of Srpska Institute of Statistics, 2016). The Table 2 gives us overview of used data and obtained modified probabilities of old age employment.

Table 2. The modified probabilities of old age retirement calculation

(Source: Authors)

As we already said, the projections calculation methodology remains the same. The only change is the modification of old age retirement probabilities according to new early retirement rule. Here, in Table 44 we give the results of our modified projections of total number of employees and pensioners for each pension benefit type.

Figure 5 - The employees and pension benefit users’ projections with current and 62 early retirement age

(Source: Authors)

The Figure 5 gives us the overview of projections of employees and pension benefit users both, with current early retirement age and the one we suggested of 62 years old. The detailed values of projected numbers are given in Table 3, while this graphical representation enables us to compare the effect of introduction of early retirement age of 62 with current early retirement age.

In order to observe the effect of introduction of early retirement age of 62 on pension fund’s sustainability, we should also observe new dependency ratio movement. Figure 6 gives us both, the “old” dependency ratio projections and “new” – with early retirement age of 62, dependency ratio projections.

Figure 6 - The dependency ratio projections with current and 62 years old retirement age

(Source: Authors)

From those figures we can conclude that raising early retirement age on 62 year old both, for males and females would have instantaneous positive effect on pension fund’s sustainability. This positive effect is present during the whole projections period and it is transmitted through the growth of employees’ number and decrease of pensions benefit users number in future. This number of employees rise and the number of pension benefit users shrink is the best visible on Figure 5. The combination of these two effects results with substantial dependency ratio stabilization, which is represented on Figure 6.

Table 3. The projections of employees and pensioners number with early retirement age of 62 years old

(Source: Authors)

At this point, it is important to mention that the methodology we suggested for adaptation of Bosnjak (Bosnjak, 2016) actuarial model for Fund PIO RS projections to retirement age of 62 relies on quite simple assumption. The only modification we have taken into consideration is the modification of old age retirement probability, where we have taken the retirement age of 62 in consideration. In reality, it is quite probable to expect that the certain number of persons will switch to disability retirement since being unable to retire earlier with old age pension benefit. Therefore, it is realistic to assume that the positive effect of retirement age growth will be smoothed due to disability retirement growth.

This incorporation of potential disability retirement growth as a reaction on retirement age rise is a guideline for further research on this topic.

Conclusion

The pension funds worldwide are facing sustainability problems due to increased life expectancy, low fertility and early retirement age. The different societies have approached these problems from different sides, but in most of developed countries the first step was a retirement age increment.

The Republic of Srpska is currently having one of the lowest retirement age boundaries in European countries. The females are allowed to retire if 55 years old and males if 57 years old and having 35/40 years of pension insurance service, respectively. Our suggestion for pension reform in this paper was simple increment of pensionable age on 62 years old for both sexes. We have tested this suggestion using actuarial projection model previously adapted for Pension and Disability Insurance Fund of Republic of Srpska.

The obtained projections of future number of employees and pension benefit users show us unambiguously that retirement age rising will improve the Fund PIO sustainability by increasing the number of employees and reducing the number of pension benefit users.

Still, these results demand for further research given that we have not taken in consideration the possibility that retirement age increment will modify disability retirement probabilities, too. It is quite probable that certain number of people will still retire before age of 65 using the right on disability retirement.

References